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December 22, 2010

Choice-of-Law Regarding Arbitrability With Non-Signatories: Wading Through the Morass

Before we part ways in flight to family hearths, groomed pistes, and pristine sandy beaches nearer to the Equator, let us return briefly to one of the favorite topics of Arbitration Commentaries and its readers:  arbitrability with non-signatories, and specifically the choice-of-law governing arbitrability in regard to non-signatories.


A war story begins today’s installment. My Hong Kong client contracted to sell software to a New York company and in the contract provided for Hong Kong governing law and the resolution of disputes by arbitration. The contract named no arbitral institution, nor any rules, place of arbitration, or method to appoint arbitrators.  A commercial dispute arose, and an agreed solution to overcome the pathology of the arbitration clause was achieved: an Arbitration Submission Agreement that called for ICDR Arbitration in New York (with the witnesses from China permitted to appear by teleconference).  Ten days prior to the hearing on the merits, the US company, arbitral respondent and counterclaimant, filed suit against the Hong Kong-resident CEO of my client, in the Southern District of New York. I filed a motion to compel arbitration, on behalf of the CEO, relying upon US arbitrability law. The motion was granted in short order, on the grounds and under the law asserted in my motion.


But wait.  Did I lead the court astray?  Should US arbitrability law have been applied in preference to Hong Kong law? Or was this a “default” application of US law because my adversary chose to assume its applicability?


The murky state of US law on the question of what law applies to arbitrability determinations involving non-signatories in international arbitration cases, is reflected in an even more recent decision by a different judge in the Southern District of New York.  (FR8 Singapore Pte. Ltd. v. Albacore Maritime  Inc., 2010 U.S. Dist LEXIS 132212 (S.D.N.Y. Dec. 14, 2010)).   In Albacore, Plaintiff Singapore company brought the action (under Section 4 of the FAA) to require non-signatory defendants, Marshall Islands companies with offices in Greece, to arbitrate a dispute arising from the purchase and sale of a ship. Plaintiff alleged that the non-signatories were the real parties in interest, and that the signatory seller was merely a shell entity, an alter ego.  Plaintiff’s commercial contract with the signatory seller provided for arbitration in London and English governing law.  The question: What law should be applied to determine whether the alter ego allegations are sufficient to require the non-signatories to arbitrate at the insistence of the counterparty signatory: Marshall Islands law? English law? or US law?


To answer the question (and settle finally upon English law), the Court looked mainly to three Second Circuit decisions. In the first, Smith/Enron Cogeneration Limited Partnership, Inc. v. Smith Cogeneration Int’l, Inc., 198 F.3d 88 (2d Cir. 1999), the Second Circuit rejected the use of the forum’s choice-of-law principles (New York) to address the non-signatories issue, on the basis that such “parochialism” would “subvert the goal of simplifying and unifying international arbitration law.”  On this basis, the Albacore Court held that while New York choice-of-law principles would indicate applying the alter ego law of the place of incorporation of the allegedly dominated entity, that approach was improper and so application of Marshall Islands law could not be justified.


The second case addressed in Albacore was Motorola Credit Corp. v. Uzan, 388 F.3d 39 (2d Cir. 2004).  In Motorola, the US manufacturer sought to litigate its claims against the non-signatory Turkish shareholder of the Turkish company with which it had contracted, providing therein for Swiss law and arbitration in Switzerland under Zurich Chamber of Commerce Rules.  The Turkish non-signatory sought in Motorola’s US District Court action to compel arbitration under American equitable estoppel principles. He failed. The Second Circuit held that the “choice-of-law clause” in the contract had to be respected by the non-signatory defendant seeking to arbitrate rather than litigate, and that under Swiss arbitration law a non-signatory could not require the signatory to arbitrate.


Let us pause here, and return for a moment to my war story.  If the foreign shareholder could not invoke the arbitration clause in Motorola to compel arbitration, because of a choice of foreign law clause, why was I able to obtain an order compelling arbitration on behalf of my foreign shareholder-CEO client under American arbitral equitable estoppel principles despite a Hong Kong choice of law clause in the contract?   Were we merely the lucky beneficiaries of the choice-of-law issue having been bypassed?   I do not think so – because what the Second Circuit really meant in Motorola, and should have said much more clearly, was that it was giving effect to the contract’s choice of Swiss arbitration law, a choice made not by reason of the general selection of Swiss contract law, but rather by the lex arbitri choice that was implied-in-law from the agreement to arbitrate in Switzerland. In my case, the Arbitration Submission Agreement provided for ICDR Arbitration in New York, and therefore, despite the general Hong Kong choice of law clause in the underlying contract, US arbitration law was the law applicable to the arbitration clause my client sought to invoke. The fact that the party seeking to dodge arbitration and sue my Chinese client in a US court was the US party to the contract and the Submission Agreement is an additional, but I think unnecessary, reason to apply the contractual American lex arbitri – and indeed the nationality of the parties played no part in the analysis by the Second Circuit in Motorola.  


But the lack of precision in Motorola’s reasoning became a difficulty for the District Court in Albacore. The Court took at face value the Motorola Court’s statement that it was respecting the contract’s “choice-of law” clause.   And it found that holding to be in possible conflict with another Second Circuit decision, Sarhank Group v. Oracle Corp., 404 F.3d 657 (2d Cir. 2005).  Oracle, the US software maker, had set up a foreign subsidiary to sell in Egypt and through that subsidiary had contracted with Sarhank and subjected the contract to Egyptian contract law and arbitration in Egypt under Cairo Arbitration Centre Rules.  Sarhank named Oracle as a party to the arbitration, and the Tribunal over Oracle’s objections found it had jurisdiction over Oracle and entered an award against Oracle, which Sarhank then sought to have confirmed in New York under the New York Convention.  Oracle presented its non-arbitrability position as a basis to refuse confirmation under Article V of the Convention, and when the case reached the Second Circuit the Court decided to apply US not  Egyptian arbitrability law to decide the issue.  The Second Circuit reasoned that Oracle had set up the foreign subsidiary precisely to avoid exposing itself to adjudication in a foreign tribunal under foreign law, and so the arbitration agreement signed by its subsidiary furnished no basis to apply the contractual choice of Egyptian arbitration law, or to give deference to the Tribunal’s jurisdiction ruling.


Reading these cases, the District Court in Albacore asked aloud how it should resolve the seeming conflict – the contractual choice of arbitration law having been respected in Motorola, but cast aside in preference to US arbitrability law in Sarhank.   The Court chose to follow Motorola, and initially suggested it might distinguish Sarhank on the basis of its procedural posture, i.e. that the non-signatory was opposing confirmation under Article V of the Convention.  That distinction seems unconvincing however; there should be no reason for the US Court to reach one conclusion about arbitrability if the issue is raised on a motion to compel (or stay) arbitration, and another if it arises at the confirmation stage.  And the Court, evidently unsatisfied, went further in search of meaningful reconciliation. The Albacore Court examined whether Motorola and Sarhank could be persuasively distinguished on the basis that in the former, the non-signatory was seeking to enforce the arbitration clause against a signatory party bound by it, whereas in the latter it was the signatory seeking to extend the clause to a non-signatory That basis for distinguishing the cases had been adopted at least once before by Southern District of New York judge, in Republic of Ecuador v. ChevronTexaco Corp., 376 F. Supp.2d 334 (S.D.N.Y. 2005).  But this was found unsatisfactory, oversimplifying matters because the signatory-nonsignatory dichotomy fails to account for the possibility that a nonsignatory seeking to compel arbitration might seek the benefit of a contractual lex arbitri that is more liberal on arbitrability than US arbitration law, and a nonsignatory seeking to resist arbitration might seek the benefit of contractual lex arbitri that is more restrictive on arbitrability with nonsignatories than US law. A blanket rule that the non-signatory’s opposition to arbitration shall be governed by US law in a US court, the Court reasoned, would motivate the signatory seeking to compel arbitration for forum shop based on whether the US law or the contractual lex arbitri is more favorable to its position. Avoidance of such forum shopping, the Court held, is promoted by adhering to the Motorola approach – which  required the non-signatory alleged real party in interest who was resisting arbitration in a US Court to invoke the contractual lex arbitri.


Distillation of these cases into a handful of applicable principles is a formidable challenge.  But I shall try.  It seems that if a party is seeking relief to avoid arbitration or its consequences (whether by filing a lawsuit to litigate the merits and opposing a motion to compel arbitration, moving for an anti-arbitration stay/injunction, or seeking to vacate or prevent confirmation of an award), that party, whether signatory or non-signatory, must plead its case under the contractual lex arbitri if it has an involvement, prima facie, with the performance of the contract. (A parent company like Oracle in Sarhank, whose corporate veil is not sought to be pierced, therefore is not bound by its subsidiary’s contractual lex arbitri, but controlling shareholders like the defendants in Motorola and Albacore, alleged to be the dominant forces behind a “shell” contracting entities, are so bound).  And if a party is seeking relief to require arbitration or confirm the results of arbitration, whether signatory or non-signatory, it must invoke the contractual lex arbitri in support of its arbitrability position, as part and parcel of its invocation of the agreement to arbitrate.


We can reasonably expect the Second Circuit to revisit these issues and seek to achieve some analytical consistency in the not too distant future.