Landmark Second Circuit Case: Provides Drafting Guidelines To Implement Clients' Choice Of Adjudication Over Arbitration

Monday, August 1, 2011 - 01:00

The Editor interviews Clifford Thau , Managing Partner, New York Office, Vinson & Elkins LLP.

Editor: Please describe your background as a litigator and the types of cases you handle.

Thau: I have been practicing law for 30 years. My main area of practice is commercial litigation with an emphasis on lawsuits involving the federal securities laws, including representation of issuers, underwriters, officers and directors, accounting firms in securities class actions; securities and private equity firms and senior management in federal and state regulatory proceedings; and audit committees in internal investigations and SEC investigations into allegations of accounting irregularities. I also represent media and real estate entities and other corporations including accounting firms in commercial litigation and accounting firms in malpractice actions, bankruptcy court proceedings and SEC investigations.

I began my career at Shea & Gould and was there for 13 years. I was fortunate early in my career to work for both Milton Gould and Bill Shea. Gould was a litigator, and I handled litigation for Shea's clients. Both were giants of the New York Bar.After that, I worked for nine years at Squadron Ellenoff. I have been with Vinson & Elkins in its New York office for nine and a half years.

I am pleased that you found the decision of the United States Court of Appeals for the Second Circuit on July 13 in Applied Energetics, Incorporated v. NewOak Capital Markets, LLC (the "case") of interest.Appearing before the Second Circuit is really one of the most rewarding and challenging things an attorney can do.

Editor: The case is of great importance to corporate counsel. Please describe the facts involved.

Thau: The case was an appeal of a decision of the United States District Court for the Southern District of New York to the Second Circuit regarding whether disputes between our client, Applied Energetics, Incorporated ("Applied") and NewOak Capital Markets, LLC ("NewOak") must be resolved by arbitration. The case involved the construction of the language of two agreements. The first agreement executed was an Engagement Letter that contained a provision providing for arbitration.

What was relevant for the purpose of the Second Circuit was that the second agreement entered into by the parties, the Placement Agreement, contained language that any "dispute" between the parties "shall be adjudicated."The Second Circuit held that this language expressed the parties' intention to proceed in court as opposed to arbitration.

We were able to win this appeal because the court could discern the parties' intent from the four corners of the Placement Agreement. Therefore, there was no need to resort to parole evidence of any kind.

Editor: How did the case get to the Second Circuit?

Thau: The case was first decided by Magistrate Judge Gorenstein in the Southern District of New York, who ruled the same way as the Second Circuit.Subsequently, District Judge Berman reversed the Magistrate Judge, concluding that the initial Engagement Letter and Placement Agreement could be read as complementary agreements. Applied appealed the District Court's decision.

Editor: Why was it important for Applied to have the case adjudicated in a court of law?

Thau: Applied wanted to be in court, where it would have an early opportunity to make a motion to dismiss.Arbitration would have made it very difficult for Applied to make these motions and, if necessary, a motion for summary judgment.Another reason is that in the court system you have a right to appeal, whereas there are very limited grounds for appeal in arbitration.

Editor: Was the arbitration language in the Engagement Letter similar to that found in many such agreements?

Thau: I don't know if the same language was used but there is frequently language in an engagement letter that definitive terms will be contained in subsequent documents.

Editor: Please describe the Placement Agreement. Thau: The Placement Agreement that was subsequently executed by Applied and NewOak provided specifically that the parties shall adjudicate their disputes. Also, there was a merger clause that made it clear that all earlier agreements were superseded by the Placement Agreement.

Editor: Why did you feel that an appeal was warranted?

Thau: My colleagues on the case, Hilary Preston and Armita Cohen, and I felt the District Court had decided this issue incorrectly. That feeling was reinforced by the earlier decision by the Magistrate Judge. My firm was not responsible for drafting the agreements involved in the case, but the transactional lawyers who negotiated the deal on behalf of Applied were convinced that the agreements they negotiated provided for litigation, and they were absolutely correct.

Editor: It seemed to me on reading the case that it took some pretty great advocacy to distinguish the Bank Julius case.

Thau: We had better language in our agreements than existed in Bank Julius; the Bank Julius agreements provided for nonexclusive jurisdiction and did not have the language "shall be adjudicated." The lawyers responsible for drafting of the agreements at issue in this case did a better job of reflecting Applied's intention.

Editor: How was the presumption in favor of arbitration overcome?

Thau: In its opinion in the case, the Second Circuit cited the opinion of the U.S. Supreme Court in Granite Rock Co. v. International Brotherhood of Teamsters, which held that the presumption should only be applied "where a validly formed and enforceable arbitration agreement is ambiguous about whether it covers the dispute at hand." Here, because we disputed the continued validity of the arbitration provision, that presumption should not apply. We were very confident that the Second Circuit panel would understand this distinction, which it did.

Editor: What lessons in terms of drafting should corporate counsel take away from this decision?

Thau: Two things: first, the lawyers who drafted the agreements used the words "shall be adjudicated," which the Second Circuit found to be a very clear expression of intention that the parties intended to litigate and not arbitrate. It included the mandatory word "shall." In its decision the Second Circuit picked up the quote from Black's Law Dictionary from our briefing to the effect that the term "adjudicate" unmistakably means to rule upon judicially and defining "judicially" as relating to or by the court or a judge. That language was treated by the Second Circuit as very clear in expressing the parties' intention to litigate.

Another pointer for good practice for corporate counsel is found in the Supreme Court's decision in Granite Rock Co. v. International Brotherhood of Teamsters. The decision pours meaning into the "presumption in favor of arbitration" by making it clear that it applies only "where a validly formed and enforceable arbitration agreement is ambiguous about whether it covers the dispute at hand."

This counters the tendency on the part of some lawyers to treat that presumption as a sweeping one that can justify, as argued by counsel for NewOak, the treatment of clear and unambiguous language in a subsequent agreement as merely complementary to an earlier agreement to arbitrate.

What the Supreme Court made clear in Granite Rock and the Second Circuit made clear in the case is that the presumption does not apply to disputes concerning whether an agreement to arbitrate has been made, but only as to whether "it is applicable to the dispute at hand."

In other words, a court will first have to reach a determination as to whether the parties intended to litigate or arbitrate their dispute, and only if a court determines they agreed to arbitrate does the presumption in favor of arbitration come into play. There is the following great quote from Vera v. Saks & Co., an earlier Second Circuit decision:"A party cannot be required to submit to arbitration any dispute which it has not agreed so to submit."

What the Second Circuit found in the case was that since the parties' dispute was not as to the scope of an arbitration clause, but rather whether an obligation to arbitrate exists, the presumption in favor of arbitration does not apply. The important practice point here is that the presumption comes into play only if the court concludes that the parties intended as a matter of law to arbitrate based on the agreements before the court.

Let me conclude by saying that Ihave represented clients in FINRA arbitrations as well as AAA arbitrations. Both are very effective and good methods of resolving disputes when the parties intend to go that route.

Our client, Applied, wished to gain particular benefits by being in court relevant to its interests. Our intention in the case was to give effect to the client's desire, and the parties' agreement, to litigate and not arbitrate.

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