When An Arbitration Provision Governs, Should a Court Sua Sponte Direct The Parties To Arbitrate? The Second Department Says No

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Posted on: Feb 21 2023

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 For this reason, “New York courts interfere as little as possible with the freedom of consenting parties to submit disputes to arbitration.”³

Since arbitration is a “creature of contract”,⁴ courts will enforce arbitration provisions as they would enforce contractual rights generally.⁵

Even though parties have agreed to arbitrate their disputes, one or more parties may resist availing themselves of the arbitral forum. For this reason, an aggrieved party will file a motion to compel arbitration to force the resisting party to settle the dispute in the arbitral forum.

In P.S. Finance, LLC v. Eureka Woodworks, Inc., 2023 N.Y. Slip Op. 00877 (2d Dept. Feb. 15, 2023) (here), the Appellate Division, Second Department was faced with a “novel” question: whether, upon reviewing an agreement and determining that an arbitration provision governs, a court should, sua sponte, direct the parties to arbitrate though neither party had requested such relief? As discussed below, the Court answered the question in the negative.

P.S. Finance involved a litigation funder and the effects of the Deepwater Horizon oil spill on the hotel industry along the Gulf of Mexico.

Defendant Eureka Woodworks, Inc. (“Eureka”) was in the business of designing and manufacturing beach furniture and wooden advertising displays. Following the oil spill from the Deepwater Horizon oil rig in April 2010, Eureka filed a claim for damages with the Gulf Coast Claims Facility (“GCCF”), alleging that its revenue and profits decreased due to the effects the oil spill had on the hotel industry along the Gulf of Mexico. The law firm defendants, as well as nonparty Watts Guerra, LLP (“Watts Guerra”), represented Eureka in connection with its claim with the GCCF.

Plaintiff P.S. Finance, LLC (“PSF”) was a New York limited liability company engaged in the business of advancing funding to plaintiffs in litigation, including personal injury litigation and commercial claims. According to PSF, in exchange for the funds that PSF advanced to plaintiffs in litigation, the plaintiffs agreed to pay a portion of the potential proceeds of their litigation to PSF. However, if the plaintiffs did not recover money from their litigation, then the plaintiffs were not obligated to pay PSF.

On March 14, 2012, PSF and Eureka entered into an agreement, entitled “Plaintiff’s Agreement to Pay Proceeds Contingent on Successful Settlement, Judgment or Verdict and Receipt of Proceeds: Agreement to Assign Proceeds” (the “Agreement to Pay”). Pursuant to the Agreement to Pay, PSF agreed to provide $120,250 to Eureka in connection with the Eureka’s claim with the GCCF and any other related actions or claims. Among other provisions, the Agreement to Pay included an arbitration provision.

On April 2017, PSF commenced the action in the Supreme Court, Richmond County, against Eureka and the attorney defendants by summons and motion for summary judgment in lieu of complaint pursuant to CPLR § 3213. PSF alleged that, in exchange for $120,250, Eureka and the attorney defendants assigned to PSF a portion of the proceeds of Eureka’s claim with the GCCF, and despite Eureka and the attorney defendants receiving settlement funds from the GCCF, they failed to pay PSF its portion of the proceeds. PSF requested that the motion court grant PSF summary judgment on its causes of action based on breach of contract, breach of the covenant of good faith and fair dealing, and breach of fiduciary duty in handling trust funds.

On May 12, 2017, Eureka and the attorney defendants opposed PSF’s motion. In addition, the attorney defendants moved pursuant to CPLR § 3211(a)(8) to dismiss the action insofar as asserted against them for lack of personal jurisdiction, raising the same contentions as those raised in opposition to PSF’s motion for summary judgment in lieu of complaint.

By order dated December 14, 2017, the motion court held that, inter alia, pursuant to the Agreement to Pay, it did not have jurisdiction over the matter, sua sponte directed the parties to arbitrate, directed dismissal of the action, and, in effect, denied, as academic, the attorney defendants’ motions.

On appeal, the Second Department reversed the portion of the motion court’s order directing the parties to arbitrate the dispute.

In arguing for reversal, the attorney defendants noted that no party had sought arbitration at the time the motion court sua sponte directed arbitration. As such, the attorney defendants contended that the motion court’s sua sponte directive was improper. The attorney defendants further contended that PSF waived any potential right to arbitrate by commencing the action in court, and in any event, the attorney defendants were not bound by the arbitration provision in the Agreement to Pay.

Initially, the Court took issue with the motion court’s conclusion that the existence of the arbitration provision in the Agreement to Pay by itself divested it of jurisdiction over the matter: “contrary to the Supreme Court’s determination, ‘the mere existence of an arbitration clause in the contract [does] not … authorize dismissal of the action. Only an arbitration and award would warrant such a dismissal.’”⁶ The Court noted that “[t]here is no provision of the CPLR that requires a court to direct arbitration based upon the existence of what the court believes to be an applicable arbitration provision covering the subject matter of the action, absent a request from one of the parties to arbitrate.”⁷

The Court also noted that under the Federal Arbitration Act (“FAA”), “there is no provision in the statute that requires a court to sua sponte enforce an arbitration provision.”⁸ The Court explained that under United States Supreme Court jurisprudence, the FAA “does not mandate the arbitration of all claims, but merely the enforcement—upon the motion of one of the parties—of privately negotiated arbitration agreements.”⁹ “Numerous federal courts considering the issue have also held that sua sponte directions to arbitrate are improper,” observed the Court.¹⁰ Accordingly, the Court held “that a court should not direct arbitration absent a request from one of the parties to arbitrate.”¹¹

From a policy perspective, the Court held that courts should not be creating “special rules to promote arbitration.”¹² “In our view,” said the Court, “a policy favoring arbitration does not authorize courts to create special rules to promote arbitration.”¹³

Having determined that the motion court erred in directing, sua sponte, the parties to arbitrate, the Court addressed the issue of whether plaintiff waived the right to compel arbitration. Since arbitration agreements are like any other agreement,¹⁴ “a right to arbitration may be modified, waived or abandoned.”¹⁵ “A litigant waives arbitration when its conduct is ‘clearly inconsistent with [its] later claim that the parties were obligated to settle their differences by arbitration.’”¹⁶

The Court found that, as against the attorney defendants, PSF waived its right to arbitrate through its conduct.¹⁷ “First,” said the Court, “PSF chose to commence this action instead of seeking to enforce the arbitration provision in the Agreement to Pay.”¹⁸ “Second,” said the Court, “PSF did not move to compel arbitration or even mention the arbitration provision of the Agreement to Pay in its papers in support of its motion for summary judgment in lieu of complaint.”¹⁹ The same was true, noted the Court, when PSF moved to add an additional defendant to the action and made a second motion for summary judgment in lieu of complaint more than two months later.²⁰ “Indeed,” noted the Court, “up until the time the Supreme Court decided the parties’ motions and cross-motion, no party had ever requested or even mentioned arbitration.”²¹

The Court rejected PSF’s contention that it did not waive the right to arbitrate because it resorted to litigation in order to seek protective relief and to preserve the status quo pending arbitration.²² While acknowledging the law that “[n]ot every foray into the courthouse effects a waiver of the right to arbitrate,”²³ the Court found that PSF’s claim of urgency failed because it did not explain “why, after it commenced the action, [it] did not then take any action to demand arbitration in response to the attorney defendants’ motion or the cross-motion or in the eight months before the Supreme Court made its sua sponte directive to arbitrate.”²⁴

“To the extent that PSF contends that [the Court’s] waiver analysis should take into account the parties’ conduct after the Supreme Court’s sua sponte directive to arbitrate,” the Court “disagree[d].”²⁵ The Court held that “the parties’ subsequent conduct ha[d] no bearing on the court’s determination to direct arbitration in December 2017.”²⁶ The Court explained that “PSF’s purported demand to arbitrate, made after the court’s directive, [did] not change the fact that PSF had waived the right to arbitrate before the court’s directive.”²⁷ “Once waived,” said the Court, “the right to arbitrate cannot be regained.”²⁸

Takeaway

P.S. Finance presented the Court with a novel issue: whether a court, on its own, can direct the parties to arbitrate their dispute in the absence of a motion to compel. As discussed, the Court held that the courts do not have such power. In our view, this issue was correctly decided. If the parties do not request arbitration, then the courts should not, on its own, force them to do so.

In addition, the Court’s decision brings the courts of New York in lockstep with those federal courts addressing the same issue. As noted, those courts held that a court should not direct arbitration absent a request from one of the parties to arbitrate.

Footnotes

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); Stark v. Molod Spitz DeSantis & Stark, P.C., 9 N.Y.3d 59, 66 (2007) (internal citation omitted).
Stark, 9 N.Y.3d at 66 (internal quotation marks and citation omitted).
Louis Dreyfus Negoce S.A. v. Blystad Shipping & Trading Inc., 252 F.3d 218, 224 (2d Cir. 2001).
Matter of Monarch Consulting, Inc. v. National Union Fire Ins. Co. of Pittsburgh, PA, 26 N.Y.3d 659, 665 (2016); Sablosky v. Gordon Co., 73 N.Y.2d 133, 136 (1989).
Slip Op. at *4 (quoting, BR Ambulance Serv. v. Nationwide Nassau Ambulance, 150 A.D.2d 745, 746 (2d Dept. 1989), and citing Lischinskaya v. Carnival Corp., 56 A.D.3d 116, 122 (2d Dept. 2008) (rejecting contention that the jurisdiction of the court can be divested by a term of the contract between the parties)).
Id. (citations omitted).
Id. (footnote omitted). The FAA applies to any arbitration agreement evidencing a transaction involving interstate commerce (see 9 U.S.C. § 2). The United States Supreme Court has interpreted the term “involving commerce” in the FAA as the functional equivalent of “affecting commerce” — words of art that ordinarily signal the broadest permissible exercise of Congress’ Commerce Clause power. Citizens Bank v. Alafabco, Inc., 539 U.S. 52, 56 (2003). None of the parties argued that the FAA applied.
Id. at *4-*5 (quoting, Dean Witter Reynolds, Inc. v. Byrd, 470 U.S. 213, 219 (1985)).
Id. at *5 (citations omitted).
Id.
Id. (citing, Morgan v. Sundance, Inc., _____ US _____, _____, 142 S.Ct. 1708, 1713 (2022) (“a court may not devise novel rules to favor arbitration over litigation”)).
Id.
Id. (citations omitted).
Id. (citations omitted).
Id. (quoting, Cusimano v. Schnurr, 26 N.Y.3d 391, 400 (2015) (internal quotation marks omitted)).
Id.
Id.See also De Sapio v. Kohlmeyer, 35 N.Y.2d 402, 405 (1974) (“[T]he party who commences an action may generally be assumed to have waived any right it may have had to submit the issues to arbitration.”).
Id. at *6.
Id.
Id. (citations omitted).
Id.
Id. (citing, Sherrill v. Grayco Bldrs., 64 N.Y.2d 261, 273 (1985) (“[W]here urgent need to preserve the status quo requires some immediate action which cannot await the appointment of arbitrators, waiver will not occur”)).
Id. (citing, Hyde v. Jewish Home Lifecare, 149 A.D.3d 674 (1st Dept. 2017) (finding, the defendant waived arbitration where, among other things, the defendant did not move to compel arbitration until approximately four months after the commencement of the plaintiff’s action)).
Id.
Id. (citations omitted).
Id.
Id. (quoting, Matter of Village of Bronxville v. Bronxville Police Taylor Act Comm., 171 A.D.3d 932, 934 (2d Dept. 2019) (internal quotation marks omitted), and citing, Sherrill, 64 N.Y.2d at 274)).

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.