On 15 March 2016, the US Court of Appeals for the Ninth Circuit reversed a California district court’s order granting a petition to compel arbitration pursuant to the Convention on the Recognition and Enforcement of Foreign Arbitral Awards 1958 (“New York Convention”). The Ninth Circuit held that the parties’ “Commercial Contract” did not constitute a binding agreement under federal common law because there was no mutual intention to be bound. Reading the Commercial Contract and the parties’ contemporaneously executed “Hold Harmless Agreement” together, the Ninth Circuit concluded that the Commercial Contract was no more than a sham agreement. Accordingly, the arbitration clause in the Commercial Contract was not enforceable. Dissenting, Judge Callahan wrote that the parties did initially agree to be bound by the Commercial Contract. She therefore would affirm the district court’s order referring to arbitration the question of whether and when the Commercial Contract was terminated (Casa del Caffe Vergnano v. ItalFlavors, LLC, No. 13-56091 (9th Cir. 2016)).
In early 2010, Cesar and Hector Rabellino began planning to open an Italian-style coffee shop in the United States. The Rabellinos formed ItalFlavors LLC and began discussions with Caffe Vergnano, an Italian corporation, to open a franchise in America.
On 23 September 2010, the Rabellinos met with Tommaso Lambert, a representative of Caffe Vergnano, in Italy. During the course of their meeting, the parties signed the Commercial Contract, which contained an arbitration clause providing that: “Any dispute, controversy or claim arising out of or in connection with this Agreement, or the breach, termination or validity thereof, which is not [resolved] directly between the Parties, shall be settled by final and binding arbitration in accordance with the UNICTRAL Arbitration Rules as presently in force.” The Commercial Contract was to be construed according to Italian law with arbitration to be held in Geneva, Switzerland.
On the same day, the parties also signed the Hold Harmless Agreement, which provided in relevant part: “The [‘Commercial Contract’] does not have any validity or effectiveness between the parties, as it was prepared and delivered by Casa del Caffe Vergnano S.p.A. solely for the purpose of allowing Mr. Hector Rabellino to submit a copy of it to the pertinent international agencies in order to obtain an entry visa to work in the United States of America. …This contract does not produce any effect between the parties, who as agreed will sign a future contract which will regulate their commercial relationship ….”
ItalFlavors opened its franchise branch in San Diego on 20 April 2011, but after months of struggles and financial failures, the store closed on 20 December 2011.
Thereafter, ItalFlavors filed suit in California, alleging a series of violations of California’s Franchise Investment Law and Business and Professions Code. Subsequently, that action was stayed after Caffe Vergnano filed the petition to compel arbitration in the district court.
According to the Rabellinos, the parties entered into the Hold Harmless Agreement because Caffe Vergnano had concerns that the Commercial Contract did not conform to US franchise law and so sought to shield itself from liability by making the contract void, while, at the same time, allowing Hector Rabellino to use the Contract to obtain his visa. They contended that the parties intended to sign a binding contract at a later date.
According to Lambert, the representative from Caffe Vergnano, the purpose of the Hold Harmless Agreement was not to render the Commercial Contract void, but rather to protect Caffe Vergnano from any liability in the event that Hector Rabellino used the contract in any way that ran afoul of US immigration laws.
The district court held that “the issue of whether the broad arbitration clause contained in the Commercial Contract survives after the September 24, 2010 agreement took effect should be submitted to the arbitrator”. Therefore, the district court issued an order compelling arbitration.
Thereafter, ItalFlavors appealed the district court’s order before the US Court of Appeals for the Ninth Circuit.
The Opinion of the Ninth Circuit
The Ninth Circuit reiterated the Supreme Court’s repeated admonition that “[a]rbitration is strictly a matter of consent” and that it was “well settled that where the dispute at issue concerns contract formation, the dispute is generally for courts to decide” Granite Rock Co. v. Int’l Bhd. of Teamsters, 561 U.S. 287, 296-299 (2010). According to the Ninth Circuit, while the Commercial Contract at issue contained an arbitration clause, the threshold issue was whether that document constituted a binding agreement at all. If it did not constitute such an agreement, it followed that the arbitration clause was not enforceable.
Under federal common law, parties to a “contract” who have not mutually consented to be bound by their agreement, have not formed a true contract. The Ninth Circuit found that the parties did not manifest their intent to be bound by the Commercial Contract containing the arbitration clause. Reading the Commercial Contract and the contemporaneously executed Hold Harmless Agreement side by side, it was plain to the Ninth Circuit that the Commercial Contract was nothing more than a sham agreement designed as a ploy to aid Hector Rabellino’s visa application. Even apart from the language in the Hold Harmless Agreement expressly declaring the Commercial Contract was not a binding agreement, the provision that the parties “will sign a future contract which will regulate their commercial relationship as soon as it is prepared in accordance with the federal and national laws of the United States of America” made little sense if the Commercial Contract – which purportedly regulated their commercial relationship – was a binding agreement.
Accordingly, the Ninth Circuit concluded that the Commercial Contract was not a contract, but a sham, and was thus unenforceable. It found that the arbitration clause was no more enforceable than any other provision in that document. Thus, the Ninth Circuit reversed the order of the district court which compelled the parties to arbitrate their dispute.
Judge Callahan dissented noting that she would affirm the district court’s order referring the question of whether and when the Commercial Contract was terminated to arbitration.
Judge Callahan disagreed with the majority’s factual premise, i.e., treating the Commercial Contract and Hold Harmless Agreement as a single document and concluding that the parties have not formed a true contract. According to Judge Callahan, the parties first entered into the Commercial Contract. They mutually agreed to be bound by the Commercial Contract and its broad arbitration clause. They then entered into a separate and distinct Hold Harmless Agreement. They disagreed as to the effect of this document. Caffe Vergnano argued that the Hold Harmless Agreement did not really terminate the Commercial Contract, but was intended to protect it from possibly violating US franchise laws or misuse of the Commercial Contract by Hector Rabellino in seeking a visa. ItalFlavors, however, argued that the Hold Harmless Agreement terminated the Commercial Contract.
Accordingly, to Judge Callahan, because the Commercial Contract was entered into before the Hold Harmless Agreement was signed, the district court was correct in determining that the dispute over whether and when the Commercial Contract was terminated should be referred to arbitration.
Amore detailed summary and an excerpt of this decision, indexed and searchable according to the list of topics published in http://www.newyorkconvention.org/court+decisions/description will be published in the 2016 volume of the Yearbook Commercial Arbitration, published by the International Council of Commercial Arbitration (ICCA).
Source: Original Opinion of the Ninth Circuit available at http://law.justia.com