The highest court in the State of New York, the New York Court of Appeals, last week rejected an effort to compel a non-signatory respondent to arbitrate tax reimbursement claims on a theory of “direct benefits estoppel.”  Given the commercial and financial importance of New York and the influence of the New York State courts, the case is of interest.  The Court agreed that the “direct benefits estoppel” theory was available to bind non-signatories to arbitrate, but that the particular facts surrounding the dispute did not fulfill the requirements of the theory.

 

In Matter of Belzberg v Verus Invs. Holdings Inc., 2013 NY Slip Op 06729 (No. 149,  October 17, 2013), Jefferies & Co.  (a securities brokerage) sought to recover in arbitration from its securities customer (Verus Investment Holdings) certain sums that Jefferies paid to Canadian tax authorities on account of withholding taxes related to a securities purchase, pursuant to an arbitration clause in their securities account agreement.  Verus answered the claim in arbitration and, in turn, sought to bring third-party claims in the same  arbitration for their share of the Canadian taxes against several persons and entities (Samuel Belzberg, Doris Lindbergh, Winton Capital and Gibralt Capital) who were involved in supplying Verus the moneys for the securities purchase that triggered the tax claims.  Belzberg et al had not signed the securities account agreement between Jefferies and Verus containing the arbitration clause. 

 

The underlying facts giving rise to the funding of the securities purchase and payment of the resulting  proceeds involved several parties (footnotes omitted).

 

In October 2008, Belzberg contacted a long time business associate, Ajmal Khan, the principal of Respondent Verus Investment Holdings (“Verus”), about an investment opportunity involving the purchase of securities in Fording Canadian Coal Trust to arbitrage a merger between Fording and another Canadian company (the “Fording Trade”).  After several discussions about potential tax consequences, Belzberg and Khan decided to proceed with the Fording Trade.  To complete the securities purchase Belzberg required an American brokerage account, and therefore agreed with Khan to use Verus’ account at Jefferies & Co., Inc. (“Jefferies”). Belzberg’s source for the investment money would be Winton Capital Holding (“Winton”), a British Virgin Islands Corporation owned by a trust established by Belzberg and naming Belzberg’s children as the sole beneficiaries, and for which Belzberg served as an unpaid financial advisor.  Belzberg directed that $5 million dollars be sent from Winton to the Jefferies account for the purchase, and Verus wired an additional $1 million dollars of its own funds.

 

After the merger, Jefferies wired to Verus both the original $5 million investment and $233,655.25 in profits attributable to the Winton funds.  Verus thereafter wired the $5 million to Winton and upon instructions from Gibralt Capital, a Canadian holding company that Belzberg used to facilitate the Fording Trade, wired the profits to Doris Lindbergh (“Lindbergh”), a friend of Belzberg. This money apparently was intended for Lindbergh to purchase a summer home.

 

Belzberg et al sought a stay of arbitration from the New York State courts while the question of whether they were proper parties in the arbitration was litigated in those courts.  Verus argued that the non-signatories were bound to arbitrate Verus’s claim for proportionate reimbursement of taxes under a variety of theories, including  the doctrine of estoppel.  The lower New York State trial court permanently stayed the arbitration as against Gibralt Capital, granted the motion to compel Winton Cpital to arbitrate, and held the proceeding against Belzberg and Lindbergh in abeyance, pending a hearing.  

 

Winton Capital did not further contest the order to arbitrate.  Upon conclusion of the hearing, Belzberg and Lindbergh succeeded in obtaining an order from the trial court to permanently stay the arbitration as against them.  At the intermediate New York State court appellate level, though, Verus prevailed and arbitration was ordered against the two individuals on the basis of the theory of estoppel.  Belzberg and Lindbergh appealed to the New York State Court of Appeals, which then reversed the intermediate appellate ruling and denied Verus’s demand for Belzberg to arbitrate.  Oddly, the decision is silent regarding whether Lindbergh should be compelled to arbitrate, even though her situation was more remote from the Jefferies-Verus contract than was the case for Belzberg. 

 

Notably, the New York State Court of Appeals relied upon US Federal court jurisprudence under the Federal Arbitration Act (FAA) to conclude that “[u]nder the direct benefits theory of estoppel, a nonsignatory may be compelled to arbitrate where the nonsignatory “knowingly exploits” the benefits of an agreement containing an arbitration clause, and receives benefits flowing directly from the agreement.”  However, again relying on Federal FAA decisions, “[w]here the benefits are merely “indirect,” a nonsignatory cannot be compelled to arbitrate a claim. A benefit is indirect where the nonsignatory exploits the contractual relation of the parties, but not the agreement itself.”  The Court admitted “it can be difficult to distinguish between direct and indirect benefits.”

 

The guiding principle is whether the benefit gained by the nonsignatory is one that can be traced directly to the agreement containing the arbitration clause.  The mere existence of an agreement with attendant circumstances that prove advantageous to the nonsignatory would not constitute the type of direct benefits justifying compelling arbitration by a nonparty to the underlying contract.  Also, absent the nonsignatory’s reliance on the agreement itself for the derived benefit, the theory would extend beyond those who gain something of value as a direct consequence of the agreement.

 

The Court of Appeals applied these principles to the facts, and concluded that, in the circumstances, Belzberg derived his benefits from the financial advisory services he provided to Winton Capital, not from the Jefferies-Verus securities account agreement.

 

Verus asserts that this estoppel theory applies to compel Belzberg to arbitrate because he derived a direct benefit from the Jefferies-Verus agreement namely the profits attributable to the $5 million dollar Winton investment in the Fording Trade.  Belzberg denies any such direct benefit and asserts that the funds from the Fording Trade belong to Winton.  We agree that Belzberg did not receive the type of direct benefit from the Jefferies-Verus agreement encompassed by this estoppel theory.  We are not persuaded by Verus’ argument that Belzberg’s diversion to his friend of the profits attributable to Winton’s investment in the Fording Trade constitutes a direct benefit from the underlying Jefferies-Verus agreement.  The profits belong to Winton, not Belzberg. Belzberg’s access to, and appropriations of, the profits is based not on any agreement involving Jefferies and Verus, but rather on his relationship with Winton.  It is in his position as financial advisor that Belzberg gained access to the profits attributed to Winton’s $5 million dollar investment.  Belzberg’s ability to divert those profits flows directly from his status vis-a-vis Winton, not as a result of any relationship with Verus or Jefferies, and certainly not based on the underlying agreement between those parties.

 

Of course, but for the Fording Trade, and Verus and Belzberg’s use of the Jefferies account, there would be no profits for Belzberg to divert to his friend for her personal use.  However, a connection based on mere extended causality is beyond the intended scope of the direct benefits estoppel theory.  Belzberg is several steps removed from the formation of the arbitration agreement between Jefferies and Verus.  In order to compel Belzberg to arbitrate the direct benefits theory of estoppel would have to recognize that the benefit flows initially from Belzberg’s relationship with Winton, allowing him the ready access to investment funds and trade profits, then from the use of the Jefferies-Verus agreement to accomplish the financial investment that resulted in the profits, followed by the final event in which Belzberg takes the profits for his own use, i.e. to give his friend the money to purchase a summer home.  This is simply too attenuated a connection to justify application of the direct benefits estoppel theory, a theory intended as justification for an exception to the usual rule that nonsignatories cannot be compelled to arbitrate.

 

It would be interesting to hear from counsel for the non-signatories why Winton Capital did not seek to overturn the order against that company compelling arbitration.  Did counsel consider the factual circumstances of Winton Capital constituted “direct benefit” while the circumstances of Belzberg did not?

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