Fifth Circuit Denies Compelled Arbitration Under Theory of Direct Benefits Estoppel

The 5^th Circuit Court of Appeals has held that a court may not compel arbitration under the theory of direct benefits estoppel where there was no evidence a party had actual knowledge a contract containing an arbitration clause existed and no attempt was made by the party to enforce the specific provision which contained the arbitration clause.

In Noble Drilling Services, Inc. v. Certex USA, Inc., No. 10-20083 (5^th Cir., September 15, 2010), Noble Drilling Services (Noble) entered an agreement to purchase wire mooring rope from Bridon International, Ltd. and Bridon-American Corporation (Bridon) through Bridon’s distributor Certex USA, Inc. (Certex). The distribution agreement between Certex and Bridon contained an arbitration clause that “expressly disclaims any intention to benefit any third party.” Based upon various representations made by both Bridon and Certex regarding the strength of Bridon’s ropes, Noble entered into a sales contract with Certex to purchase wire rope manufactured by Bridon.

To fulfill the sales contract, Certex entered into purchase order agreements with Bridon. These agreements specified the type of wire required by Noble and directed that Bridon ship the wire rope directly to Noble. The purchase order agreements also incorporated Bridon’s “terms and conditions,” including a provision that stated where “any dispute or difference arises out of or in connection with the contract” upon written notice of either party to the contract it “shall be referred to the arbitration of a person . . .”

The court noted that no evidence was presented to establish Noble was presented a copy of the purchase order agreements or distribution agreement existing between Certex and Bridon, or viewed Bridon’s terms and conditions containing the arbitration clause. Noble’s agreement with Certex did not contain an arbitration clause and included a clause which stated the sales contract between Noble and Certex, together with Noble’s terms and conditions, constituted the complete agreement between the two parties.

After the wire ropes failed during Hurricane Ike and resulted in damage to Noble’s rigs in the Gulf of Mexico, Noble brought suit against Certex and Bridon. Noble’s suit alleged breach of the sales contract as to the quality of the ropes, negligence in the design of the wire ropes, breach of an express warranty that the ropes conformed to Noble’s specifications, breach of an implied warranty of merchantability, negligence and gross negligence in making representations about the ropes, fraud and fraudulent inducement, liability under Louisiana’s law of redhibtion and violations of the Louisiana Products Liability Law.

Certex and Bridon moved to compel Noble to arbitrate under the terms and conditions contained in the distribution and purchase agreements. Despite that Noble was not a signatory to any agreement between Certex and Bridon, Certex and Bridon argued that Noble could nevertheless be compelled to arbitrate under the theory of direct benefits estoppel. The district court found that Noble was bound to arbitrate because Noble’s claims were “premised on Bridon’s failure to perform” according to the purchase order agreements with Certex and that Noble was the direct beneficiary of those orders. After the district court dismissed the case, Noble appealed.

Relying on Hellenic Inv. Fund, Inc. v. Det Norske Veritas, 464 F.3d 514, (5th Cir. 2006), the Fifth Circuit noted the theory of direct benefits estoppel requires that a non-signatory party “embrace” a contract during the life of the contract only to repudiate an arbitration clause contained in the contract once litigation has begun. This “embrace” can occur in one of two ways: by “knowingly seeking ‘direct benefits’ from that contract,” or, “by seeking to enforce the terms of that contract or asserting claims that must be determined by reference to that contract.” The Fifth Circuit further noted that it would review the facts under both methods because it appeared that both were invoked in Hellenic Inv. Fund.

To satisfy the knowledge requirement of knowingly seeking direct benefits, a non-signatory party must “have had actual knowledge of the contract containing the arbitration clause.” Because Noble alleged it “was never apprised of the existence, much less any specific terms” of the purchase order agreements between Certex and Birdon until after litigation began and Certex and Bridon offered no such evidence, no evidence existed to support the “knowingly seeking” method of embracing the contract under the theory of direct benefits estoppel.

The Fifth Circuit then noted that since Noble was not seeking to enforce the specific terms of the purchase order contract containing the arbitration clause, the second method of embracing the contract necessary for direct benefits estoppel could only apply if “Noble’s claims can be determined solely by reference to the Purchase Order Agreements.” Noble expressly disclaimed any provisions in the purchase order agreements, instead relying on the pre-purchase representations made by Certex and Bridon, as well as the basic legal duties imposed by law on manufacturers and distributors.

Because the Fifth Circuit found no evidence to establish Noble embraced the contract under the theory of direct benefits estoppel, the case was reversed and remanded in order to be tried on the merits of Noble’s claims.

Disputing has discussed direct benefits estoppel frequently in the past:

• In 2009 Developments in Arbitration: Binding Non-Signatories;
• In a law review article: “Disappearing Juries and Jury Verdicts,” 39 Tex. Tech L. Rev. 289, written by the Honorable Sam Sparks, U.S. District Judge for the Western District of Texas and DLA Piper attorney George B. Butts;
• In a 2007 blog posting entitled Concerted-Misconduct Equitable Estoppel;
• In Non-Signatories and Arbitration of Personal Injury Claims;
• and in Karl Bayer’s Continuing Legal Education paper entitled “Arbitration: What’s a Trial Lawyer to Do?“

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