A federal district court in New York has refused to compel a non-signatory law firm to arbitrate a claim by another firm to share attorney's fees under either the direct estoppel or de facto merger exceptions to the general rule of arbitrability.

In Barrack, Rodos & Bacine v. Ballon Stoll Bader & Nadler, P.C., No. 08 Civ. 02152, 2008 WL 759353 (S.D.N.Y. Mar. 20, 2008), law firm Barrack, Rodos & Bacine (BRB) hired attorney Gershon, who had previously been of counsel to another firm, Ballon, Stoll, Bader & Nadler (BSBN). While he was with BSBN, Gershon originated a case that eventually settled after he was hired by BRB. Since BRB had negotiated the settlement, BRB was paid the attorney's fees awarded under the settlement agreement.

BSBN filed suit to enjoin BRB from distributing the fees until BSBN's interest in the fees was determined, but the request was denied. BSBN then filed an arbitration demand with the American Arbitration Association (AAA) against BRB, seeking a determination of fees owed. BRB objected to arbitration, claiming it was not a party to the arbitration agreement between BSBN and Gershon. The AAA responded by stating that the arbitration would proceed barring a court order.

From the start of the arbitration proceedings, BRB renewed its objections to the arbitrator's jurisdiction. Eventually, the arbitrator determined that BRB was bound by the arbitration agreement under the theory that there was a de facto merger of Gershon's former independent professional practice and BRB. BRB then filed an action seeking a preliminary injunction to prohibit the arbitration from proceeding with BRB as a party.

The Court found there was no clear and unmistakable evidence that BRB agreed to have the arbitrator determine arbitrability. The Court stated that BRB's delay in seeking an injunction and its participation in the proceedings did not constitute a waiver of the right to object, since it renewed its objections to the arbitrator's authority at every stage. Therefore, absent a clear statement or waiver, the Court held that it retained the authority to determine whether BRB was bound to arbitrate as a non-signatory.

Moreover, the Court determined that a preliminary injunction was warranted. It noted that a party forced to arbitrate in the absence of a valid agreement suffers irreparable harm if an injunction is not granted.

The Court also found that BRB would likely succeed on the merits, since it could not be bound as a non-signatory under either a direct estoppel or de facto merger theory. Since BRB only experienced an indirect benefit through the disbursement of fees to the firm, there was no direct benefit to BRB of the type necessary to trigger direct benefits estoppel.

Furthermore, the facts failed to show the necessary continuity of ownership to apply the de facto merger exception, since BRB merely purchased the assets of Gershon's former professional practice and did not grant Gershon any property interest in BRB as consideration.