Court Denies Petition to Stay Arbitration of Claims Between Shareholders of a Closely Held Corporation

• Posted on: Sep 7 2020

Alternative dispute resolution (“ADR”) is the name given for the procedures by which parties can settle their disputes without litigation, such as arbitration, mediation, or negotiation. ADR procedures are generally, though not always, less costly and more expeditious. [This Blog wrote about a case that was anything but less costly and more expeditious. Here.]

Although arbitration has increased in popularity over the years and is part of most business and commercial contracts and employment agreements, there remains resistance to engaging in ADR procedures. This resistance is sometimes manifested in a motion to stay arbitration – that is, a motion to stop a pending arbitration from proceeding on the grounds that, inter alia, the parties did not agree to arbitrate their disputes. In Gol v. TNJ Holdings, Inc., 2020 N.Y. Slip Op. 50974(U) (Sup. Ct., N.Y. County Aug. 13, 2020) (here), the Court was asked to stay an arbitration pending before the American Arbitration Association (“AAA”). As discussed below, the Court denied the petition to stay the arbitration of claims asserted by TNJ Holdings, Inc. but granted the petition brough by Respondents Jossef and Julian Kahlon because they were not parties to any agreement mandating arbitration for dispute resolution.

On May 15, 2020, Respondents Jossef Kahlon (“Jossef”) and Julian Kahlon (“Julian”), co-founders of Project Verte, Inc. (“Verte”), a closely held corporation, initiated an arbitration against Petitioners Jane Gol (“Gol”) and Amir Chaluts (“Chaluts”), Verte’s other co-founders, claiming that Gol and Chaluts abused their powers as controlling shareholders and harmed Respondents and Verte itself. Respondents alleged in arbitration that their claims arose out of, or related to, the parties’ Initial Stockholders Agreement (“ISA”) and a subsequent Share Forfeiture and Note Transfer Agreement (“SFNTA”), both of which contained mandatory arbitration provisions to which Petitioners (including Gol and Chaluts individually) were contractually bound. Accordingly, Respondents contended that AAA arbitration was the appropriate forum for their dispute.

Petitioners argued that the ISA could not be a basis for mandatory arbitration against Gol and Chaluts because it was superseded by an Amended and Restated Stockholders Agreement (“ARSA”) to which Gol and Chaluts were not parties. Unlike the ISA, which Gol and Chaluts signed in their own names as initial stockholders, they signed the ARSA (which contained a mandatory arbitration provision) solely on behalf of Verte and the AJ Entities (entities through which Gol held a stake in Verte). Further, they argued that the SFNTA could not be a basis for mandatory arbitration because the claims in the arbitration did not relate to the SFNTA. Finally, they argued that even if there was an agreement permitting TNJ Holdings, Inc. (“TNJ”) (the entity through which the Kahlons held a stake in Verte) to arbitrate claims against one or more of the Petitioners, TNJ’s owners Jossef and Julian (who are not parties to the ISA or SFNTA) could not do so. Petitioners sought to stay the arbitration.

For the reasons discussed below, the Court denied the petition to stay arbitration of claims asserted by TNJ. Given the Verte shareholders’ broad contractual agreements to resolve disputes through arbitration, the Court held that Petitioners did not establish grounds to stop TNJ from arbitrating its claims. Under the terms of the parties’ agreements, concluded the Court, which incorporated AAA’s Rules, it was for the arbitrator (not the Court) to decide whether TNJ’s specific claims were within or beyond the scope of the arbitration provisions.

However, the Court granted the petition to stay arbitration of claims asserted by Jossef and Julian. Unlike TNJ, noted the Court, the Kahlons were not Verte shareholders and, more importantly, were not parties to the relevant agreements containing mandatory arbitration provisions.

As the Court noted, the threshold question in assessing a petition to stay arbitration is whether there is a valid and binding agreement to arbitrate. Slip Op. at *4-*5 (citing CPLR § 7503(b); Matter of Belzberg v. Verus Invs. Holdings Inc., 21 N.Y.3d 626, 630 (2013)). If, as the Court noted, it “finds that a valid arbitration agreement exists, the next question is whether the dispute comes within the scope of that agreement.” Slip Op. at *5. Courts look to the agreement to see if the parties delegated to the arbitrator (rather than the court) the issue of arbitrability. Id. (citing Zachariou v. Manios, 68 A.D.3d 539, 539 (1st Dept. 2009) (“Whether a dispute is arbitrable is generally an issue for the court to decide unless the parties clearly and unmistakably provide otherwise.”); see also Henry Schein, Inc. v. Archer and White Sales, Inc., 139 S.Ct. 524, 530 (2019) (“[i]f a valid agreement exists, and if the agreement delegates the arbitrability issue to an arbitrator, a court may not decide the arbitrability issue”)).

The Court found that “[t]he threshold question of whether there [was] a valid agreement mandating arbitration of disputes between TNJ and Petitioners [was] easily answered here.” Slip Op. at *5. The reason, noted the Court, was because there were three agreements to arbitrate. Id. Each of the ISA, SFNTA and ARSA, said the Court, required the arbitration of disputes. Id.  “Collectively,” explained the Court, “those agreements bind all of the Petitioners.” Id. Even the ARSA, observed the Court, “upon which Petitioners rely to free Gol and Chaluts from arbitration,” “broadly mandate[d] arbitration of disputes between TNJ and all Petitioners other than Gol and Chaluts.” Id. See also id. at *5-*6. Having determined that there was a valid arbitration agreement, the Court turned its attention to the next question: whether the matter in dispute came within the scope of the agreement. The Court held that the parties “clearly and unmistakably” reserved that question for decision by the arbitrator. Id. at *6-*7. This was reinforced, explained the Court, by the incorporation of the AAA rules. Id. at *7 (quoting Zachariou v. Manios, 68 A.D.3d 539, 539 (1st Dept. 2009) (“[w]here there is a broad arbitration clause and the parties’ agreement specifically incorporates by reference the AAA rules providing that the arbitration panel shall have the power to rule on its own jurisdiction, courts will ‘leave the question of arbitrability to the arbitrators’”) (citations omitted)).

The ISA, SFNTA, and ARSA all expressly incorporate the AAA Rules which, in turn, provide that the arbitrator “shall have the power to rule on his or her own jurisdiction, including any objections with respect to the existence, scope, or validity of the arbitration agreement or to the arbitrability of any claim or counterclaim.” By expressly invoking such Rules, the parties have agreed to have the AAA arbitrator determine questions such as the applicability of the ISA, SFNTA, and ARSA arbitration agreements and whether Petitioners’ claims in the arbitration arise out of or relate to one or more of those agreements.

Id. at *7 (citation and footnote omitted).

The Court rejected the argument that certain exceptions to dispute resolution, “such as for intellectual property disputes”, undermined the requirement to arbitrate the parties’ disputes. Id. at *8. “For the matters that are covered by the arbitration provision,” held the Court, “the parties opted for the application of AAA Rules, which include[d] deference to the arbitrator to decide issues with respect to scope of the provision and the like.” Id.

The Court also rejected “Petitioners’ reliance on Loan Agreements and related documents with forum clauses pointing to litigation.…” Id.  The Court noted that “Respondents [did] not rely on those agreements.” Id. Instead, they relied on the ISA, SFNTA, and ARSA, all of which contained “broad, straightforward arbitration provisions that incorporate[d] [the] AAA Rules.” Id. “Under Zachariou, concluded the Court, “that is sufficient to indicate an intent to adopt the AAA Rule[s] with respect to deferring certain decisions — including whether the dispute arises under these agreements — to the arbitrator.” Id.

Finally, the Court held that there was no agreement to arbitrate the Kahlons’ claims – a point that Petitioners did not contest. Nevertheless, Petitioners argued that Kahlons should be forced to arbitrate because they were “the parties of interest behind TNJ, both as the sole shareholders of the corporation, and as corporate representatives and signatories.” Id. (citation to record and internal quotation marks omitted). The Court found “no legal support for that proposition.” Id. See Funk v. Golden Hands, Inc., 168 A.D.2d 220, 221 (1st Dept. 1990) (“[a] party to a written arbitration agreement may not be compelled to arbitrate disputes which arise thereunder with a nonparty.”); Groval Knitted Fabrics, Inc. v. Alcott, 39 A.D.2d 524, 524 (1st Dept. 1972) (“It is axiomatic that arbitration is consequent upon an agreement to arbitrate and no one can be forced to arbitrate with one whom he has not contracted to do so”), aff’d sub nom., Groval Knitted Fabrics v. Alcott, 31 N.Y.2d 796 (1972)).

The Court rejected the Kahlons’ reliance on Hirschfeld Prods. v. Mirvish, 88 N.Y.2d 1054 (1996), which held that non-signatory corporate officers could compel arbitration of a dispute arising out of a contract between their corporate employer and the plaintiff. The Court noted that the underlying predicate for that decision was the principal-agent relationship. Slip Op. at *8 (quoting Hirschfeld, 88 N.Y.2d at 1056 (“[t]he Federal courts have consistently afforded agents the benefit of arbitration agreements entered into by their principals to the extent that the alleged misconduct relates to their behavior as officers or directors or in their capacities as agents of the corporation. The rule is necessary not only to prevent circumvention of arbitration agreements but also to effectuate the intent of the signatory parties to protect individuals acting on behalf of the principal in furtherance of the agreement.”); and citing Huntsman Intl. LLC v. Albemarle Corp., 163 A.D.3d 420, 421 (1st Dept. 2018) (affirming grant of a motion by non-signatory officer defendants to compel arbitration “because any breach of [the agreement] would have to be the result of an action or inaction attributable to [the officers]”), lv to appeal dismissed in part, denied in part, 32 N.Y.3d 1040 (2018)).

The Court explained that neither case, as Respondents suggested, stood for the proposition that a corporate representative could vindicate the rights of the corporation through an arbitration agreement to which the corporation was a party. Id. at *8. “At most,” said the Court, Hirschfeld and Huntsman “stand for the proposition that in certain circumstances a non-signatory defendant in a civil action may be permitted to compel arbitration of a claim that is, effectively, against the signatory (acting through its non-signatory corporate officer).” Id. The Court noted that Respondents failed to cite “any cases applying that rationale in the context of a non-signatory plaintiff seeking to enforce an arbitration agreement as a sword rather than as a shield.” Id. Accordingly, concluded the Court, “Hirschfeld and Huntsman [did] not apply.” Id.

Takeaway

Whether a dispute is arbitrable is generally an issue for the court to decide unless the parties clearly and unmistakably provide otherwise. Where there is a broad arbitration clause and the parties’ agreement specifically incorporates by reference the rules of a dispute resolution organization, such as the AAA, in which the arbitration panel is given the power to rule on its own jurisdiction, courts will “leave the question of arbitrability to the arbitrators.” Life Receivables Trust v. Goshawk Syndicate 102 at Lloyd’s, 66 A.D.3d 495, 496 (1st Dept. 2009), quoting Matter of Smith Barney Shearson v. Sacharow, 91 N.Y.2d 39, 47 (1997)).

In Gol, the parties’ agreements contained broad arbitration provisions that incorporated by reference the AAA rules. As such, consistent with the law in New York, the Court found that there was clear and unmistakable evidence that the parties (i.e., Petitioners and TNJ) intended to have an arbitrator decide the issue of arbitrability. However, there was no such intent with regard to the Kahlons. As the Court noted, neither were Verte shareholders nor parties to any of the relevant agreements.