The Direct Benefits Theory of EstoppelPrint Article
- Posted on: Oct 25 2023
By: Jeffrey M. Haber
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.1 In business and commercial transactions, arbitration is the preferred means of resolving disputes. It is encouraged and recognized as the public policy of the State of New York.2 Consequently, courts will interfere as little as possible with the agreement of consenting parties to submit their disputes to arbitration.3
Since arbitration is a “creature of contract”,4 only signatories to a contract containing an arbitration agreement can be compelled to arbitrate.5 Consequently, “a party cannot be required to submit to arbitration any dispute which he has not agreed so to submit.”6
Like all rules, there are exceptions, such as incorporation by reference, assumption, agency, veil-piercing/alter ego and estoppel.7 In Gilat v. Sutton, 2023 N.Y. Slip Op. 05363 (1st Dept. Oct. 24, 2023) (here), the exception at issue was the “direct benefits theory of estoppel.” Under this theory, “a nonsignatory may be compelled to arbitrate where the nonsignatory ‘knowingly exploits’ the benefits of an agreement containing an arbitration clause, and receives benefits flowing directly from the agreement.”8 Where “the benefits are merely ‘indirect,’ a nonsignatory cannot be compelled to arbitrate a claim.”9 “A benefit is indirect where the nonsignatory exploits the contractual relation of the parties, but not the agreement itself.”10
Gilat involved a claim that defendants interfered with plaintiff’s rights in a partnership and company that she obtained from her deceased husband, most notably not paying her or the subject company any distributions.
In 2015, plaintiff’s husband passed while owning a 100% interest in Rosh, Inc. (“Rosh”) and an 8% interest in 44-45 Realty Associates, L.P. (“Partnership”). 44 G.P. LLC (“LLC”) is allegedly the general partner and owns 20% of the Partnership. Rosh allegedly owns 10% of the LLC. Thus, plaintiff alleged that she owned 8% of the Partnership directly and another 2% vis-à-vis her interest through Rosh.
Plaintiff sued defendants, asserting fourteen causes of action in her complaint. In essence, plaintiff maintained that defendants were depriving her of her rights, including the right to receive distributions from her ownership of the Partnership and LLC.
Defendants moved to compel arbitration pursuant to CPLR 7503. Defendants maintained that the partnership agreement that plaintiff’s husband signed (the “Partnership Agreement”) contained an arbitration provision requiring “[a]ny dispute or controversy arising out of or relating to [the] agreement [to] be determined and settled by arbitration.” The LLC operating agreement did not, however contain such a provision.
Plaintiff argued that she could not be compelled to arbitrate because defendants could not simultaneously claim she was not a partner while enforcing the Partnership Agreement against her.
The motion court rejected plaintiff’s contention, finding that it was “at odds with [plaintiff’s] first cause of action for breach of the Partnership Agreement and fourteenth cause of action for a declaration that she is a partner, which necessarily implicates the Partnership Agreement.” The motion court also noted that plaintiff did not challenge that her husband had entered the Partnership Agreement and that she sought to enforce rights under that agreement. Thus, the motion court granted the motion.
The Appellate Division, First Department unanimously reversed.
The Court held that “[t]he [motion] court should have denied the motion to compel arbitration of Rosh’s claims because Rosh [was] a nonsignatory to the agreement that contain[ed] the arbitration clause.”11 The Court found that defendants “failed to show that the direct benefits theory of estoppel applie[d].”12
The Court noted that the arbitration clause was contained in the Partnership Agreement to which Rosh was not a party and not a partner in the Partnership.13 “Rather,” said the Court, “Rosh was a ten percent owner in a limited liability company that was the general partner of the partnership. This did not constitute a direct benefit to Rosh from the partnership agreement.”14
Finally, said the Court, “before Rosh could be compelled to arbitrate, it had to invoke or attempt to enforce the terms of the partnership agreement.”15 “The Court found, however, that “all of Rosh’s claims were asserted under the operating agreement of the limited liability company or based on its status as a member of that company.”16
Although State policy favors arbitration, a party cannot be required to submit to arbitration any dispute that he/she has not agreed to submit. For this reason, courts are “wary of imposing a contractual obligation to arbitrate on a non-contracting party.”17 Notwithstanding, where a non-party knowingly exploits and directly receives a benefit from an agreement containing an arbitration clause, the courts will compel the non-signatory to arbitrate any disputes flowing from the agreement.
In Gilat, defendants were unable to demonstrate that the direct benefits theory of estoppel applied to Rosh. As noted by the Court, being a non-signatory to the Partnership Agreement and minority owner of the Partnership did not suffice to trigger the theory.
- Rent-A-Ctr., W, Inc. v. Jackson, 561 U.S. 63, 67 (2010) (noting that “arbitration is a matter of contract”).
- Matter of Smith Barney Shearson v. Sacharow, 91 N.Y.2d 39, 49 (1997) (citations and quotation marks omitted).
- Id. at 49-50. (citations omitted).
- Louis Dreyfus Negoce S.A. v. Blystad Shipping & Trading Inc., 252 F.3d 218, 224 (2d Cir. 2001).
- TBA Global, LLC v. Fidus Partners, LLC, 132 A.D.3d 195, 202 (1st Dept. 2015).
- AT&T Techs., Inc. v. Communications Workers of Am., 475 U.S. 643, 648 (1986) (quoting Steelworkers v. Warrior & Gulf Nav. Co., 363 U.S. 574, 582 (1960)).
- Merrill Lynch Inv. Managers v. Opibase, Ltd., 337 F.3d 125, 129 (2d Cir. 2003).
- Belzberg v. Verus Inv. Holdings Inc., 21 N.Y.3d 626, 631 (2013) (adopting the doctrine from federal law and citing federal cases).
- Id. (citations omitted).
- Slip Op. at *1.
- Id. (citing Belzberg, 21 N.Y.3d at 631)).
- Id. (citations omitted).
- Id. (citing Oxbow Calcining USA Inc. v. American Indus. Partners, 96 A.D.3d 646, 649-650 (1st Dept. 2012)).
- Smith/Enron Cogeneration Ltd. P’ship, Inc. v. Smith Cogeneration Int’l, Inc., 198 F.3d 88, 97 (2d Cir. 1999).
Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP.
This article is for informational purposes and is not intended to be and should not be taken as legal advice.