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Court Holds that Motion to Compel Arbitration Cannot be Made Until the Non-Movant Initiates Litigation

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  • Posted on: Nov 5 2018

Arbitration is an alternative form of dispute resolution where the parties voluntarily agree that a neutral, private person will resolve any legal disputes between them, instead of a judge or jury in a court of law. In recent years, arbitration has increased in popularity and is part of most business and commercial contracts and employment agreements.

This increase in popularity reflects the state (and federal) policy that arbitration is a favored means of resolving disputes. See, e.g., CPLR § 7501 (“A written agreement to submit any controversy . . . to arbitration is enforceable without regard to the justiciable character of the controversy and confers jurisdiction on the courts of the state to enforce it and to enter judgment on an award.”); Harris v. Shearson Hayden Stone, Inc., 82 A.D. 2d 87, 91-93 (1st Dep’t), aff’d, 56 N.Y.2d 627 (1981) (“[T]his State favors and encourages arbitration as a means of conserving the time and resources of the courts and the contracting parties. . . .”). Although favored, this method of dispute resolution is not always preferred.  Sometimes, a party to an arbitration agreement will resist resolving his/her disputes outside of the courthouse. When that happens, the non-resisting party can seek to compel arbitration. The question, though, is at what point should the motion to compel arbitration be made?

In New York, CPLR § 7503(a) provides the framework from which the courts attempt to answer the question. Under CPLR § 7503(a), a motion to compel may be made by “[a] party aggrieved by the failure of another to arbitrate ….” The same is true under the Federal Arbitration Act (“FAA”). See 9 U.S.C. § 4 (“a party aggrieved by the alleged failure, neglect, or refusal of another to arbitrate under a written agreement for arbitration may petition … for an order” compelling arbitration).

Under both New York law and the FAA, a party is aggrieved when the non-aggrieved party (a) commences litigation in lieu of arbitration, or (b) refuses to comply with an order of a relevant arbitral authority to arbitrate the dispute. See Jacobs v. USA Track & Field, 374 F.3d 85, 89 (2d Cir. 2004) (holding that the petitioner was not an aggrieved party where the respondents had neither commenced litigation nor failed to comply with an order to arbitrate by the arbitral authority). See also Koob v. IDS Fin’l Servs., Inc., 213 A.D.2d 26, 30-31 (1st Dept. 1995) (holding that “a party to an arbitration agreement is not aggrieved until litigation of an issue within the operation of the arbitration provision is attempted”); SH Tankers Ltd. v. Koch Shipping Inc., 2012 WL 2357314, at *3 (S.D.N.Y. 2012) (noting that “unless the respondent has resisted arbitration, the petitioner has not been ‘aggrieved’ by anything, and there is nothing for the court to compel”)  (internal quotations and citations omitted); LAIF X SPRL v. Axtel, SA. de CV, 390 F.3d 194, 198 (2d Cir. 2004) (stating that a party is aggrieved if the other party “commences litigation or is ordered to arbitrate the dispute by the relevant arbitral authority and fails to do so”) (internal quotations omitted).

Last month, Justice Barry R. Ostrager of the Supreme Court, New York County, Commercial Division, applied the foregoing principles in KPMG LLP v. Kirschner, 2018 N.Y. Slip Op. 32661(U) (Oct. 16, 2018) (here), in which he found that KPMG lacked standing compel arbitration because it was not an aggrieved party within the meaning of CPLR § 7503(a).

KPMG arose from an attempt by KPMG to arbitrate its dispute with the trustee of two bankrupt entities, Millennium Lab Holdings, Inc. and Millennium Lab Holdings II, LLC (together, “Millennium”), privately held laboratory services companies based in California. KPMG provided audit services to Millennium in connection with government investigations into the companies’ sales and marketing practices and related litigation. The engagement letter between KPMG and Millennium contained an arbitration provision.

In 2015, Millennium filed for bankruptcy. The bankruptcy court confirmed a reorganization plan that, inter alia, created two separate litigation trusts to handle pre-bankruptcy claims of Millennium itself and pre-bankruptcy claims of certain lenders. Respondent, Marc Kirschner (the “Kirschner” or “Trustee”), was appointed trustee of the two trusts.

The Trustee sought discovery from KPMG regarding Millennium’s pre-bankruptcy claims against KPMG. The parties started negotiating a potential settlement and allegedly entered into statute of limitations tolling agreements so that the parties could achieve pre-litigation resolution of the dispute.

On August 3, 2018, KPMG commenced a special proceeding pursuant to CPLR § 7503(a) to compel Kirschner to submit to arbitration all claims arising out of KPMG’s provision of auditing services to Millennium. Three days later, on August 6, 2018, the Trustee filed an action against KPMG in California Superior Court (the “California Action”).

The Trustee moved to dismiss the petition for lack of subject matter jurisdiction, lack of standing, and failure to state a cause of action. The Trustee argued that KPMG lacked standing at the time it filed the petition because KPMG was not “aggrieved” as required by the CPLR and the FAA. The Trustee further argued that because the California Action was subsequently commenced after the filing of the New York special proceeding, KPMG’s only recourse to compel arbitration was to make such a motion in the California Action.

In opposition, KPMG argued that litigation is not a necessary precondition to a party being “aggrieved” by a failure or refusal to arbitrate under New York law and the FAA. Further, KPMG argued that even if it was not an aggrieved party when it filed the petition, it became an aggrieved party once the California Action was initiated in violation of the agreement to arbitrate.

The Court’s Decision

Noting that the “relatively narrow issue before this Court” was “whether KPMG had standing to commence [the] special proceeding pursuant to CPLR § 7503(a),” the Court held that KPMG did not possess such standing.

After discussing the meaning of “aggrieved” under CPLR § 7503(a), the Court found that “(1) the Trustee had not commenced litigation at the time KPMG’s petition was filed, and (2) no order had been issued by an arbitral authority.” Thus, KPMG was not aggrieved within the meaning of the CPLR or the FAA.

The Court also held that the pendency of the California Action did not make KPMG an aggrieved party. In that regard, the Court held that the dispositive point in time to consider whether KPMG was “aggrieved” under the CPLR and FAA was the date on which the New York special proceeding was commenced.

KPMG filed this petition before the Trustee commenced the California Action, and thus, the Court does not have jurisdiction to adjudicate such a petition from a non-aggrieved party even though the California Action has since been commenced. See Grupo Dataflux v. Atlas Global Group, L.P., 541 U.S. 567, 570 (2004) (“It has long been the case that the jurisdiction of the court depends upon the state of things at the time of the action brought.”). Further, courts “have adhered to the time-of-filing rule regardless of the costs it imposes.” Id. at 571. Thus, the petition in this special proceeding must be dismissed for lack of subject matter jurisdiction and lack of standing.

Finally, the Court addressed the question whether the petition should be dismissed with prejudice on the grounds that CPLR § 7503(a) required the motion to compel be made in the California Action. The Court determined that CPLR § 7503(a) did “not dictate such a result.”

In addition to the language quoted above, CPLR § 7503(a) provides, in pertinent part, that: “If an issue claimed to be arbitrable is involved in an action pending in a court having jurisdiction to hear a motion to compel arbitration, the application shall be made by motion in that action.”

The Court explained that the while “judicial efficiency would be achieved by KPMG filing its motion to compel in the California Action,” courts in New York have “enjoined litigation in other states pending New York actions under CPLR 7503.” Indeed, noted the Court, “[f]or over half a century, New York courts have enjoined parties from litigating a foreign action in contravention of an agreement to arbitrate in New York.” Thus, “an aggrieved party may seek to compel arbitration and enjoin pending proceedings in other states under CPLR § 7503(a).”  For this reason, the Court granted “the Trustee’s motion to dismiss” but did so “without prejudice to KPMG renewing its petition with proper standing.”

Takeaway

It has become commonplace for corporations and small businesses to incorporate arbitration provisions into their agreements with customers and employees. While these clauses often seem to be merely procedural, they are not.  They prevent consumers and employees from having their day in court before a judge or a jury.

Over the past few decades, the courts have endorsed the use of arbitration as an alternative to litigation, reduced the ability of individuals to avoid arbitrating their disputes, and narrowed the possibility of obtaining judicial review. They have adopted pro-arbitration doctrines such that arbitration agreements are almost always upheld when challenged, even when individuals can show that an arbitration clause was buried in fine print or incorporated by reference to an obscure and inaccessible source.

KPMG shows that even with the weight of authority firmly behind arbitration, a party cannot compel arbitration simply because there is an agreement to arbitrate. The party seeking arbitration must be “aggrieved” – that is, the other party (a) commenced litigation in lieu of arbitration, or (b) refused to comply with an order of a relevant arbitral authority to arbitrate the dispute. Absent these circumstances, a motion to compel arbitration cannot succeed.

KPMG is also notable for its refusal to stay the New York proceedings in favor of the California Action. While the language of CPLR § 7503(a) seems to require adjudication of a motion to compel arbitration in the jurisdiction in which an action involving the dispute is pending – i.e., that if there is an arbitrable issue “involved in an action pending in a court having jurisdiction to hear a motion to compel arbitration a motion to compel,” the motion “shall be made … in that action” – the courts in New York have declined to read the CPLR in that manner. As the KPMG court observed, “the CPLR does not dictate such a result.”

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