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The California Court of Appeals held that a derivative action brought by a company shareholder on behalf of the company was subject to arbitration because the company was a third-party beneficiary of the agreement containing an arbitration clause.
In Oviedo v. Grace, No. B188018, 2007 WL 316519 (Cal. Ct. App. Feb. 5, 2007), Oviedo and ten other people, including Grace and Rotondo, owned a limited liability company called Pacific Imaging. Each member of the company (i.e., each shareholder) signed an operating agreement that contained an arbitration clause.
After receiving phone calls from several creditors, Oviedo investigated the company's finances. His investigation led him to believe that Grace and Rotondo were deliberately mismanaging Pacific Imaging for personal gain.
Accordingly, Oviedo brought a derivative action on behalf of Pacific Imaging against Grace and Rotondo, alleging breach of contract and several other causes of action. In a derivative action, the shareholder or owner stands in the company's shoes.
Grace and Rotondo moved to compel arbitration pursuant to the operating agreement. In opposing the motion, Oviedo argued that Pacific Imaging was not bound by the arbitration clause because it did not sign the operating agreement. The trial court denied the motion.
On appeal, the Court held that Pacific Imaging was bound by the arbitration provision under the principles of agency law. Specifically, the Court reasoned that Pacific Imaging could not sue for a breach of contract claim unless it were a party to the operating agreement or a third-party beneficiary, and under California law, an arbitration clause may be enforced against a third-party beneficiary of the underlying contract.
While there are numerous cases allowing nonsignatories to enforce arbitration agreements, this case presents the inverse scenario whereby an arbitration agreement is enforced against a nonsignatory. This scenario is decidedly less common because the doctrine of equitable estoppel – the predominant theory for allowing a nonsignatory to enforce an arbitration agreement – is not universally regarded as a basis for enforcing arbitration agreements against a nonsignatory. See Legacy Wireless Services, Inc. v. Human Capital, L.L.C., 314 F.Supp.2d 1045, 1056 (D. Or. 2004).
As an alternative to equitable estoppel, some courts rely on direct-benefits estoppel as a basis for ordering nonsignatories to arbitrate. See, e.g., Wood v. PennTex Resources, L.P., 458 F.Supp.2d 355 (S.D. Tex. 2006). This form of estoppel is similar to the third-party beneficiary approach used by the Court in this case insofar as both rest on the principle that a party cannot claim the benefits of a contract and still avoid its obligations.
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