Opinion
1:02cv24-T
April 23, 2002
MEMORANDUM AND RECOMMENDATION
THIS MATTER is before the court upon defendants' Motion to Compel Arbitration and to Stay the Proceedings. The undersigned has considered defendants' motion and brief, plaintiff's response, and defendants' reply.
FINDINGS AND CONCLUSIONS
I. Background
A. The Complaint
Plaintiff filed this action on January 28, 2002, pursuant to this court's original jurisdiction over federal questions. 28 U.S.C. § 1331. According to the allegations of the complaint, this matter arises under 15, United States Code, Section 78J, and SEC Rule 10b-5. In such complaint, plaintiff asserted causes of action for (1) securities fraud and (2) breach of contract.
In his first cause of action for securities fraud, plaintiff contends that he entered into a stock-purchase/capital-contribution agreement ("purchase agreement") with defendants. Complaint, ¶ 17. In accordance with the terms of the purchase agreement, plaintiff exchanged all of his interest in his own outdoor-advertising company for one "Class E Unit" in defendant PNE Media Holdings, LLC ("PNE"), which appears to be an outdoor-advertising conglomerate. Complaint, ¶ 18. The "Class E Unit" was authorized and issued to plaintiff pursuant to the "sixth amendment" to defendants' "LLC Operating Agreement." Id. According to plaintiff, Article 7 of the LLC Operating Agreement made his Class E Unit negotiable and entitled him to distributions. Plaintiff further alleges that PNE is a member-managed LLC, but while a member of the LLC, he was never made a member of the "Board of Managers," which maintains exclusive control over the affairs of PNE. Complaint, at ¶¶ 19-20.
Plaintiff further contends that the Class E Unit that he owns is a security subject to the Securities Exchange Act of 1934 and that the purchase agreement is an investment contract that is governed by the Act, making both the agreement and the security issued subject to the rules of the Commission, including Rule 10b- 5. Complaint, at ¶¶ 21-22. In addition, plaintiff claims that the consideration he gave for his interest in defendants' company, i.e., his stock in Able Outdoor, Inc., is also subject to the Act and the same rules.
It is plaintiff's contention that the individual defendants, who are alleged to be managing members of the LLC, committed securities fraud by violating SEC Rule 10b-5 by and through the making of false and misleading representations concerning the financial condition and stability of PNE on which plaintiff allegedly relied when he entered into the alleged investment contract and purchased the alleged security offered. Plaintiff outlines 13 omissions of alleged material fact that he contends should have been disclosed by defendants. See Complaint, at ¶ 37. Plaintiff claims he has suffered damages in excess of 1.7 million dollars.
In his second cause of action for breach of contract, plaintiff alleges that PNE failed to make the distribution allegedly required by Section 7.2.2.5 of Article 7 of the LLC Operating Agreement. Plaintiff claims that PNE sold the "Able division" to a third-party, thereby triggering his entitlement to a distribution under the agreement. According to plaintiff, that failure to make payment in accordance with the agreement was a material breach, entitling him to damages in the amount of 1.7 million dollars.
B. The Motion to Compel Arbitration and to Stay the Proceedings
On March 15, 2002, defendants filed their Motion to Compel Arbitration and to Stay the Proceedings, contending that the parties were bound by the terms of their agreement to arbitrate any dispute in Boston, Massachusetts. Defendants argue in their supporting memorandum that plaintiff is obligated to submit both of his claims to binding arbitration pursuant to the terms of the LLC Operating Agreement, which provides in relevant part, as follows:
[A]ny controversy or dispute arising out of this Agreement, the interpretation of any of the provisions hereof, or the action or inaction of any Member hereunder shall be submitted to arbitration in Boston, Massachusetts before the American Arbitration Association. . . .
LLC Operating Agreement, at § 17.5. Defendants contend that plaintiff subjected himself to the terms of such agreement upon his execution of the sixth amendment thereto, which made him a member of the LLC, and that the agreement is enforceable in this forum in accordance with 9, United States Code, Sections 1, et seq., the Federal Arbitration Act ("FAA").
C. Plaintiff's "Notice of Partial Voluntary Dismissal"
In what appears to be an initial response to defendants' motion to enforce the agreed-to arbitration, plaintiff filed a "Notice of Partial Voluntary Dismissal Without Prejudice," citing Rule 41(a)(1)(i), Federal Rules of Civil Procedure. Through such pleading, plaintiff attempted to dismiss his claim for breach of contract. In Gahagan v. North Carolina Hwy. Patrol, 1:00cv52 (W.D.N.C. Oct. 25, 2000), the district court held, as follows:
Rule 41 . . . speaks only to the dismissal of "actions." Plaintiff does not seek, at this juncture, to dismiss the entire action; rather, as stated supra, he wishes to dismiss certain claims within this action . . . . Rather than a Rule 41 dismissal, the Plaintiff should seek to amend his complaint by meeting the requirements of Rule 15. "A plaintiff wishing to eliminate particular claims or issues from the action should amend the complaint under Rule 15(a) rather than dismiss under Rule 41(a)." Moore's Federal Practice 3d, § 41, 21[2] (citing Skinner v. First Am. Bank of Virginia, 64 F.3d 659 (table), 1995 WL 507264 (4th Cir. 1995).
Id., at 3-4 (citations omitted). Based on the decision in Gahagan, it would appear that plaintiff's "Notice of Partial Voluntary Dismissal" is ineffectual, because it sought to dismiss less than the action in its entirety.
To aid the parties and further review, the undersigned has attached to this Memorandum and Recommendation a copy of the district court's decision.
II. Discussion
A. Summary Finding
Assuming that the plaintiff's attempted partial dismissal has no effect, defendants' Motion to Compel Arbitration and to Stay the Proceedings should be summarily granted, for there is no doubt that plaintiff's breach-of-contract claim arises out of the LLC Operating Agreement, which contains the binding arbitration agreement.
B. Alternative Findings
Assuming that the district court would allow plaintiff an opportunity to correct his procedural misstep by filing an appropriate amendment to his complaint that eliminates the second cause of action, the questions become complex: Absent the breach-of-contract claim, is plaintiff's claim of securities fraud subject to binding arbitration anticipated by the parties in the LLC Operating Agreement? If so, can this court require the parties to arbitrate in a forum outside this district?
1. Stay Pending Arbitration
Without doubt, the chicken came before the egg in this case. First, the parties entered into a purchase agreement on February 3, 1999. Nine days later, on February 12, 1999, the purchase agreement was consummated when plaintiff executed the sixth amendment to the LLC Operating Agreement and thereby became a member of the LLC and received his Class E Unit in exchange for his interest in Able Outdoor, Inc.
In the context of an arms-length transaction, this court does not hesitate to enforce a bargained-for arbitration agreement. Indeed, prompt court enforcement of arbitration agreements is the linchpin of Title 9, United States Code, Section 2.
Although the arbitrability of disputes is governed by Title 9, the initial question for this court is whether the arbitration provision asserted has any relation to plaintiff's claim of securities fraud. Section 2 of Title 9 governs the effect of a IV contractually agreed-upon arbitration provision," but state law prevails on general principles concerning contract formation. Supak Sons Mfg. Co., Inc. v. Pervel Indus. Inc., 593 F.2d 135 (4th Cir. 1979). In the 20 years since Supak, both the United States Supreme Court and the Court of Appeals for the Fourth Circuit have indicated a strong preference for arbitration:
Whether a party has agreed to arbitrate an issue is a matter of contract interpretation: "[A] party cannot be required to submit to arbitration any dispute which it has not agreed so to submit." Nevertheless, the Supreme Court has announced its "Healthy regard for the federal policy favoring arbitration" and has explained that the Federal Arbitration Act . . . "establishes that, as a matter of federal law, any doubts concerning the scope of arbitrable issues should be resolved in favor of arbitration, whether the problem at hand is the construction of the contract language itself or an allegation of waiver, delay, or a like defense to arbitrability."
American Recovery Corp. v. Computerized Thermal Imaging, Inc., 96 F.3d 88, 92 (4th Cir. 1996) (quoting United Steelworkers of America v. Warrior Gulf Navigation Co., 363 U.S. 574, 582 (1960), and Moses H. Cone Memorial Hosp. v. Mercury Constr. Co., 460 U.S. 1, 24-25 (1983)). Interpretation of the contract is governed by state law, and federal law requires that ambiguities or doubts in a contract be construed in favor of arbitration. McKee v. Home Buyers Warranty Corp. II, 45 F.3d 981, 984 (5th Cir. 1995).
North Carolina substantive law reveals that it takes very little to create a valid arbitration contract. In Howard v. Oakwood Homes, Inc., 516 S.E.2d 879 (N.C.App. 1999), the North Carolina Court of Appeals held, as follows:
We note at the outset that North Carolina "`has a strong public policy favoring the settlement of disputes by arbitration,'" and that "[o]ur Supreme Court has held that where there is any doubt concerning the existence of an arbitration agreement, it should be resolved in favor of arbitration." Martin v. Vance, ___N.C. App. ___, ___ 514 S.E.2d 306, 309 (1999) (citing Johnston County v. R.N. Rouse Co., 331 N.C. 88, 91-92, 414 5.E.2d 30, 32 (1992)). Although arbitration is favored in the law, in order to be enforced, the underlying agreement must first be shown to be valid as determined by a common law contract analysis. Routh v. Snap-On Tools Corp., 108 N.C. App. 268, 423 S.E.2d 791 (1992). . . .
Id., at 881. In Arrants v. Buck, 130 F.3d 636 (4th Cir. 1997), the Court of Appeals for the Fourth Circuit, held, as follows:
Even though arbitration has a favored place, there still must be an underlying agreement between the parties to arbitrate. Courts decide whether there is an agreement to arbitrate according to common law principles of contract law.
Without the contract claim, plaintiff argues, the remaining claim is not subject to arbitration, because it arises out of the purchase agreement, not the LLC Operating Agreement that contains the arbitration agreement. Applying fundamental contract law, the court has looked to the four corners of the agreement to determine its scope. The agreement to arbitrate applies in three situations:
(1) "any controversy or dispute arising out of this [LLC Operating] Agreement";
(2) "the interpretation of any of the provisions" of the LLC Operating Agreement; and
(3) "the action or inaction of any Member" of the LLC.
The court must construe the terms of the agreement "in such as manner as to favor arbitration." Millar v. Reliaster Life Ins. Co., 157 F. Supp.2d 645, 647 (W.D.N.C. 2000).
Other than the fact that the purchase agreement and the LLC Operating Agreement were executed on different days, the court can discern little distinction between the two, inasmuch as each is dependent upon the other. The purchase agreement specifically provides that plaintiff will be acquiring an "equity interest" in the LLC, the LLC Operating Agreement is referenced to define the "equity interest" that plaintiff will acquire, and the "Class E Unit" was issued to plaintiff pursuant to the sixth amendment to the LLC Operating Agreement. It is clear that the purchase agreement would have little meaning, absent the LLC Operating Agreement, making the two instruments one agreement among the parties. Nowhere is this better shown than in paragraph 25 of the complaint, wherein plaintiff alleges that as "an inducement to enter into the Purchase Contract and to accent the Class E Unit in exchange for all his shares of Able, the Defendant PNE, through its officers and managers . . . made representations to the Plaintiff. . . ." Complaint, at ¶ 25 (emphasis added). The undersigned finds that the emphasized language in the complaint is but another way of stating the "sixth amendment to the LLC Operating Agreement." Further, as a basis for his remaining claim, plaintiff specifies in separate paragraphs of his claim that the purchase contract, the "Class E Unit", and the stock he traded for such interest were all securities and were all subject to the requirements of Rule 10b-5. Reading the broad language of the arbitration agreement "in a manner as to favor arbitration," Millar, supra, the undersigned must find that the claim of securities fraud is a "controversy or dispute arising out of this [LLC Operating] Agreement." Finally, there is no doubt that this is an action against members of the LLC and, as such, must be arbitrated in accordance with the agreement as to the individual defendants without reference as to which agreement such claims fall under. The undersigned, therefore, will recommend that this matter be stayed in accordance with Section 3 of the FAA.
2. Extra-District Enforcement of Forum Selection for Arbitration
Finally, the undersigned can find no rational basis for finding that this district lacks the authority to compel plaintiff to arbitrate this matter in another district. Section 4 of the FAA clearly allows any federal court to compel arbitration in whatever forum to which the parties have agreed, regardless of whether such forum is within or without the district in which the court sits. Dupuy-Busching General Agency, Inc. v. Ambassador Ins. Co., 524 F.2d 1275 (5th Cir. 1975). Section 4 provides, as follows:
A party aggrieved by the alleged failure, neglect, or refusal of another to arbitrate under a written agreement for arbitration may petition any United States district court which, save for such agreement, would have jurisdiction under Title 28, in a civil action or in admiralty of the subject matter of a suit arising out of the controversy between the parties, for an order directing that such arbitration proceed in the manner provided for in such agreement. Five days' notice in writing of such application shall be served upon the party in default. Service thereof shall be made in the manner provided by the Federal Rules of Civil Procedure. The court shall hear the parties, and upon being satisfied that the making of the agreement for arbitration or the failure to comply therewith is not in issue, the court shall make an order directing the parties to proceed to arbitration in accordance with the terms of the agreement. The hearing and proceedings, under such agreement, shall be within the district in which the petition for an order directing such arbitration is filed. If the making of the arbitration agreement or the failure, neglect, or refusal to perform the same be in issue, the court shall proceed summarily to the trial thereof. If no jury trial be demanded by the party alleged to be in default, or if the matter in dispute is within admiralty jurisdiction, the court shall hear and determine such issue. Where such an issue is raised, the party alleged to be in default may, except in cases of admiralty, on or before the return day of the notice of application, demand a jury trial of such issue, and upon such demand the court shall make an order referring the issue or issues to a jury in the manner provided by the Federal Rules of Civil Procedure, or may specially call a jury for that purpose. If the jury find that no agreement in writing for arbitration was made or that there is no default in proceeding thereunder, the proceeding shall be dismissed. If the jury find that an agreement for arbitration was made in writing and that there is a default in proceeding thereunder, the court shall make an order summarily directing the parties to proceed with the arbitration in accordance with the terms thereof.
Based on his reading of Section 4, plaintiff argues that the FAA prohibits a district court from enforcing a forum-selection provision where that provision provides for arbitration in another federal judicial district.
In addition to the case law discussed by the respective parties in their briefs, the Court of Appeals for the Fourth Circuit has likewise held that "if a court orders arbitration, the arbitration must be held in the same district as the court." Elox Corp. v. Colt Industries, Inc., 952 F.2d 395 (up), 1991 WL 263127, at 1 (4th Cir. 1991) (citations omitted). In the cases cited in support of plaintiff's argument and in Elox, it was plaintiffs that brought the actions in district court under Section 4 to compel defendants to participate in arbitration. As in the cases cited by these defendants in their reply, where the motion to compel arbitration is raised by defendants in response to a lawsuit that seeks to avoid the obligation of arbitration, courts have consistently enforced arbitration, even where the arbitration was to be held outside that district. See Dupuy-Busching General Agency, Inc., supra.
Inasmuch as all parties are represented by counsel, the undersigned has provided full-text references to citations of "unpublished" appellate decisions rather than attach copies of such opinions.
Read in such a context, the Act simply requires a party that files an action seeking declaratory relief under Section 4 to file the action in the forum in which the arbitration is to be conducted. To extend such requirement to motions to compel filed by defendants, who have been brought into court in contravention of the arbitration agreement, would create a quagmire for courts, penalize the parties attempting to enforce arbitration, and unnecessarily frustrate the purpose of the Act. Indeed, to do so would offend traditional notions of equity by encouraging and providing a safe harbor to those seeking to avoid their obligations of arbitration. The undersigned can find no reason to extend the Section 4 requirement to parties other than those seeking affirmative relief under Section 4 as plaintiffs.
Finally, reading the Act in the manner suggested by plaintiff would require this court to determine that it fundamentally lacks the power to compel a party that has voluntarily subjected itself to the court's jurisdiction to participate in extra-judicial arbitration. Such a reading would be contrary not only to the broad jurisdiction afforded under Article III, Section 2, of the United States Constitution, but also to case law that requires district courts to defer to the terms of arbitration agreements, including forum-selection clauses, and to case law that finds district courts have the authority to compel arbitration not only outside the district, but also outside the country. In Elox Corp., supra, the Court of Appeals for the Fourth Circuit held, as follows:
Article III, Section II, of the United States Constitution provides, in relevant part, as follows: "The Judicial Power shall extend to all Cases, in Law and Equity, arising under this Constitution, the Laws of the United States, and Treaties made, or which shall be made, under their Authority;—to all cases affecting Ambassadors, other public Ministers and Consuls;—to all Cases of admiralty and maritime Jurisdiction;—to Controversies to which the United States shall be a Party;—to Controversies between two or more States;—between a State and Citizens of another State;—between Citizens of different States;—between Citizens of the same State claiming Lands under Grants of different States, and between a State, or a Citizen thereof, and foreign States, Citizens or Subjects."
The Federal Arbitration Act provides that a district court deciding a motion to compel arbitration shall defer to the terms of the parties' agreement. 9 U.S.C. § 4. The district court must, therefore, apply a forum selection clause contained in the agreement if such a clause exists.
Id. (citations omitted). In addition, the Court of Appeals for the Fourth Circuit has held that the Act "expressly authorizes a district court to order arbitration outside of the United States," Silkworm Screen Printers, Inc. v. Abrams, 978 F.2d 1256 (up), 1992 WL 317187, at 4 (4th Cir. 1992), pursuant to a forum-selection clause. See 9 U.S.C. § 206.
The undersigned, therefore, will recommend that the district court compel plaintiff to arbitrate his claims in the agreed-to forum, which is Boston, Massachusetts. In the alternative, if the district court finds that Section 4 prohibits compelling arbitration extrajudicially where a defendant moves to compel arbitration, the undersigned would recommend that this action be transferred to the United States District Court for the District of Massachusetts for further consideration.
RECOMMENDATION
IT IS, THEREFORE, RESPECTFULLY RECOMMENDED that defendants' Motion to Compel Arbitration and to Stay the Proceedings (#7) be ALLOWED in its entirety for all of the reasons discussed above.
IT IS ALTERNATIVELY RECOMMENDED that if the district court finds that Section 4 prohibits compelling arbitration extrajudicially where a defendant moves to compel arbitration, this action be TRANSFERRED to the United States District Court for the District of Massachusetts for further consideration.
The parties are hereby advised that, pursuant to 28, United States Code, Section 636(b)(1)(C), written objections to the findings of fact, conclusions of law, and recommendation contained herein must be filed within ten (10) days of service of same. Failure to file objections to this Memorandum and Recommendation with the district court will preclude the parties from raising such objections on appeal. Thomas v. Arn, 474 U.S. 140 (1985), reh'g denied, 474 U.S. 1111 (1986); United States v. Schronce, 727 F.2d 91 (4th Cir.), cert. denied, 467 U.S. 1208 (1984).