Monday, December 14, 2015

Second Circuit Denies Retroactive Application of Arbitration Clauses

The Second Circuit’s recent decision in Holick v. Cellular Sales of New York, LLC, 802 F.3d 391 (2nd Cir. 2015), did not involve a construction dispute, but the decision is a reminder that parties to construction contracts cannot rely on retroactive application of dispute resolution provisions in a later contract if the parties’ contractual relationship changes on a  project.

Holick involved a putative class action in which the plaintiffs claimed that their former employer, Cellular Sales of New York, and its parent company, Cellular Sales of Knoxville, unlawfully denied the plaintiffs various compensation and benefits because the defendants improperly classified the plaintiffs as independent contracts instead of employees. 

The plaintiffs’ original relationship with the defendants arose from a “Non-Exclusive Independent Sales Agreement” that the plaintiffs executed on behalf of respective limited liability companies that the plaintiffs formed.  That Sales Agreement required the parties to resolve disputes by mediation, then by litigation if the parties did not settle a dispute in mediation.  Cellular Sales later offered the plaintiffs full-time employment.  The plaintiffs then signed Compensation Agreements with arbitration clauses.  The plaintiffs confined their claims to events occurring before they executed the Compensation Agreements.

The defendants moved to compel arbitration based on arbitration clauses that were contained in the Compensation Agreements.  The defendants argued that the Compensation Agreements’ arbitration provisions applied retroactively.  The district denied the defendants’ motion, finding that the Compensation Agreements with the arbitration clauses were not in effect at the time when the plaintiffs’ claims arose.
The Second Circuit affirmed.  The court acknowledged that the court had held in previous cases that broad arbitration provisions that contain no express temporal limitation can apply to claims that arose prior to the execution of the arbitration agreement.  However, the court declined to interpret the Compensation Agreement at issue to have expansive temporal scope just because the court had done so in other cases regarding other agreements.

The court determined that the temporal scope of the Compensation Agreement regarding arbitrability was limited because “when the Compensation Agreements were signed, the parties’ contractual positions changed in a way that impacted arbitrability.”  Id. at 398.  The court found that the parties in the Sales Agreement expressly agreed the plaintiffs were not employees, so it “would be inconsistent with the parties’ conduct to construe the Compensation Agreement, which referenced ‘employment,’ to apply to a period when the parties themselves did not contemplate such a relationship.”  Id.

So, why is the Holick decision relevant to construction disputes?  The decision reminds us that, although most jurisdictions favor arbitration and might even rule in favor of arbitrability when a later contract is the only contract with an arbitration provision, the result might be different if there is a change in the parties’ relationship.  By way of example, a court might be inclined to rule in favor of arbitration when the parties sign a letter of intent without an arbitration clause, then execute a more formal contract for the work that has an arbitration clause, but a court might not reach the same result if a contractor and owner execute a contract for a contractor to perform a constructability review for a project without an arbitration clause, but then execute a separate contract for the contract to build the project that has an arbitration clause regarding any disputes arising from “construction of the project”.  In the latter scenario, a party might argue that, under Holik, a court should not apply latter contract’s arbitration clause retroactively because the parties’ relationship status changed between the two contracts.  Of course, if the parties intend an arbitration clause to apply retroactively, the best way to avoid the issue in Holick is for the parties to include language confirming retroactive application.

A copy of the decision is linked here.

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