El Paso COA Affirms Trial Court’s Order Denying Arbitration

Texas’ Eighth District Court of Appeals in El Paso has affirmed a trial court’s order stating two companies did not agree to exclusively arbitrate their claims against one another under Delaware law.  In Encore Enterprises, Inc., et al. v. Borderplex Realty Trust, et al., No. 08-17-00134-CV (September 28, 2018), two real estate investment companies, Encore and Borderplex, signed a Contribution Agreement to jointly develop, fund, and manage multi-family properties.  The Contribution Agreement did not contain an arbitration clause.  In the Contribution Agreement, however, the two companies agreed to also enter into an Operating Agreement prior to any anticipated real estate closings.  The Operating Agreement contained an arbitration clause, but was never signed by the parties.

Later, Encore accused Borderplex of violating the signed Contribution Agreement by failing to secure the funding necessary to close on any properties.  After that, Borderplex sought a declaratory injunction against Encore in El Paso County, Texas.  Encore responded to Borderplex’s case by filing a motion to compel the dispute to arbitration based on the arbitration provision included in the unsigned Operating Agreement.  The trial court denied Encore’s motion for arbitration and the company filed an interlocutory appeal with the Eighth District Court of Appeals.

On appeal, the El Paso court first stated:

The nub of the dispute is this: the Contribution Agreement itself contains no arbitration clause, but the unsigned Operating Agreement does. With that in mind, we set forth more of the parties’ agreement as it pertains to how the Contribution Agreement incorporated the unsigned Operating Agreement.

The appellate court then examined the two agreements before stating Delaware law and the Federal Arbitration Act governed the dispute.  The court then dismissed Borderplex’s claim that Encore waived its right to arbitration.  After that, the Court of Appeals examined whether the incorporation by reference of the parties’ unsigned Operating Agreement that was included in the signed Contribution Agreement was sufficient to make the Operating Agreement’s arbitration provision effective.

According to the El Paso court, the fact that the Operating Agreement was never signed was not dispositive.  Despite this, the appellate court stated:

While we do not dispute the importance of incorporation by reference, we think it misses the point of why the Operating Agreement was included as an attachment and when its terms should become effective. The parties contemplated that in the future they would close on several properties, and then would develop and manage those properties. When they did so, they required an agreement to govern the properties. The Contribution Agreement itself refers to the future execution of the Operating Agreement. Recital G. states that “upon the issuance” of ownership units in the yet to be formed company, and as of the date of an initial closing, the parties would have certain rights stated in the Operating Agreement. Section 1.01 of the Contribution Agreement similarly provided that “on or prior to the date of the Initial Closing” the parties would execute the Operating Agreement. The closing was the event which would necessitate the execution of the Operating Agreement.

Encore does not contend otherwise, but nonetheless claims Section 9.10 by incorporating the draft Operating Agreement made all its terms, including the arbitration clause, immediately enforceable. This construction, however, is at odds with how we view a Delaware court would construe the Contribution Agreement.

The Court of Appeals then examined Delaware case law before stating Encore’s argument in favor of incorporating the entirety of the draft Operating Agreement into the terms of the signed Contribution Agreement would unnecessarily subvert the parties’ “intended plan or scheme.”

The appellate court also said the Contribution Agreement’s venue clause undermined Encore’s claim that the case should be arbitrated.  According to the court:

Section 9.07 of the Contribution Agreement provides that any action or proceeding brought to enforce any term or provision of the Contribution agreement “shall be brought only” in a court in El Paso or Dallas. Borderplex contends this provision belies any construction requiring all disputes to be arbitrated. In its second issue, Encore suggests this provision is boilerplate, or only applies to a suit to enforce an arbitration award, or for specific performance or injunctive relief. But if the provision was so limited, it would have said so, rather than using the broader language covering enforcement of any term or provision of the Contribution Agreement. Instead, Section 9.07 buttresses our construction of the Contribution Agreement: one class of disputes requires arbitration, but one class does not. Encore through its notice of default letter initiated a dispute not governed by the mediation/arbitration provisions, effectively leaving the dispute for a Dallas or El Paso court.

Next, the Eighth District dismissed Encore’s assertion that the issue of arbitrability was for an arbitrator to decide.  The appellate court stated:

Guided by two Delaware opinions, we conclude the parties did not clearly and unmistakably leave the issue of arbitrability to the arbitrator under the first prong of the test. In Willie Gary, the court upheld the trial court denial of arbitration. 906 A.2d at 82. The agreement there required arbitration of any controversy arising out of the parties’ contract and it incorporated the AAA rules. Id. at 79-80. However, it expressly authorized the non-breaching party to obtain injunctive relief and specific performance in the courts. Id. “Thus, despite the broad language at the outset, not all disputes must be referred to arbitration. Since this arbitration clause does not generally refer all controversies to arbitration, the federal majority rule does not apply, and something other than the incorporation of the AAA rules would be needed to establish that the parties intended to submit arbitrability questions to an arbitrator.” Id. at 81. In other words, the injunctive relief carve out was sufficiently broad to negate the first prong of the Willie Gary test (that arbitration applies to all disputes).

We contrast Willie Gary with BAYPO Ltd. Partnership v. Technology JV, LP, where a court reached the opposite result, but based on a more narrowly tailored carve out clause. 940 A.2d 20, 26 (Del. Ch. 2007). The contract in BAYPRO allowed the parties to seek injunctive or equitable relief, but only as necessary to protect “the rights and property of such party or maintain the status quo before, during or after the pendency” of any arbitration. Id. The agreement additionally directed that an arbitrator decide all substantive and procedural issues. Id at 27.

Read together, the decisions teach that the “carve outs and exceptions to committing disputes to arbitration should not be so obviously broad and substantial as to overcome a heavy presumption” that incorporating the AAA Rules intends that the arbitrator decide all issue of arbitrability. McLaughlin, 942 A.2d at 625. In the Contribution Agreement before us, those carve outs are sufficiently broad to overcome the presumption. As we discuss above, Section 8.01 broadly includes any breaches of the Contribution Agreements, and under the most appropriate construction, allows them to be judicially resolved. Only a narrower class of claims–those post-closing–are clearly governed by the arbitration agreement in the Operating Agreement. And like Willie Gary, the Contribution Agreement additionally carves out specific performance and injunctive relief to prevent breaches of the Contribution Agreement, or to enforce its terms. We conclude that because of the scope of these carve outs, Encore has failed to show the agreement commits all disputes to arbitration, and thus no presumption arises that the parties intended to have an arbitrator determine arbitrability. Accordingly, we overrule Issue Three.

Finally, the El Paso Court of Appeals declined to consider Encore’s claim that Borderplex invoked the arbitration provision included in the unsigned Operating Agreement in a superseded pleading before ultimately affirming the trial court’s order denying Encore’s motion to compel arbitration.

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