When A Third Party (And Non-Party) Can Enforce An Arbitration Provision

arbitrationThe Northern District compelled arbitration of a multi-count fraud suit filed by a software company against a former salesman and his new employer in Paragon Micro, Inc. v. Bundy, 2014 WL 2441969 (N.D.Ill. 2014).

The ex-employee formed his own company and started steering business from his former employer.  The former employer sued for computer tampering, breach of fiduciary duty, unfair competition, and conversion.

The Independent Contractor Agreement signed by the defendant salesman said “any and all disputes” would be resolved by binding arbitration.  After the plaintiff refused defendants’ demand for arbitration, the defendants moved to compel arbitration.

Result: motion granted.

Reasons:

– The Federal Arbitration Act, 9 U.S.C. § 1 (FAA), reflects a liberal policy favoring arbitration agreements;

– Courts should enforce arbitration clauses unless they are tainted by fraud, duress, unconscionability or other standard contract defenses;

– The FAA permits a court to compel arbitration where there is (1) a written agreement to arbitrate; (2) a dispute covered by or within the scope of an arbitration agreement; and (3) a refusal to arbitrate;

– Federal courts rely on state contract formation rules in deciding whether parties agreed to arbitrate a particular issue and a party can be compelled to arbitrate only those issues he agreed to arbitrate;

– The party opposing arbitration agreement bears the burden of showing why the agreement is unenforceable;

– Any doubts concerning arbitration, should be resolved in favor of it;

– Contractual arbitration provisions survive termination of the contract unless the contract expressly states otherwise;

–   “arising out of”, “relating to” and “any and all” phrasing leads to a strong presumption of arbitrability.

(**3-5, 8).

Application:

The Court held that the contract’s arbitration clause applied to the plaintiff’s various claims against the defendants.  Finding that plaintiff’s Complaint allegations fell within the scope of the arbitration clause, the Court pointed to the arbitration clause’s applicability to “any and all disputes” connected to the individual defendant’s account representative duties.

The Court also found that the corporate defendant – a non-party to the Independent Contractor Agreement – could still enforce the arbitration clause against the plaintiff.

Under Illinois law, a non-party can require arbitration where (1) the plaintiff lodges claims against the non-party that reference a written agreement (that has an arbitration clause); and (2) when the plaintiff’s claims against the third party are factually intertwined with the claims against another party that did sign the contract.

Here, both non-party exceptions applied.  The plaintiff’s claims referred to a written agreement – the Independent Contractor Agreement –  and the allegations directed to the corporate defendant (non-party) were enmeshed with the plaintiff’s claims against the individual defendant (the account rep).

Finally, the court nixed the plaintiff’s waiver argument.  The Court cited case law that suggests that at least a several-month delay – from suit filing to the arbitration demand – is usually required for a party to waive an arbitration provision. (*10).

Afterwords:

This case illustrates that contractual arbitration clauses will be upheld where they are broad and clearly worded.  The presence of “any and all disputes” or “arising out of” verbiage will likely signal all-encompassing arbitration coverage. 

Non-parties can enforce an arbitration clause where they’re third-party beneficiaries of the contract or where the claims against the third party are factually connected to claims against a party that did agree to arbitration.

 

Consultant’s Quantum Meruit and Time-And-Materials Contract Claims Fail Against Contractor (IL 2d Dist)

Mostardi Platt Environmental, Inc. v. Power Holdings, LLC, 2014 IL App (2d) 130737-U shows the importance of clarity in contract drafting – particularly compensation terms.  The case also illustrates the crucial distinction between a time-and-expense (or time and materials) contract and a lump-sum payment contract.

Plaintiff was hired to perform environmental assessment services and to secure government permits for the defendant contractor who was building a gas facility in southern Illinois.  The parties’ original agreement was a time-and-expense contract and was later amended to a lump sum contract totaling about $100,000.

A dispute arose when the plaintiff realized that it underestimated the project’s scope and time commitment and sought additional monies from the defendant.  The defendant refused after the plaintiff failed to specify the needed extra work.  The plaintiff sued for damages and the defendant counterclaimed.  The trial court ruled against the plaintiff on all counts and for defendant on its counterclaim.

Held: Affirmed

Reasons:

The Court first rejected the consultant’s quantum meruit claim.  Quantum meruit is an equitable theory of recovery used by a party to obtain restitution for the unjust enrichment of the other party. 

Illinois law allows alternative pleading and quantum meruit is often pled as a fallback theory to a breach of contract claim.  It allows a plaintiff to recover the reasonable value of his work where there is no contract a contractual defect.  A quantum meruit claim can’t co-exist with an express contract. 

Here, the court found that the parties had an express contract – the environmental consulting agreement.  Because of this, the trial court properly denied plaintiff’s quantum meruit claim.  (¶¶ 75-78).

The Court also agreed that the plaintiff breached the consulting contract.  Under basic contract law, where parties reduce an agreement to writing, that writing is presumed to reflect the parties’ intent. 

The contract is interpreted as a whole and the court applies the plain and ordinary meaning of unambiguous contract terms.  A party who seeks to enforce a contract must establish “substantial performance” – that he substantially complied with the material terms of the agreement.  (¶¶ 81-82, 95).

The Court found that the plaintiff breached the contract in multiple respects.  Reading the original and amended consulting contracts together, the court found that the plaintiff was required but failed to provide itemized invoices for extra or “out-of-scope” work and also failed to complete its permitting tasks.  By walking off the job before it secured the required environmental permit, the plaintiff breached a material contract term. (¶¶  89-91).

The Court also rejected plaintiff’s impossibility defense, based on the claim that a substitute contractor (hired after the plaintiff walked off the job) changed the scope of the project and made it impossible for the plaintiff to perform.

Impossibility refers to situations where a contract’s purpose or subject matter has been destroyed; making performance impossible.  But the defense is applied sparingly since the purpose of contract law is to allow parties to freely allocate risks among themselves and a party’s performance should only be excused in extreme circumstances.  (¶ 97).

Finding no impossibility, the Court noted that the plaintiff only showed that the stated contract price was underbid and didn’t adequately compensate it for the needed extra work.  The Court held that impossibility of performance requires a litigant to show more than mere difficulty in performing or that he struck a bad bargain.  Performance must truly be rendered impossible due to factors beyond the party’s control.  ¶¶ 97-98.

 Take-aways: In the construction realm, some typical contractual compensation schemes include time-and-materials or time and expense, cost-plus arrangements or lump sum payment agreements.  Labeling a contract with the proper payment designation is critical; especially when a project’s scope and duration is uncertain.  This case makes it clear that in situations involving commercially sophisticated parties, a court will hold them to the clear language of their contract – even if has harsh results for one of the parties after the fact.  

Illinois Fraud Law, Corporate Opportunity Doctrine and Recoverable Damages – A Case Note

The Court also affirmed summary judgment on the plaintiff’s fraud claims against its former corporate President defendant in Star Forge, Inc. v. F.C. Mason Co., 2014 IL App (2d) 130527-U.  Plaintiff’s two-fold fraud claims were premised on (1) defendant misrepresenting to plaintiff the requirements of a big money contract involving John Deere so that a competitor of plaintiff’s got the contract and (2) defendant concealing his contractual relationship with different steel maker competitors.

In Illinois, fraud encompasses affirmative misrepresentations as well as omissions or concealment.  A fraud by omission plaintiff must show (1) defendant concealed a material fact under circumstances that created a duty to speak; (2) the defendant intended to induce a false belief, (3) the plaintiff could not have discovered the truth through reasonable inquiry or inspection, or was prevented from making a reasonable inquiry or inspection, (4) plaintiff relied on the defendant’s silence as a representation that the fact didn’t exist and (5) the concealed information was such that plaintiff would have acted differently had he been aware of it; and (6) plaintiff’s reliance resulted in damages.  (¶ 35).

Affirming the trial court’s fraud judgment for the plaintiff, the Second District held that the existence of a fiduciary relationship between plaintiff and defendant (the corporate President) obligated the defendant to apprise the plaintiff of material facts concerning the defendant’s other business dealings and that he violated this duty by hiding his financial interest in competing companies from the plaintiff.  The Court further found that the plaintiff established that its reliance on the defendant’s silence was equivalent to a representation that the defendant was not working for plaintiff’s competitors.  The plaintiff also showed that it would have acted differently in deciding which jobs to pursue with customers had it known the extent of plaintiff’s anti-competitive conduct and that plaintiff suffered damages as a result of its reliance on defendant’s silence.  (¶ 36).

The Court upheld the trial court’s damage award which equaled nine (9) years’ worth of compensation the plaintiff paid to the defendant during the time he was simultaneously representing both the plaintiff and competing steel companies.  In Illinois, a corporate officer who defrauds his company can be liable for the full forfeiture of compensation during the time he breaches his fiduciary duties or actively defrauds the company.   This is because a duty-breaching defendant isn’t entitled to compensation for the time span that he acts adversely to his employer’s interests.  The purpose of this damage rule is to deprive the wrongdoer of gains resulting from his breach of fiduciary duty.   A corporate plaintiff can recover both the compensation it paid to an unfaithful fiduciary as well as lost profits from competitors who benefitted from the fiduciary’s faithless conduct.  (¶ 48).(¶¶ 45-46, 48).

The Court rejected defendant’s set-off argument too: that plaintiff’s damages should be reduced or “set off” by the amount the plaintiff received from the settling corporate defendants.  But the Court refused to reduce plaintiff’s damages (lost profits against the corporate defendants plus the compensation paid out to the individual defendant) because the plaintiff’s injuries caused by the individual defendant differed from those caused by the corporate defendants.

The injury sustained as a result of the individual defendant’s (the corporate President) conduct was the loss of his impartial and undivided services during the time he was a corporate officer.  In contrast, the injury resulting from the corporate competitors’ conduct was the lost profits that the individual defendant steered away from the plaintiff and toward the competitors.

Afterword: This case shows that a fraud and breach of fiduciary duty plaintiff – at least in the corporate officer context – can recover both (1) compensation paid to the officer for the time span covering his breach as well as (2) lost profits against the competing businesses that reaped the benefits of the officer’s conduct.  It also illustrates that there is often factual overlap between breach of fiduciary duty claims and fraud claims against a corporate agent that violates his obligations of business loyalty to his corporate employer.