Fifth Circuit Reverses Order Compelling Non-Signatory to Arbitrate

In an unpublished opinion, the Fifth Circuit has reversed a United States District Court’s order compelling a ship builder and a propulsion system manufacturer to arbitrate a dispute between them. In VT Halter Marine, Inc. v. Wartsila North America, Inc., No. 12-60051, (5th Cir. Feb. 8, 2013), a ship operator, Vessel Management Services, Inc. (“Vessel Management”) contracted with a ship manufacturer, VT Halter Marine, Inc. (“VTHM”), to build a number of large vessels. The contract between the parties did not contain an arbitration clause. Vessel Management also contracted with Wartsila North America, Inc. (“Wartsila”) to purchase several vessel propulsion systems for the ships that VTHM was building. The contract between Vessel Management and Wartsila contained an arbitration clause that stated:

This Agreement shall be construed in accordance with the laws of the State of New York, without reference to its conflict of laws provisions. Any dispute between the parties arising out of or in connection with this Agreement shall be finally settled under the Rules of Arbitration of the American Arbitration Association by one or more arbitrators appointed in accordance with the said rules, in New York, New York.

VTHM did not enter into a contract with Wartsila and was not a signatory to the contract between Vessel Management and Wartsila. Once the propulsion systems were completed, however, Wartsila delivered them directly to VTHM for installation. After the propulsion system on one of the ships built by VTHM failed inspection, Vessel Management demanded that VTHM purchase a new propulsion system. According to VTHM, Vessel Management did so based on Wartsila’s misrepresentation regarding the quality of VTHM’s workmanship. VTHM eventually purchased the new system in an effort to avoid paying any potential liquidated damages.

VTHM later filed a lawsuit against Wartsila in the United States District Court for the Southern District of Mississippi alleging breach of warranty and tortious interference with contractual relations. According to VTHM, the company stood in the shoes of Vessel Management for purposes of equitable subrogation. Wartsila responded by filing a motion to compel arbitration. Although VTHM conceded that its breach of warranty claim was subject to arbitration, the company argued that its tortious interference claim was not. Still, the district court ordered both claims to arbitration and dismissed the case. VTHM then filed an appeal in the Fifth Circuit.

Initially, the appeals court dismissed Wartsila’s claim that de novo was an incorrect standard of review because the district court relied on principles of equitable estoppel. According to the court:

Wartsila provides no case, and we can find none, where this Court reviewed for abuse of discretion a district court order compelling arbitration that did not clearly apply equitable estoppel. Because there is no indication from the district court’s order that it applied equitable estoppel, we assume that it did not.

Next, the Fifth Circuit said,

This Court in Pennzoil articulated the two general requirements for compelling a party to arbitrate a particular dispute: the court must determine both that (1) the two parties have a valid agreement to arbitrate, and (2) the dispute in question falls within the scope of that arbitration agreement. 139 F.3d at 1065.

According to the Fifth Circuit, the lower court completely overlooked the fact that VTHM was not a party to the sales contract that contained an arbitration clause. Instead, the appeals court said the district court incorrectly addressed the scope of the agreement.

Finally, the appellate court held,

Ultimately, regardless of whether the district court correctly understood the nature of the contracts between the parties, Wartsila concedes that it has no valid agreement to arbitrate with VTHM. Thus, the first requirement of Pennzoil cannot be satisfied; VTHM cannot be compelled to arbitrate under general arbitration principles and the district court erred in so holding.

We decline to determine whether equitable estoppel compels arbitration at this point. Instead, we remand this case to the district court to determine whether direct benefits equitable estoppel applies, as Wartsila urges.

The Fifth Circuit reversed the lower court’s holding and remanded the case for a determination regarding whether an exception that binds non-signatories to an arbitration agreement applied.