Federal Court Holds That Trust Beneficiaries’ Claims Against Brokerage Firm Should Not Be Compelled To Arbitration

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In Freeman v. Fid. Brokerage Servs., LLC, the mother of the plaintiffs executed a living trust agreement. No 3:18-CV-0947-G, 2019 U.S. Dist. LEXIS 34694 (N.D. Tex. March 5, 2019). Upon her death, the trust agreement directed that the trust assets were to be divided and allocated into trusts for the benefit of her husband if he was still living and for the benefit of the plaintiffs. Upon the death of the husband, his trust would terminate and all remaining assets of that trust would be distributed to the plaintiffs’ trust. The mother died, and the husband proceeded to manage the assets and affairs of both trusts alone, without a co-trustee, in direct violation of the terms and requirements of the trust agreement. The husband then transferred the assets of the trusts to trust accounts managed by Fidelity. The plaintiffs assert that at all times the trust assets in Fidelity’s possession were subject to trust restrictions and fiduciary obligations under the trust agreement. Fidelity received a hard copy of the trust agreement and thus knew of the co-trustee requirement to manage the assets and accounts of the trusts.

Following the husband’s death, the plaintiffs discovered that he had “withdrawn, transferred, disbursed and depleted the assets of the trust accounts maintained at Fidelity, without the required involvement of a co-trustee, in violation of the terms and conditions of the Trust Agreement, and in breach of Crisler’s fiduciary duties” with Fidelity’s knowledge, participation, and support. Id. The plaintiffs asserted that although Fidelity knew the terms of the trust, including the co-trustee requirement, Fidelity ignored those terms and “never took any measures to see that the trust assets in Fidelity’s custody and possession were administered properly and protected from depletion by a single, self-interested trustee.” Id. The plaintiffs sued Fidelity for breach of fiduciary duty and knowing participation in breach of fiduciary duty, and Fidelity removed the case to federal court. Fidelity then filed a motion to compel the case to arbitration under an arbitration clause contained in account agreements signed by the husband when he opened the accounts.

The federal district court described the grounds for compelling a case to arbitration:

The Fifth Circuit applies six theories under which a court may compel a nonsignatory to arbitration: (1) incorporation by reference; (2) assumption; (3) agency; (4) veil-piercing/alter ego; (5) estoppel; and (6) third-party beneficiary…The Fifth Circuit has described these two types of equitable estoppel as follows.

Id. Fidelity contended that “[t]his case presents an uncommon twist on typical doctrines of equitable estoppel like ‘direct benefits’ and ‘intertwined claims’ estoppel” and thus the Customer Agreement’s arbitration clause binds the Freemans as nonsignatory plaintiffs to arbitrate their claims. The plaintiffs, on the other hand, insist their case “simply calls for application of ordinary principles of contract law” independent of the agreements between Fidelity and the trust, and equitable estoppel is thereby inapplicable. The court first rejected the first type of estoppel:

The “intertwined claims” theory governs motions to compel arbitration when a signatory-plaintiff brings an action against a nonsignatory-defendant asserting claims dependent on a contract that includes an arbitration agreement that the defendant did not sign. It does not govern the present case, where a signatory-defendant seeks to compel arbitration with a nonsignatory-plaintiff.

Id. The court then rejected the second type of estoppel:

The “direct benefits” theory of equitable estoppel “prevents a nonsignatory from knowingly exploiting an agreement containing the arbitration clause.” That is, “a nonsignatory cannot sue under an agreement while at the same time avoiding its arbitration clause.” This theory is inapplicable here because the Receiver does not seek to enforce the various contracts containing the arbitration agreements; rather, he seeks to unwind them and reclaim the benefits fraudulently distributed to the defendants under the contracts.

Id. The court concluded:

There is no evidence that the Freemans sought to derive direct benefits from or knowingly exploited the Customer Agreement, embraced the Customer Agreement as nonsignatories but now attempt to repudiate the arbitration clause, or that they brought suit against Fidelity premised on an agreement which includes or is intertwined with an arbitration clause. Here, the Freemans seek to reclaim the monies alleged to have been fraudulently disbursed to Crisler. Moreover, pursuant to the terms of the Trust Agreement, the trust assets were to be managed by co-trustees. Nowhere in the Trust Agreement does it state that the signature of co-trustee Crisler was sufficient to bind the trusts. Nevertheless, Fidelity permitted Crisler, acting alone and also in the capacity as a primary beneficiary, to sign the Fidelity Application, to open the Fidelity account, and to deplete the trust assets. Fidelity cannot now compel the Freemans, as nonsignatories to the Fidelity Application and Customer Agreement, to arbitrate. In short, there exists no valid and enforceable arbitration agreement between the parties in this case. The court therefore need not consider whether there are any external legal constraints on arbitration.

Id. The court denied the motion to compel arbitration.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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