Marc J. Goldstein Arbitrator & Mediator NYC
January 29, 2014

Judicial Discretion to Allow Proceedings on Related Non-Arbitrable Claims

Today we will applaud a new decision of the US Seventh Circuit Court of Appeals that sustains a district court judge’s refusal to stay all discovery in a litigation mainly involving arbitrable issues in a pending foreign arbitration. (GEA Group AG v. Flex-N-Gate Corp., 2014 WL 97289 (7th Cir. Jan. 10, 2014)).  Such applause may strike readers as anomalous, if not heretical. But this is a special case, and the treatment of the issues by the eminent jurist Richard A. Posner deserves our close attention.

Matters begin simply enough. A US company gets cold feet on the eve of a deal closing, fails to buy the subsidiary of a German company after a long negotiation, and the German company files a breach of contract arbitration in Germany in 2004 under the “DIS” German arbitration rules as provided in the arbitration clause. Nearly five years into the arbitration, in 2009, the Claimant, no longer willing to tolerate known asset-stripping of the Respondent US Company by its non-signatory non-party alter ego CEO and controlling shareholder, replicates the arbitration claim with a federal court lawsuit that makes no mention of the pending arbitration, and includes the CEO as a defendant, alleging fraud by him both in connection with the failed transaction and in transferring assets in derogation of the rights of Claimant/Plaintiff as a prospective award/judgment creditor . (The opinion sheds no light on why the CEO was not joined as a party to the arbitration. One might surmise that German arbitration law as compared to US law is less accommodating to alter ego arguments for jurisdiction over non-signatories).

By the time this case reached appellate decision in January 2014, the arbitration in Germany remained unresolved ten years after it began — a $290 million award in favor of the German company having been vacated in the German courts (for reasons not disclosed in this opinion) and a new arbitration making the same claims having been commenced (again without naming the CEO as a Respondent) in 2012. In the meantime, the US litigation had made two prior visit to the Seventh Circuit, in each case based on the question of what is the proper scope of an FAA Section 3 stay of litigation pending arbitration where the Plaintiff is the arbitration Claimant, seeks a stay of a litigation it commenced, and argues that the stay should be total such that it would prevent the non-arbitrating alter ego CEO defendant from conducting discovery in support of his litigation defenses and counterclaims.

The Seventh Circuit here rejects the notion that it is an absolute responsibility of US courts under the FAA, in a case that presents related arbitrable and non-arbitrable claims, to stay the case entirely and until the arbitration is entirely completed, in order to prevent inconsistent decisions or use of in the arbitration of evidence derived from discovery. And the Court’s premises for this position are sound: (1) the risk of inconsistent decisions was remote as the US case was not nearing either trial or any motion for summary judgment, (ii) the non-arbitrating CEO had the right to defend himself and to pursue his counterclaims, especially since the German arbitration Claimant had commenced the lawsuit, and (iii) the arbitral tribunal in Germany retained full control over the admissibility in the arbitration of evidence derived from discovery in the US litigation.

There is a Section 1782 subtext to the decision, and indeed Section 1782 commands brief mention, with the Court pointing out that either party to the German arbitration might have sought evidence located in the United States, and possibly obtained it. Without taking a position on whether Section 1782 applies to foreign commercial arbitral tribunals, the Seventh Circuit here points out that the disclosure itself is not objectionable because the arbitral tribunal still retains control over use of the evidence in the arbitration.

Readers of the decision will find some digression into issues about whether the German Claimant/Plaintiff had any sound rationale for bringing the US case when it did. The Court points out that the one clearly justifiable basis for US proceedings, to enjoin assets stripping by the alter ego CEO, was effectively waived by Claimant/Plaintiff since it sought of stay of all proceedings in the action it commenced.

But for us this case should mainly be about the potential discretionary limitations the district courts might impose on a stay of US litigation related to foreign arbitration. Whereas FAA Chapter Two has no specific provision concerning a stay of litigation involving arbitrable issues, FAA Section 3 applies and its relevant language “upon any issue referable to arbitration” is malleable and judges therefore retain considerable discretion to stay the entire case or only the claims and counterclaims that involve precisely the parties to and the claims asserted in the arbitration. To the extent the action is not brought upon an “issue referable to arbitration” — here, the CEO’s potential liability, and the CEO’s personal counterclaims against the Claimant/Plaintiff — a court might in some situations prudently stay everything, and in other situations might justifiably allow the non-arbitrable claim to move ahead even if this might generate evidence usable in the arbitration. Here it was the party who invoked arbitration in the first place that also invoked litigation, and the party asking to move ahead with the litigation could sensibly point to the long duration of the German arbitration and related German judicial proceedings and say that he should not be required to wait ad infinitum for an adjudication of his individual rights and duties.

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