Arbitration Waiver, Quirky Question # 131

We have employment agreements with our employees that contain mandatory arbitration provisions. Recently, one of our senior executives departed and joined a competitor. This arguably violated his non-competition agreement, though that involves issues unrelated to my present inquiry.

We filed a lawsuit against our executive alleging breach of contract and other wrongful conduct. At the same time we filed our Complaint, we filed a Motion for Preliminary Injunction and a Motion to Compel Arbitration. We decided not to pursue the Motion to Compel Arbitration, electing instead to see what kind of result we could first obtain from the federal court on our preliminary injunction motion. Our thinking was that if we could get a positive outcome from the federal judge on the injunction motion, we could keep the case in federal court and disregard the arbitration forum. Unfortunately, the federal judge ruled against us on our motion for injunctive relief, so our former employee continues to compete with us.

We now are trying to schedule our motion to compel arbitration. Our ex-employee's attorney, however, claims that we "waived" our right to pursue our claims in arbitration. How can that be? We filed our Motion to Compel Arbitration at the beginning of the case, some four months ago, so our ex-employee was on notice all along regarding our desire to arbitrate. Moreover, shouldn't the arbitrator decide the issue of whether we "waived" our right to pursue arbitration

Roy's Analysis of Quirky Question # 131, Arbitration Waiver

You ask whether your company’s conduct could be construed as a waiver of your company’s right to arbitrate. Let’s start with the basics. To establish an enforceable arbitration agreement, three conditions must be satisfied: a) a written agreement to arbitrate must exist; b) the dispute must fall within the scope of the arbitration agreement; and c) the party seeking arbitration must not have waived its right to arbitrate.

You stated that your company uses employment agreements that contain arbitration provisions, so the first requirement is satisfied. Presumably, your former employee’s competition with your company falls within the scope of your arbitration provision. So, the enforceability of the arbitration agreement will turn on whether your organization has waived its right to arbitrate.

Your last question was: “Who decides the issue of waiver – the court or the arbitrator?” This seemingly straightforward question is not quite as easy as one might assume, since the decision-maker on “waiver” is dependent on the type of waiver that is alleged. When waiver claims are based on the argument that critical evidence has been lost due to the delay of the other party, the arbitrator decides the issue. This type of waiver is referred to as “laches” or “estoppel” waiver. (See, e.g., Parler vs. KFC Corp., 529 F. Supp. 2d 1009, 1012 (D. Minn. 2009)).

When the waiver argument is based on actions involving the initial pursuit of claims in court, however, a judge, not an arbitrator, decides whether waiver has occurred. As the District Court recently summarized in the Parler decision, “courts generally decide whether a party has waived its right to arbitrate by ‘actively participat[ing] in a lawsuit or tak[ing] other actions inconsistent with the right to arbitration.’” Id. (internal citations omitted). In short, for the type of waiver involved in the fact pattern you described, the court, not the arbitrator, decides the waiver issue.

Courts focus on three questions when assessing this type of waiver: 1) did the party seeking arbitration know of an existing right to arbitrate; 2) did the party act inconsistently with that right; and 3) did those inconsistent actions prejudice the other party? That is the analytical framework that should be applied to your fact situation.

As you note, your company included an arbitration obligation. Moreover, your firm clearly was aware of that provision (you pointed out that you filed a Motion to Compel Arbitration at the same time you filed the Complaint). So the first question clearly would be answered in the affirmative.

The second inquiry – whether your company acted inconsistently with your right to arbitrate – will be the legal battleground on this issue. As the courts have pointed out, this type of waiver is evaluated from the “totality of the circumstances” and must be assessed “in context.” There are no per se rules dictating the way this issue is assessed. So, courts have the opportunity to look at any and all factors they consider relevant to the waiver issue.

Further, courts have recognized that a party to an arbitration agreement “acts inconsistently” with its right to arbitrate when it: delays assertion of its right to arbitrate; actually participates in a lawsuit; substantially invokes the litigation machinery; or takes other actions inconsistent with the right to arbitrate. These are the standards that will be applied to your company’s conduct.

In support of your argument that your company has not waived its arbitration rights, you will be able to point out that you filed your Motion to Compel Arbitration simultaneously with your filing of your Complaint. Arguably, that action put your employee on notice of your intent to arbitrate.

The other facts you describe, however, are more problematic for you. You note, for example, that you filed your Motion to Compel Arbitration. But, apparently, you did not serve your arbitration motion on the opposing party, the action that starts the clock running on when the opposing side must respond to a pending motion. Even worse, your company took no steps to pursue its Motion to Compel Arbitration. Juxtapose that decision with your effort to pursue your Motion for a Preliminary Injunction. In the period since the filing of your Complaint, you have been able to schedule, brief and argue your Preliminary Injunction Motion. Presumably, you could have done the same with Motion to Compel Arbitration had you been serious about pursuing that motion.

You also state, “We decided not to pursue the Motion to Compel Arbitration, electing instead to see what kind of result we could first obtain from the federal court on our preliminary injunction motion. Our thinking was that if we could get a positive outcome from the federal judge on the injunction motion, we could keep the case in federal court and disregard the arbitration forum.”

In sum, as you acknowledge, you made a conscious decision not to pursue arbitration initially, hoping first to obtain a favorable ruling from the federal court on your preliminary injunction motion. You also point out that had your company been able to obtain a positive outcome from the federal court on your injunction motion, you would have elected to forego arbitration altogether.

These facts are particularly problematic for you. As a number of courts have noted, filing a case in federal court and “seeking arbitration only after the litigation goes badly is acting inconsistently with the right to arbitrate.” See, e.g., Parler, 529 F. Supp. 2nd at 1015. As the Eighth Circuit emphasized in a recent decision, the defendant “wanted to see how the case was going to go in federal district court before deciding whether it would be better off there or in arbitration. [Defendant] wanted to play ‘heads I win, tails you lose’ [which] is the worst possible reason for failing to move for arbitration sooner than it did.” Hooper v. Advance America Cash Advance Centers of Missouri, Inc., No. 08-3252 (December 16, 2009).

The bottom line is that your company seemingly engaged in the very conduct that a number of courts have decried, first testing the waters in a judicial forum and only after suffering a setback, attempting to pursue the claim in arbitration. Whether your company’s efforts to pursue your federal court action constituted a waiver of your right to pursue claims in arbitration will be for the court to decide but, as discussed above, some of the facts you revealed are problematic.

Now, some readers may be wondering whether I’ve missed an important point, specifically, the idea that your federal court lawsuit was only a Motion for a Preliminary Injunction, arguably intended to preserve the status quo pending a merits resolution of the underlying dispute. With regard to this issue, I’d make several quick observations. First, whether a company has the right to pursue an injunction motion in court (state or federal) in advance of an arbitration may depend, at least in part, on how the arbitration provision in the employment agreement is drafted. Some arbitration provisions specifically state that a company may pursue an injunction in court without prejudice to the right to later pursue arbitration. Other arbitration provisions do not. As to the latter group of contracts, the federal circuits are divided on whether a company may first seek an injunction in court. Second, note that a company could pursue an injunction in an arbitral forum. Third, as noted above, the time lag between the employee’s departure and the filing of the Complaint and injunction motion may bear upon the court’s analysis. How did the status quo change since the employee’s departure?

Finally, the third part of the waiver analysis is whether the opposing party would be prejudiced by requiring arbitration. Here, too, there is a split among the circuit courts, with some minimizing the significance of this variable. But, for those courts that do examine this issue, they look at the consequences for the adverse party, focusing on: a) how much has the party expended on the litigation in the period preceding the motion to compel arbitration; b) how much of the work already conducted would have to be repeated in the arbitration; and c) what costs would be associated with repeating some or all of the work in the arbitral forum. Some courts also factor in the investment by the judiciary in the pre-arbitration period, with some sensitivity to the issue of wasting not just parties’, but judicial, resources as well.

As stated by the Eighth Circuit just one month ago in the Hooper case, a party must do “all it could reasonably have been expected to do to make the earliest feasible determination of whether to proceed in arbitration.” It does not appear to me that your company did so, a fact that enhances your opponent’s waiver argument.