The United States District Court for the District of South Carolina recently ruled in Sunland Logistics Solutions Inc. v. Zhejiang Wanfeng Auto Wheel Co., Ltd.[1] that an arbitration clause naming a non-existent arbitral forum was void and unenforceable, in a decision likely to have significant impacts on international business cases.
The Defendant, Zhejiang Wanfeng Auto Wheel Co., Ltd. (Wanfeng), and Plaintiff Sunland Logistics Solutions Inc. (Sunland) initially entered into a contract (the Agreement) wherein Sunland, a South Carolina corporation providing warehousing and logistics services, agreed to provide storage, handling, and management for automotive wheels manufactured and produced by China-based Wanfeng.
In the event of a dispute, the Agreement’s voluntary arbitration provision allowed either party to submit disputes to the “America International Economic and Trade Arbitration Commission,” which unfortunately was a non-existent entity.
When a dispute arose, Wanfeng made a formal demand for arbitration, asserting the parties actually intended to name the China International Economic and Trade Arbitration Commission (CIETAC) in the Agreement, rather than the fictitious arbitral institution. Sunland promptly rejected Wanfeng’s demand and litigation commenced, invoking the application of the Federal Arbitration Act (FAA), 9 U.S.C. §§ 1-307, which affirms that a party may enforce an arbitration agreement by obtaining either a stay of litigation in any case that raises a dispute referable to arbitration (9 U.S.C. § 3), or an affirmative order to engage in arbitration. 9 U.S.C. § 4.
To compel arbitration under § 4 of the FAA, a party must demonstrate (1) a dispute between the parties; (2) an arbitration provision in a written agreement reputedly applicable to the dispute; (3) a relationship between the transaction, as demonstrated by the agreement, with interstate or foreign commerce; and (4) the failure or refusal of the non-moving party to arbitrate. In the present case, Wanfeng brought a motion to compel arbitration, implicating § 4 of the FAA.
To obtain a stay in the litigation under § 3 of the FAA, a party must likewise establish the enforceability, validity, and scope of the arbitration clause.
The Court in this case specifically addressed whether the arbitration clause itself was valid and enforceable and held that federal courts must apply state contract law on the question. Under general principles of contract law in South Carolina, a valid contract requires a “meeting of the minds” between the parties as to the essential and material terms of their agreement. Further, arbitration agreements must be strictly enforced according to their terms, including those terms purportedly specifying which arbitral forum has the power to administer the claim.
The court first rejected the legal authority cited by both Wanfeng and Sunland, finding that none of the cases cited were analogous to a situation where the entire arbitration clause was merely one sentence; the exclusive arbitral forum was a nonexistent entity; the clause was permissive rather than mandatory; and there was no indication from the Agreement that the parties truly intended to arbitrate their disputes.
In arguing in favor of arbitration, Wanfeng asserted § 5 of the FAA allowed the court to reform an arbitration agreement and name another arbitral forum to replace a non-existent forum. Declining to follow this reasoning, the court instead found that although the South Carolina Supreme Court had not explicitly ruled on this issue, the Court of Appeals previously determined that § 5 of the FAA reformation did not apply when the named arbitrator did not exist or became unavailable. see Keller v. ING Fin. Partners, Inc., No. 2013-UP-014, 2013 WL 8482243, at *2 (S.C. Ct. App. Jan. 9, 2013), cert. dismissed as improvidently granted, No. 2015-MO-006, 2015 WL 631005 (S.C. Feb. 11, 2015). In Keller, the Court of Appeals ruled that § 5 of the FAA did not permit the court to “rewrite the parties’ agreement” in cases where a specifically designated arbitrator was unavailable. Although § 5 could be implicated if there was a breakdown in the process of selecting a specific arbitrator, the provision was not designed to remedy a situation where the parties merely named a forum that did not exist.
After concluding § 5 of the FAA did not permit unilateral reformation of the Agreement, the court then determined that naming a non-existent arbitral institution rendered the arbitration clause void and unenforceable under prevailing state law precedent. Citing the South Carolina Supreme Court’s decision in Dean v. Heritage Healthcare of Ridgeway, LLC, the court found that if the designation of the specific forum was deemed integral to the parties’ agreement, the unavailability of the arbitral forum should be treated as a failure of an essential term. 408 S.C. 371, 759 S.E.2d 727 (2014). The court distinguished between arbitration agreements dictating a proceeding be “administered by” a particular forum, and agreements merely conducted “in accordance with” a named forum’s procedures, citing the former as evidence of an arbitration forum integral to the clause.
In finding the Agreement’s arbitration clause unenforceable, the court held that the clause’s requirement that any dispute be administered by the named forum was the practical equivalent of explicitly stating the arbitration be “administered by” that forum. Based on the precedent established in Dean, this forum selection constituted the parties’ express statement of an intention to arbitrate solely in that forum. The court also found it persuasive that the parties actually negotiated the arbitration forum prior to signing the Agreement, and that Wanfeng’s initial proposal of CIETAC was conclusively rejected by Sunland.
The court’s decision affects a sweeping range of arbitration agreements, as similar clauses could potentially be rendered invalid under this decision, if they likewise name a non-existent (or simply unavailable) arbitration forum. The case also signals a warning to parties engaged in international business that “pathological” clauses could result in the total unavailability of arbitration as a dispute resolution mechanism. To avoid a situation where the arbitration agreement is deemed unenforceable or void, contact your legal counsel.
[1] Sunland Logistics Solutions Inc. v. Zhejiang Wanfeng Auto Wheel Co., Ltd., No. 6:20-cv-1470-TMC, 2021 WL 5991085 (D.S.C. Apr. 30, 2021).
