Wake Forest Law Review
30Nov

Much Ado About Something: The Foreseeability Problem in Breach of Contract Claims Arising out of International Economic Sanctions

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13 Wake Forest L. Rev. Online 59

Clare Magee

Introduction

Russia’s 2022 invasion of Ukraine catalyzed a waterfall of political and economic upheaval across a world already reeling from the continuing COVID-19 pandemic. According to the World Bank, global trade in oil and natural gas from Russia and agricultural products from Ukraine suffered immense setbacks.[1] The Russian invasion and subsequent response from Western nations, in particular, disrupted numerous commercial agreements, many of which were directly impacted by the imposition of economic sanctions by the United States government.[2] A 2022 congressional report suggests that these economic sanctions resulted in hundreds of billions of dollars lost for the Russian economy, as well as a mass exodus of foreign companies from the Russian market, resulting in political and economic instability.[3]

Russia’s military offensive will likely result in a host of contractual legal issues coming to the fore over the next several decades. Russia-Ukraine sanctions-related commercial litigation governed by United States law is already slowly trickling into United States courts.[4] However, given that many commercial contracts customarily include mandatory arbitration provisions, courts will not have occasion to fully evaluate these claims for several years.[5] Instead, arbitrators will be met with the foreseeability problem that accompanies invocation of force majeure clauses and other common law defenses to breach of contract.

Part I of this Comment briefly discusses the legal foundation for economic sanctions both under United States and international law. Next, Part II explains how force majeure clauses operate in the background of contract disputes. Part III introduces the “foreseeability problem” generally, and details different analyses courts employ to evaluate force majeure depending on whether the jurisdiction has adopted a requirement that the force majeure event be foreseeable. Then, Part IV explores common law defenses to nonperformance of a contract complicated by economic sanctions that could be workable altneratives to force majeure clauses. Finally, Part V analyzes the contours of the “foreseeability problem” in the specific context of cases involving economic sanctions.

Ultimately, this Comment argues that while courts tasked with evaluating breach of contract cases arising out of economic sanctions may choose to adopt a straightforward approach to force majeure interpretation, the complications of a foreseeability approach could have costly implications for global commercial contracts. This Comment thus argues that until courts have occasion to reach the issues discussed below, litigants should focus their breach of contract defenses on the common law defenses of illegality and public policy.

I. Overview of Economic Sanctions

At the outset, it is important to explore how international economic sanctions operate at both a domestic and international level. Sanctions in the international context are a proverbial stick used to penalize states, individuals, or other actors that “endanger [the issuing entity’s] interests or violate international norms of behavior.”[6] International sanctions most often take the form of economic sanctions, which “are defined as the withdrawal of customary trade and financial relations for foreign- and security-policy purposes.”[7] Economic sanctions vary in type and scope, but may include travel bans, asset freezes, arms embargoes, capital restraints, foreign aid reductions, and other restrictions on trade and economic activity.[8]

The scope of this Comment is limited to economic sanctions issued by the United States government. While a brief overview of the broad international and domestic legal authorities for economic sanctions follows, it should be noted that the legitimacy, enforceability, and mass use of economic sanctions are expansive topics of legal and political scholarship that are well beyond the scope of this Comment.

A. Sanctions Under International Law

To begin, there is no general prohibition against economic sanctions in international law.[9] In fact, examples of economic sanctions have existed in international relations since 432 B.C. “when Athens imposed a trade embargo on its neighbor Megara.”[10] The modern international legal order is often considered to have begun after World War I with the formation of the League of Nations, which continued to promulgate sanctions as a tool of international relations.[11] For example, the League imposed a sweeping economic sanctions package against Benito Mussolini’s Italy after his invasion of Ethiopia in 1935.[12] The sanctions included an arms embargo, freeze on financial transactions, and significant export and import restrictions.[13] Various sanctions regimes have continuously been promulgated since 1935, and the recent trend has been towards issuing sanctions known as “smart sanctions” designed to “minimize the suffering of innocent civilians.”[14]

Today, the international legal authority for sanctions is largely grounded in the United Nations Charter, which contemplates the imposition of sanctions as collective security mechanisms available both to member states and to the UN as an international body.[15] Article 2 of the Charter lays out the expectations and rights of UN member states.[16] A majority of scholars do not believe that economic coercion through sanctions fall under Article 2(4)’s prohibition against “the threat or use of force” that is “inconsistent with the purposes of the United Nations.”[17] This is a logical interpretation given that any other reading would render later articles of the Charter inconsistent.[18] Article 41 of the Charter explicitly illustrates permissible uses of unarmed force, including “complete or partial interruption of economic relations and of rail, sea, air, postal, telegraphic, radio, and other means of communication.”[19]

However, the evolution of customary international law does impose some guardrails on sanctions. Generally, lawful sanctions imposed against an actor should include five components: (1) the actor must have violated or continues to violate a primary rule of international law, (2) good faith efforts have been attempted to deter or induce the actor to cease its violation, (3) the sanctions are proportional to the violation, (4) the sanctions are appropriately tailored or limited, and (5) the sanctions are terminable upon the actor’s cessation of its violation.[20]

The general acceptance of proportional and appropriately applied sanctions does not mean that actors view all sanctions as legal, however. For example, Iran–which has recently been the target of expansive economic sanctions regimes–has attempted to challenge the legality of sanctions under treaty law and other international legal principles.[21] Iran has a lawsuit before the International Court of Justice (“ICJ”) which suggests that in addition to the general customary rules of sanctions, there may also be treaties, UN General Assembly resolutions, and general principles of international law that inform the legality of sanctions.[22] For the purposes of this Comment, however, international economic sanctions as a general economic concept are assumed to be valid under international law and capable of interrupting contractual relationships.

B. Economic Sanctions Under United States Law

Within the United States, international economic sanctions are governed by a patchwork of legal authorities including acts of Congress, executive orders, decisions of agencies, and the Constitution itself. As a nation-state under international law, the United States’ jurisdiction to prescribe law includes “certain conduct outside its territory by persons not its nationals that is directed against the security of the state or against a limited class of other state interests.”[23] This constraint of international law on the United States, paired with the Constitution’s provisions on prescriptive jurisdiction, form the legal basis of the United States’ authority to promulgate economic sanctions.[24] Article 1 of the Constitution vests legislative powers in the Congress of the United States and authorizes Congress to make laws related to economic sanctions, while Article 2 outlines the authority of the Executive to do the same.[25]

One foundational authority governing sanctions promulgated by the United States is the International Emergency Economic Powers Act (“IEEPA”). IEEPA was enacted in 1977 “to govern the President’s authority to regulate international economic transactions during wars or national emergencies.”[26] IEEPA forms the basis of most–if not all–Executive action related to sanctions.[27] On average, 1.5 IEEPA emergencies are declared every year, which may result in sanctions targeting thousands of persons or entities.[28] IEEPA also includes the power to impose “secondary sanctions” on individuals and entities who are outside U.S. jurisdiction and cannot be legally required to adhere to sanctions.[29] These secondary sanctions are broadly applicable to those “suspected of transacting with sanctioned or sanctionable entities.”[30] Further, IEEPA sanctions often last for decades, which means that once sanctions regimes are imposed, they are not quickly undone.[31] Congress can also crystallize executive orders imposing sanctions by codifying them to ensure they are not revoked later on.[32]

In addition to legal authorities governing imposition of sanctions, there are also authorities governing execution and monitoring of sanctions. Once sanctions are imposed, the Office of Foreign Assets Control (“OFAC”) in the Department of the Treasury “administers and enforces economic and trade sanctions based on U.S. foreign policy and national security goals.”[33] OFAC maintains and publishes lists of “individuals and companies owned or controlled by, or acting for or on behalf of, targeted countries,” as well as groups that are “designated under programs that are not country-specific.”[34] Sanctions that are country-based may be (1) comprehensive, which means they cover “all transactions with the country and its nationals,” or (2) limited, which means they prohibit “only certain types of transitions with the target country or with certain persons in the government of that country.”[35] Activity-based sanctions “address particular actions, and the targets can be anywhere in the world.”[36]

While United States companies and individuals are expected to immediately abide by sanctions, foreign entities may also be prohibited from engaging in transactions with sanctioned countries, individuals, or groups if they have sufficient “contacts” with the United States or “conduct their transactions in U.S. dollars.”[37] OFAC exercises its discretion to claim jurisdiction over foreign companies and individuals broadly, increasing the power of United States sanctions regimes.[38] Thus, the impact of economic sanctions is far-reaching and can create challenges in a number of legal relationships, including in contractual obligations.

II. Force Majeure in Operation

With the aforementioned principles of sanctions in place, the remainder of this Comment turns to the interplay between contracts and economic sanctions – specifically, the role of force majeure clauses. Force majeure clauses are standard provisions that can be found in almost any contractual agreement.[39] These clauses typically cover “an event or effect that can be neither anticipated nor controlled,” including “both acts of nature (e.g., floods and hurricanes) and acts of people (e.g., riots, strikes, and wars).”[40]

Typically, what constitutes a force majeure “event” is determined by the language in the clause itself, which will delineate events the parties have included or excluded.[41] Parties might choose to negotiate specific events for inclusion or exclusion in order to dictate the application, effect, and scope of the force majeure clause.[42] For example, in Sage Realty Corp. v. Jugobanka, D.D.,[43] which involved a contractual dispute arising from the imposition of United States sanctions on Yugoslavian entities after the end of the Bosnian War, the relevant agreement’s force majeure clause contained the following exclusion:

[t]he obligation of Tenant to pay rent hereunder…shall in no way be affected, impaired or excused because Landlord is unable to fulfill any of its obligations under this Lease…by reason of any rule, order or regulation of any department of subdivision thereof of any government agency.[44]

More commonly, parties may opt for boilerplate or “catch-all” language that typically consists of: “acts of God, war, government regulation, terrorism, disaster, strikes (except those involving [a party’s] employees or agents), civil disorder…,” etcetera.[45]

As creatures of common law, force majeure provisions are governed by state law in the United States.[46] A court’s analysis of a force majeure clause thus can vary significantly by jurisdiction. Still, there are some foundational principles that courts tend to follow. For example, in breach of contract cases, the party invoking force majeure as an affirmative defense bears the burden to prove that the event causing the breach: (1) qualifies as a force majeure event, and (2) was not caused by the party’s own fault or negligence.[47]

Courts typically construe force majeure clauses narrowly and will “only excuse a party’s nonperformance if the event that caused the party’s nonperformance is specifically identified.”[48] Importantly, force majeure clauses do not excuse a party’s nonperformance “dictated by economic hardship” or because of a “mere increase in expense.”[49] Rather, the party asserting the force majeure clause as a defense must prove that an event within the clause “was beyond its control and without its fault or negligence.”[50] However, one aspect of force majeure interpretation that remains unclear is whether and to what extent courts include a “foreseeability” component.

III. The Foreseeability Problem

Because force majeure interpretation has evolved through common law, courts’ analyses reveal different approaches to whether a force majeure event must have been foreseeable or unforeseeable for the clause to adhere.[51] For example, Alabama and Maine have limited case law on force majeure clauses, with the primary analysis in reported decisions centering on the definition of force majeure with no evaluation of foreseeability.[52]

Conversely, consider the variance in states that have directly addressed foreseeability. Alaskan courts tend to require unforeseeability for force majeure events in certain types of contracts like oil and gas leases.[53] California and Florida have robust force majeure case law reflecting the most common practice where foreseeability is typically only an issue for catch-all or boilerplate language, and the rule is that “unless a contract explicitly identifies an event as force majeure, the event must be unforeseeable at the time of contracting to excuse performance.”[54] In Idaho, even if a force majeure clause does not expressly use the word “foreseeability,” courts are expected to engage in a foreseeability analysis.[55] By contrast, in New York and Ohio, courts do not read foreseeability issues into contracts that are otherwise silent on foreseeability.[56]

As illustrated by case law, courts may not have robust or consistent jurisprudence on the issue of foreseeability if it has not been frequently litigated.[57] But as one author notes, “Courts who have addressed this question can be placed into two categories.”[58] On one side are courts who import a force majeure clause’s “common-law significance” and “tend to impose an unforeseeability requirement upon the force majeure event.”[59] This means that in order for the court to allow the force majeure clause to excuse a party’s nonperformance, the event contemplated by the clause must have been truly unforeseeable. On the other side are courts who “regard the words of a self-defined force majeure clause as controlling and permit common-law notions to fill in the gaps.”[60] These courts are more likely to “not impose an unforeseeability requirement on enumerated force majeure events.”[61]

This variance in approach is mirrored not only from state to state, but system to system. Federal courts “have expressly advocated for an interpretive presumption that parties intend common-law components of force majeure, such as unforeseeability, to be read into a contract.”[62] But various state courts “allow the terms of an enumerated force majeure clause to control the scope and application of a force majeure analysis.”[63]

Yet another differentiating factor dividing courts’ analyses is whether the force majeure event that a nonperforming party bases its defense upon is explicitly listed in the clause or not. Given the potential implications of this difference for litigation arising out of economic sanctions, and because there is an apparent circuit split on enumerated force majeure clauses, this Part focuses on different courts’ analyses on force majeure events depending on whether they are explicit or not explicitly identified.

A. When Force Majeure Event is Explicit

At least two circuits have come to different conclusions about whether, and under what circumstances, a force majeure event that is explicitly included in the clause must be unforeseeable for the clause to adhere.[64] The Third Circuit and the Fifth Circuit have each had occasion to address whether “specifically listed” events require a showing of unforeseeability, coming to opposite conclusions.[65]

In Eastern Air Lines v. McDonnell Douglas Corp.,[66] the Fifth Circuit addressed an appeal for damages for breach of contract in favor of an airline against a jet plane manufacturer.[67] The lower court was unconvinced by the manufacturer’s argument that the delays leading to its breach of contract were the result of “escalation of the war in Vietnam,” finding in part that “any excusing event must have been unforeseeable.”[68] The Fifth Circuit disagreed and explained that underlying general contract principles is an understanding that “a promisor can protect himself against foreseeable events by means of an express provision in the agreement.”[69] Thus, argued the court, “when the promisor has anticipated a particular event by specifically providing for it in a contract, he should be relieved of liability for the occurrence of such event regardless of whether it was foreseeable.”[70] The Fifth Circuit concluded that the lower court erred in finding that “specifically listed” events “must have been unforeseeable at the time the contracts were entered into.”[71] This holding set up a foreseeability clash with the Third Circuit several years later.

In Gulf Oil Corp. v. FERC,[72] the Third Circuit adopted a “showing of unforeseeability” requirement.[73] Gulf Oil breached its obligations to deliver daily oil supplies to a Texas gas corporation under a contract which included among its enumerated list of twenty-seven force majeure events mechanical breakdowns, equipment downtimes, and maintenance repairs.[74] The Third Circuit held that Gulf Oil could not invoke the use of force majeure absent a showing that “the events which delayed its performance were unforeseeable and infrequent.”[75] Explaining its reasoning, the Third Circuit noted that “it is possible to accurately describe an event at its initial occurrence as unforeseeable and later because of the regularity with which it occurs, to find that such a description is no longer applicable.”[76] The court determined that the mechanical repairs which interrupted Gulf Oil’s delivery of gas had become so frequent and predictable that they could no longer be considered an excuse to nonperformance, even if they were specifically enumerated within the force majeure clause.[77] Importantly, the court articulated the insufficiency of arguing that “because the mechanical repairs were listed in the contract, they were force majeure events.”[78]

B. When Force Majeure Event is Not Explicitly Identified

The majority of states appear to read a foreseeability requirement into force majeure clauses only when the force majeure event is not explicitly enumerated or a catch-all provision is used.[79] One recent appellate case from Texas provides an illustrative discussion.[80] TEC Olmos, LLC v. ConocoPhillips[81] involved breach of an oil and gas drilling contract as the result of changes in global supply and demand for oil.[82] The contract included a force majeure clause that explicitly listed several events as well as a “catch-all” provision.[83] Drawing on common law principles, the court imported an “unforeseeability” requirement to ‘fill the gaps’ in the [catch-all] force majeure clause.”[84] The court explained:

To dispense with the unforeseeability requirement in the context of a general “catch-all” provision would, in our opinion, render the clause meaningless because any event outside the control of the nonperforming party could excuse performance, even if it were an event that the parties were aware of and took into consideration in drafting the contract.[85]

Key to the court’s reasoning was its concern for avoiding an “overly broad definition of force majeure” in accordance with traditional common law principles.[86]

Courts in California follow the same rules of construction and also read a foreseeability requirement into boilerplate or catch-all force majeure clauses.[87] In granting a motion to dismiss a breach of contract claim based on a force majeure defense, a United States District Court applied California law and held that “unless a contract explicitly identifies an event as a force majeure, the event must be unforeseeable at the time of contracting to qualify as such.”[88]

However, there are some state courts who have reached different conclusions as to the relevance of foreseeability when force majeure events are not explicitly listed.[89] For example, in a case involving a breach of contract arising out of an alleged “trade war” between the United States and China, a Michigan appellate court suggested that the court could find no Michigan cases to “support a conclusion that the foreseeability of a force-majeure event is relevant to the interpretation of a force-majeure clause.”[90] There, the litigant invoking force majeure argued that the case should have been allowed to proceed to discovery so “the issue of the foreseeability of China’s alleged illegal actions in the solar market and the parties’ intent with regard to allocation of risk [could] be explored.”[91] The court disagreed and construed the force majeure clause narrowly, rejecting any foreseeability arguments where the force majeure event was not explicitly listed.[92]

These cases illustrate the uncertainty awaiting litigants who have already included or might consider including sanctions-related force majeure clauses in their contracts. Basic contract principles favor giving meaning to the parties’ intentions as explicitly expressed in their written agreement, so conventional wisdom suggests that litigants who fear their contracts may be disrupted by sanctions in the future should negotiate force majeure clauses with explicit coverage for sanctions. However, if litigants do so and are met with a breach of contract action in a court that shares the Third Circuit’s attitude towards foreseeability in explicit force majeure clauses, they may be subject to an unwelcome holding.

On the other hand, litigants may not contemplate the possibility of sanctions and thus may rely on catch-all force majeure language to defend against breach of contract arising out of sanctions. The trouble with this approach, however, is that courts are more likely to include a foreseeability requirement in their analyses.[93] This opens litigants up to judges acting as political and foreign policy analysts who opine as to whether the parties should have foreseen a deterioration in relations between states leading to the imposition of sanctions. And while Supreme Court Justices have historically been asked to wade into the depths of foreign policy as a consequence of their rulings on multi-dimensional economic and political questions, there should be a measure of wariness towards granting such consequential authority to district and state court judges who may lack the expertise and time to carefully engage in such an analysis.[94]

Faced with these options, or perhaps by sheer mistake, litigants may end up without a sanctions-related force majeure provision entirely. Without such a provision, there are still some common law defenses available to litigants, such as impracticability/impossibility, illegality, or public policy. However, these defenses do not entirely dispense with—and in some cases actually enhance—the problem of the foreseeability requirement.

IV. Other Defenses
A. Impracticability and Impossibility

The shared common law origins of force majeure and impracticability (sometimes called impossibility) plays a key role in understanding how foreseeability can complicate a court’s analysis of alternative common law defenses. Impracticability and force majeure are similar but separate defenses to nonperformance. Impracticability excuses either “contracting party from performance in the fact of an act of God” such as “natural planetary elements or unforeseen, dramatic events.”[95] Even though it often covers “acts of God,” a force majeure clause is intended to relieve liability where “nonperformance is due to causes beyond the control of a person who is performing under a contract.”[96]

The clearest distinction between the two defenses is most easily understood temporally—when and how they are raised. As a contractual provision, a force majeure clause can only be invoked if the contract actually includes the clause.[97] Conversely, impracticability is a common law defense available to litigants even when a contract contains no force majeure clause.[98]

Foreseeability is the key aspect of the impracticability defense to breach of contract, which has three general requirements:

(1) the occurrence, or nonoccurrence, of the event causing the impracticability was unexpected; (2) performance of the duty by the promisor would be extremely difficult and burdensome, if not impossible; and (3) the promisor did not assume the risk of the event’s occurrence or nonoccurrence.[99]

Thus, in cases where litigants raise an impracticability defense, the court will almost always investigate the foreseeability of the event alleged to have caused the breach. One interesting example comes from the Fifth Circuit opinion in National Iranian Oil Co. v. Ashland Oil.[100] While National Iranian Oil Co. occurred in the context of an arbitration dispute, it revealed the court’s foreseeability analysis when determining whether a party can assert impossibility or impracticability.[101]

Beginning in 1973, Ashland Oil contracted with the state-owned National Iranian Oil Company (“NIOC”) to supply Ashland with crude oil.[102] Following the takeover of the United States Embassy in Tehran in 1979, then-President Carter issued several executive orders imposing sanctions against Iran, including banning imports of Iranian crude oil.[103] When Ashland refused to pay NIOC under the agreement, NIOC attempted to compel arbitration proceedings, which resulted in the Fifth Circuit’s opinion quoted in part at the outset of this comment.[104] Among the court’s evaluation of the arbitration claims is a helpful discussion of foreseeability as it relates to the defense of impossibility or impracticability.

As to the first element of the defense as articulated at the time—that the asserting party must not have been able to foresee the event—the Fifth Circuit held that it was “unimaginable” that the “NIOC–an instrumentality of the Republic of Iran–could not reasonably have foreseen” at the time of renewing their contract with Ashland that the agreement might be made impracticable by the deterioration of relations between Iran and the United States.[105] On the second element of the defense—that the event cannot have been the fault of the party asserting impracticability—the Fifth Circuit held that “as part of the revolutionary Government, NIOC certainly bears responsibility for creating the chain of events” that led to Ashland’s breach.[106]

Ashland Oil offers two principles that litigants should be aware of in choosing to invoke the impracticability defense, and potentially force majeure in jurisdictions where foreseeability is imported. First, depending on the political history and recency of conflict-ridden relations between the United States and foreign nations, a court may be willing to find that the imposition of sanctions was foreseeable, even if the parties did not contemplate them at the time of contracting. Second, litigants should be on notice that contracts with state- or quasi-state-owned entities may receive higher scrutiny on the foreseeability component since sanctions typically first target governments and government-owned enterprises.

B. Illegality and Public Policy

Illegality and public policy, which do not typically implicate foreseeability, provide a meaningful defense for nonperformance of a contract complicated by economic sanctions. As a general rule, illegality may be available to litigants as a defense against a breach of contract claim “whenever the performance of an act would be either a crime or a tort.”[107] Because parties cannot preemptively contract for something that would be illegal, the defense of illegality is available if, at the time the parties entered into the contract, the promise or obligation was not illegal but later became illegal.[108]

Public policy is an inherently ambiguous term, but courts are routinely asked to articulate what constitutes “public policy.”[109] They may define public policy as “that rule of law which declares that no one can lawfully do that which tends to injure the public, or is detrimental to the public good,”[110] “laws enacted for the common good,”[111] or policy and statutes that are established in the interests of the public or society.”[112] The Restatement (Second) of Contracts explains why courts may determine that a contractual promise is void as against public policy:

First, a refusal to enforce the promise may be an appropriate sanction to discourage undesirable conduct, either by the parties themselves or by others. Second, enforcement of the promise may be an inappropriate use of the judicial process in carrying out an unsavory transaction.[113]

In evaluating both illegality and public policy defenses, courts must often rely on the facts before them and the common law evolution of a court’s specific notions of what constitutes public policy, fairness, and illegality, meaning the success of either of these defenses is not automatic.

Unlike the impracticability or impossibility defense, courts do not typically import a foreseeability requirement into the illegality or public policy defenses. For example, Kashani v. Tsann Kuen China Enter. Co.[114] involved an American computer manufacturer entering an agreement with a Taiwanese corporation to establish a parts manufacturing plant in Iran.[115] Soon after the manufacturer began arranging financing, the Taiwanese corporation withdrew from the computer industry and refused to proceed with the agreement, arguing it had become illegal and against public policy because it violated executive orders issued by then-President Clinton to sanction Iran by restricting various business and financial transactions.[116] The California Court of Appeals held that the agreement was plainly illegal and violated public policy because the content of the agreement expressly violated the executive orders and other regulations imposing sanctions on Iran, so the corporation’s “actual and anticipated performance under the agreement were…prohibited.”[117]

Interestingly, the court distinguished between contracts that would be violative of domestic public policy versus international public policy in situations involving arbitration enforcement, indicating that the public policy defense might be evaluated differently in arbitration proceedings as opposed to court proceedings.[118] Ultimately, while the Kashani court acknowledged the public policy arguments, its decision was predicated on the more straightforward recognition that the agreement at issue violated an executive order and thus was illegal.[119]

Another example is a case from the United States Court of Federal Claims involving a motion to dismiss a breach of a government contract between the United States Agency for International Development (“USAID”) and Transfair International, Inc. to deliver humanitarian relief supplies to Eritrea.[120] In fulfilling its obligations under the agreement, Transfair subcontracted with a British company which ultimately hired Iranian aircraft to deliver the supplies.[121] USAID refused to pay the contract amount based on a defense that Transfair was in violation of OFAC sanctions. In response, Transfair filed a claim with the contract officer who found that “public policy considerations counseled against payment, which would be the equivalent of a transfer of government funds directly to an Iranian organization.”[122] The Court of Federal Claims reversed this decision at the motion to dismiss stage for two primary reasons: first, the court held that it must be determined whether a primary subcontractor should be held responsible for the illegal conduct of its subcontractor, and second, the court held that the illegality defense was not absolute, but rather subject to a fact intensive balancing test.[123] The court suggested that such a balancing test might weigh: (1) the promisee’s culpability, including what it knew about the alleged illegality, (2) the promisor’s corresponding culpability and knowledge of the illegality, (3) whether forfeiture would serve the public purposes at issue or serve as a deterrent against future violations, and (4) whether forfeiture resulting from nonenforcement of the agreement would be proportional to the illegality.[124]

These cases teach that when choosing among the available common law defenses to breach of contract, litigants can avoid the foreseeability problem by relying on illegality or public policy defenses. Impossibility or impracticability almost always require a court to inquire into the foreseeability of the event giving rise to the defense. Thus, if litigants are concerned about whether a court will read foreseeability into their force majeure clause, they should not expect to find a safe haven in the impossibility or impracticability defense. Thus, litigants should carefully consider whether the balancing approaches to illegality and public policy discussed above may instead be more advantageous to their position. Still, because of the canons of construction for contracts, if the litigants do have a force majeure provision that includes either explicit sanctions-related events or more general catch-all language, courts may begin and end their analyses with the force majeure clause, bringing litigants back to the foreseeability problem.

V. The Foreseeability Problem Redux: Sanctions Cases

The remainder of this Comment turns to cases which directly implicate force majeure or common law defenses in breach of contract cases arising directly out of sanctions. These cases do not appear to be often litigated to their full extent because of contractual arbitration provisions and the numerous other grounds on which a case may be decided or dismissed. Still, the cases that have been reported, combined with the general principles discussed above, provide a framework by which pending sanctions-related cases may be understood. As qualified previously, the discussion in this Part does not address the causation or culpability requirements of force majeure, or other elements of common law defenses. Instead, the focus is on the most unclear hurdle of them all: foreseeability.

A. A Straightforward Approach

Most likely, courts will adopt a straightforward approach to foreseeability in adjudicating sanctions-related litigation. In 1985, the Eighth Circuit reviewed an appeal from Iran after it lost a summary judgment motion to McDonnell, an American aircraft parts manufacturer over a breach of contract dispute.[125] Ten years earlier, the parties had entered into an agreement which included a force majeure clause explicitly excusing the manufacturer from nonperformance caused by “acts of the United States Government and embargoes.”[126] After the Iranian Revolution in 1979, when the U.S. Treasury Department and State Department imposed limitations on commercial dealings with Iran, McDonnell stopped shipping parts to the Iranian government.[127] The Iranian government sued for breach of contract, and the Eighth Circuit held that the economic restrictions imposed by the United States fell within the force majeure clause and excused McDonnell’s nonperformance.[128] Similarly, the Southern District of New York concluded in a 1998 case that the language of a force majeure clause which said the parties’ obligations would not be excused by “any rule, order or regulation…of any government” included executive orders and OFAC sanctions imposed against Yugoslavian entities in the wake of armed conflict in the Baltics.[129]

The ease with which these courts came to a decision regarding force majeure clauses should not be lightly disregarded. These cases illustrate the straightforward approach available to courts evaluating contractual provisions under traditional canons of construction. If, as is the case when analyzing any disputed contractual provision, the court’s aim is to give meaning and effect to the parties’ intentions when interpreting a force majeure clause, the court can rely on the terms of the agreement and end its analysis.[130] This is just what the Eighth Circuit did in McDonnell and the Southern District of New York did in Sage Realty.

If courts uniformly adopted this approach, litigants who contract with states or entities that eventually become targets of economic sanctions could negotiate specific force majeure provisions with this in mind at the beginning of the contractual relationship.Litigants would then have at least some measure of confidence that if all other force majeure elements were proven, they would be successful in their affirmative defense. Yet, the foreseeability problem lurks as a still-unknown potential disruptor to this straightforward approach.

B. The Unknowns of a Foreseeability Approach

Alternatively, courts might import foreseeability into their analyses of sanctions-related litigation, resulting in unknown but potentially far-reaching ramifications. This author could not find a single reported case in the last three decades where a court had occasion to directly address whether they would read a foreseeability requirement into a force majeure clause related to breach of contract arising out of sanctions. However, recent COVID-19 litigation seemingly indicates that such a question on sanctions cases may be forthcoming.[131] Over the past two years, courts have become increasingly skeptical of parties attempting to invoke force majeure clauses to cover pandemic-related breach of contract, finding that the pandemic and its impact on contracts are now foreseeable.[132] Notably, this skepticism seems most common in cases involving catch-all provisions where litigants attempt to stretch the meaning of the force majeure clause to cover the non-explicitly listed pandemic event.[133]

Economic sanctions as a tool of international relations are becoming more prevalent and widespread, with the Russia-Ukraine sanctions among the latest to garner public attention.[134] If “what’s past is prologue,”[135] there is a sound argument to be made that, when faced with questions about force majeure applicability to breach of contract arising out of sanctions, courts will look to cases like McDonnell and Sage Realty to interpret how litigants’ force majeure clauses apply to their claims. But in a world where courts have imported foreseeability requirements into force majeure cases like TEC Olmos and Gulf Oil, and where the recent COVID-19 litigation indicates that courts may consider the relative foreseeability of the force majeure event giving rise to contractual breach, it is possible that courts will turn to state common law and the foreseeability requirements of other common law defenses to read a foreseeability requirement into future force majeure litigation.

This approach could have costly implications for a range of contracts in a variety of industries given the nature of fully globalized trade. Imagine, for example, what would happen if a party today entered into a contract with a Chinese-owned entity that later became the target of United States sanctions. Could a court rationalize its opinion in state common law importation of foreseeability requirements that a force majeure clause and the common law defense of impracticability were unavailable because the sanctions were foreseeable given the slow devolution of relations between the United States and China since the end of the Cold War? While such a hypothetical might seem far-fetched and does not consider the potential relevance of common law defenses, there is certainly case law discussed in previous Parts that could support this reasoning if the facts and arguments were analogous enough.

Conclusion

The question of whether and to what extent foreseeability will impact sanctions-related litigation involving breach of contract claims is uncertain. Though courts will most likely rely on traditional canons of interpretation in evaluating force majeure events that litigants invoke as a shield against sanctions-involved breaches, the divide across state common law over importing a foreseeability requirement into force majeure interpretations lurks as a threat that raises more questions than it answers. Until courts are given an opportunity to develop a coherent body of case law on this question, litigants in cases involving breach of contract arising out of sanctions may be best served by adopting one of the following approaches. First, litigants could deliberately include sanctions in the force majeure clause and negotiate a favorable choice of law provision to ensure the force majeure clause is interpreted under the straightfoward approach adopted by the Eighth Circuit and Southern District of New York. Second, if their dispute reached a court, litigants could emphasize their public policy and illegality common law defenses in an attempt to avoid the question of foreseeability altogether.

  1. . See Russian Invasion of Ukraine Impedes Post-Pandemic Economic Recovery in Emerging Europe and Central Asia, The World Bank (Oct. 4, 2022), https://www.worldbank.org/en/news/press-release/2022/10/04/russian-invasion-of-ukraine-impedes-post-pandemic-economic-recovery-in-emerging-europe-and-central-asia. ↑

  2. . Peter Neger & Bryan Woll, Applying U.S. Contract Law Amid Ukraine-Related Sanctions, Law360 (Mar. 24, 2022, 5:44 PM), https://www.law360.com/articles/1476924/applying-us-contract-law-amid-ukraine-related-sanctions. ↑

  3. . Cong. Rsch. Serv., IFI2092, The Economic Impact of Russian Sanctions, https://crsreports.congress.gov/product/pdf/IF/IF12092 (last updated Dec. 13, 2022). ↑

  4. . See, e.g., Joe Schneider, Carlyle Aviation Sues Insurers Over Seized Planes Leased to Russian Airlines, Ins. J. (Nov. 1, 2022), https://www.insurancejournal.com/news/international/2022/11/01/692558.htm. ↑

  5. . Marco P. Falco, Business Contract Arbitration Clauses: Why the Words Matter, Law360 Canada (May 18, 2023 2:07 PM), https://www.law360.ca/articles/46864/business-contract-arbitration-clauses-why-the-words-matter?category=analysis. ↑

  6. . Jonathan Masters, What Are Economic Sanctions, Council on Foreign Rel., https://www.cfr.org/backgrounder/what-are-economic-sanctions (last updated Aug. 12, 2019, 8:00 AM). ↑

  7. . Id. ↑

  8. . Id. ↑

  9. . Syed Ali Akhtar, Do Sanctions Violate International Law?, Econ. & Pol. Wkly. (Apr. 27, 2019), https://www.epw.in/engage/article/do-sanctions-violate-international-law. ↑

  10. . Uri Friedman, Smart Sanctions: A Short History, Foreign Pol’y (Apr. 23, 2012, 2:33 AM), https://foreignpolicy.com/2012/04/23/smart-sanctions-a-short-history/. ↑

  11. . IMF, The Sanctions Weapon, Finance & Development (June 2022), https://www.imf.org/en/Publications/fandd/issues/2022/06/the-sanctions-weapon-mulder. ↑

  12. . Id. ↑

  13. . Id. ↑

  14. . Masters, supra note 6. ↑

  15. . See U.N. Charter art. 2, ¶ 5–6; see also U.N. Charter arts. 39–51. ↑

  16. . U.N. Charter, art. 2. ↑

  17. . J. Curtis Henderson, Legality of Economic Sanctions Under International Law: The Case of Nicaragua, 43 Wash. & Lee L. Rev. 167, 180 (1986). ↑

  18. . Id. at 181. ↑

  19. . U.N. Charter, art. 41. ↑

  20. . Anthony D’Amato, Groundwork for International Law, 108 Am. J. Int’l. L. 650, 670 (2014). ↑

  21. . See Certain Iranian Assets (Iran v. U.S.), Application Instituting Proceedings, 2016 I.C.J. (June 14) (arguing that U.S. sanctions violate the Treaty of Amity and international law). ↑

  22. . See id. See generally Henderson, supra note 17, at 187–93. ↑

  23. . Restatement (Third) of Foreign Rel. L. of the U.S. § 402 (1987). ↑

  24. . Id., cmt. j. ↑

  25. . U.S. Const. art. I §§ 1, 8; id. art. II. ↑

  26. . Barbara J. Van Arsdale, Annotation, Validity, Construction, and Operation of International Emergency Economic Powers Act, 50 U.S.C.A. §§ 1701 to 1707, 183 A.L.R. Fed. 57 (2003). ↑

  27. . Andrew Boyle, Checking the President’s Sanctions Powers, Brennan Center for Justice 3 (June 10, 2021), https://www.brennancenter.org/sites/default/files/2021-06/BCJ-128%20IEEPA%20report.pdf. ↑

  28. . Id. ↑

  29. . Id. at 8. ↑

  30. . Id. ↑

  31. . Id. at 3. ↑

  32. . Abigail A. Graber, Cong. Rsch. Serv., R46738, Executive Orders: An Introduction, at 19 (Mar. 29, 2021). ↑

  33. . Office of Foreign Assets Control, U.S. Department of the Treasury, https://home.treasury.gov/policy-issues/office-of-foreign-assets-control-sanctions-programs-and-information (last visited Nov. 20, 2023). ↑

  34. . Id.; Office of Foreign Assets Control, Specially Designated Nationals List – Data Formats & Data Schemas, U.S. Department of the Treasury, https://ofac.treasury.gov/specially-designated-nationals-list-data-formats-data-schemas (last updated Nov. 17, 2023). ↑

  35. . Boyle, supra note 27, at 7. ↑

  36. . Id. ↑

  37. . Id. at 8. ↑

  38. . Id. at 8 (discussing OFAC’s claim of jurisdiction “over a Taiwanese company that transferred oil to an Iranian company, simply because that Taiwanese company had previously filed for bankruptcy in U.S. court”). ↑

  39. . See J. Hunter Robinson et. al., Use the Force? Understanding Force Majeure Clauses, 44 Am. J. Trial Advoc. 1, 8 (2020) (explaining that “[f]orce majeure clauses may be found in any contract,” particularly construction and real estate contracts. ↑

  40. . Force Majeure, Black’s Law Dictionary (11th ed. 2019). ↑

  41. . 30 Williston on Contracts § 77:31 (4th ed.). ↑

  42. . Id. ↑

  43. . No. 95 CIV. 0323, 1998 WL 702272 (S.D.N.Y. Oct. 8, 1998). ↑

  44. . Id. at *4. ↑

  45. . Williston, supra note 41. ↑

  46. . Robinson et. al., supra note 39, at 4 (“the application of force majeure principles can vary from jurisdiction to jurisdiction and case to case.”). ↑

  47. . Williston, supra note 41. ↑

  48. . Id. ↑

  49. . Id. ↑

  50. . Id. ↑

  51. . TEC Olmos, LLC v. ConocoPhillips Co., 555 S.W.3d 176, 181 (Tex. App. 2018) (explaining that “foreseeability of force majeure events is rooted in the common law of the force majeure doctrine”). See generally Robyn S. Lessans, Comment, Force Majeure and the Coronavirus: Exposing the “Foreseeable” Clash Between Force Majeure’s Common Law and Contractual Significance, 80 Md. L. Rev. 799, 809–10 (2021). ↑

  52. . See Practical Law Commercial Transactions, Key Issues When Invoking a Force Majeure Clause: State Law Chart, https://1.next.westlaw.com/Document/I1e7ec4ae774e11ea80afece799150095/View/FullText.html?transitionType=SearchItem&contextData=(sc.Search) (last visited Nov. 20, 2023). ↑

  53. . Alaskan Crude Corp. v. State Dep’t of Nat. Res., Div. of Oil & Gas, 261 P.3d 412, 420 (Alaska 2011) (stating the rule that “Force majeure clauses extend [mineral] leases only when the nonperformance is ‘caused by circumstances beyond the reasonable control of the lessee or by an event which is unforeseeable at the time the parties entered into the contract’”). ↑

  54. . Free Range Content, Inc. v. Google Inc., No. 14-CV-02329, 2016 WL 2902332, at *6 (N.D. Cal. May 13, 2016); see also In re. Flying Cow Ranch HC, LLC, No. 18-12681, 2018 WL 7500475, at *3 (Bankr. S.D. Fla. June 22, 2018)(finding that a force majeure event that was not explicitly listed in the clause was subject to a foreseeability analysis). ↑

  55. . Roost Project, LLC v. Andersen Constr. Co., 437 F. Supp. 3d 808, 821 (D. Idaho 2020). ↑

  56. . See Drummond Coal Sales Inc. v. Kinder Morgan Operating LP “C”, 836 F. App’x 857, 867 (11th Cir. 2021) (applying New York law); see also Sabine Corp. v. ONG W., Inc., 725 F. Supp. 1157, 1170 (W.D. Okla. 1989). ↑

  57. . See, e.g., Kyocera Corp. v. Hemlock Semiconductor, LLC, 886 N.W.2d 445, 451 (Mich. Ct. App. 2015) (explaining “[t]his Court has previously observed that there is a paucity of Michigan cases interpreting force-majeure clauses…and that remains the case today”). ↑

  58. . Lessans, supra note 51, at 810. ↑

  59. . Id. ↑

  60. . Id. ↑

  61. . Id. ↑

  62. . Id. ↑

  63. . Id. at 812. ↑

  64. . TEC Olmos, LLC v. ConocoPhillips Co., 555 S.W.3d 176, 182 (Tex. Ct. App. 2018). ↑

  65. . Id. ↑

  66. . 532 F.2d 957 (5th Cir. 1976). ↑

  67. . Id. at 961. ↑

  68. . Id. at 980. ↑

  69. . Id. at 992. ↑

  70. . Id. ↑

  71. . Id. ↑

  72. . 706 F.2d 444 (3d Cir. 1983). ↑

  73. . Id. ↑

  74. . Id. at 448–49 n.8, 453. ↑

  75. . Id. at 454. ↑

  76. . Id. at 453. ↑

  77. . Id. at 453–54 (explaining that “[t]he element of uncertainty that defines unforeseeability is negated by the regularity with which the events occurred.”). ↑

  78. . Id. at 454. ↑

  79. . Compare Roost Project, LLC v. Anderson Constr. Co., 437 F. Supp. 3d 808, 821 (D. Idaho 2020) (explaining that courts should engage in a foreseeability analysis for events that are not expressly listed in the force majeure provision), with Kyocera Corp. v. Hemlock Semiconductor, LLC, 886 N.W.2d 445 (Mich. App. 2015) (finding that courts need not engage in a foreseeablity analysis to interpret a force majeure provision). ↑

  80. . See TEC Olmos, 555 S.W. 3d at 182–85. ↑

  81. . Id. ↑

  82. . Id. at 179–180. ↑

  83. . Id. at 179. ↑

  84. . Id. at 184 (quoting Sun Operating LTD. P’ship v. Holt, 984 S.W.2d 277, 283 (Tex. App. 1998)). ↑

  85. . Id. ↑

  86. . TEC Olmos, LLC v. ConocoPhillips Co., 555 S.W.3d 176, 185 (Tex. App. 2018). ↑

  87. . Free Range Content, Inc. v. Google, Inc., No. 14-CV-02329, 2016 WL 2902332, at *6 (N.D. Cal. May 13, 2016). ↑

  88. . Id. ↑

  89. . See, e.g., Morgan St. Partners, LLC v. Chicago Climbing Gym Co., No. 20-CV-4468, 2022 WL 602893, at *5 (N.D. Ill. Mar. 1, 2022) (rejecting a plaintiff’s argument that “foreseeability is paramount” for evaluating a force majeure clause that did not explicitly mention the COVID-19 pandemic). ↑

  90. . Kyocera Corp. v. Hemlock Semiconductor, LLC, 886 N.W.2d 445, 454–55 (Mich. App. 2015). ↑

  91. . Id. at 455. ↑

  92. . Id. at 456. ↑

  93. . Lessans, supra note 51, at 810. ↑

  94. . See Noah Feldman, When Judges Make Foreign Policy, The New York Times Magazine (Sept. 25, 2008), https://www.nytimes.com/2008/09/28/magazine/28law-t.html. ↑

  95. . 30 Williston on Contracts § 77:31 (4th ed.), Westlaw (database updated May 2023). ↑

  96. . Id. ↑

  97. . Id. ↑

  98. . See 30 Williston on Contracts § 77:1 (4th ed.), Westlaw (database updated May 2023). ↑

  99. . Id. ↑

  100. . 817 F.2d 326 (5th Cir. 1987). ↑

  101. . Nat’l Iranian Oil Co., 817 F.2d 326. ↑

  102. . Id. at 328. ↑

  103. . Id. ↑

  104. . Id. ↑

  105. . Id. at 333. ↑

  106. . Id. ↑

  107. . 5 Williston on Contracts § 12:1 (4th ed.), Westlaw (database updated May 2023). ↑

  108. . See id. ↑

  109. . Id. ↑

  110. . Calvert v. Mayberry, 440 P.3d 424, 430 (Colo. 2019). ↑

  111. . In re Santiago G., 121 A.3d 708, 722 n.17 (Conn. 2015). ↑

  112. . See In re Estate of Feinberg, 919 N.E.2d 888, 894 (Ill. 2009). ↑

  113. . Restatement (Second) of Contracts ch. 8, intro. note (Am. L. Inst. 1981). ↑

  114. . 118 Cal. App. 4th 531 (2004). ↑

  115. . Id. at 536. ↑

  116. . Id. at 536–37. ↑

  117. . Id. at 548. ↑

  118. . See id. at 555 (explaining that “[t]here is an ‘important distinction between domestic and international public policy…According to this distinction what is considered to pertain to public policy in domestic relations does not necessarily pertain to public policy in international relations…’”) (internal citations omitted). ↑

  119. . Id. at 548. ↑

  120. . Transfair Int’l, Inc. v. United States, 54 Fed. Cl. 78, 78 (2002). ↑

  121. . Id. ↑

  122. . Id. at 80. ↑

  123. . Id. at 87. ↑

  124. . Id. at 85. ↑

  125. . McDonnell Douglas Corp. v. Islamic Republic of Iran, 758 F.2d 341, 343 (8th Cir. 1985). ↑

  126. . Id. ↑

  127. . Id. at 344. ↑

  128. . Id. at 347–48. ↑

  129. . See Sage Realty Corp. v. Jugobanka, D.D., No. 95 CIV 0323, 1998 WL 702272, at*1, *4–*5 (S.D.N.Y. Oct. 8, 1998) (discussing the reasonable foreseeability of sanctions for a related frustration of purpose defense). ↑

  130. . Rocky Mountain Helium, LLC v. United States, 145 Fed. Cl. 92, 97 (2019). ↑

  131. . Erin Webb, Analysis: No Longer Unforeseeable? Force Majeure and COVID-19?, BL (Nov. 1, 2021, 3:03 AM), https://news.bloomberglaw.com/bloomberg-law-analysis/analysis-no-longer-unforeseeable-force-majeure-and-covid-19 (stating that “[s]ome courts have found that the parties’ ability to name a risk—like a pandemic or a government shutdown risk—in a force majeure clause means that the risk was not only foreseeable at the time of contracting, but actually foreseen, defeating other defenses to nonperformance, such as impossibility of performance or frustration of purpose.”). ↑

  132. . Id. ↑

  133. . Ryan Franklin & Nicholas Wind, Force Majeure Clauses in the Aftermath of the COVID-19 Pandemic and the Implications for Government Entities, A.B.A. Blog (March 14, 2022), https://www.americanbar.org/groups/government_public/publications/pass-it-on/spring-2022/spring22-franklin-wind-forcemajeure/. ↑

  134. . Nicholas Mulder, The Sanctions Weapon, Fin. & Dev., June 2022, at 20, 20–21. Conflict between Israel and Hamas began in October 2023, just as this Comment was published. While OFAC’s sanctions carefully target Hamas affiliates in an effort to avoid direct state-to-state sanctions against Iran, sanctions penalizing money transfers between “Iran-aligned” entities and Gaza provide yet another contemporary example of the increasing prevalance of economic sanctions as an international stick that businesses should not ignore in contract drafting. See Press Release, U.S. Dept. of the Treasury, Following Terrorist Attack on Israel, Treasury Sanctions Hamas Operatives and Financial Facilitators (Oct. 18, 2023) https://home.treasury.gov/news/press-releases/jy1816. ↑

  135. . William Shakespeare, The Tempest 131 (Barbara A. Mowat & Paul Werstine, eds., Simon & Schuster Paperbacks 2015) (1623). ↑

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3Oct

Musk’s Attempt to Undo Twitter’s Payment of Wachtell’s Fee

Categories: Current Issues Blog
Comments Off on Musk’s Attempt to Undo Twitter’s Payment of Wachtell’s Fee

J. Stillman Hanson, Jr. 

Last year was dramatic for Elon Musk (“Musk”), even by his standards, largely due to his highly publicized acquisition of Twitter, Inc. (“Twitter”).[1]  In April 2022, Twitter’s board of directors accepted Musk’s offer to buy Twitter at a price of $54.20 per share, and the parties entered into a binding merger agreement.[2]  Musk attempted to back out of the deal which culminated in Twitter suing Musk in July 2022, for material breach of the merger agreement.[3]  Twitter sought to compel Musk to specifically perform his obligations under the merger agreement by closing the deal on its terms.[4]  With a deal volume of $44 billion at stake, Twitter engaged Wachtell, Lipton, Rosen & Katz (“Wachtell”) to enforce its contract with Musk.[5]

Wachtell’s litigation team moved quickly to expedite the trial to October 2022, and performed a considerable amount of legal work for Twitter in a condensed timeline of 3 months.[6]  Engaging Wachtell ultimately paid off for Twitter’s shareholders; in early October 2022, Musk informed the court he would complete the transaction under the merger agreement’s terms.[7]  The $44 billion deal closed on October 27, 2022, the same date Twitter paid Wachtell’s total legal fee of $90 million.[8]  A Bloomberg columnist evaluated Wachtell’s successful result as “worth about $25 billion to Twitter’s shareholders,” and he additionally opined that “[p]aying Wachtell 0.3% of the value recovered as a success fee seems pretty reasonable.”[9]  Musk, however, does not share this opinion, as illustrated by the complaint filed by X Corp., Twitter’s successor-in-interest, against Wachtell on July 5, 2023.[10]

X Corp. alleges that Twitter engaged Wachtell’s representation on a strictly hourly fee arrangement and that at the last minute before the deal closed, Wachtell acted improperly by seeking and receiving the final legal fee approved by Twitter’s board of directors.[11]  X Corp. seeks equitable relief from Wachtell for the claims of restitution, breaches of fiduciary duty, and charging an unconscionable fee in violation of state laws.[12]  X Corp. faces an uphill legal battle against Wachtell which it should ultimately lose.

         I. X Corp. v. Wachtell should be arbitrated.

The initial challenge for X Corp. is that this lawsuit is likely headed for arbitration, where Twitter and Wachtell already agreed that it should go.  Wachtell responded to X Corp.’s complaint by filing a Motion to Compel Arbitration and a supporting memorandum on September 8, 2023.[13]  Wachtell’s memorandum contends that by filing this lawsuit, Musk and X Corp. breached the Arbitration Clause of Twitter’s Master Retention Agreement with Wachtell.[14]  X Corp.’s own complaint affirms that the Master Retention Agreement is a binding contract,[15] so Wachtell reasons that neither its validity nor enforceability are contested.[16]  Instead, Wachtell speculates that X Corp.’s claims for relief are styled as equitable or injunctive to exempt them from the Arbitration Clause.[17]

Wachtell has two strong arguments for compelling arbitration.  First, when the scope of arbitration is disputed, the parties contracted to have the arbitrator decide this threshold issue by both express delegation and incorporated JAMS[18] rules.[19]  Second, X Corp.’s claims seeking restitution of Wachtell’s fee are not automatically considered equitable if there is an adequate remedy at law.[20]  Despite X Corp.’s characterization as restitution in equity, Wachtell solidly argues X Corp. is actually claiming for restitution at law because it seeks money damages: repayment of Wachtell’s purportedly excessive fee.[21]  For these reasons, the judge should stay this proceeding pending arbitration that will resolve the scope issues and potentially the entire case.

         II. Wachtell’s fee was reasonable.

X Corp.’s case against Wachtell is also weak because Wachtell’s legal fee was fair and reasonable.  X Corp. advances that the Master Retention Agreement executed by Wachtell on June 21, 2022, and by Twitter on July 28, 2022, dictated only paying Wachtell by the billable hour, lacked a provision for a potential success fee, and contained a merger clause superseding all prior agreements.[22]  Twitter’s former head of litigation, Karen Colangelo, sent an email prior to the execution of the Master Retention Agreement mentioning a potential success fee, and X Corp. has a valid point that this provision did not make it into the executed Master Retention Agreement.[23]  However, the Master Retention Agreement was not the final understanding of the parties prior to the deal closing.

Wachtell handled the merger litigation under the hourly Master Retention Agreement and billed Twitter for a total of $17,943,567.49 between August and September 2022, and Wachtell estimated an additional accrual of $11 million in October, 2022.[24]  In the complaint, X Corp. posits that Wachtell’s $90 million legal fee is unconscionable because it is well beyond the total amount of Wachtell’s hourly invoices.[25]  Wachtell’s memorandum addresses this allegation by stating its lawyers invested over $40 million into the case in time and expenses, which decreases the gap between the total hourly fees and final legal fee.[26]  Furthermore, Wachtell references multiple news outlets reporting that the $90 million fee was a tiny fraction of the total $44 billion transaction volume, and that Twitter got “its money’s worth” and a “fantastic deal” given that the deal would have collapsed without forcing Musk to comply with the merger agreement.[27]

X Corp. alleges that although Wachtell’s litigation work had successfully concluded, Wachtell pressured Twitter in the two weeks preceding the closing to amend the Master Retention Agreement to pay a success fee.[28]  X Corp. laments that the final legal fee paid to Wachtell “provided no value to Twitter or its shareholders” and “amounted to a huge cash gift.”[29]  X Corp.’s proffered gift violations, under Cal. Rule of Pro. Conduct 1.8.3 and N.Y. Rule of Pro. Conduct 1.8(c), fail to see the value of Wachtell’s hard work.

While X Corp. feels Wachtell and Twitter’s former officers and directors acted improperly, Twitter chose to recognize the $44 billion value Wachtell provided to the company’s shareholders.  In fact, Colangelo’s email[30] indicates Twitter and Wachtell may have had an understanding of the success fee all along, weakening X Corp.’s claim that the success fee was hurriedly paid by Twitter’s board of directors lacking factual information and authority for the decision.

         III. Twitter’s board of directors had authority to pay Wachtell.

Twitter’s board of directors acted independently in good faith to compensate Wachtell for high-quality legal services, a far cry from unlawful business practices under Cal. Bus & Prof. Code § 17200.  Although Cal. Bus & Prof. Code § 6147 gives requirements for contingent fees, as X Corp. repeatedly points out, the details of the success fee were agreed upon after the deal had already become a success; this rendered the fee no longer contingent on anything.  Under Cal. Rule of Pro. Conduct 1.5, Twitter gave informed consent to the fee, and considering the labor required under the time limitations and the results obtained, Wachtell’s fee was fair.  Despite X Corp.’s interpretation that Section 6.1(e) of the merger agreement[31] limited Twitter’s discretion to increase Wachtell’s fee prior to closing,[32] Twitter agreed to pay Wachtell’s legal fee in the ordinary course of business considering Twitter had never faced this extraordinary merger litigation in the past.

Investment banks regularly receive success fees on large transactions,[33] but Wachtell’s fee is not covered by Section 4.21 of the merger agreement[34] limiting investment banking and similar fees because it is a fee for legal rather than brokerage services.  On October 20, 2022, Wachtell disclosed to Twitter similar legal fee arrangements from mergers or acquisitions in the past three years where Wachtell had received fees ranging from 67% to 100% of the investment banking fees on those deals.[35]  Wachtell was transparent about these past arrangements, and Twitter’s board of directors felt comfortable following a similar compensation route.  Just before the closing, Wachtell and Twitter effectively amended their fee arrangement and memorialized their final contract in the Closing Day Letter Agreement approved by Twitter’s independently advised board of directors at the last board meeting.[36]

X Corp. pleads that Twitter’s board of directors were lame ducks when they approved Wachtell’s fee,[37] yet when Twitter authorized the wire to Wachtell at 12:07 p.m. on the closing date, and when the wire processed and posted at 3:50 p.m., 10 minutes before the deal closed,[38] Twitter was still under the full control of its board of directors who had every right to pay Wachtell’s legal fee.[39]  Twitter knew what it was doing: paying a legal fee that it is doubtful Musk ever would have honored considering that under his leadership, X Corp. has followed a consistent pattern of refusing to pay Twitter’s former employees, landlords, and vendors.[40]  Contrary to Musk’s belief, honoring to pay a legal vendor for services rendered does not amount to a breach of fiduciary duty.

Twitter’s board of directors acted with authority in paying Wachtell’s legal fee.  Clients and attorneys regularly agree to fee arrangements.  If the amount of work performed exceeds a previously agreed upon fee, the parties are free to amend the final fee to accurately reflect the value of the services.  Here, Twitter paid Wachtell according to its reasonable appraisal of Wachtell’s legal services, and the court should not question Twitter’s judgment.

 

 

[1] See Isaac Hopkin, How Twitter’s Whistleblower Helps Musk, Wake Forest L. Rev. Current Issues Blog (Oct. 5, 2022), https://www.wakeforestlawreview.com/2022/10/how-twitters-whistleblower-helps-musk%ef%bf%bc/.

[2] Press Release, Twitter, Inc., Elon Musk to Acquire Twitter (Apr. 25, 2022).

[3] See Verified Complaint at 5, Twitter, Inc. v. Musk, C.A. No. 2022-0613-KSJM (Del. Ch. Jul. 12, 2022).

[4] See id.

[5] See Memorandum of Points and Authorities in Support of Defendant Wachtell, Lipton, Rosen & Katz’s Motion to Compel Arbitration and for a Stay of Proceedings Pending Disposition of this Motion and Arbitration at 6, X Corp. v. Wachtell, Case No. CGC-23-607461 (Cal. Super. Ct. Sept. 9, 2023) [hereinafter Wachtell’s Memorandum].

[6] See id. at 8.

[7] See id.

[8] See Complaint for (1) Restitution (Unjust Enrichment) (2) Breach of Fiduciary Duty (3) Aiding and Abetting Breach of Fiduciary Duty (4) Violation of Cal. Bus. & Prof. Code § 17200 at 1, X Corp. v. Wachtell, Case No. CGC-23-607461 (Cal. Super. Ct. Jul. 5, 2023) [hereinafter Complaint].

[9] Wachtell’s Memorandum, supra note 5, at 9 (quoting Matt Levine, Elon Musk Blames the Lawyers, Bloomberg (Jul. 11, 2023), https://www.bloomberg.com/opinion/articles/2023-07-11/matt-levine-s-money-stuff-elon-musk-blames-the-lawyers#xj4y7vzkg).

[10] See Complaint, supra note 8, at 1–2.

[11] See id.

[12] See id. at 24–31.

[13] See Wachtell’s Memorandum, supra note 5, at 5.

[14] See id. at 9.

[15] See Complaint, supra note 8, at 2.

[16] See Wachtell’s Memorandum, supra note 5, at 10.

[17] See id.

[18] See, e.g., The JAMS Name, JAMS, https://www.jamsadr.com/about-the-jams-name/ (last visited Oct. 3, 2023) (stating that JAMS is a leading provider of alternative dispute resolution services, and the name JAMS was previously an acronym for Judicial Arbitration and Mediation Services, Inc.).

[19] See Wachtell’s Memorandum, supra note 5, at 13.

[20] See id. at 17 (citing Martin v. Cnty. of Los Angeles, 51 Cal. App. 4th 688, 695–98 (1996)).

[21] See id. (citing Jogani v. Super. Ct. 165 Cal. App. 4th 901, 910 (2008); Lectrodryer v. Seoulbank 77 Cal. App. 4th 723, 728 (2000)).

[22] See Complaint, supra note 8, at 8–9.

[23] See id.

[24] See id. at 9–10.

[25] See id. at 1–2.

[26] See Wachtell’s Memorandum, supra note 5, at 8.

[27] Id.

[28] See Complaint, supra note 8, at 26–27.

[29] Id. at 27.

[30] See id. at 8.

[31] See Twitter, Inc., Annual Report (Form 8-K) Ex. 2.1 (Apr. 25, 2022).

[32] See Complaint, supra note 8, at 6.

[33] See Success Fee, Corporate Finance Institute, https://corporatefinanceinstitute.com/resources/valuation/success-fee/ (last visited Oct. 3, 2023).

[34] See Annual Report (Form 8-K) Ex. 2.1, supra note 31.

[35] See Complaint, supra note 8, at Ex. 7.

[36] See Wachtell’s Memorandum, supra note 5, at 8–9.

[37] See Complaint, supra note 8, at 4.

[38] See id. at 19.

[39] See Wachtell’s Memorandum, supra note 5, at 8–9.

[40] See id. at 9; see also Jennifer Kay, Musk’s Twitter, Tesla Fights Ramp Up in Delaware: Explained, Bloomberg Law (Sept. 27, 2023), https://news.bloomberglaw.com/litigation/musks-twitter-tesla-fights-ramp-up-in-delaware-explained.

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27Feb

Weekly Roundup – 2/26 – 3/2

Categories: 4th Cir. Blog Weekly Roundup
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Weekly Roundup: 2/26-3/2

By: Cara Katrinak & Raquel Macgregor

Carlton & Harris Chiropractic, Inc. v. PDR Network, LLC

In this civil case, Carlton & Harris Chiropractic appealed the district court’s dismissal of its claim against PDR Network for violating the Telephone Consumer Protection Act (TCPA) by sending an unsolicited advertisement via fax. Carlton & Harris argued that the district court erred by failing to defer to a 2006 rule promulgated by the Federal Communications Commission (FCC) interpreting provisions of the TCPA–specifically, interpreting the term “unsolicited advertisement.” Carlton & Harris further argued that the Hobbs Act required the district court to defer to the FCC’s rule. The Fourth Circuit vacated and remanded the case, holding both that the Hobbs Act deprived the district court of jurisdiction to consider the validity of the FCC rule and the district court’s reading of the FCC rule conflicted with the plain meaning of the rule’s text.  

Singer v. Reali

This appeal and cross-appeal arose from the district court’s dismissal of a securities fraud class action complaint related to the healthcare provider reimbursement practices of defendant TranS1 and four of its officers in connection with TranS1’s AxiaLIF system (the “System”). Named plaintiff Phillip J. Singer alleged that TranS1 and its officers, through the System, enabled surgeons to secure fraudulent reimbursements from health insurers and government-funded healthcare programs. Singer initiated this class action against TranS1 and its officers pursuant to Section 10(b) of the Securities Exchange Act, claiming that TranS1 and its officers concealed the fraudulent reimbursement scheme from the market through false and misleading statements and omissions and that TranS1’s stock price plummeted when the scheme was revealed.

Here, Singer appealed (No. 15-2579) the district court’s dismissal of his complaint for failure to sufficiently plead the material misrepresentation element or the scienter element of his Section 10(b) claim. TranS1 and its officers cross-appealed (No. 16-1019), contending that the district court erred in dismissing their challenge to the loss causation element of Singer’s claim. In reviewing the complaint, the Fourth Circuit held that Singer sufficiently pleaded the misrepresentation and scienter elements because the complaint specified statements made by TranS1 and its officers about its reimbursement practices that support Singer’s claim. In addition, the Court held that Singer also sufficiently pleaded the loss causation element because the complaint alleged losses resulting from “the relevant truth . . . leak[ing] out” about TranS1’s previously concealed fraudulent reimbursement scheme. Accordingly, the Fourth Circuit vacated and remanded No. 15-2579 and affirmed No. 16-1019.

Norfolk Southern Railway Co. v. Sprint Communications Co. L.P.

In this civil case, Sprint Communications appealed the district court’s order granting Norfolk Southern Railway’s motion to confirm an arbitration award. The arbitration arose from a disputed license agreement between the parties. The agreement granted use of Norfolk Southern’s railroad rights of way for Sprint’s fiber optic telecommunications system. The parties disagreed over the amount Sprint owed Norfolk Southern for such continued use and, pursuant to their agreement, hired three appraisers to determine an appropriate amount. On appeal, the parties disputed whether the final decision of the appraisers constituted a “final” arbitration award under the Federal Arbitration Act (FAA). Because the text of the appraisers’ final decision reserved the right to withdraw assent in the future, the award could not be considered “final.” Accordingly, the Fourth Circuit reversed and remanded the case, holding that the arbitration award was not “mutual, final, and definite” as required by the FAA.        

U.S. v. Phillips

In this civil case, claimant Damian Phillips appealed the district court’s holding that he lacked standing to intervene in his brother Byron Phillips’ forfeiture case. Damian sought to intervene after the United States claimed that $200,000 in cash found in a storage unit leased by Byron was subject to forfeiture under 21 U.S.C. § 881(a)(6) for being connected to the “exchange [of] a controlled substance.” Damian claimed that the cash was his life savings and, therefore, was not connected with drugs in violation of the statute. The Fourth Circuit affirmed the district court, holding that–based on the record–Damian lacked the necessary colorable interest in the $200,000 to establish standing.     

Janvey v. Romero

The Fourth Circuit affirmed the District Court of Maryland’s decision denying a motion to dismiss a bankruptcy petition. Appellee, Romero, had originally filed a Chapter 7 bankruptcy petition after he was found liable for a $1.275 million Ponzi scheme. The receiver, Janvey, moved to dismiss the bankruptcy petition due to bad faith under 11 U.S.C. §707(a). The Fourth Circuit was tasked with assessing whether the district court abused its discretion in deciding that Romero’s decision to file bankruptcy had not risen to the level of “bad faith.” The Fourth Circuit emphasized that the purpose of the Bankruptcy Code is to “grant a fresh start to the honest but unfortunate debtor,” and dismissing a bankruptcy petition for cause under bad faith is only warranted “in those egregious cases that entail concealed or misrepresented assets . . . excessive and continued expenditures, [and] lavish life-style.” The Court rejected Appellant’s arguments that filing bankruptcy in response to a single debt or the debtor’s ability to pay the debt constitute bad faith per se. The Court noted that although Romero had $5.348 million in assets, most of these assets were statutorily exempt. Moreover, Romero was supporting his wife’s medical costs, which averaged $12,000 a month for a bacterial brain infection that had left her incapacitated. The Court noted that Romero filed for bankruptcy in part for legitimate reasons, such as the inability to pay his wife’s medical expenses, and Romero was unable to find work after the Ponzi scheme was made public. Thus, the Court found that the district court had not abused its discretion in finding that Romero’s bankruptcy petition had not risen to the level of bad faith.

Hickerson v. Yamaha Motor Corp.

In this case, the Fourth Circuit affirmed the District Court of South Carolina’s decision to exclude the Plaintiff’s expert testimony and enter summary judgment for the Defendant. The Plaintiff had filed suit against Yamaha for a WaveRunner’s (jet ski) inadequate warnings and defective design that resulted in serious internal injuries during a watercraft accident. The WaveRunner itself contained several warnings to wear a swimsuit bottom and to only have three passengers riding the craft at a time. When the accident occurred, a ten-year-old was driving, the Plaintiff was only wearing a bikini bottom, and she was the fourth passenger. The district court excluded the Plaintiff’s expert testimony regarding potential warnings because the expert’s proposals were scientifically untested and thus were unreliable under the Daubert standard. The Fourth Circuit offered little independent analysis regarding the expert testimony exclusion, but the Court agreed with the district court’s reasoning under the abuse of discretion standard of review. Moreover, regarding Plaintiff’s defective design claims, the Court noted that in South Carolina, design defects can be “cured” by adequate product warnings. The Court found that the warnings were adequate as a matter of law, and thus the district court did not err in granting summary judgment on the Plaintiff’s design defect claims.

Elliott v. American States Insurance Co.

This appeal arose from Plaintiff Elliott’s claim against her automobile insurer. In 2013, Elliott was in an automobile accident that left her with serious bodily injuries. As Plaintiff’s insurance coverage through the Defendant was capped at $100,000 and Plaintiff claimed more than $200,000 in damages, her recovery was insufficient to cover her expenses. The Plaintiff then initiated an action to recover damages first against Jones, the other driver in the accident, and then against her insurer. The District Court for the Middle District of North Carolina ultimately denied Plaintiff’s motion to remand the case back to the Superior Court (where she originally filed the case) and granted Defendant’s 12(b)(6) motion for failure to state a claim. On appeal to the Fourth Circuit, the Plaintiff had three claims: (1) that the Defendant’s filing for removal to the district court was untimely, (2) that the district court erred in determining parties were diverse, and thus subject matter jurisdiction did not exist in federal court; and (3) the district court erred in granting Defendant’s motion to dismiss for failure to state a claim. On the Plaintiff’s first claim, the Court concluded that the original service of process was made on a “statutory agent,” not an agent appointed by the defendant. Thus, the thirty-day time period to file the notice of removal did not start until the Defendant actually received a copy of the complaint, not when the service of process was actually delivered. Consequently, the Defendant filed its notice of removal within the allotted time period. As to the second claim, the Court held that the “direct action” variation on diversity jurisdiction from § 1332(c)(1) does not include an insured’s suit against his or her own insurer for breach of the insurance policy terms; thus the parties were diverse. Lastly, the Court rejected the Plaintiff’s claims regarding the Defendant’s motion to dismiss on multiple grounds, including that the Defendant had no obligation to settle the Elliot’s claims until after a judgment was settled against the other motorist, Jones.

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30Nov

Fourth Circuit Refuses to Challenge Arbitration Award

Categories: 4th Cir. Blog Civil Cases
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By Ali Fenno

On November 22, 2016, the Fourth Circuit issued a published opinion in the civil case of UBS Financial Services, Inc. v. Padussis. In UBS Financial, the Fourth Circuit addressed whether an arbitration award of over $900,000 to Gary Padussis (“Padussis”) could be vacated or modified in light of Padussis’s insolvency and UBS Financial Services’ (“UBSFS”) lack of participation in the selection of the arbitrators. In affirming the district court, the Fourth Circuit held that there was no basis for overturning the arbitrators’ award and that UBSFS’s motion should be dismissed in its entirety.

Facts of the Case and Procedural History

Padussis began working for UBSFS in 2009, bringing with him a team of financial advisors and an established list of clients. As part of his initial compensation, UBSFS granted Padussis a $2.7 million loan, for which he signed a promissory note that provided the balance of the loan would become fully due in the event he ended his employment with UBSFS. Also executed by Padussis was a Letter of Understanding describing his compensation and a Financial Advisor Team Agreement that governed the operations of his team. Each agreement entered into by the parties provided that any dispute would be subject to arbitration before the Financial Industry Regulatory Authority (“FINRA”).

Two years later, Padussis resigned from UBSFS on the grounds that it had ruined his team of financial advisors and cost him valuable clients. When he did not pay the $1.6 million remaining balance on the promissory note, USBS initiated arbitration proceedings.  Padussis responded with counterclaims alleging that UBSFS’s interference with his team of financial advisors and clients amounted to tortious conduct and a breach of contractual duties.

Pursuant to the FINRA Code of Arbitration Procedure for Industry Disputes (the “FINRA Code”), the Director of FINRA Dispute Resolution (the “Director”) mailed a list of potential arbitrators to Padussis and USBFS on August 21, 2013. Each party was then supposed to indicate their preferences by striking four arbitrators from the list and ranking the remaining ones. The lists were to be returned to the Director within 20 days of their being sent so he could then select a three-person arbitration panel based on those rankings. Padussis returned his list of preferences within the proscribed time, but USBFS did not, allegedly because it never received the list from the Director.

On September 11, UBSFS received a letter, dated September 3, reminding the parties to return their list of preferences by the September 10 deadline. It then filed a motion to extend the deadline. Padussis opposed the motion, claiming that UBSFS had notified him in mid-August that it was transferring to new counsel and that the list of preferences had not yet been sent. Padussis argued that this transfer of counsel caused confusion over who was sending the list and was the reason the list was never sent.

Although FINRA Rule 13207(c) allows a Director to extend the Code’s deadlines for good cause, FINRA’s Regional Director, acting for the Director as consistent with FINRA Rule 13100(k), denied UBSFS’s motion. The Director affirmed the denial, finding that UBSFS did not have good cause to extend the deadline because the list of arbitrators and a courtesy reminder of the deadline were both timely mailed, and FINRA did not receive any mail returned as undeliverable. Accordingly, FINRA proceeded with the arbitration process and selected a three-person panel of arbitrators based off of Padussis’s list of preferences.

UBSFS challenged the composition of the panel based on his lack of participation in the selection of the arbitrators, but his challenge was denied. Then, on October 27, 2014, the panel issued its final decision, awarding UBSFS $1,683,262 for the balance on the promissory note and Padussis $932,887 for damages UBSFS caused to his business.

However, faced with a statutory lien and the prospect of bankruptcy, Padussis admitted that he could not pay the full $932,887, leaving UBSFS in a position of owing Padussis over $900,000. UBSFS subsequently filed the present action to vacate the award on the grounds that UBSFS did not participate in the arbitrator selection process. It argued in the alternative that the award should be offset because of Padussis’s admission of being unable to pay the award owed to UBSFS.

The district court declined to vacate the arbitration award and to impose an offset, and UBSFS appealed.

Narrow Standard of Review

The Fourth Circuit first established the extremely narrow scope of judicial review of an arbitration award. It noted that an arbitration award should only be modified if it is one of the limited circumstances listed in the Federal Arbitration Act, or if under common law, it “fails to draw its essence from the contract” or “evidence a manifest disregard of the law.” The court emphasized that in reviewing an arbitration award, whether an arbitrator did their job “well, or correctly, or reasonably,” is not the concern. Instead, courts should ask whether the arbitrators exceeded their powers because they did not meet certain thresholds of arbitrability such as not being appointed according to the parties’ agreement. Deference should be given to arbitrators on questions outside those thresholds that regard the merits of the case or procedural questions.

The court found support for this narrow scope in public policies that focus on using arbitration as a tool to avoid the costs and delays of litigation. It noted that parties entering into agreements to arbitration do so in the hope of avoiding “a protracted set of legal proceedings.” Narrowing the judicial review of arbitration awards furthers this intent.

Rightful Appointment of Arbitrators

The Fourth Circuit next addressed UBSFS’s claim that the arbitrators were not selected according to the parties’ agreement. It first confirmed that, pursuant to Section 5 of the Federal Arbitration Act, arbitration awards will be vacated where the arbitrators’ appointment violates the parties’ contract. It then noted that here, UBSFS and Padussis agreed that all disputes would be subject to arbitration before FINRA and thus subject to the FINRA Code.

However, the Fourth Circuit rejected UBSFS’s claim that the rules for selecting arbitrators were not followed. The court listed every step FINRA and the Director took in selecting the panel and noted that not a single requirement was skipped. And even though UBSFS did not get to participate in the selection of the arbitrators, the court found that this outcome was explicitly allowed in FINRA Rule 13404(d), which requires a Director to appoint arbitrators without a party’s input when the list of arbitrators is not returned.

Because FINRA clearly followed the FINRA Code’s rules for selecting arbitrators, the Court decided that the issue raised by UBSFS was instead whether FINRA properly applied the rules when it found that UBSFS did not have good cause to extend the deadline for submitting its list of preferences. But the Fourth Circuit concluded that this constituted a procedural question, and relying on the Supreme Court’s decision in Howsam v. Dean Witter Reynolds, Inc., affirmed that such a “procedural question[] which grow[s] out of the dispute and bear[s] on its final disposition [is] presumptively not for the judge, but for the arbitrator, to decide.” The court also noted that the power to determine whether good cause existed was explicitly given to FINRA in FINRA Rule 13412. Furthermore, the court reasoned that arbitrators would be more expert about the issue because it concerned, as stated in Dockser v. Schwartzberg, “the written rules governing the parties’ proceeding.” Accordingly, the Court refused to question FINRA’s decision that there was not good cause for extending the deadline for returning the list of preferences.

Refusal to Reduce the Award

The court next addressed UBSFS’s request for the arbitral award to be offset based on Padussis’s admission of being unable to pay his portion of the award. The court first noted that complying with UBSFS’s request would result in a net profit for UBSFS and thus eliminate any damages he might owe to Padussis. It also found that the offset would constitute a modification of the arbitration award because the agreement explicitly denied “any and all relief not specifically addressed” in the arbitrators’ final decision, which never mentioned the possibility of an offset.

Pursuant to the Federal Arbitration Act, a court may modify an award if it will effectuate the intent of the arbitrators. Here, the court concluded that this modification would not effectuate the intent of the arbitrators because the award never mentioned an offset and there is no other evidence in the record suggesting such an intention. UBSFS contended that the offset of the award would reflect the intent of the arbitrators because it would provide a “simple, fair result” without changing the arbitrators’ valuation decision. But the court rejected this claim, reasoning that UBSFS should have determined the arbitrators’ intent by asking for an offset during the arbitration proceedings. Accordingly, because evidence in the record and the arbitration award did not indicate that the intent of the arbitrators would be effectuated by an offset, the Fourth Circuit chose to not impose an offset on these grounds.

UBSFS last claimed that the offset should be imposed regardless of the arbitrators’ actual intent and that the court should recognize a presumption favoring an offset. The court disagreed, reasoning that such an action would put a “judicial gloss” on the arbitration award. A judicial gloss on this award would be impermissible because the award explicitly limited itself to the relief specifically rendered in the arbitrators’ final decision.

Accordingly, because the intent of the arbitrators would not be effectuated by the offset, and because a presumption of an offset would directly conflict with the arbitrator’s final decision, the court held that granting an offset in this case would be inappropriate.

Conclusion

The Fourth Circuit concluded that UBSFS simply did not want to abide by a result it did not like. Because UBSFS had agreed to arbitration, the dispute was within the scope of that agreement, and the rules for arbitration were selected in the agreement and then followed, the court could find no reason to vacate or modify the award. Accordingly, it affirmed the district court’s decision to deny UBSFS’s motion in its entirety.

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28Mar

Parties Fail to Construct Arbitration Agreement Properly, Fourth Circuit Steps In

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construction

By Taylor Anderson

On March 28, 2016, the Fourth Circuit issued its published opinion regarding the civil case Del Webb Communities, Inc. v. Carlson. Appellant PulteGroup, Inc. and its subsidiary Del Webb Communities, Inc. (together, “Pulte”) appealed the district court’s denial of its partial summary judgment motion and dismissal of its Petition compelling bilateral arbitration. On appeal, Pulte contends that the district court erred in concluding that whether an arbitration clause permits class arbitration is a procedural question for the arbitrator to decide. Instead, Pulte argued that this question is one of arbitrability; therefore, the court is to determine the answer to that question. For the reasons that follow, the Fourth Circuit reversed, vacated, and remanded the district court’s conclusions.

Sales Agreement for Hilton Head, South Carolina House

Respondents Roger and Mary Jo Carlson (together, “Carlsons”) signed a sales agreement with Pulte for the purchase of a lot and construction of a home in Hilton Head, South Carolina. The agreement contained an arbitration clause which stated, “Any controversy or claim arising out of or relating to this Agreement or Your purchase of the Property shall be finally settled by arbitration . . . . Any party to this Agreement may bring action . . . to compel arbitration . . . .”

After they noticed several construction defects in their new home, the Carlsons brought suit against Pulte. The Carlsons later amended their complaint to add class-action allegations because their lawsuit was one of approximately 140 like cases pending against Pulte. The Carlsons contended that the question of class-arbitration was a procedural question and therefore the arbitrator would decide whether class arbitration was appropriate and contemplated under the sales agreement. Pulte filed a petition in federal court arguing that whether the sales agreement authorized class arbitration was a question of arbitrability for the court to determine—not a procedural question for the arbitrator. Later, Pulte filed a motion for partial summary judgment, which was the subject of the appeal, as to whether class arbitration was appropriate was a question for the arbitrator or the court to decide.

The federal district court dismissed Pulte’s Petition and denied Pulte’s motion for partial summary judgment. The district court reasoned that whether the arbitration clause permits class arbitration is a simple contract interpretation issue. Since the question “concerns the procedural arbitration mechanisms available to the Carlsons,” the threshold inquiry is a question for the arbitrator rather than for the court. This appeal followed.

Initial Subject Matter Jurisdiction Issue

As an initial matter, the Fourth Circuit addressed the Carlsons’ contention that the district court never had subject matter jurisdiction over Pulte’s Petition and partial motion for summary judgment. Although the Carlsons asserted several arguments as to why the district court did not have subject matter jurisdiction, the Fourth Circuit easily found subject matter jurisdiction based on diversity because both the amount-in-controversy and the complete diversity requirements were met in this case. The Carlsons’ claim was $75,000 plus treble damages and attorneys’ fees, which satisfied the “statutory floor.” Additionally, the Carlsons are South Carolina citizens and the Pulte parties are Michigan and Arizona citizens, making the parties completely diverse.

Class Arbitration Question is One of “Arbitrability”

The Fourth Circuit started out by stating its holding: the question of whether an arbitration clause permits class arbitration is a gateway question of arbitrability for the court to decide. First, the Fourth Circuit cited United States Supreme Court precedent stating that in determining the contractual nature of arbitration agreements, the court should be careful to avoid forcing parties to resolve their disputes through means not intended at the time of contract formation.

Next, the Fourth Circuit defined a “procedural” question in the context of arbitration. Procedural questions arise once the obligation to arbitrate a matter is established, and may include such issues as the application of statutes of limitations, notice requirements, laches, and estoppel. The Fourth Circuit, backed by Supreme Court precedent, explained that these are questions for the arbitrator because the questions do not present any legal challenge to the arbitrator’s underlying power and the parties would likely expect that an arbitrator would decide procedural questions.

Questions of arbitrability, on the other hand, are completely different. The Fourth Circuit stated that “[w]hen the answer to a question ‘determine[s] whether the underlying controversy will proceed to arbitration on the merits,’ that question necessarily falls within the ‘narrow circumstance[s]’ of arbitrable issues for the court to decide.” In this case, the question of whether class arbitration was allowed under the agreement went directly to whether the arbitrator was granted the power to hear class arbitration. That is, whether the agreement indicated that the controversy can proceed to arbitration at all. Because the parties were not explicit in the agreement that the arbitrator would decide whether their agreement authorizes class arbitration, a court is to decide whether class arbitration is allowed under the agreement. For this reason, the Fourth Circuit held that the district court erred in concluding that the question was a procedural one for the arbitrator.

Judgment Reversed, Vacated, and Remanded

The Fourth Circuit held that the parties did not unmistakably provide that the arbitrator had the power to decide whether their agreement authorizes class arbitration, and for that reason, the district court erred in concluding that the question was a procedural one for the arbitrator. Therefore, the Fourth Circuit reversed the district court’s order denying Pulte’s motion for partial summary judgment, vacated the judgment dismissing the Petition, and remanded the case for further proceedings.

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13Mar

Fourth Circuit Holds That Arbitrators Have Opportunity to Resolve Liability and Damage Disputes Before Moving to Federal Court

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mining

By Daniel Stratton

On March 8, 2016, the  Fourth Circuit issued a published opinion in the civil case Peabody Holding Company, LLC v. United Mine Workers of America, vacating the district court’s decision. The Fourth Circuit held that under the complete arbitration rule, an arbitrator handling a labor dispute between Peabody Holding and United Mine Workers of America should have been allowed to finish resolving both the liability and remedial phases of the dispute before the matter was moved to federal court.

United Mine Workers and Peabody Coal Company Enter into Job Opportunity Agreement

In 2007, the United Mine Workers of America and Peabody Coal company entered into a Memorandum of Understanding Regarding  Job Opportunities (“Jobs MOU”). Peabody Coal signed the agreement on behalf of itself and its parent company, Peabody Holding. The purpose of the Jobs MOU was to require non-unionized companies within the Peabody corporation to give preference to coal miners who either worked for or were laid off by Peabody Coal with regards to hiring treatment. The Jobs MOU included an arbitration clause that required all disputes involving the MOU to be submitted to an arbitrator, whose decisions would be final and binding.

That same year, Peabody Energy Corp., the ultimate corporate parent of Peabody Holding,  Peabody Coal, and another company, Black Beauty Coal Company, began a process to spinoff part of its mining operation into a new entity known as Patriot Coal Corporation. Peabody Coal was spun off into Patriot. All of the Peabody subsidiaries that became part of Patriot had been signatories to the Jobs MOU. The only subsidiary that had been a signer to the Jobs MOU that was not spun off into Patriot was Black Beauty. At the completion of the spinoff, Peabody Coal had no corporate relationship with Peabody Holding or Black Beauty.

In 2008, Black Beauty hired United Minerals Company to assist with mining operations on Black Beauty’s property. Both United Minerals Company and Black Beauty were non-unionized. Shortly after United Minerals Company began working with Black Beauty, the United Mine Workers of America sent a letter to Peabody Energy and Peabody Holding explaining that Peabody Holding and Black beauty were still bound by the Jobs MOU. Peabody disagreed, arguing that after Peabody Coal had been spun off, the rest of the Peabody corporate family no longer had any obligation under the Jobs MOU.

Peabody initially argued that this dispute with United Mine Workers was not arbitrable, an argument that the Fourth Circuit rejected in 2012. After being sent back to arbitration, the union and Peabody agreed to bifurcate the dispute into separate liability and remedy phases. The arbitrator ruled that the Jobs MOU remained in effect despite the fact that Peabody Coal had no corporate relationship with Peabody Holding. The arbitrator declined to rule on whether or not Black Beauty was actually exempt from the Jobs MOU, deferring its decision on that question until the remedy stage.

Peabody and United Mine Workers Take Their Dispute to the Courts

Peabody sought to vacate the arbitrator’s decision, filing an declaratory judgment action in the U.S. District Court for the Eastern District of Virginia. At the same time, the United Mine Workers filed a counterclaim to enforce the decision by the arbitrator.  Under Section 301 of the Labor Management Relations Act (“LMRA”), some courts viewed their jurisdiction as being limited to “review of final arbitration awards,” while others believed that Section 301 provided “sweeping jurisdiction.” The district court ultimately declined to weigh in on that debate, instead noting that because the liability portion of the arbitration was finished, it was final and therefore reviewable. The district court found in favor of the union, holding that the arbitrator was right to find the Jobs MOU still valid. Peabody and its subsidiaries appealed the district court’s decision. After the parties briefed the appeal, the Fourth Circuit asked for additional briefing on whether the arbitrator’s decision was even properly before the circuit, because the arbitration was not yet complete.

The Limits and Scope of the Complete Arbitration Rule

Under Section 301 of LMRA, federal district courts have jurisdiction over suits involving contract violations between employers and unions. The Supreme Court has long held that Section 301 can be used to seek enforcement of an arbitration award made under a collective bargaining agreement’s arbitration clause. As a threshold matter however, a court must determine that the award is final and binding. Many courts have held this to mean that an arbitrator must have ruled on both liability and remedies before the decision can be reviewable.

Some judicial decision viewed the complete arbitration rule as a restriction on federal jurisdiction. Other decisions had focused on Section 301’s broad language, and have viewed the complete arbitration rule to be “only a prudential limitation on judicial involvement” in an arbitrated labor dispute.

The Fourth Circuit Finds that the Arbitration Decision was sent to the Courts Too Soon

The Fourth Circuit noted that several courts which view the complete arbitration rule in jurisdictional terms still concede that there are exceptions to the rule in extreme cases. Based on this, the Fourth Circuit noted that this necessarily meant that the complete arbitration rule only constituted a prudential limitation. The Court also noted many policy rationales for the complete arbitration rule were the same as those used for strictly jurisdictional relatives. Like the rules that require a district court to enter a final judgment or order before an appellate court can review the case, the complete arbitration rule promotes the same goals of preventing “piecemeal litigation and repeated appeals.” Applying the complete arbitration rule also helps prevent a party from using courts to delay the arbitration, the Fourth Circuit noted.

In terms of actually applying the complete arbitration rule, the Fourth Circuit noted that the application was straightforward. Generally, when an arbitrator decides liability and “reserves jurisdiction to decide remedial questions” later, a federal court should wait to review until all questions have been resolved.  The Court was unpersuaded by Peabody’s arguments that the liability phase was final and thus reviewable. The Fourth Circuit noted that such a division was sensible and common. Just because the parties decided to split their dispute did not change the fact that they agreed to submit the entire dispute to the arbitrator.

The Fourth Circuit also quickly dismissed Peabody’s arguments that reviewing the liability portion now would promote efficiency. Such efficiency arguments could potentially be applied to virtually any case, the court noted, before explaining that by waiting until after the remedy portion was resolved the court was actually promoting efficiency. This was because the parties could still reach a settlement at some point, making a review of the liability portion moot. The Fourth Circuit concluded by explaining that arbitration is a matter of contract, and as such the parties should be able to design an arbitral process that best suits the needs of the parties.

The Fourth Circuit Remands the Case Back to the Arbitrator

The Fourth Circuit ultimately held that the arbitrator’s decision had been prematurely sent to the courts, and remanded the case back to the district court to remand the case back to the arbitrator to continue the arbitration.

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17Nov

Fourth Circuit Vacates Maryland District Court’s Decision, Compels Arbitration in Franchise Dispute

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By Anthony Biraglia

In the civil case of Chorley Enterprises v. Dickey’s Barbecue Restaurants, Inc., the Fourth Circuit vacated a Maryland district court’s decision to hold a jury trial on a purportedly ambiguous contract provision, rather than compel arbitration, in a franchise dispute between two sets of plaintiffs and Dickey’s Barbecue Restaurants (“Dickey’s”). The Court determined that it could resolve the purported ambiguity in the contract provision as a matter of law, and found that the “clear and unambiguous language” of the provisions mandated that Dickey’s common law claims be arbitrated, while the plaintiff’s Maryland Franchise Law claims go forward in Maryland district court. In a published opinion released on August 5, 2015, the Court stated that the Federal Arbitration Act (“FAA”) requires this result despite the inefficiency of piecemeal litigation in multiple forums.

Arbitration or Litigation? Pre-Trial Maneuvering

Both sets of plaintiffs (collectively “Franchisees”) were franchisees operating Dickey’s restaurants in Maryland. The first set of plaintiffs, Matthew Chorley, Carla Chorley, and Chorley Enterprises (collectively “Chorleys”), were involved in a dispute with Dickey’s over the franchise’s management. Dickey’s brought arbitration proceedings, alleging common law breach of contract claims for the franchise and development agreements between Dickey’s and the Chorleys. In turn, the Chorleys brought suit in federal court seeking to enjoin arbitration and declare the arbitration provision unenforceable. The Chorley’s also claimed that Dickey’s fraudulently misrepresented start-up and operating costs in violation of the Maryland Franchise Regulation and Disclosure Law (“Maryland Franchise Law”). Dickey’s filed a similar set of claims against the second set of plaintiffs, Justin Trouard and Jessica Shelton (collectively “Trouard and Shelton”). Trouard and Shelton responded in the same fashion as the Chorleys by filing suit in Maryland district court. Dickey’s filed motions to compel arbitration in both matters. The district court consolidated these two cases to decide the pre-trial motions because the provisions in question were virtually identical.

The Franchisees agreed to similar contracts with Dickey’s that included several forum selection provisions, two of which were at issue here. The first was an arbitration provision (“the Arbitration Clause”) in which the parties agreed to arbitrate all claims arising out of the agreement at the American Arbitration Association nearest to Dickey’s headquarters in Texas. The second was a state specific provision (“the Maryland Clause”) that created an exception to arbitration provision with regard to claims under the Maryland Franchise Law. The agreement provided that the Franchisees could file such claims in any competent court in Maryland. In the district court, both the Franchisees and Dickey’s presented an all-or-nothing argument. The Franchisees argued that the Maryland Clause fundamentally conflicted with the Arbitration Clause such that the Arbitration Clause was void, whereas Dickey’s argued that the Maryland Clause merely preserved the right to bring a Maryland Franchise Law claim in either arbitration or in court.

The district court found both the Franchisees’ and Dickey’s arguments to be plausible. Thus, it ordered a jury trial to determine which, if any, issues the parties agreed to arbitrate. The parties filed interlocutory appeals challenging the denial of their motions.

The FAA Requires Arbitration of Claims that Parties Agree to Arbitrate

Section 2 of the FAA provides that arbitration clauses may only be invalidated on “such grounds as exist at law or in equity for the revocation of any contract.” Courts will compel arbitration under § 4 of the FAA if (i) the parties have entered into valid agreement to arbitrate and (ii) the dispute in question falls within the scope of the agreement. If a federal court finds both of these elements, it must enforce the agreement as written. To make these findings, the Court applied Maryland contract law, which required it to look at the intent of the parties to determine whether the agreement was valid with respect to the Arbitration Clause.

The Fourth Circuit found that the Franchisees and Dickey’s intended to arbitrate Dickey’s common law claims. The claims arose out of the relationship between the parties, and thus were within the scope of the Arbitration Clause. Because the Court found the intent to arbitrate, which was evidence of a valid agreement, and the claims were within the scope of the agreement, the Court compelled arbitration on Dickey’s common law claims. In doing so, the Court rejected the Franchisees’ claim that an adverse arbitration decision would be prejudicial to their Maryland Franchise Law claims, as well as a claim that the Maryland Clause trumped the entire Arbitration Clause. Supreme Court precedent instructed that the FAA requires piecemeal litigation in cases where some claims were subject to arbitration and some were not.

On the other hand, the Court agreed with the Franchisees that the Maryland clause trumped as it pertains to Maryland Franchise Law claims. The agreement provided that the Franchisees could bring Maryland Franchise Law claims in Maryland courts notwithstanding the Arbitration Clause. The Court determined that the plain language of the agreement provided that Maryland Franchise Law claims should go forward in the Maryland district court.

Dickey’s also argued that the FAA preempted the Maryland Clause. The Court rejected this argument on the basis that the FAA preemption upon which Dickey’s relied applied to state law that prevented arbitration of certain claims rather than contractual provisions.

Vacated and Remanded

Because the FAA requires claims that can be arbitrated to be arbitrated even if there are other related claims that may not be arbitrated, the Court vacated the district court’s decision to order a jury trial to resolve an ambiguous contract provision and decided the dispute as a matter of law. The Court remanded to the district court the issue of whether the stay the proceedings in that court pending arbitration.

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28Oct

Arbitration Award Upheld in Debt Reduction Service Case

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By Eric Jones

On July 6, 2015, the Fourth Circuit issued a published opinion in the civil case Jones v. Dancel.  Several plaintiffs, representing a class of individuals who utilized a credit management and debt reduction service, appealed to the Circuit asking that an arbitration award be reversed.  Because the arbitrator had not manifestly disregarded the law, the award was affirmed.

 

The Dispute and Arbitration

Laverne Jones, Stacey Jones, and Kerry Ness (collectively, the Plaintiffs) separately entered into contracts with Genus Credit Management (Genus) for the purposes of debt management and credit counseling.  Under those contracts, Genus was authorized to seek reductions in the Plaintiffs’ owed debts.  Although Genus held itself out as a non-profit organization providing debt management services free of charge, Genus accepted voluntary contributions from both debtors and creditors.  Pursuant to an arbitration clause in their contracts, the Plaintiffs initiated an arbitration action alleging individual and class claims against several original defendants alleging violations of the Credit Repair Organizations Act (CROA or the Act), the Racketeer Influenced and Corrupt Organizations Act, the Maryland Consumer Protection Act (MCPA), the Maryland Debt Management Services Act, and Maryland common law on matters of fraud and breach of fiduciary duty.  After certifying the class for the Plaintiffs’ CROA and MCPA claims, many of the original defendants entered into settle agreements with the class.  These settlements included $2.6 million in attorneys’ fees, and were approved by the arbitrator.  Amerix Corporation, Amerix’s founder Bernaldo Dancel, and several of Amerix’s affiliates (collectively, the Defendants) remained in arbitration.

Plaintiffs specifically alleged that the Defendants had violated CROA by making untrue or mislead statements, and by unlawfully billing consumers for debt management services.  After extensive hearings, however, the arbitrator found that the Defendants had violated CROA only in failing to make certain disclosures to consumers which are mandated under CROA, including a document summarizing their right to accurate information in certain credit reports.  CROA’s damages provision, 15 U.S.C. § 1679g(a)(1)(B), actual damages include “any amount paid by the person to the credit repair organization.”  In interpreting this provision, the arbitrator found that it contemplated payments on a quid pro quo basis, where the payment was in exchange a defined credit repair service.  The arbitrator then reasoned that the Plaintiff’s voluntary contributions were not “amount[s] paid” under CROA, primarily because a significant percentage of class members had not made any voluntary contributions.  Accordingly, the arbitrator denied any actual damages.

As to CROA’s punitive damages provision, 15 U.S.C. § 1679g(a)(2), the arbitrator awarded Plaintiffs $1,948,264 for failing to provide the required disclosures.  This amount was intended to serve as a powerful deterrent to the Defendants.

Finally, as to attorneys’ fees, the arbitrator found that the Plaintiffs had failed to account separately for time spent on the successful and unsuccessful claims, to substantiate proposed lodestar billing rates, and had submitted time and expense entries that were otherwise “defective.”  The arbitrator then concluded that the $2.6 million already received from settlements more than covered the amounts payable, and declined to award additional fees.  The district court affirmed the arbitrator based on the limited standard of review applicable to arbitration awards, and the Plaintiffs filed a timely appeal.

 

The Arbitrator Did Not Manifestly Disregard the Law as to Actual Damages

As explained by the Fourth Circuit, a court may vacate an arbitration award only when the disputed legal principle is clearly defined and not subject to reasonable debate, and the arbitrator refused to apply that principle.  The Plaintiff’s first argument was that their voluntary contributions to Genus constituted “payment” under CROA, and that the arbitrator had manifestly disregarded CROA by finding that they were outside the scope of the Act.  The Circuit disagreed, holding that the definition of “payment” under CROA was well within the scope of reasonable debate, largely because the Act defined a “credit repair organization” as somebody who provided credit repair services “in return for the payment of money.”  Thus, given the absence of any binding precedence on the exact meaning of the term, the arbitrator’s finding that the voluntary contributions were not “payment” was not a clear disregard for established law.  The Circuit explained that other arbitrators may have come to the opposite conclusion, but that the appropriate standard of was limited and thus they could not “pass judgment on the strength of the arbitrator’s chosen rationale.”

 

The Refusal to Award Attorneys’ Fees Did Not Violate CROA

In 15 U.S.C. § 1679g(a)(3), CROA directs that in the case of any successful action under the Act, plaintiffs may recover actual damages as well as “the costs of the action, together with reasonable attorneys’ fees.”  On appeal, the Plaintiffs argued that the arbitrator had thus manifestly disregarded CROA by refusing to award additional attorneys’ fees.  The Fourth Circuit noted, however, that the arbitrator declined to award attorneys’ fees because they were not “reasonable,” and thus were not within the mandate of CROA.  The arbitrator identified several deficiencies with the Plaintiff’s fee requests, including “counsel’s use of “block billing” practices, quotation of unjustified billing rates, and submission of time entries that failed to segregate successful claims from unsuccessful claims.”  The arbitrator also highlighted other improper requests for questionable litigation fees, including “bills from costly restaurants” and excessive travel and lodging costs.  The arbitrator thus did not refuse to heed CROA, but instead found that the fee request in its entirety could be disregarded.  Rather than do so, the arbitrator decided to set off the established amount with the already received fees, and declined to award additional fees.  As explained by the Fourth Circuit, the arbitrator acted well within the law, and thus this argument failed as well.

 

The Fourth Circuit Affirmed the Arbitrator’s Award

Because the arbitrator’s reasoning and ruling did not indicate a manifest disregard for CROA, the Fourth Circuit affirmed the district court’s denial of the Plaintiff’s motion to vacate in part the final award.  As of October 28, 2015, the Plaintiffs have filed a petition for certiorari to the Supreme Court of the United States, which awaits response.

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30Sep

Fourth Circuit Vacates Denial of Motion to Compel Arbitration in Payday Loan Case

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By Eric Jones

On May 29, 2015, the Fourth Circuit issued a published opinion in the civil case Dillon v. BMO Harris Bank.  The Circuit Court held that the district court erred when it denied appellant’s renewed motion to compel arbitration pursuant to loan agreements that the plaintiff had signed.  Thus, the Fourth Circuit vacated and remanded to the district court for further proceedings.

The Automated Clearing House Network and Payday Lenders

In 2013, James Dillon obtained loans from several online lenders that carried interest rates which substantially exceed the maximum allowable rates under North Carolina State law.  The defendants, BMO Harris Bank, N.A., Generations Federal Credit Union, and Bay Cities Bank (the “Banks”) operated as Originating Depository Financial Institutions (“ODFIs”) in connection with the loans.  Dillon alleges that in doing so they provided the payday lenders with access to the Automated Clearing House (the “ACH”) network, a system to enable secure electronic payments.  When payments were due under Dillon’s loans, the lenders initiated payment transactions through the ACH network.  The Banks then entered the transactions into the ACH network.  Soon after, a central clearing facility transferred funds directly from Dillon’s account to those of the lenders.  In this way, Dillon alleges that the payday lenders were able to establish loans in states where those loans are illegal and unenforceable.

The Motions to Compel Arbitration

Dillon filed a putative class action against the Banks alleging that by operating as OFDIs for payday lenders, they were complicit and necessary parties to the lenders’ unlawful practices.  The Banks filed initial motions to compel arbitration, pointing to clauses in the loan agreements stating that any claims arising from those loans would be submitted to arbitration.  To these motions, the Banks attached the loan agreements themselves bearing Dillon’s name.  In opposition, Dillon argued that the Banks had failed to offer proof that the attached loan agreements had been authenticated.  The Banks argued that because Dillon used the same loan agreements in his complaint, the pleadings themselves established the authenticity of the agreements and the arbitration clause.  Nevertheless, the district court denied the motion to compel arbitration, finding that the Banks had failed to provide authenticating evidence.

To cure the deficiency, the Banks obtained declarations from the lenders purporting to authenticate the loan agreements and filed renewed motions to compel arbitration.  Dillon opposed, arguing that the district court had already ruled on the motion to compel arbitration, and thus the law of the case doctrine should bar reconsideration.  The district court agreed, and the Banks filed a timely interlocutory appeal.

The Federal Arbitration Act and Interlocutory Appeals

The Fourth Circuit began by explaining the history of the Federal Arbitration Act (FAA) and the requirement that courts rigorously enforce agreements to arbitrate.  Section 16(a)(1)(A) of the FAA provides for immediate appeal from an order refusing a stay in any litigation that is referable to arbitration, and § 16(a)(1)(B) provides for immediate appeal for any order denying a petition to compel arbitration.  The Banks argued that the district court’s denial of the renewed motion to compel arbitration and stay the proceedings thus allows immediate appeal.  Dillon, in opposition, argued that the district court’s order denied reconsideration of the motion to compel arbitration, and thus fell outside of the FAA.  The Fourth Circuit, looking to the title of the motions and the clear intention to seek enforcement of an arbitration clause, held that valid jurisdiction existed over the appeal.

The District Court Erred by Interpreting the Renewed Motions as Motions for Reconsideration

Although the district court did not explain why it considered the renewed motions to be motions for reconsideration, the Circuit Court found two potential reasons.  The Fourth Circuit held that neither were convincing.  First, the district court could have believed that the Banks were allowed only one opportunity to invoke the FAA’s enforcement mechanisms.  Alternatively, the district court could have relied on the law of the case doctrine, believing that both motions invoked the same issues.  The Circuit Court addressed each of these in turn.

First, the Fourth Circuit could find no authority which limited a party’s access to FAA’s enforcement mechanisms unless the party is found to be in default.  A party is found to be in default, and thus barred from compelling arbitration or staying the proceedings, only if they have utilized the litigation machinery so substantially that to subsequently permit arbitration would prejudice the party opposing the stay.  Because the district court did not find that the Banks were in default, the order could not have rested upon these grounds.

Second, the Fourth Circuit held that the initial motions to compel arbitration and the renewed motions raised different issues, and thus were not barred by the rule of the case doctrine.  In their initial motions, the Banks argued that the loan agreements were substantially authenticated.  When the district court disagreed, the Banks did not challenge that ruling in their renewed motions.  Rather, they attempted to cure the evidentiary deficiencies that the district court relied on in denying the initial motion.  Thus, the law of the case doctrine did not bar the renewed motions.

The Fourth Circuit Vacated and Remanded for Further Proceedings

Because the district court erred in its interpretation of the Banks’ renewed motions to compel arbitration, the Fourth Circuit vacated the court’s order and remanded for further proceedings.

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17Mar

Fourth Circuit Splits On Arbitration Requirements and Bankruptcy Proceedings

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By Chad M. Zimlich

On Monday, March 16, 2015, the Fourth Circuit in Moses v. CashCall, Inc., a published civil opinion, considered an appeal from a district court affirmation of a bankruptcy court decision from the Eastern District of North Carolina.

The appeal centered around whether claims for declaratory relief and for monetary damages asserted by Oteria Moses, a resident of Goldsboro, North Carolina, against CashCall, Inc. were subject to arbitration. The bankruptcy court retained jurisdiction over both claims, denying CashCall’s motions to compel arbitration. With respect to the claim of monetary damages, the bankruptcy court also made recommended findings of fact and conclusions of law. The district court affirmed the bankruptcy court’s decision.

On appeal, the Fourth Circuit held that that the district court did not err in affirming the bankruptcy court’s exercise of discretion to retain in bankruptcy Moses’ first claim for declaratory relief. However, the majority of the Court found that the district court erred in retaining in bankruptcy Moses’ claim for damages under the North Carolina Debt Collection Act and denying CashCall’s motion to compel arbitration of that claim. As to this part of the holding, the judges were split three ways, Judges Gregory and Davis for concurring in a judgment reversing the issue of arbitration for the money damages, and Judge Niemeyer dissenting.

A Question of Where the Case Belongs: Bankruptcy or Arbitration

The issue that the Fourth Circuit was confronted with was whether it was appropriate for either of Moses’ claims to be submitted to arbitration, or if one or both claims required the use of the bankruptcy court system. The question may seem simple, however, there were two distinct inquiries regarding each claim centered on the jurisdiction that the bankruptcy court had.

Loan Sharking By Western Sky

Facing financial difficulties, Moses signed a Western Sky Consumer Loan Agreement (“Loan Agreement”) on May 10, 2012, and agreeing to pay Western Sky, or any subsequent holder of the debt, $1,500 plus 149% interest. Pursuant to the agreement, Western Sky gave Moses $1,000, and retained $500 as a “prepaid finance charge/origination fee.” The Loan Agreement stated that the annual percentage rate for the loan was 233.10%, with the amount of all scheduled totaling $4,893.14. North Carolina law limits interest rates to a maximum of 16%. The Loan Agreement also gave Western Sky’s address as being in South Dakota and stated that the agreement was subject to the Indian Commerce Clause of the Constitution. Additionally, Western Sky was not licensed to make loans in North Carolina.

The Loan Agreement provided that any disputes relating to it were to be resolved by arbitration “conducted by the Cheyenne River Sioux Tribal Nation.” Lastly, the Loan Agreement stated that the arbitration could take place either on tribal land or within 30 miles of Moses’ residence, but in either case the Cheyenne River Sioux Tribe would retain sovereign status or immunity.

Three days after signing the Loan Agreement, Moses received a notice from Western Sky that the Agreement had been sold to WS Funding, LLC, a subsidiary of CashCall, Inc., and would be serviced by CashCall. Three months later Moses filed a Chapter 13 bankruptcy petition in the Eastern District of North Carolina. One week later, CashCall filed a proof of claim in the bankruptcy proceeding, asserting that Moses owed it $1,929.02. Moses objected on the basis the loan was not enforceable in North Carolina, both because of the unlicensed lending and the 16% limit. Moses also filed an adversary proceeding against CashCall seeking a declaratory judgment that the loan was void under North Carolina law, as well as damages against CashCall for its illegal debt collection.

After the bankruptcy court approved Moses’ bankruptcy plan, CashCall filed simultaneous motions to withdraw it’s claims, or, in the alternative, to compel Moses to arbitrate pursuant to the Loan Agreement. Because Moses had already filed an adversary proceeding against CashCall, CashCall could not withdraw its proof of claim without court approval. Moses objected to CashCall’s motion to withdraw its proof of claim. She contended that CashCall, which had 118 similar claims in the Eastern District of North Carolina, sought to withdraw its proof of claim in her case only after she had challenged its practices. The purpose of the withdrawal, Moses argued, was simply an attempt by CashCall to divest the bankruptcy court of jurisdiction.

The bankruptcy court denied CashCall’s motion to dismiss the complaint or to stay and compel arbitration, concluding that Moses’ claim for a declaratory judgment that CashCall’s loan was void was a “core” bankruptcy claim. As to Moses’ second claim, which sought damages, the court concluded that the claim was non-core, over which it could only recommend findings of fact and conclusions of law for a decision by the district court. The bankruptcy court also denied CashCall’s motion to withdraw its proof of claim, finding that the withdrawal would prejudice Moses by removing the court’s jurisdiction over the other causes of action. CashCall filed interlocutory appeals on both counts to the district court. The district court affirmed the bankruptcy court’s orders.

Whether a Claim is Statutorily or Constitutionally Core, and Tensions Between the FAA and Bankruptcy Code

The rule iterated by the Fourth Circuit was the basis of this decision hinges on whether or not the claim in question was constitutionally core according to the Supreme Court’s decision in Stern v. Marshall. The Court there held that “Article III of the Constitution prohibits bankruptcy courts from issuing final orders regarding statutorily core claims unless they ‘stem[] from the bankruptcy itself or would necessarily be resolved in the claims allowance process.’” That means that, should the claim be based in a statute but raise no constitutional questions, it should be treated as statutorily non-core and the district court is given de novo review, making it the court of first impression.

However, a further issue was the tension between the Federal Arbitration Act (“FAA”), which favors the use of arbitration and grants the decision to arbitrate to the court of first impression, and the Bankruptcy Code, which gives the bankruptcy courts their jurisdiction and lays out a completely separate purpose intended by Congress.

The Claim of a Declaratory Judgment Belonged to the Bankruptcy Court

The Court first noted that previous courts that have considered agreements similar to the Loan Agreement, specifically the Eleventh and Seventh Circuits and the District of South Dakota, have “found that the Cheyenne River Sioux Tribe has no laws or facilities for arbitration and that the arbitration procedure specified is a ‘sham from stem to stern.’” The Fourth Circuit agreed and found that the Loan Agreement was clearly illegal under North Carolina law due to the extreme interest rate, however that did not negate the fact that the agreement specified that Indian tribal law would apply and that any dispute under the agreement would be resolved by the Sioux Tribe’s arbitration.

However, while arbitration agreements should normally be enforced, in this case the Court found that the fundamental public policy present in the Bankruptcy Code was in direct conflict with a decision to arbitrate. Meaning that, should it be declared that the Loan Agreement was illegal this would have a direct and substantial impact on Moses’ Chapter 13 bankruptcy proceedings. Therefore, as the bankruptcy court had first impression for this claim, its denial of arbitration was not a violation of its discretion.

The Problem of the Claim of Damages and a Flurry of Opinions

Moses’ claim for damages was based on the North Carolina Debt Collection Act, and the majority’s opinion found no inherent conflict between the Bankruptcy Code and the effect that arbitration would have on Moses’ bankruptcy proceeding. However, even the two-judge majority split in their reasoning for this conclusion.

Judge Gregory relied on the Ninth Circuit’s opinion in Ackerman v. Eber in stating that bankruptcy courts generally have no discretion in refusing to arbitrate a claim that is found to not be constitutionally core. His concurrence went on to state that, while the claims shared a common question, the claim of damages did not pose an inherent conflict with the reorganization of Moses’ estate under the Chapter 13 bankruptcy proceeding. Additionally, Judge Gregory saw no issue with conflicting results, as the arbitrator’s order would be subject to enforcement by the district court. In this case, any conflicts that may arise would not be “inherent” and “sufficient” to the point that they overrode the presumption in favor of arbitration.

Judge Davis relied on a previous Fourth Circuit decision from 2005, In re White Mountain Mining Co., L.L.C., which spoke indirectly on the subject. Judge Davis’ opinion, while reflecting on the “odiousness” of CashCall’s practices and perhaps faulty arbitration procedures, emphasized the fact that the non-core claim of damages that Moses had in this case would in no way be frustrated by arbitration itself, and therefore the lack of direct conflict required deference to the FAA.

Judge Niemeyer’s dissent argued that the district court’s exercise of discretion to retain the damages claim presented the same question as the declaratory judgment. So in this view, if the loan agreement were invalid, separating the two claims would be inefficient and create issues of collateral estoppel. Therefore, the district court had not abused its discretion.

Bankruptcy Court May Keep Declaratory Judgment But Must Lose Damages Claim

The Fourth Circuit concluded that resolution of Moses’ claim for a declaratory judgment could directly impact the claims against her estate, and arbitration with the Cheyenne River Sioux Tribe would “significantly interfere” with the bankruptcy reorganization. Therefore, the district court was not in error in upholding the bankruptcy court’s decision. However, the money damages sought were not in direct conflict with the Bankruptcy Code and its procedures for Moses under Chapter 13, and the question of damages was one for an arbitrator and not the bankruptcy court.

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16Mar

Fourth Circuit Holds that Second Termination Did Not Violate Arbitration Award

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By Ashley Escoe

In Fraternal Order of Police v. WMATA, a published civil opinion released on March 10, 2015, the Fourth Circuit reversed a district court’s order of summary judgment for the appellee, the Fraternal Order of Police (FOP), holding that the appellant, the Washington Metropolitan Area Transit Authority (WMATA), complied with the arbitration award.

Officers Allege That Termination Violates Arbitration Award

This labor dispute arose when the WMATA fired two of its police officers for a second time, after an arbitration award required WMATA to rehire them. WMATA fired Mark Spencer and Sherman Benton initially for making untruthful statements during investigations into their alleged improper conduct. The FOP, the bargaining agent for officers, filed grievances for the two officers culminating in arbitration. The Board of Arbitration determined that a lengthy suspension was more appropriate than termination and ordered WMATA to rehire the officers.

When the two officers were fired, they lost their Maryland certification to work as police officers. Once reinstated, they had to apply for recertification with the Maryland Commission before resuming their police duties. The Maryland Commission denied the officers recertification. Because the two officers were not recertified, WMATA fired them a second time. The FOP filed this action in federal court, contending that WMATA violated the decision of the Arbitration Board. The district court held that WMATA failed to comply with the arbitration order and instructed WMATA to rehire Benton and Spencer.

Fourth Circuit Follows Seventh and Third Circuits

The decision in this case turns on whether firing the two officers the second time, when they were denied recertification, constitutes a violation of the arbitration order. There is no Fourth Circuit authority that addresses this issue directly. Therefore, the Court looked to the Seventh and Third Circuits, which had decided cases with similar facts. The Seventh Circuit in Chrysler Motors Corp. v. International Union, Allied Industrial Workers and the Third Circuit in United Food & Commercial Workers Union Local 1776 v. Excel Corp. held that an employee cannot challenge a second termination by seeking to enforce an arbitration award where an employee was terminated, ordered to be reinstated after arbitration, then fired again for independent reasons.

Second Termination was Based on Independent Grounds

The Fourth Circuit Found that that WMATA fired the officers the second time on independent grounds not related to the first termination. The reasons for the second termination, that the Maryland Commission denied recertification, was distinct from firing the officers for disciplinary infractions and was also never before the Arbitration Board.

The Court noted that WMATA provided the Maryland Commission with derogatory information seeking to discourage the officers’ recertification. While the Court does not condone that behavior, it concluded that it did not have jurisdiction to consider if WMATA’s actions violated the “just cause” provision of the collective bargaining agreement between the officers and WMATA. That issue, according to the agreement, must be settled by arbitration.

Summary Judgment Reversed

The Fourth Circuit held that the WMATA’s choice to fire the two officers after their recertification was denied, did not violate the arbitration award, reversing the district court’s order of summary judgment for the FOP.

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20Jan

Redressing the Arbitration Process: An Alternative to the Arbitration Fairness Act of 2009

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By: Darren P. Lindamood*

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* J.D. Candidate, May 2011, Wake Forest University School of Law. The author would like to thank all of the members of Wake Forest Law Review for their diligent work in editing this Comment.

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