There is perhaps no richer vein of literary gold than conflict between fathers and sons. Hamlet, Robinson Crusoe, multiple characters drawn by Charles Dickens, not to mention the mother of all family contretemps, Oedipus Rex, touch on this deeply human power struggle.

One such conflict was the backdrop for the Pennsylvania Superior Court’s recent decision in MBC Development, LP v. James W. Miller, 281 A.3d 332 (Pa. Super. Ct. 2022). The decision serves as an important reminder that courts overwhelmingly favor arbitration as a means of dispute resolution, and gives us an opportunity to think about the virtues of arbitration provisions in organizational documents like limited partnership and operating agreements.

In for a penny, in for a pound with arbitration agreements

In MBC Development, the appellant, James W. Miller (“Little James”) was a limited partner in two partnerships with James L. Miller (“Big James”), his father. Big James owned over fifty percent of each of the partnerships.

In the summer of 2019, Little James made a written demand on the partnerships, asking they bring legal action against Big James. The partnerships invoked the special litigation committee (“SLC”) process provided for by the Pennsylvania Uniform Limited Partnership Act (“the LPA”) to evaluate Little James’s demands. (Pennsylvania’s Limited Liability Company Act has a nearly identical provision; more about the SLC process here: Can Closely Held Companies Investigate Shareholder Complaints without Breaking the Bank?)

The SLC produced a report that the partnerships should not initiate litigation against Big James. This, of course, made Big James happy. But Little James? Not so much.

Relying on the arbitration clauses in the partnership agreements, Little James then filed a demand for arbitration against Big James and the partnerships, among others, asserting derivative claims for breach of fiduciary duty, and a direct claim against one of the partnerships for failing to make a mandatory distribution to him.

In their response, Big James and the partnerships sought a stay of the arbitration, arguing that Little James’s challenges were actually challenges to the SLC’s determinations under the LPA and not claims arising under the partnership agreements. Thus, they argued, Little James’s challenges could not be arbitrated. In addition, they argued the LPA requires a court—and not an arbitrator—to determine whether an SLC’s determination concerning a legal claim prevents a derivative action regarding that same claim.

The trial court issued an order in favor of Big James permanently staying the arbitration. The court concluded Little James’s claims were within the partnership agreement’s arbitration clauses, but that his claims could not proceed through arbitration because: (1) the dispute over the SLC’s findings was a statutory matter that was not arbitrable, and (2) the language of the LPA requires a court to determine whether an SLC’s rejection of derivative claims must be enforced.

In a matter of first impression, the Superior Court reversed, vacating the trial court’s decision that Little James’s claims were not arbitrable. The Court adopted a broad reading of the “any dispute or controversy” arbitration provision in the partnership agreements and held that Little James’s derivative claims were within the scope of the partnership agreement. In arriving at its decision, the Court referenced the comments to the LPA which recognize that derivative actions may be subject to arbitration as well as decisions in other jurisdictions.

The Court further held that just because a defense or restriction on an arbitrable claim “is statutory, rather than based on the language of the parties’ agreement, does not change the fact that it must be determined by an arbitrator and not by a court.” The court noted that whether a “prerequisite or limitation bars a claim that is within the scope of a valid arbitration agreement is a question that must be resolved by the arbitrator, not an additional requirement for arbitration that a court may be determine before allowing arbitration to proceed.”

As to the trial court’s ruling that the LPA requires a court—and not an arbitrator—to determine whether an SLC’s rejection of derivative claims must be enforced, the Superior Court explained that the LPA’s reference to a court as an adjudicator does not require that only a court can make an adjudication or prohibit arbitration of a claim or issue. The Court noted there were no provisions of the LPA that suggested its reference to a court as an adjudicator required only courts to decide these issues or barred arbitrators from doing so.

Arbitration provisions in operating agreements? You could convince me.

The Superior Court’s decision here is yet another reminder how broadly Pennsylvania courts interpret arbitration provisions. The broader question of whether to include an arbitration provision in a company’s organizational documents at all is an interesting one. I generally don’t like arbitration for several reasons, but a well drafted provision may be prudent for certain types of Pennsylvania closely held companies.

Arbitration is not always the low-cost option for resolving legal disputes its advocates often make it out to be. But an operating agreement with an arbitration agreement and provisions eliminating the demand and SCL procedures could net a real savings.

In MBC, Little James made a pre-suit demand and Big James invoked the SCL procedure in response. I’ve mentioned previously how the demand requirement is a trap for the unwary and is generally pointless in the context of closely held companies. An SCL can add significant cost to a dispute and often, as it did in MBC, generates additional litigation in the form of challenges to the committee’s independence.

Both Pennsylvania’s LPA and LLC act allow organizational documents to modify the statutory default to eliminate the possibility of an SCL and the demand requirement, although the partnership agreements in MBC did not do so. See e.g.,15 Pa.C.S.A. § 8815(c)(17)-(18). The removal of such provisions offer an opportunity to reduce the procedural and substantive complexity of business divorce litigation. Such benefits could be particularly helpful in 50/50 ownership disputes where the rationale for a demand requirement breaks down or lower value companies where the organization of an SCL would be difficult to justify.

Arbitrators with commercial litigation backgrounds also offer the possibility of helpful subject matter expertise. With some exceptions (notably, Philadelphia’s commerce program), complex business divorce cases make up a microscopic percentage of the state court docket in Pennsylvania. In some counties, there may be years between cases involving complex shareholder litigation.

An arbitration provision in an organizational document? You could convince me.