Li v. Standard Fiber, LLC, C.A. No. 8191-VCN (Del. Ch. Mar. 28, 2013) (Noble, V.C.)

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In this memorandum opinion, the Delaware Court of Chancery stayed an action for advancement of legal fees and expenses, ruling that provisions in four separate agreements, when viewed together, demonstrated the parties’ intent to arbitrate the issue of substantive arbitrability.

Plaintiff, a 25% holder and former CEO of defendant Standard Fiber, LLC (“Standard Fiber” or the “Company”), initiated this action against the Company for advancement of legal fees and expenses arising out of a California arbitration proceeding.  Plaintiff was the founder of the Company’s predecessor, which was purchased by the Company under the terms of a 2006 asset purchase agreement (the “APA”).  Besides the APA, three other agreements govern the parties’ relationship: a limited liability company agreement (the “LLC Agreement”), an employment agreement, and an indemnification agreement (the “Indemnification Agreement”).

Plaintiff sought advancement under the terms of the Indemnification Agreement which, unlike the parties’ other agreements, did not contain a mandatory arbitration provision.  It did, however, include an integration clause, which provided that the Indemnification Agreement would “supersede[] any and all previous agreements between [the parties] covering the subject matter herein.”  The Company moved to dismiss for lack of subject matter jurisdiction or, in the alternative, for a stay in favor of the arbitration, arguing that the parties had agreed to have all of their disputes determined by arbitration.  The Court was thus called upon to decide the threshold issue of whether, under the terms of the parties’ contractual relationship, the Court itself should decide whether plaintiff’s claim was subject to arbitration, or if that question should be answered by the arbitrator.

According to the Delaware Supreme Court’s decision in James & Jackson, LLC v. Willie Gary, LLC, 906 A.2d 76 (Del. 2006), Delaware follows federal law in presuming “that the question of substantive arbitrability, ‘i.e., whether the parties agreed to arbitrate[,] is generally one for the courts to decide and not for the arbitrators.’ ”  A party may only overcome that presumption with “clear and unmistakable evidence that the parties agreed to arbitrate.”  Under Willie Gary, such evidence “is present when an arbitration clause (1) ‘generally provides for arbitration of all disputes,’ and (2) ‘incorporates a set of arbitration rules that empower arbitrators to decide arbitrability.’ ”  In addition to considering the two-part Willie Gary test, a Delaware Court must “ ‘make a preliminary evaluation of whether the party seeking to avoid arbitration of arbitrability has made a clear showing that its adversary has made essentially no non-frivolous argument about substantive arbitrability.’ ”

Because the Indemnification Agreement contained no arbitration provision, the Court could only stay or dismiss in favor of arbitration if it concluded that it could look outside the terms of that agreement.  Plaintiff argued that the court could not do so because of the Indemnification Agreement’s integration clause.  The Court disagreed.  Although, under Delaware law, “an integration clause serves as a presumption of integration,” the Court concluded that it could not ignore the parties’ other agreements under the “limited inquiry permitted under Willie Gary and its progeny” because the Indemnification Agreement’s integration clause failed to “conclusively establish that the valid arbitration clauses in the prior agreements were terminated.”

By focusing on the Indemnification Agreement, the Court reasoned, plaintiff  essentially argued “that the claims asserted in the complaint do not relate to the prior agreements.”  The Court found, however, that plaintiff’s claims “could arguably not have been brought absent the parties’ prior agreements that made him a member and officer of Standard Fiber.”  Based on a review of Delaware precedent, the Court concluded that plaintiff’s argument “essentially invites the Court to resolve the first-order issue of substantive arbitrability at the outset, contravening a central tenet of Willie Gary.”  The Court therefore stayed the action pending a determination by the arbitrator “whether the parties contractually agreed for [plaintiff’s] claims to be arbitrated.”

The full opinion is available here.