Arbitration Fails to Resolve Business Divorce Dispute

  • The failure of the parties to submit evidence on an issue during arbitration caused a failure to decide all of the issues of the dispute.

  • A Court may modify an arbitration award rather than vacate and permit partial enforcement while permitting litigation of claims were not included in an arbitration hearing.

  • Failure to clearly define the mechanics of an arbitration and to agree on the issues that the arbitrator is to decide can make an award unenforceable.

This court decision addresses a recurring issue when parties agree to resolve their dispute by arbitration: exactly what was it that we agreed to arbitrate? Unless the answer to that question is clear and unambiguous, trouble is likely to follow.

Failure to Agree on the Matters Submitted to Arbitration

It is another case with an often recurring theme, particularly in business divorce and corporate governance cases in which you frequently find boilerplate arbitration clauses. Parties that did not give the same attention to the mechanics of the dispute resolution process, only to later receive a decision that not only went against them but was a surprise,

Here, the issue was exactly what was submitted for decision by the parties during the multiple days of evidentiary hearings before the arbitrator. In other cases, the problem lies in the language of the agreement—or, more often, the lack of language in the agreement.

The party that got a bad decision in this case, Rappaport v. Pasternak, dodged a bullet when the Appellate Division reversed the trial court. It is one of the rare opinions in which a court vacates the decision of an arbitrator and then, even rarer, lets one of the parties proceed with traditional litigation.

The Pitfalls of Boilerplate Arbitration Clauses

As lawyers or as parties to contracts, when we fail to think through the arbitration in enough detail or to manage the scope of exactly what is being arbitrated, we may find ourselves dealing with a result that was arbitrary, unexpected, and often very difficult, if not impossible, to undo.

The fact is that parties and their lawyers may spend many hours negotiating the details of an agreement and then tack on a paragraph or two of boilerplate stating that any disputes between them are to be arbitrated. Or they may spend months preparing and arbitrating a matter without making certain there is a clear and definite agreement about what issues are before the arbitrator and what are not.

In either case, not precisely defining the arbitration’s scope and making it clear what issues need to be decided, what law needs to be applied, and how the arbitration will work could lead to big problems in the future.

You’ll find no fan of arbitration here. In most commercial transactions, it is just as slow and expensive as traditional litigation. Perhaps worse is that arbitration that is badly managed may result in arbitrary and unpredictable results.

Dispute with Manager of Multiple LLCs

The case here involved a dispute between the owners and managers of a series of real estate projects. In 2019, the plaintiff Rappaport filed a complaint alleging he was unlawfully terminated as the manager of limited liability companies that owned and operated real estate projects. Rappaport was a manager, an equity holder, and the lawyer representing the group of entities.

Rappaport sought declaratory relief in the form of a preliminary and final injunction, including access to documents, records, books, financial information, and access to the entities’ offices. He claimed that he had been damaged by his termination and that he was the victim of minority member oppression.

The defendants opposed the action, filed a counterclaim, and moved to compel arbitration. The court granted the motion to compel arbitration. They then entered into an agreement to arbitrate and ordered the parties to submit to binding arbitration. The relevant language defined the matter as

[the parties’] dispute related to the Claim and Counterclaim, and related matters, including but not limited to, any claims that could be asserted by any Party as part of the Claim or the Counterclaim or with respect to the dissolution or disassociation of Rappaport …

* * *

The scope of the arbitration shall be confined to adjudicating the Claim, Counterclaim, and related matters,

Rappaport won a substantial net award I the arbitration of $3,851,147, but he rejected Rappaport’s request for reinstatement, holding that the environment had become “toxic” . The arbitrator clarified the initial award following the parties’ motions for reconsideration, clarification, and modification. The arbitrator determined an award of prejudgment interest was appropriate and ordered the parties to confer and ascertain an appropriate amount.

The parties actually secured a series of arbitration awards, the net result of which was that the arbitrator held that the award had not only compensated Rappaport for all of his interest in the entities, including his equity interests and right to receive a share of profits.

It was clear that the parties had agreed that the scope of the arbitration would include the interests of Rappaport as an owner of the businesses, not just whether he had been wrongfully terminated.

However, Rappaport argued, and the appellate court ultimately agreed, that although the parties agreed to arbitrate the issues raised by them as owners of the business, they had failed to actually press those claims in the arbitration hearings. And the issue presented to the appellate division was whether the arbitrator exceeded his authority when he ruled on a claim that had not actually been litigated during the 19 days of hearings. The issue was described this way:

[W]e consider whether arbitration awards that include a claim within the scope of an arbitration agreement but which all parties specifically excluded in the arbitration may be modified to exclude the award on the omitted claim.

The court modified the award to exclude any aspect of Rappaport’s claims as an investor, relying the authority of a court to modify an award insofar as it rules on a claim not submitted to the arbitrator and that portion of the award could be excluded without affecting the other aspects of the award.

Thus, the damages award for wrongful termination stood, but Rappaport’s claims as investor were still viable and unresolved, and he had the right to sue on them. The court resolved the issue as follows:

Here, although the Arbitration Agreement specifically references dissociation, and the issue is thus “within the scope of the arbitration,” precluding the vacating of the award, neither party had notice Rappaport’s membership interest would be valued as part of the arbitration. Like Block, the arbitrator issued an award revoking Rappaport’s membership interest in the KABR entities, divesting him of any future carried interest payments, without hearing testimony as to the value of those interests and after finding Rappaport had done nothing to merit termination. The statement of claims submitted to the arbitrator by defendants sought damages only for Rappaport’s behavior “as a manager, officer and director of the KABR [e]ntities” and specifically excluded his interest as an investor. Such statements were insufficient to ascribe notice to Rappaport he could potentially be divested of his membership interest or future carried interest payments because of his failure to simply invoke his equity interest in KABR entities.

The Need for Carefully Drawn Arbitration and Agreements

The lesson here is that a carefully drawn agreement may be useless if there is a dispute and the parties have not paid adequate attention to the dispute resolution clause. Boilerplate arbitration clauses are worse that no clause at all.

As to what should go into the arbitration agreement itself, plainly it should include clearly articulated decisions on what is subject to the agreement. It should define the forum and the rules; most forum rules are too vague to be useful. It should specify the applicable law and the requirements for the form of award. It should set the standards for arbitrator selection, the timing of the hearing and the award.

The list of what I think is important for the agreement is long. I generally intend to limit the arbitrator’s overly broad discretion, and ability to make a surprise award, and to hold him or her to the law as it was planned by the parties.

The other important detail, as demonstrated by this case, is to clearly articulate the issues that are being submitted for the hearing. The time to object to any disputed submissions is before the hearings start and, critically, before the award is rendered.






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