The federal district court for the District of New Jersey recently decided that two corporate officers could be required to arbitrate a dispute, even though the arbitration agreement was signed only by their company. Neal v Asta Funding, Inc. (June 30, 2016). The court decided the corporate officers were individually bound to arbitrate under three theories: (1) they were alter egos of the corporate signatory, (2) they were equitably estopped from refusing to arbitrate after they had relied on the contract to assert a counterclaim in the arbitration, and (3) one of the officers was found to be the successor-in-interest to the corporate signatory.

In 2007 Neal and Coyne had established New World Solutions, Inc. (“NWS”), a Delaware corporation, to provide IT services to Asta.  Neal and Coyne were the sole owners, officers and directors of NWS. Neal had previously provided those same services through another entity owned by Coyne. In 2009 NWS and Asta entered into an IT Services Agreement. After Asta had paid NWS approximately $4 million, Asta terminated the ITS Agreement, claiming that NWS had breached the contract by submitting inflated invoices, creating a malfunctioning replacement autodialer system, and retaining a subcontractor controlled by Coyne to provide virtually useless network monitoring services.  Unbeknownst to Asta, during the contract, Coyne had dissolved NWS and formed a new NWS entity incorporated in Wyoming. After Asta terminated the agreement, the Wyoming entity was administratively dissolved for failure to file certain reports and pay license taxes. Asta did not receive notice of any of these corporate changes.  

Asta commenced an arbitration, relying on the arbitration clause in the ITS Agreement that provided that “in the event of a dispute … between the Parties arising directly or indirectly out of or in connection with [the] Agreement, either Party may elect to have such dispute  . . . resolved by arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association (AAA).” At the arbitration, NWS was initially represented by counsel, but Coyne then took over the representation and filed a counterclaim in arbitration claiming that Asta had breached the agreement and owed NWS money. Asta also initiated a separate arbitration against Neal and Coyne personally based on the same claims it had asserted against NWS and additional claims that Neal and Coyne had improperly accessed and disclosed confidential documents. The arbitrator determined that Neal and Coyne were bound by the arbitration clause and consolidated both arbitrations.  Neal appeared for only the first day of the arbitration. Coyne did not appear at all and failed to comply with a subpoena to appear at the hearing. 

The arbitrator found that Coyne and Neal had used NWS to “defraud Asta of hundreds of thousands if not millions of dollars” and that NWS was simply “a façade for the illicit operations of the two shareholders . . . and their efforts to extract money from Asta.”  NWS had not been able to produce any of the corporate documentation that would be expected of a functioning entity, and the documents that were produced showed that NWS was simply a conduit for the Asta proceeds to be funneled to Neal and Coyne. The arbitrator also held that because the two men had filed a counterclaim on behalf of NWS and Neal was the sole beneficiary of the counterclaim, they were estopped from disavowing the arbitration clause. Neal and Coyne were also found to be alter egos of NWS and jointly and severally liable with NWS for damages in excess of $3 million. Neal and Coyne both filed declaratory judgment actions arguing that they were not bound by the arbitration provision of the ITS agreement. Asta filed a petition to confirm the arbitration award and Neal and Coyne both filed petitions to vacate the arbitration awards. All of the actions were consolidated before Judge Kevin J. McNulty in the District of New Jersey and the parties all moved for summary judgment.

Judge McNulty confirmed the arbitration award in full and held that Neal and Coyne were bound under the arbitration clause. First, the court had to decide whether the arbitrator had the power to assert jurisdiction over Neal and Coyne, who were not parties to the arbitration agreement. Under the Federal Arbitration Act, 9. U.S.C. §1 et seq., the court should determine whether a dispute is to be arbitrated, unless the parties agree otherwise. In the ITS Agreement, the parties had agreed the arbitration would be governed under the AAA’s Commercial Arbitration Rules, Section R-7(a) of which gave the arbitrator “the power to rule on his or her own jurisdiction, including with respect to the existence, scope or validity of the arbitration agreement.” Judge McNulty therefore found that the arbitrator was empowered to extend jurisdiction to the two corporate principals, particularly since they were not strangers to the contract and had used the corporation as their alter ego for fraudulent purposes. The court then independently determined that Neal and Coyne were alter egos of NWS, which (i) served merely as a “pass through” for Neal’s personal services, (ii) had been dissolved and restructured repeatedly to suit the personal needs of the principals and without notice to Asta, (iii) had no corporate records apart from two tax returns, (iv) maintained no significant assets and was insolvent when the contract was terminated, and (v) funneled all proceeds to its two principals. Even though Neal and Coyne were non-signatories, the court found they had directly benefited from the ITS agreement, and because Neal had also asserted a counterclaim in the arbitration proceeding on behalf of NWS, the benefits of which would flow solely to him, the court held that he could not use the parts of the Agreement that benefited him but then avoid the arbitration clause also contained the Agreement. Judge McNulty also held that Neal was a successor in interest to NWS, the contracting party, and would be bound under the Agreement.  Thus, the court confirmed the arbitration award against Neal and Coyne even though they had not individually agreed to arbitrate and refused to participate in the arbitration proceeding.

The Neal decision is a reminder that, if the equities are compelling enough, arbitrators and judges can bind individual corporate officers and shareholders to arbitration agreements entered into by their corporate principals.