On January 31, 2017, the Fifth Circuit Court of Appeals authorized a court-appointed Receiver to avoid arbitration clauses contained in employment and employment-related agreements.[1]  While, at first glance, the Court’s decision not to compel a non-signatory to arbitration appears unremarkable, in fact the decision reflects how far the Court was willing to go in order to protect a Receiver’s choice of a judicial forum.

Background

Allen Stanford, through a network of companies, operated a now-infamous Ponzi scheme, pursuant to which he and his entities raised over $7 billion in connection with the sale of certificates of deposit. As a result, in 2012, Stanford was convicted of fraud, conspiracy and obstruction charges and sentenced to 110 years in prison. However, the litigation surrounding the fraudulent enterprise continues today, as the court-appointed Receiver pursues multiple lawsuits in an effort to “claw back” investor monies from individuals and entities that received various forms of payments from Stanford’s numerous interconnected companies.

Shortly after the Receiver sued former employees under the Texas Uniform Fraudulent Transfer Act, certain of them moved to compel arbitration based on arbitration clauses contained in one or more agreements: (1) promissory notes between defendants and Stanford Group Company (SGC); (2) broker-dealer forms that SGC submitted to the Financial Industry Regulatory Authority (FINRA); (3) FINRA’s internal rules requiring arbitration between employees and their employers; and (4) Stanford Group Holdings, Inc.’s (SGH) Performance Appreciation Plan.  In addition, one of the defendants signed an arbitration agreement with Stanford International Bank (Bank).

The Texas federal district court, in denying the motions to compel arbitration, reached three conclusions:

(1)  The Receiver was precluded from choosing which Stanford entity on whose behalf he could sue.  Thus, the district court required him to sue on behalf of SGC, which was a party to the arbitration agreements;

(2)  The Receiver’s rejection of the arbitration agreements was permissible; and

(3)  Arbitration of the claims would conflict with the purposes and objectives of the federal equity receivership statutory scheme.

Fifth Circuit’s Decision

  1. A Receiver of Multiple Companies may Avoid Arbitration by Suing on behalf of a Company not a Party to the Arbitration Agreements.

Although the Receiver represented all of the Stanford entities, he chose to bring claims against the defendant employees only on behalf of the Bank.  He argued that the Bank collected deposits from investors and then “diverted those deposits” into the Company, which then paid its employees.  Contrary to the district court’s opinion, the Fifth Circuit found no fault in the Receiver’s choice of entities because “[n]ow that Stanford no longer controls the Bank and the Company . . . . the Bank and the Company are separate actors . . . [Thus, t]he Receiver . . . may bring his claim on behalf of whichever of the entities he chooses. . . . ”  Accordingly, because defendant employees (except one) did not have arbitration agreements with the Bank, they were precluded from compelling the Bank to arbitration.

Nevertheless, the employee defendants argued that the Bank, even as a non-signatory to the agreements, was bound thereby based upon equitable theories of alter ego, estoppel and third-party beneficiary status.  The Fifth Circuit rejected each of those theories.

The Court first held that the alter ego claim was vitiated once Stanford was removed from the helm of his companies because his wrongful acts “no longer equitably affect[ed] the hostage corporations.”  In other words, the Court found that, to the extent the Stanford entities were previously alter egos of each other, they obtained their separateness once the Receiver took over operations.  As a result, claims of alter ego vanished at that point.

The defendants’ equitable estoppel argument was two-fold.  First, they argued that the Receiver’s claims against the former employees were dependent on the contracts that included the arbitration agreements.  However, the Court held that such an argument was impermissible when the non-signatory to the agreements was the plaintiff (Receiver), as opposed to the defendants.  Second, defendants argued that a non-signatory cannot sue under an agreement, while simultaneously avoiding the arbitration clause contained in the agreement.  The Court found the argument inapplicable because the Receiver was not seeking to enforce the agreements but, rather, was seeking to unwind them.

Finally, defendants argued that an intended beneficiary of a contract is precluded from avoiding the terms of the contract.  However, the Court held that the Bank was not an intended beneficiary of any of the contracts because the Bank did not benefit therefrom.

  1. A Party Waives Arbitration by Substantially Participating in the Judicial Process.

Unsurprisingly, the Fifth Circuit also found that the defendant who was a party to an arbitration agreement with the Bank had waived his right to arbitration because he substantially participated in the judicial process to the prejudice of the Bank.  Specifically, the defendant, who was sued in 2011, filed answers and participated in the discovery process without moving to compel arbitration until 2014.  According to the Court, the Bank was prejudiced by these activities because it caused delay and increased litigation expenses.  Accordingly, the Receiver could not be compelled to arbitrate his claims.

  1. The Fifth Circuit Declines to Address the Argument that Federal Equity Receivership Statutes are at Odds with the Federal Arbitration Act.

As an additional ground for rejecting the arbitration clauses, the Receiver argued that applying the Federal Arbitration Act’s mandate in favor of arbitration would undermine “Congress’s goal of consolidating receivership claims before a single court.”  The Court, however, declined to address “these broad policy arguments in the absence of specific direction from the Supreme Court.”[2]

Important Takeaways from the Decision

The Fifth Circuit allowed more leeway to the Receiver than would typically be afforded to a civil plaintiff.  In particular, despite the fact that the Receiver was trying to “claw back” employee salaries and bonuses, the Court did not require him to sue on behalf of the employing entity – the entity which unquestionably had consented to arbitration.  Instead, the Court allowed the Receiver to sue on behalf of an entity with no direct employment relationship, thereby allowing the Receiver to avoid arbitration through artful pleading.  In addition, the outright rejection of the equitable bases to require a non-signatory to arbitrate also showed great deference to the Receiver’s efforts to avoid arbitration.

In short, once a Receiver is appointed, defendants may be precluded from enforcing arbitration clauses, at least until the U.S. Supreme Court determines otherwise.

[1] Ralph S. Janvey v. James R. Alguire, et al, No. 14-10857, in the United States Court of Appeals for the Fifth Circuit (Jan. 31, 2017)(publication pending).

[2] Importantly, however, Circuit Judge Patrick E. Higginbotham, one of the three Judges opining in the case, issued a concurring opinion in which he stated that, in his view, the arbitration clauses were unenforceable because they were “instruments of a criminal enterprise,” i.e., the Stanford Ponzi scheme.