New York’s Highest Court Rejects Attempt to Compel Nonsignatory to Arbitrate Under the Direct Benefits Estoppel Doctrine

by Louis A. Russo & Donald Houser, Alston & Bird[1]
In Matter of Belzberg v. Verus Invs. Holdings Inc., 2013 NY Slip. Op. 06729 (No. 149, October 17, 2013), the New York State Court of Appeals (the highest court in New York State) reversed a decision of the Appellate Division, holding that a non-signatory could be compelled to arbitrate under the direct benefits estoppel doctrine (i.e. an exception to the general rule that only signatories to an arbitration agreement are bound to that agreement). In considering the law developed under the Federal Arbitration Act for guidance, the Court relied on previous precedent set by the Second, Fourth, Fifth and Eighth Circuit Court of Appeals of the United States. In doing so, the Court concluded that the benefit received by the non-signatory was indirect, rather than direct, because it could not be traced directly to the agreement containing the arbitration clause.

 

Belzberg

In Matter of Belzberg, petitioner appealed a decision of the Appellate Division (the appeals court in New York State), contending that he should be estopped from avoiding arbitration “because he knowingly exploited and received direct benefits from” an agreement containing an arbitration clause but to which he was not a signatory. Slip Op. at p. 4. Specifically, petitioner transferred US$5 million from a trust he controlled to Verus Investment Holdings (“Verus”) in connection with an arbitrage investment opportunity. Verus carried out the transaction through its brokerage account. After the transaction was complete, the broker returned the US$5 million to Verus, along with approximately US$233,000 in profits. Verus then wired the profits to Belzberg’s friend for the purchase of a summer home.

Ultimately, the Canadian tax authorities notified Jefferies of a withholding tax relating to the transaction. The broker commenced arbitration against Verus pursuant to an arbitration clause in a brokerage agreement between it and Verus (the “Agreement”). Verus thereafter asserted third-party arbitration claims against Belzberg, among others, for their share of the taxes.

 

The Direct Benefits Doctrine

At issue was whether Belzberg could be compelled to arbitrate under the direct benefits estoppel doctrine, which is an exception to the general rule that only signatories to an arbitration agreement are bound to that agreement. Under this doctrine, “a nonsignatory may be compelled to arbitrate where the nonsignatory ‘knowingly exploits’ the benefits of an agreement containing an arbitration clause, and receives benefits flowing directly from the agreement.” Slip Op. at p. 6 (emphasis added). “The benefits must be direct – which is to say, flowing directly from the agreement. . . . By contrast, the benefit derived from an agreement is indirect where the nonsignatory exploits the contractual relation of parties to an agreement, but does not exploit (and thereby assume) the agreement itself.” Id. at p. 7 (quoting MAG Portfolio Consultant, GmbH v. Merlin Biomed Group LLC, 268 F.3d 58, 61 (2d Cir. 2001)).

Verus submitted that the doctrine compelled Belzberg to arbitrate because “he derived a direct benefit from the Verus-Jefferies Agreement – namely the profits attributable to the US$5 million [trust] investment in the” transaction. Slip Op. at p. 11. The Court rejected this argument, finding that Belzberg’s benefit was indirect. “The profits belong to [the trust], not Belzberg.” Id. The Court also found it important that Belzberg’s ability to access the funds did not derive from the Agreement but ‘rather on his relationship with [the trust].” Finally, the Court considered the fact that, “but for” the Agreement there would have been no profits to divert. However, it found this “connection to be based on mere causality” and “beyond the intended scope of the direct benefits estoppel theory.” Slip Op. p. 12.

 

Direct Benefits in the United States

This represents a significant transition from many United States’ court rulings where a non-signatory party’s “close relationship” with a signatory party and its “alleged wrongs” was sufficient to bring it into the arbitration proceedings. Sunkist Soft Drinks v. Sunkist Growers, 10 F.3d 753, 757 (11th Cir. 1993). To the contrary, the courts in the Second, Fourth, and Fifth Circuit Court of Appeals of the United States have held that a non-signatory should only be compelled to arbitrate a claim if it derives a “direct benefit from the contract containing the arbitration provision.” Moreover, a non-signatory cannot sue if its claim can “stand independently of the underlying contract of the signatories.” In re Kellogg Brown & Root, Inc., 166 S.W.3d 739–40 (Tex. 2005).

 

Few Analogs Outside of the United States

Although extending an arbitration clause to a non-signatory is a highly controversial issue in some European courts, France is one of the few countries in Europe that has actually bound non-signatories under the “group of companies” doctrine. In Dow Chemicals, the tribunal decided that the existence of a group of companies and the “mutual intentions of all parties” to an agreement can bind a non-signatory to an agreement to arbitration proceedings (ICC Case No. 4131, Y.C.A. Vol. IX (1984), 131). Similarly, in Y.S.A.L. v Z Sarl ATF 129 III 727-4P.115/2003 (X.S.A.L) the Swiss courts held that a non-signatory can be bound by the arbitration agreement only if it intervenes and is actively involved with the matter in dispute.

While French courts have ruled that a non-signatory who has been directly involved in the negotiation, performance, or termination of the contract will be subjected to the arbitration clause, English courts are reluctant to infringe upon the principle that arbitration is a “consensual process.” Fortress Value Recovery Fund I LLC v. Blue Skye Special Opportunities Fund LP, Court of Appeal, EWCA Civ 367 (17 April 2013). Even when called to apply French law to an English case, both the High Court and the Court of Appeal of England emphasized that the applicable standard was whether the non-signatory “had the common intention (whether expressed or implied) to be bound by said agreement and, as a result, by the arbitration clause.” Dallah Real Estate & Tourism Holding Co. v. Min. of Religious Affairs, Gov. of Pakistan [2008] APP.L.R. 08/01. Similarly, the German Federal Court in BGH Docket No III ZR 371/12 cited fundamental principles of German law and public policy when it refused to apply the “group of companies” doctrine to a non-signatory third-party that never consented to arbitration proceedings. Lastly, in China, only signatories to an arbitration agreement can be bound under an arbitration clause.

 

Conclusion

While not often implemented abroad, parties engaged in dispute resolution in the United States should be cognizant of the direct benefits doctrine.

 

[1] Louis A. Russo is Counsel in Alston & Bird, LLP’s New York office. Donald Houser is a Senior Associate in the firm’s Atlanta office. Many thanks to Ms. Silvia Stanciu for her diligent research assistance and helpful comments and revisions.

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