Arbitration By Estoppel: Can You Be Compelled to Arbitrate Even Though You Never Signed An Agreement?

Continuing our coverage of the sexual discrimination lawsuit between former partner Ellen Pao and venture capital firm Kleiner Perkins (prior stories are here and here), on Friday, Kleiner Perkins moved the San Francisco Superior Court to compel arbitration of its dispute for a second time -- this time with a twist.

Initially, Kleiner Perkins argued that Ms. Pao’s employment contract contained an express agreement to arbitrate; that argument was rejected by the Court on July 10, 2012 on the grounds that Kleiner Perkins was not a signatory to those clauses.  Rather, the court held, the clauses were contained in various agreements Ms. Pao signed with investment funds owned by Kleiner Perkins, and not the firm itself.

Now, however, Kleiner Perkins is arguing that it is entitled to the benefit of the arbitration clauses under theories of equitable estoppel and as a third-party beneficiary.  Commentators have described this theory as “novel.”

It may be novel, but, as it turns out, this issue has indeed been litigated before.  In Thomson-CSF, S.A. v. American Arbitration Association, 64 F.3d 773 (2d Cir. 1995), the U.S. Court of Appeals for the Second Circuit held that in some cases, equitable estoppel considerations can permit a nonsignatory plaintiff to compel arbitration against a signatory party to an arbitration agreement where that party has acted in a matter inconsistent with avoiding the obligations of arbitration.  Id. at 778.  Put simply:  if a party who has signed an arbitration agreement acts to take advantage of that agreement (“knowingly exploiting the Agreement,” in the words of the Second Circuit”), then that party can be estopped from avoiding arbitration and compelled to arbitrate even by a plaintiff who is not a direct signatory to the arbitration agreement itself.

What the Second Circuit did not do, however, was hold that estoppel can be utilized in the manner that Kleiner Perkins seeks; that is, to be used offensively to bind a nonsignatory to an arbitration agreement.  As the Court held:

As these cases indicate, the circuits have been willing to estop a signatory from avoiding arbitration with a nonsignatory when the issues the nonsignatory is seeking to resolve in arbitration are intertwined with the agreement that the estopped party has signed. … [H]owever, the situation here is inverse:  E&S, as signatory, seeks to compel Thomson, a non-signatory.  While E&S suggests that this is a non-distinction, the nature of arbitration makes it important.  Arbitration is strictly a matter of contract; if the parties have not agreed to arbitrate, the courts have no authority to mandate that they do so.

Thomson-CSF, 64 F.3d at 779.

Kleiner Perkins’s argument is not frivolous; there are indeed cases – such as Fluehmann v. Associates Fin. Svcs., 2002 WL 500564 (D.Mass. 2002) in which courts have “converted” a non-signatory into a signatory on equitable grounds – but it is unprecedented.

With respect to Kleiner Perkins’s third-party beneficiary argument, generally the law requires that the contracting parties manifest an intent to make a non-party to a contract a beneficiary under that contract.  As a California appellate court put it:  “[I]t is not enough that the third party would incidentally have benefited from performance” under the contract; rather, “[t]he contracting parties must have intended to confer a benefit on the third party.”  Souza v. Westlands Water District, 38 Cal.Rptr. 3d 78, 88 (2006).

Presumably Kleiner Perkins drafted both its employment contract and the contracts at issue between Ms. Pao and the subject investment funds; if so, the doctrine of contra preferentem will apply to strictly construe any ambiguities against Kleiner Perkins and in Ms. Pao’s favor.

Kleiner Perkins’s motion is set for a hearing this Friday, July 20.