Delaware Business Litigation Report

Arbitrator to Decide Arbitrability of Breach of Fiduciary Duty Claim

In Angus v. Ajio, C.A. No. 11895-VCG (Del. Ch. May 13, 2016), the plaintiffs sought to enjoin an arbitration initiated against them as officers of MoGo Sport. In the arbitration, certain members of the company (who were defendants in the court proceeding) asserted claims for breach of fiduciary duty, fraud and violations of the company's operating agreement, arising from the alleged misappropriation of an opportunity presented to the company. The plaintiffs argued, among other things, that the arbitration provision was too narrow to encompass the breach of fiduciary duty claims, as it covered "all disputes among members or former members over the provisions of [the operating agreement]." Applying the holdings in James & Jackson v. Willie Gary, C.A. No. 59 (March 14, 2006),and McLaughlin v. McCann, C.A. No. 3067-VCS (Feb. 21, 2008), the court found that, because the defendants' argument for arbitrability of the claim for breach of fiduciary duty was not frivolous, it should be decided by the arbitrator. Thus, the plaintiffs' request for injunctive relief was denied and the question of arbitrability of the breach of fiduciary claim was referred to arbitration.

Analysis

The defendants alleged in the arbitration that the plaintiffs had misappropriated a concussion prevention program initially presented to the company. In particular, the defendants alleged that, after they introduced the plaintiffs to the doctor who ultimately developed the program and related products, the plaintiffs "repeatedly and secretly communicated with [the doctor] without disclosing material information regarding those communications to the defendant-members." After such communications, according to the defendants, the plaintiffs formed a separate company for purposes of diverting the "unique opportunity" presented by the concussion products, which subsequently "entered into a multimillion-dollar licensing agreement" that was not disclosed to the defendants.

Four days after entering into the licensing agreement, an entity controlled by one of the plaintiffs made an offer to purchase all of the company's membership interests for a price that the defendants assert "did not take into account the considerable value of the misappropriated ... opportunity/asset." Unaware of the allegedly misappropriated opportunity, two of the defendants were among the more than 80 percent of the total membership interests that consented to the offer. By virtue of the company's "drag along" rights, by crossing the 80 percent threshold, all of the remaining members were required to sell under the same terms as those members who accepted the offer. Less than a month later, the defendants learned of the plaintiffs' alleged misconduct and attempted to rescind their consents. When the plaintiffs failed to confirm acceptance of the defendants' requested rescission, the defendants initiated the arbitration.

In determining whether the court or the arbitrator should decide the question of arbitrability, the court began by analyzing the Supreme Court's decision in Willie Gary. Under Willie Gary, the intent to arbitrate arbitrability is shown where there is "an arbitration clause that generally provides for arbitration of all disputes; and a reference to a set of arbitration rules that empower arbitrators to decide arbitrability, such as the American Arbitration Association (AAA) Rules." The court next recognized that the Court of Chancery's decision in McLaughlin expanded the Willie Gary test "to include a third prong, which allow[s] the party seeking judicial relief to argue that the party seeking arbitration ha[s] essentially no nonfrivolous argument about the substantive arbitrability of the dispute." The court explained that the third prong was included because it would be a waste of resources for the Court to send a "clearly frivolous" arbitrability claim for resolution by the arbitrator.

In determining whether a claim of arbitrability is frivolous, the court found that its review is limited—"in cases where more than a quick, facial review of the claims would be required of the court, the matter should proceed to the arbitrator for a determination of substantive arbitrability." Regarding the breach of fiduciary duty claim, the plaintiffs argued that the operating agreement was silent as to fiduciary duty and, therefore, such duties arise from statute and not the agreement. As such, a breach of fiduciary duty claim is not a dispute "over the provisions" of the operating agreement, as required under the arbitration provision. In rejecting the plaintiffs' argument, and referring the question of arbitrability to the arbitrator, the court found: "While the plaintiff-officers find this self-evident, it strikes me as a nice question whether a breach of fiduciary duty claim arises from an agreement which by its (presumably intentional) silence incorporates—presumably intentionally—default fiduciary duties by operation of statute. This question, which warrants more than a cursory inquiry by the court into the frivolousness of the claim, should be referred to arbitration pursuant to the agreement of the parties." 

Delaware Business Court Insider | July 20, 2016

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