Delaware Chancery Court Confirms Broad Arbitration Clauses Cover Questions of Substantive Arbitrability
In Bennett J. Glazer, et al. v. Alliance Beverage Distributing Co., LLC, Civil Action No. 12647-VCMR (Del. Ch. Ct. March 2, 2017), the Delaware Court of Chancery granted the defendant’s motion to stay, holding that the Court lacks subject matter jurisdiction to decide the question of substantive arbitrability when the disputing parties are bound by an LLC agreement containing a broad arbitration clause.
This case arises from an ongoing dispute between the parties’ parent companies, Glazer’s Inc. (“Glazer’s”) and Breakthru Beverage Group (“Breakthru”). Glazer allegedly entered into a nationwide distribution agreement with Bacardi, Inc., depriving Alliance Beverage Distributing Co., LLC (“Alliance”) of that business opportunity. Alliance’s two members are Cactus Beverage Distributing Company (“Cactus”), a subsidiary of Glazer’s, and Arizona Beverage Distributing Co., LLC, a subsidiary of Breakthru.
The plaintiffs in this case are Cactus and certain managers of Alliance. They assert a claim for the advancement of legal fees and expenses incurred in the larger litigation between Glazer and Breakthru, relying on Section 18-108 of the Delaware Limited Liability Company Act and Section 5.5 of the Limited Liability Company Agreement of Alliance (the “Alliance LLC Agreement”). The Alliance LLC Agreement contains a dispute resolution provision, however, which states among other things: “Any controversy or claim arising out of or relating to this Agreement, or the breach thereof, shall be settled by arbitration in the State of Arizona[.]”
The plaintiffs’ main argument for avoiding arbitration was that their right to advancement of legal fees and expenses must be adjudicated summarily to be of any value as a right separate from indemnification. The plaintiffs argued that the court should hear their claim for advancement because of the extended process for choosing arbitrators—making arbitration take longer than litigation. Defendant Alliance moved to dismiss the claim for lack of subject matter jurisdiction, or stay the case pending the resolution of the arbitration process.
The Court agreed with Alliance. The Court first noted that as a matter of public policy Delaware favors arbitration. Where litigants have agreed to arbitrate, “Delaware courts lack subject matter jurisdiction to resolve disputes.” The Court then turned to the Delaware Supreme Court’s substantive arbitrability jurisprudence to determine the threshold question of who may decide whether the present dispute is subject to arbitration, citing James & Jackson, LLC v. Willie Gary, LLC, 906 A.2d 76, 78 (Del. 2006).
In Willie Gary, the Delaware Supreme Court explained the general rule that courts should decide questions of substantive arbitrability may be altered by contract when there is “clear and unmistakable evidence that the parties agreed to arbitrate.” The two-prong test for such “clear and unmistakable evidence” is “(1) an arbitration clause that generally provides for arbitration of all disputes; and (2) a reference to a set of arbitration rules that empower arbitrators to decide arbitrability[.]”
Applying the Willie Gary test here, the Court of Chancery found that Alliance LLC Agreement was clear and unmistakable evidence of the intent to arbitrate the question of substantive arbitrability. First, the Agreement’s broad arbitration clause stated that “[a]ny controversy or claim” would be submitted to arbitration, and the parties did not point out any exceptions to that clause. Second, the arbitration provision incorporated by reference the AAA Commercial Arbitration Rules, including Rule 7, which provides that the arbitrator has the power to rule on his or her own jurisdiction. This satisfies both prongs of Willie Gary: (1) a broad arbitration clause covering all disputes, and (2) a rule empowering arbitrators to decide arbitrability.
In addition, the plaintiffs failed to meet the standard set by the Court of Chancery after Willie Gary. In McLaughlin v. McCann, the Court of Chancery ruled that signatories to an arbitration clause should address arguments against arbitrability to the arbitrator “absent a clear showing that the party desiring arbitration has essentially no nonfrivolous argument about substantive arbitrability to make before the arbitrator.” 942 A.2d 616, 627 (Del. Ch. 2008). The Court found that the plaintiffs did not carry that burden here. The Court noted that the plaintiffs failed to argue that their advancement claim fell outside either the arbitration clause specifically or the Alliance LLC Agreement in general. Nor did the plaintiffs present evidence that any exception to the broad contract language vesting the arbitrator with the power to decide arbitrability was intended. The plaintiffs therefore failed to show that the defendant had only a frivolous argument that substantive arbitrability should be decided by the arbitrators in Arizona.
In sum, the Court held that it lacked subject matter jurisdiction to decide substantive arbitrability because the parties agreed in broad language that the arbitrator would have that power. The plaintiffs failed to present evidence to the contrary, running against both Delaware’s established case law and expressed public policy preferences.