First Department Addresses Scope of Federal Arbitration Act

On August 7, 2014, the First Department issued a decision in Cusimano v. Schnurr, 2014 NY Slip Op. 05702, addressing two issues that arise frequently in the context of commercial arbitration: (1) whether the parties’ arbitration agreement is covered by the Federal Arbitration Act (FAA), in which case threshold issues, such as the timeliness of the claims, are determined in the first instance by the arbitrator; and (2) whether the claimant waived the right to arbitration by first pursuing litigation in court.

In Cusimano, the plaintiffs brought suit against their former accountants for allegedly conspiring with plaintiffs' business partners to misappropriate distributions and assets from an entity, commit tax fraud, and fraudulently induce one of the plaintiffs to sell her interest in a property. Justice Ramos of the New York County Commercial Division dismissed plaintiffs' fraud and breach of fiduciary duty claims for lack of specificity under CPLR 3016(b) with leave to replead. Rather than filing an amended complaint, however, the plaintiffs commenced an arbitration with the American Arbitration Association, asserting claims similar to those raised in the lawsuit, and moved, under CPLR 7503(a), for a stay of the lawsuit pending the arbitration. The defendant accountants cross-moved for a permanent stay of the arbitration, under CPLR 7503(b), on the ground that the arbitration claims were time-barred. Plaintiffs opposed the cross-motion, arguing that because the parties' arbitration agreement was covered by the FAA, the issue of timeliness should be decided by the arbitrator, not the court. Justice Ramos found that the FAA was inapplicable because the agreements at issue "do not involve interstate commerce." He proceeded to hold that many of the claims were time-barred, and that plaintiffs waived any right they may have had to arbitrate those claims by commencing, and participating in, the litigation in New York Supreme Court.

The First Department (in a decision by Justice Richter) reversed. First, the Court found that the FAA applied given the broad interpretation the courts apply to the term "involving commerce" as used in the statute:

The FAA governs agreements which "evidenc[e] a transaction involving commerce" (9 USC § 2). In determining if the FAA applies to a contract, the central question is whether the agreement is a contract evidencing a transaction involving commerce within the meaning of the FAA.

Courts have interpreted the term "involving commerce" broadly. In Allied-Bruce [Terminix Companies, Inc. v. Dobson, 513 US 265, 270 (1995)], the United States Supreme Court concluded that the purpose of the FAA — to reduce the amount of litigation through the enforcement of arbitration agreements — supports a broad interpretation of the term "involving commerce" (513 US at 275). The Court declined to restrict transactions involving commerce only to those "activities within the flow of commerce" (id. at 273 [internal quotation marks and emphasis omitted]). Rather, it found the phrase "involving commerce" to be the equivalent of "affecting commerce," a term associated with the broad application of Congress's power under the Commerce Clause (id. at 273-274).

. . .

Based on a broad application of the term "involving commerce," we find that the FAA applies to the agreements at issue. Each of the agreements concerns transactions that affect commerce, and all of the entities are involved in the rental of commercial property. FLIP's rental property, which is located in Florida, is leased by a CVS drug store; Berita owns an interest in an entity that in turn owns a Marriott Hotel; and Seaview owns two commercial buildings. Because commercial real estate can affect interstate commerce, the ownership of and investment in the commercial buildings here, one of which is occupied by an international chain hotel and another which houses a national chain drug store located out-of-state, renders the FAA applicable to these agreements.

We reject respondents' claims that the FAA is inapplicable because, in their view, this is a dispute about the mismanagement of the family entities in New York State. The proper inquiry is whether the economic activity in question represents a general practice that bears on interstate commerce in a substantial way. This dispute not only involves substantial commercial transactions covering real properties, some of which are not in this state, but as plaintiffs note, the properties are part of national hotel and drug store chains.

Second, the Court found that the fact that plaintiffs filed a lawsuit in Supreme Court did not effect a waiver of the right to arbitrate, as the parties did not engage in "protracted litigation" prior to the commencement of the arbitration, and there was no prejudice to the defendants:

Although a party may have a right to arbitrate, the court may determine that a party has waived this right by having participated in litigation. There is a strong federal policy favoring arbitration, and waiver should not be lightly inferred under the FAA. A party does not waive the right to arbitrate simply by pursuing litigation, but by engaging in protracted litigation that results in prejudice to the opposing party.

In determining what constitutes protracted litigation for the purposes of waiver, there is no bright line rule. Rather, the court should consider three factors: (1) the amount of time between the commencement of the action and the request for arbitration; (2) the amount of litigation thus far; and (3) proof of prejudice to the opposing party Indeed, the key to a waiver analysis is prejudice. Prejudice may either be substantive prejudice or result from excessive delay or costs caused by the moving party's pursuit of litigation prior to seeking arbitration, though cost alone is not sufficient to establish prejudice. A party may be substantively prejudiced when the other party is attempting to relitigate an issue through arbitration, has participated in substantial motion practice, or seeks arbitration after engaging in discovery that is unavailable in arbitration.

Applying these principles, we find that plaintiffs' actions in this litigation have not prejudiced respondents such that the court must find waiver. Although plaintiffs commenced this action in court, they did not engage in aggressive litigation involving multiple motions addressed to the merits, nor did they pursue state court appeals. Importantly, the only substantive motion in this action was made by the accountants. Plaintiffs moved only to disqualify defense counsel, relief which could have been sought in arbitration. In any event, this type of motion would be insufficient to constitute waiver under the federal case law. Respondents point to the fact that plaintiffs requested subpoenas while the motion to dismiss was pending, but no actual discovery took place. Therefore, plaintiffs did not obtain any evidence that would not be available to them in arbitration.

Respondents assert that plaintiffs, by seeking arbitration, are attempting to relitigate the issues they lost before the motion court. However the motion court gave plaintiffs leave to replead with specificity, effectively giving plaintiffs "another bite at the apple," at least as to the sufficiency of the pleadings. Thus, plaintiffs have not received any greater advantage by filing a statement of claim in an arbitration than they would have obtained had they filed an amended complaint. In any event, respondents point to no case finding waiver solely because a party filed an arbitration demand after limited motion practice, particularly where, as here, only one year had passed and no discovery had been exchanged.

The accountants argue that plaintiffs' delay in seeking arbitration is prejudicial because it caused them to experience unnecessary delay and expenses. They stress the amount of time that passed between plaintiffs' filing their complaint and pursuing arbitration and argue that they incurred legal fees in challenging plaintiffs' subpoenas. A delay of one year does not, in itself, amount to protracted litigation, particularly where a delay was not accompanied by substantial motion practice or discovery. Further, the expense the accountants incurred in responding to plaintiffs' procedural motion and subpoenas does not, by itself, establish waiver. Indeed, this Court has found that "pretrial expense and delay, without more, does not constitute prejudice sufficient to support" waiver.

Although plaintiffs could have sought arbitration sooner, the fact that they did not file a substantive motion or obtain discovery material that would not have been available in arbitration weighs in favor of allowing arbitration to proceed. Indeed, when assessing the question of waiver, any doubts concerning whether there has been a waiver are resolved in favor of arbitration. In light of the strong preference for arbitration and the lack of prejudice to respondents, we find that no waiver has occurred.

(Citations omitted).