The right of non-signatories to arbitrate

IT is fairly routine in the maritime industry for shipowners, charterers and cargo owners to operate within a corporate structure in which the various affiliates and related companies deal in specific areas for a variety of business reasons. This is especially true of petroleum companies, such as Mobil, Hess, Chevron etc, but is also the case for the major commodity trading companies such as Cargill, Reynolds, Alcoa and the various Japanese houses. The question that often arises is whether, under US law, the signing of a contract containing an arbitration clause, such as a charter party, by one member of the corporate group can bind or create rights for other members of the same group who didn't sign the contract.

This is a question that has been presented to, analysed and ruled upon by arbitrators and federal courts on a regular basis. In short, can a non-signing affiliated company that operates a vessel for the owner compel arbitration against a signatory? Can a non-signing subsidiary cargo owner participate in an arbitration between a shipowner and its corporate related charterer? The Emerald decision falls into this latter category. These are questions that have been before the federal courts either in actions to compel arbitration or as motions to confirm an award.

The decision on whether a non-signing affiliate has the obligation and/or the right to arbitrate or compel arbitration falls within the jurisdiction of the District Court pursuant to Section 4 of the US Arbitration Act, as it relates to the making of the arbitration agreement or the failure, neglect or refusal to perform the same . Therefore, the proper time to bring the issue of participation by a parent or subsidiary in the arbitration before the court is at the outset of the proceeding by means of a motion to compel.

Surprisingly - or, perhaps, not so surprisingly - the overwhelming number of disputes involving non-signatories have been submitted to arbitration panels for their rulings and sometimes later presented to the District Court and Court of Appeals on Motions to Vacate. There are a number of arbitration decisions affirming the right of related non-signatory parties to participate in the arbitration. (See Volere, SMA 1885 (1983); Wapello, SMA 3615 (2000); Heering Kirse, SMA 1171 (1971)).

Typically, the issue is whether there is an agreement to arbitrate between the party that signed the agreement and seeking to enforce it, and another who has not signed it and seeks to avoid it. The case involving the Emerald is just the opposite. The non-signatory cargo owner seeks to enforce the arbitration agreement against a signatory shipowner.

Background to the Emerald dispute

The shipowner, Rover Navigation, and voyage charterer, AOT, entered into a tanker voyage charter party for the carriage of gasoil from Taiwan to ports in the US. The charter contained the typical broad tanker arbitration language calling for the arbitration of any and all differences and disputes of whatever nature arising out of the charter . Astra, the cargo consignee, and AOT were affiliated companies, both owned by Astra Oil Trading in the Netherlands, and both engaged in international oil trading. A few days after the charter was concluded, Astra sold the gasoil to Sprague Energy under a contract that called for the product to be delivered between December 25 and January 5.

During the vessel's transpacific voyage, the Emerald developed engine problems, limped about in the vicinity of Hawaii and then drifted for some eleven days performing engine repairs at sea. The Emerald eventually made its way to Boston on January 25 for the discharge of some of its cargo and to then carry the Sprague gasoil cargo on to Portland, Maine. While in Boston, the USCG issued a SOLAS detention order after an inspector discovered a crack in a main deck plate. The vessel remained in Boston until February pursuant to this detention order.

After the main deck crack was discovered, the owner declared General Average to both Astra and AOT and liened the cargo. Astra, on the other hand, threatened to arrest the vessel to secure its claim for commercial damages caused by the cargo's late delivery. Consistent with the usual practice, counsel exchanged security for their respective claims - Rover posted a Club Letter of Undertaking (LOU) that included the claims of AOT as voyage charterer and Astra as cargo seller and consignee. Astra posted a Lloyd's Average Bond for the General Average.

Subsequently, Astra presented its claim for commercial damages, representing the loss in the price of gasoil on account of late delivery, approximating $400,000. The owner declined liability. Astra and AOT demanded arbitration, both parties appointed arbitrators and the two arbitrators appointed a chairman. After initial submissions, Rover contested Astra's standing to arbitrate its cargo claim, arguing that Astra was not a signatory to the charter party. Thereafter, Astra filed a petition to compel arbitration in the USDC for the Southern District of New York and the arbitration proceedings were suspended pending the District Court's ruling.

The District Court decision

First addressing general principles, District Judge Laura Taylor Swain noted that arbitration under the US Arbitration Act is a matter of consent, not coercion, and that parties are generally free to structure their agreements as they see fit. Further, she stated that it is well established that arbitration is a matter of contract and a party cannot be required to submit to arbitration any dispute that it has not agreed to submit.

Having stated the above general principles, the District Judge then noted that it didn't necessarily follow that the Act limits the obligation to arbitrate only to those who have personally signed the written agreement. Non-signatories may be bound to an arbitration agreement by virtue of an incorporation by reference, typically by incorporating the terms of the charter party and arbitration provision in the bill of lading. Non-signatories may also be bound by assumption, agency, veil piercing/alter ego and estoppel. Citing Thomson-CSF v AAA, the court noted that the party seeking to compel arbitration has the burden of demonstrating by a preponderance of the evidence the existence of an agreement to arbitrate.

Judge Swain recognised that the Second Circuit has been willing to estop a signatory from avoiding arbitration with a non-signatory when the issues the non-signatory seeks to resolve in arbitration are intertwined with the agreement the signatory has executed. In determining whether the claims are sufficiently related to the underlying agreement to support an order to compel arbitration, the court generally examines the relationship of the entities involved and the relationship of the alleged wrongs to the agreement at issue.

In denying Astra's motion to compel arbitration, the court noted that Astra and AOT were separate but affiliated companies, that the charter party was silent regarding damages for late delivery of cargo, and - most importantly - Judge Swain concluded that the issues that Astra and Rover were seeking to resolve arose out of Astra's dealings with its buyer, Sprague Energy, rather than out of the charter party. Given this, the District Court held that Astra's claim against Rover was not so intimately founded in and intertwined with the charter party . Astra appealed the District Court decision.

The Second Circuit decision

In September 2003, Judge Sotomeyer spoke for the Second Circuit addressing Astra's appeal of the District Court decision. The court noted it had dealt with the issue of enforceability of arbitration agreements by a non-signatory in two of its recent decisions, Choctaw Generation Ltd v Am Home Assurance Co and Smith/Enron Cogeneration Ltd v Smith Cogeneration Int'l Inc. In both cases the court held that the signatory was estopped from avoiding arbitration because the issues the non-signatory was seeking to resolve in arbitration were intertwined with the agreement. Although Choctaw Generation did not specifically identify the degree of intertwining that would be required to support an estoppel theory, the court made it clear that such a finding should be made after a careful review of the relationship of the parties, the contracts they signed and the issues that were between them.

The Second Circuit reversed the District Court denial of Astra's petition and remanded the issue with instruction to the District Court to grant the Petition to Compel Arbitration. It stated that the petition should have been granted based on the undisputed evidence of the close corporate and operational relationship between Astra and AOT, the fact that Astra's claim against Rover was brought under the charter with AOT, and the fact that Rover treated Astra as if it were a party to the charter party by accepting voyage directions, by asserting a General Average demand against Astra and AOT and by accepting a General Average Bond from Astra on behalf of AOT and Astra.

The court pinpointed the District Court's fundamental misperception of the relationship between the charter party and Astra's late delivery claim. The issues that the court highlighted were those relating to the engine breakdown, the warranty of unseaworthiness and the undue delay in delivery. These issues were without doubt intertwined with the charter party. Astra's claim was not based on the Sprague sales contract but on damages it allegedly sustained by reason of the vessel's woeful performance.

Having decided the case by applying the estoppel principles of Choctaw and Smith-Enron, the court avoided dealing with counsel's alternative arguments of whether the express provisions of the Letter of Undertaking obligated Rover to arbitrate with Astra and also avoided addressing with Judge Weinfeld's decision in State Trading Corp of India v Grunstad Shipping Corp (Belgium) N.V. In State Trading, Judge Weinfeld held that a non-signatory consignee holder of a tanker bill of lading that did not specifically incorporate the charter party or arbitration clause may, nevertheless, arbitrate its cargo claim against the signatory shipowner if the arbitration clause is broad rather than narrow.

Hopefully, this has helped to clear the air on this subject and pinpoint the elements the courts take into account when called upon to address the inclusion of non-signatories into arbitration proceedings. The same principles are obviously guides to arbitrators when such issues are submitted to a panel of arbitrators as they have been in the past.

It is a pretty much recognised fact that petroleum companies, and other major shippers, charter vessels in the name of one of their companies and buy, sell and ship cargoes in the name of other subsidiary companies. The question of whether a corporate entity, as voyage charterer, must arbitrate the traditional demurrage, safe port, performance claims etc, of the shipowner, but that its related cargo trading company may not introduce its claim in the same proceeding, is impractical, wasteful and inherently unfair. To have to arbitrate and then also litigate specific issues that are, in the main, based on an identical set of facts is objectionable and wasteful.

But there is a better way, and preventative medicine is often a more practical and economically effective way to go. One of the many rider clauses we often see bloating standard charter forms can easily and without fanfare provide for the inclusion of subsidiary and affiliated companies in any arbitration proceeding. A clause along this line may obviate what could be a costly and time-consuming pre-arbitration trip through the courts:

'Arbitration shall be conducted in accordance with Clause 24 of Part II. The right to arbitrate claims against owner shall also extend to companies affiliated with, or in the same financial group, as charterer. This charter shall be governed by the general maritime law of the US, as interpreted and applied in New York.'

Practice in other jurisdictions

ICC arbitrators often apply the so-called ' group of companies doctrine'to obtain a result they perceive will reflect the parties 'intent' and the 'good usages of international commerce'. Their holding in the Dow Chemical case in 1982 reflects this approach. International Chamber of Commerce Arbitration, Third Edition, Craig, Park, Paulsson, refers to this doctrine and the holding in Dow:

' This holding is consonant with that made in a US arbitral decision rendered under the auspices of the Society of Maritime Arbitrators, where the arbitrators reviewing the industry practice of operating through multiple subsidiaries at various stages (chartering, shipping and consigning) and expressing their loathness to narrowly restrict the parties'apparent intention to arbitrate their differences stated that it was neither sensible nor practical to exclude from the arbitration claims of companies having an interest in the venture and who are member of the same corporate family. (at p. 76).'

English law does not embrace this doctrine, emphasising that, in commercial terms, the creation of a corporate structure is by definition designed to create separate legal entities for entirely legitimate purposes.