Let’s say that investors gets into an alleged tax shelter, the shelter blows up causing losses, and the investors bring a class-action lawsuit against the promoter. The promoter, in its defense to the attempted class-action certification, alleges that each investor signed a contract when they got into the deal which says that any disputes will be resolved in arbitration, i.e., each investor’s case will have to be decided one-by-one in arbitration proceeds, and not en masse through a class-action lawsuit. Will such arbitration provisions stand up?
At least under the specific facts of one case, Shivkov v. Artex Risk Solutions, Inc., full citation at the bottom of this article and a link to the Order, the U.S. District Court for the District of Arizona has answered this question in the affirmative.
I previous wrote about the Shivkov class-action complaint in my article, Class Action Targets Arthur J. Gallagher & Co. Over Captive Insurance Tax Shelter, December 10, 2018. In a nutshell, a bunch of folks unhappy with their risk-pooled 831(b) captive insurance arrangements that were managed by a Gallagher subsidiary, Artex, brought a class-action complaint to certify all the similarly-situated captive owners (likely, in the hundreds) into a class so as to prosecute their claims against Gallagher, Artex, and related persons for alleged negligence and a Caesars’ buffet of other wrongs, in relation to their risk-pooled 831(b) captive insurance companies.
The agreements signed by the captive owners (or at least the putative class representatives) against Artex contained the following arbitration clause:
You and we agree that in the event of any dispute that cannot be resolved between the parties, that we will agree to seek to resolve such disputes through mediation in Mesa, Arizona, and if that fails, that all disputes will be subject to binding arbitration in Mesa, Arizona, with arbitrators to be agreed upon by the parties, and if no agreement is reached, then arbitrated by the American Arbitration Association (AAA). Each party shall bear its own costs in such mediation and arbitration. To reduce time and expenses, we each waive our right to litigate against one another regarding the services provided and obligations pursuant to this Agreement, and instead you and we have chosen binding arbitration. All claims or disputes will be governed by Arizona law.
Artex moved to compel arbitration, the plaintiffs filed oppositions, and this brouhaha resulted in the Order which I shall next relate.
The Court first noted that the Federal Arbitration Act (“FAA”, not to be confused with the Federal Aviation Administration whose unofficial motto is known to pilots and frequent fliers as “We’re not happy until you’re not happy“) controls whether in interstate commerce — very broadly defined — such arbitration agreements will be enforced.
Under the FAA as it has been interpreted by the courts generally, arbitration is a contractual matter which is enforceable just like any other contractual matter. However, the FAA also promotes the use of arbitration as opposed to tying up the federal courts with civil litigation, so whenever there is a close-call as to whether something should go to arbitration or not, it goes to arbitration. The FAA sets up what amounts to a two-part test:
(1) Is there an arbitration agreement between the parties?
(2) Does the agreement cover the dispute?
Here, a court is to look only at these two questions and ignore the rest of the merits of the case unless they touch upon one or both of these issues, i.e., even the most egregious, horrifying and fattening case will go to arbitration if both of these questions are answered “yes”. If arbitration is required, then the rest of the case is stayed pending the arbitration (basically, until the victorious party registers the arbitration judgment).
Since they clearly signed the arbitration agreements, the plaintiff attempted to get around the arbitration agreement by arguing that Artex’s breach of fiduciary duty somehow vitiated the arbitration clause. While there was certainly sufficient allegations that Artex had breached its fiduciary duties in regard to the management of the plaintiffs’ captives, there were not sufficient allegations that Artex had breached those duties in getting the plaintiffs to sign the arbitration agreements, which is quite different.
Which is to say that there are well-accepted ways for plaintiffs to get around arbitration agreements, such as when a party suborns another party’s attorney who blessed the agreement by backdoor payments, etc., such as what happens when a tax shelter promoter kicks back some dough to the referring attorney who then also reviews the agreement. But the plaintiffs here did not show those sorts of facts.
Instead, the plaintiffs took a path that was somewhat sophomorish, such as by claiming that their clients were “rushed” into signing their agreements with Artex (never much of a defense; if it is important, you’d better take the time to read it), or, horror-of-horrors, the Artex agreements were about a dozen pages long and single-spaced. Maybe there are some jurisdictions out there where such an argument will take flight, but in federal court that won’t even back up from the terminal. A similarly weak argument was that the arbitration agreement was obscure and essentially buried deep in the Artex contract; again, not much of a defense since parties to a commercial transaction are presumed to read such contracts carefully and understand their terms.
The plaintiffs did have a more compelling argument, which was that Artex’s unconscionably attempted in its agreements to limit its liability to only its gross negligence — a very hard standard to meet. The problem here, however, was that this limitation of liability provision didn’t go to the arbitration agreement and there was no proof that the arbitration agreement itself was unconscionable. This goes back to the FAA, which basically says that the Court is to focus only upon the arbitration agreement to the exclusion of all other things that do not more-or-less directly relate to the arbitration agreement.
Finally, the plaintiff argued that because their agreement with Artex had terminated, the arbitration agreement also terminated. The Artex contract contained, however, a survival provision for certain duties and obligations and there is a wealth of case law out there which posits to the effect that an arbitration agreement for disputes arising out of an agreement will survive such a termination.
The arbitration agreement was thus valid, and it did not take the Court much time to next determine that the plaintiff’s claims were covered by that agreement, since they fell into the category of any dispute arising from the Artex contracts; stated differently, the plaintiffs would not have had any relationship with Artex at all that they could sue under in the absence of the Artex contract.
But hold on! Only Artex had an arbitration agreement with the plaintiffs; how about the other defendants besides Artex? Under the FAA, and if local state law allows, a defendant who is not a party to the arbitration agreement can likewise compel arbitration as if they had themselves been such a party. The local law, that of Arizona, so allows. Thus, all the defendants got the benefit of compelling arbitration, and not just Artex.
Having determined that there was an arbitration agreement and that the agreement covered the subject matter of the dispute, the Court next held that each individual case would have to go before arbitration individually, i.e., there would not be anything like a “class-action arbitration”. This was largely because Artex and the plaintiff had agreed to American Arbitration Association (“AAA”) rules, which requires such arbitrations to be conducted individually in the absence of an agreement to have a class-action, and here of course there was no mandate to a class-action arbitration.
Thus, the plaintiffs have now been shuffled off to arbitration where their cases will be decided one-by-one, and their cases stayed pending that arbitration.
There is not doubt that this is a big procedural win for Artex, Gallagher and the rest of the defendants, for the reason that probably quite a few of their clients will decide not to “throw good money after bad” in pursuing arbitration, and for even the ones who do proceed to arbitration, awards there are usually much smaller than those which can be obtained in jury trials.
So, the ruling is a good thing for the captive manager, but not so much for the captive owner. Folks in the captive industry should do some hard thinking about which is more important. On the other hand, there is little doubt that class action lawsuits often benefit the lawyers much more than individual plaintiffs: The lawyers get a thick cut of prime rib, but each client gets no more than a stale dinner roll.
But, hey, these captive owners knew or should have known what they were getting into when it came to having to arbitrate disputes, since they had an opportunity to read the contracts and determine what rights they had or didn’t have. Notably, the folks who signed these contracts were inherently sophisticated business people, or at least sophisticated enough to set up their own insurance company for their businesses (which is pretty sophisticated indeed). So, it is not like Artex snookered something past a bunch of folks not capable of looking out for themselves, single-spaced lines notwithstanding.
The hard truth is that the Artex clients simply looked past all the disadvantages for what they saw it all as little more than “Want some tax breaks? Sign here.” Then, they couldn’t sign fast enough, and didn’t bother to have some knowledgeable lawyer carefully look over these agreements to see what their rights were or were not in the event of a dispute. Like so many other business deals, since no dispute is expected, why bother?
Once again, we see that all the boilerplate stuff found in agreements does indeed mean something and is enforceable by one party against another. There is a reason that lawyers load agreements up with boilerplate: It works. One looking at a contract cannot merely go over the important deal points, and call it Miller Time, for the difference in the outcome based on the boilerplate can be tremendous.
This does not mean that arbitration agreements always stand up, but it takes a lot of work to do so and a litigator involved in one of these cases can’t just wing it stock arguments and pray the arbitration stuff will go away. I’ve actually gotten past an arbitration provision in a psuedo-captive case (Scolari v. Bancroft), but that took extraordinary research and effort, real burning-the-candle at 4:00 a.m. while looking at hundreds of court opinions type of stuff. Few of the other litigants against that particular defendant were so lucky as to squeak past the arbitration clause. What it takes is a lot of research and a lot of development of the facts before you even get to that dispute; if you are not willing to put that sort of effort in, don’t expect to get past the arbitration clause.
But it should be recalled that this is only a preliminary procedural win for Artex, and it will still have to defend itself in arbitration proceedings against the clients who go through with it. Presumably, the next important legal issue will be whether Artex’s attempt to limit liability to gross negligence will itself stand up (it probably will); again, that will take a lot of hard research and factual development to get around and you can’t just “mail it in” and expect a win.
Anyhow, the real unspoken lesson here is to simply avoid such clauses in contracts whenever possible, or at least try to negotiate them out or limit their impact. The same is true for limitation of liability clauses. Often, the other side will want the deal every bit as badly as you do (which is why you came to an agreement in the first place, unless one of you was just goofy), and so at that stage there is time for give-and-take negotiations. There is a good reason that some talented lawyers get paid a lot of money to review contracts and negotiate the minutiae of their terms, although their value may not become apparent until there is a dispute.
But once the contract is signed, baby, it’s over. You got your deal, now you live with it. If you didn’t protect yourself, that’s your own fault and nobody else’s, and the courts even back to the days of ancient Roman law will not upset an agreement that has been made in the absence of fraud or something much more egregious than standard boilerplate in a typical captive insurance company management contract.
Caveat emptor, redux.
Order dated August 5, 2019, Shivkov v. Artex Risk Solutions, Inc., D.Ariz. Case No. CV-18-4514. Full Order at https://captiveinsurancecompanies.com/cases/shivkov/084_190805_OrdDism2Arb.pdf