Court Refuses to Compel Arbitration by Third Parties Not Signed to Arbitration Agreement

On June 1, 2010, the California Court of Appeal refused to enforce an arbitration agreement to require the arbitration of claims asserted against third parties who did not agree to arbitration. In Valencia v. Smyth, purchasers of real property sued their agent, the property owners and the owners’ broker and listing agent, and three additional parties (two title companies and the trustee of the deed of trust) for fraud, breach of fiduciary duty, negligence, and other claims arising out of the alleged misappropriation of the purchasers’ escrow funds.  The owners attempted to enforce an arbitration agreement entered into with the buyers in which they agreed to arbitrate “any dispute or claim in Law or Equity arising between them out of this Agreement or any resulting transaction,” which neither the title companies nor the trustee were parties to. The trial court had refused to enforce the agreement, and required that all parties be joined in a consolidated judicial proceeding, because the claims against the third parties arose out of the same transaction or series of related transactions and there was a “possibility of conflicting rulings on a common issue of law or fact.”

The Court of Appeal affirmed this ruling based on the provisions of the California Arbitration Act, Code of Civil Proc. Section 1281.2, which permit a court to deny arbitration in a case involving third parties who have not agreed to arbitrate. Although arbitration of the entire dispute could have been ordered if the parties had adopted the procedural provisions of the Federal Arbitration Act, the court found that they had not done so — even though the Arbitration Agreement stated that “Interpretation  of this agreement to arbitrate shall be governed by” the FAA. 

The case demonstrates the importance of the wording of arbitration agreements to determining how they will be enforced. It is particularly important for employers who seek to enforce their agreements to arbitrate claims brought by former employees to properly reference the Federal Arbitration Act int heir agreements, if they want to compel arbitration of their disputes against third parties who have not signed the arbitration agreement.  

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