You Can Be Compelled to Arbitrate Based on an Agreement You Didn’t Sign

As a general rule, parties cannot be forced to arbitrate a dispute unless they signed a clear and binding agreement to arbitrate. However, a recent decision issued by New York County Commercial Division Judge Barry Ostrager reminds litigants that parties, who invoke the benefits of an agreement requiring arbitration, may, in fact, be compelled to arbitrate even if they are not signatories to that agreement.

In 2004 Parker Family LP v. BDO USA LLP, 2020 Slip Op 50614(U), plaintiffs, the investors in certain funds that sustained substantial losses, sued the funds’ auditors. The investors alleged that the auditors were negligent in their preparation of the annual audits, aided and abetted the fund’s managers’ breach of fiduciary duty and, finally, failed to meet their contractual obligation to audit the funds properly, thereby breaching their contractual obligations. The investors alleged that they were “third-party beneficiaries” of the engagement letters, i.e., the contracts, between the funds and the auditors for the annual audit services.

The auditors moved to compel arbitration. They argued that the investors’ claims – that they were third-party beneficiaries to the contracts – bound them to the contractual obligation to arbitrate any and all disputes that “arose out of” or were “related to” those contracts – even though they were not signatories. The investors, on the other hand, relied on the general principle that a party who does not sign an agreement to arbitrate cannot be compelled to do so.

Applying the direct-benefits theory of estoppel, the Court held that because the investors’ claims centered upon benefits they should have received as beneficiaries of the auditors’ obligations as set forth in the engagement letters (i.e. accurate audit reports), the investors sought “direct benefits” of those engagement letters. Based upon this, the investors were required to comply with all of the obligations of those engagement letters, including the requirement to arbitrate. Quoting the New York Court of Appeals case of God’s Battalion of Prayer Pentecostal Church, Inc. v. Miele Assocs., LLP, 6 NY3d 371, 374 (2006), the Court noted that the investors “may not pick and choose which provisions [of the engagement letters] suit its purposes,” and which do not. In other words, since the investors invoked those contracts to enforce their own rights, they could not selectively disclaim the arbitration clause contained in those contracts. They were “estopped” from doing so.

The decision principally highlighted the third-party beneficiary breach of contract claim. Notably, however, even with respect to the tort claims asserted, the Court observed that since the underpinning of those theories similarly relied upon the duties that were created by the engagement letters, arbitration of those claims must also be compelled.

A simple review of the docket in 2004 Parker Family LP reveals that significant time (and no doubt, the client’s money) was expended in the Commercial Division only to end up in an arbitration to start all over again.

The moral of the story is this: Be very careful with third-party beneficiary claims as you might be required to arbitrate based on the underlying contract to which you are not a party.