Recently, the U.S. Court of Appeals for the Second Circuit affirmed a district court’s ruling denying the motion of plaintiffs-appellants (collectively “LSED”) to compel arbitration of a dispute with Merrill Lynch, Pierce, Fenner & Smith Inc. (“MLPFS”), finding that LSED waived its right to arbitrate by litigating the case for nearly a year before filing its motion. See Louisiana Stadium & Exposition District and State of Louisiana, Plaintiffs-Appellants v. Merrill Lynch, Pierce, Fenner & Smith Incorporated and Merrill Lynch & Co., Inc., Defendants-Appellees, 10-889-cv (2d Cir., Nov. 22, 2010).

The Second Circuit described three factors to be considered when determining whether a party has waived its right to arbitration: (1) the time elapsed from when litigation commenced until the request for arbitration; (2) the amount of litigation to date, including motion practice and discovery; and (3) proof of prejudice. The court emphasized that proof or prejudice is key to the waiver analysis and that there are two types of prejudice that need to be examined: substantive prejudice and prejudice due to excessive cost and time delay.

The court found that both types of prejudice were present, and thus held that LSED waived its right to arbitration. With regard to the excessive cost and delay, eleven months had elapsed between LSED’s initial court filings and its motion to compel arbitration, and MLPFS had incurred substantial expenses in litigating the dispute. Moreover, the court noted that the defendants would be substantively prejudiced if arbitration were compelled since, as part of the litigation proceedings, MLPFS had filed a letter that detailed the perceived deficiencies of LSED’s complaint. This letter foreshadowed MLPFS’ inevitable motion to dismiss. The court held that by pursuing litigation, LSED obtained the benefit of the analysis of MLPFS’ deficiency letter and that it would be very difficult for MLPFS to succeed on a motion to dismiss in an arbitration since such motions were discouraged under the relevant arbitration rules.

The court also considered judicial economy, noting that because LSED was the plaintiff in the lawsuit, it had acted inconsistently with its contractual right to arbitrate by pursuing litigation initially and for many months. The court emphasized that “a litigant is not entitled to use arbitration as a means of aborting a suit that did not proceed as planned in the District Court.”

Click here to review a copy of the Second Circuit’s decision.