Arbitration is a rapidly evolving area of the law that is established on both national and international legal principles. The two forms of international arbitration are investment arbitration and commercial arbitration.[1] Investment arbitration involves a dispute between an investor and a state party, typically involving a bilateral treaty agreement.[2] Commercial arbitration encompasses disputes arising from relationships of a commercial nature, such as a business arrangement.[3]  This article will focus on a specific subset of international arbitration known as the shareholder derivative arbitration, which generally falls under the category of commercial arbitration.

Shareholder arbitration is a developing area of arbitration that seeks to enforce fiduciary duty law through arbitration modeled on the shareholder derivative suit.[4] In the derivative suit, the corporation becomes the plaintiff, and the defendant is the corporation’s current or former directors and officers.[5] The shareholders must bring the suit because the directors and officers are deemed to have a conflict of interest in bringing a suit against one of their fellow board members, and in any case would be unlikely to pursue this option if it were available. [6] Any monetary award in a derivative suit returns to the corporation, and not the shareholders.[7] The shareholder derivative suit has been declared “dead” by some scholars, yet it certainly lives on in international arbitration.[8]

When analyzing derivative suits globally, some scholars opine that jurisdictions in Continental Europe do not enforce corporate law based on the low number of derivative suits, when compared with the frequency of derivative suits in other jurisdictions such as the United States.[9] Historically, shareholders in these jurisdictions have pursued methods of enforcement other than derivative suits due to the limited availability of this option.[10] For example, according to one report, only two derivative suits where damages were awarded at trial against supervisory board members occurred in Germany prior to 1997.[11] However, the shareholders of a corporation do have the right to sue the directors on behalf of the corporation in many European countries even if they rarely use this option.[12] The challenges of litigating a derivative suit in national courts may make arbitration a more attractive option for both shareholders and corporations.

Parties to an international dispute may favor arbitration over litigation or other methods of dispute resolution for a variety of reasons. Arbitration allows the parties to choose a proceeding tailored to their specific needs through choice of arbitrators, applicable law, venue, language, and procedure.[13] The procedures may be institutional in nature, originating in an organization such as the International Chamber of Commerce, non-institution (such as the UNCITRAL model rules), or ad hoc.[14] In the international context, arbitration allows parties to avoid the unpredictability that could arise from litigation in a national court do to the risk of partiality and prolonged appeal of a decision.[15]

This article will discuss the legal principles underlying derivative suits in general, as well as how these principles specifically impact shareholders. First, it will discuss the relationship of shareholders to the arbitration agreement, and the international approach to binding shareholders to the arbitration agreement. Then it will examine the advantages and disadvantages of shareholder derivative arbitration, and how this compares to derivate lawsuits in national courts.

               I.     Extending the Arbitration Agreement to non-signatory shareholders

An evolving issue in international arbitration that may affect shareholders is the extension of an arbitration agreement to non-signatories. This issue often arises when a non-signatory party becomes involved in a transaction originally subject to an arbitration clause, and the original signatories to that clause do not want to lose the benefits of arbitration (i.e. a neutral forum, dispute finality, party autonomy, and the enforceability of an award in foreign courts) simply because subsequent contracts did not include an arbitration agreement.^[16] It can also arise in the inverse circumstance, when a non-signatory party wishes to invoke an arbitration clause against a signatory. Extending an arbitration agreement to non-signatory parties is particularly pertinent to shareholders, who are generally shielded from liability for the conduct of their corporations. Moreover, a shareholder, despite being a part owner of a corporation, may have little or no involvement in the actual business dealings of its company. As a result, when considering the extension of an arbitration agreement to a non-signatory shareholder, a court will also consider the legal principles governing the shareholder-company relationship.

When asked to bind non-signatories of an agreement to arbitration, courts have applied a variety of legal principles. According to the U.S. Supreme Court, when addressing contractual clauses in general,  “‘traditional principles’ of state law allow a contract to be enforced by or against nonparties to the contract through ‘assumption, piercing the corporate veil, alter ego, incorporation by reference, third party beneficiary theories, waiver and estoppel.’”^[17] The following section (A) summarizes the five generally recognized theories under which non-signatories, and particularly shareholders, may be bound to (or may bind signatories to) arbitration agreements: (1) alter ego or veil-piercing; (2) incorporation by reference; (3) assumption; (4) agency; and (5) equitable estoppel.^[18] Section (B) analyzes the international approach to binding non-signatory shareholders to arbitration agreements.

A.    Five theories used to bind non-signatory shareholders to arbitration

i.       Alter Ego or Veil Piercing

Shareholders are generally immune from liability for the actions of their corporation. However, a non-signatory shareholder may be bound to arbitrate a dispute if the claimant successfully “pierces the corporate veil” of the entity that agreed. Piercing the corporate veil is defined as, “[t]he judicial act of imposing personal liability on otherwise immune corporate officers, directors, or shareholders for the corporation's wrongful acts.”[19] In international arbitration, a tribunal may allow a party to pierce the corporate veil in order to force the shareholder to arbitrate.

Therefore, despite the fact that the shareholder has not agreed to arbitrate, the shareholder may be compelled to arbitrate if the corporation of which it is a shareholder has itself agreed to arbitration. To do so, the shareholder must be using the corporation merely as an “alter ego.” Courts have held that to pierce the corporate veil and find the shareholder liable under the “alter ego” theory, there must be “a unity of ownership and interest between the corporate entity and the individual such that the distinct personalities of the corporation and the individual no longer exist and to adhere to that separateness would promote a fraud or work an injustice.”^[20]

This reasoning is supported by the International Court of Justice case Barcelona Traction.[21] In that case, the ICJ held that, “the process of lifting the veil, being an exceptional one admitted by municipal law in respect of an institution of its own making, is equally admissible to play a similar role in international law…[t]he wealth of practice already accumulated on the subject in municipal law indicates that the veil is lifted, for instance, to prevent the misuse of the privileges of legal personality, as in certain cases of fraud or malfeasance, to protect third persons such as a creditor or purchaser, or to prevent the evasion of legal requirements or of obligations.”[22] A corporation that meets these conditions may therefore be “pierced” in order to impose liability on shareholders and bind them individually to an arbitration agreement.

ii.     Incorporation by Reference

Incorporation by reference is a principle of contract law that binds a non-signatory party to the terms and conditions of a preexisting contract if that contract is referred to and included in the new contract. For example, in Progressive Cas. Ins. Co. v. C.A. Reaseguradora Nacional De Venezuela, the court held that the parties’ dispute was subject to an arbitration clause because the clause was worded broadly enough to permit incorporation into future contracts.^[23] Further, in Gingiss International, Inc. v. Bormet, the Seventh Circuit court of the U.S. held that shareholders of a franchisee were compelled to arbitration because of an arbitration clause contained in the franchise agreement, despite the fact that they did not sign that agreement.^[24] By having the shareholders sign a separate agreement by which they expressly assumed the obligations of the franchisee, the franchise agreement (and the arbitration clause it contained) were incorporated by reference, and considered obligations of the shareholders.^[25]

iii.    Assumption

A non-signatory shareholder may be bound by an arbitration agreement based solely on conduct implying their willingness to be bound. For example, if a party prepares to arbitrate through the hiring of counsel to argue on its behalf in a specific case, this may evidence intent to be bound by the arbitration agreement.^[26] In other cases, courts have found that a non-signatory’s failure to object to an arbitration agreement upon notice that the agreement exists, combined with acceptance of the benefits of the same agreement, may constitute assumption of the arbitration clause.^[27]

iv.    Agency

Agency has its roots in the common law principle that binds a principal to a contract signed by the principal’s agent.^[28] Agency may be shown by “(1) a manifestation by the principal that the agent will act for him, (2) acceptance by the agent of the undertaking, and (3) an understanding between the parties that the principal will be in control of the undertaking.”^[29] In numerous cases, non-signatories have been bound to an arbitration clause based on the agency relationship. In Pritzker v. Merrill Lynch, Pierce, Fenner & Smith, Inc., trustees of a pension plan brought an action against a broker who moved to compel arbitration.^[30] The court held that the trustees were bound by an arbitration clause with respect to the broker, a financial consultant, and a sister corporation due to agency, even though the latter two never signed the agreement containing the clause.^[31] The argument to bind non-signatory trustees in Pritzker could readily be applied to shareholders, who are similar to trustees.[32]

v.     Equitable Estoppel

The doctrine of equitable estoppel broadly encompasses principles of fairness and thus estops a party from selectively accepting only portions of an agreement to their own benefit. A party may compel a non-signatory to arbitrate under the doctrine of equitable estoppel if the claims it is pursuing are “inextricably intertwined” or “inherently inseparable” from other claims the party is pursuing that are subject to arbitration.^[33] For example, in Long v. Silver, 248 F.3d 309 (4th Cir. 2001), a contractual dispute filed by a plaintiff shareholder against other shareholders in his corporation and the corporation itself, the court held that non-signatory shareholders could rely on an arbitration agreement signed by the plaintiff to compel the plaintiff to arbitration. In that case, the plaintiff’s causes of action arose under a 1972 contract (which contained an arbitration agreement but was not signed by each of the shareholders), and also under a 1999 contract (which was signed by each of the shareholders but did not contain an arbitration clause).^[34] The court found that claims against the corporation and its shareholders were so closely intertwined that claims against the non-signatory shareholders were properly referable to arbitration even though the shareholders were not signatories to the 1972 Agreement.^[35] The court further held that if the non-signatory shareholders were forced to litigate the issues arising under the 1972 Agreement, the arbitration proceeding involving the 1972 agreement “would be rendered meaningless and the federal policy in favor of arbitration effectively thwarted.^[36]

B.    International approach to binding shareholders to arbitrate: the French example

In the international arena, the broad contract principles of alter-ego or veil piercing, estoppel, assumption, agency, and incorporation by reference can be used to bind non-signatories to international arbitration agreements.[37] In particular, these principles can be applied to bind non-signatories of arbitration agreements that are governed by the New York Convention.[38] While these contract principles are generally used in the United States to bind non-signatories to an arbitration agreement in the United States, other countries have developed different principles to bind non-signatories to the arbitration agreement.[39]

Under French law, the “group of companies doctrine” has been used to bind a non-signatory party can be joined to the arbitration, either as a claimant or respondent.[40]  Where a signatory to the arbitration agreement is part of a group of companies, the group of companies doctrine permits the extension of an arbitration clause to a non-signatory company or companies within the same group as the signatory.[41] However, in order for a non-signatory to be bound under the group of companies doctrine, French courts and arbitral tribunals applying French law require a demonstration that both a) the non-signatory party played a part in the conclusion, performance, and termination of the contract containing the arbitration agreement, and b) it was the expressed or implied intent of the non-signatory party to be bound by the contract containing the arbitration agreement. [42]

This dual requirement of participation in the contract and intent to be bound by the arbitration agreement was developed in the landmark case on the group of companies doctrine, Dow Chemical Group v. Isover-Saint-Gobain.[43] There, two companies within the Dow Chemical group entered into distribution agreements with a number of other companies, the rights of which were then later assumed by Isover-Saint-Gobain. Each distribution agreement contained an arbitration clause. When a dispute under the contracts arose, arbitration proceedings were commenced by the two Dow Chemical companies, and also by their parent company and a subsidiary, neither of which had signed the arbitration agreement.[44] The respondent, Isover-Saint-Gobain, objected to the claims brought by parent company and subsidiary, arguing that since the claimant parties had not signed the arbitration agreement, they did not have standing to bring claims against the respondent.[45]

The arbitral tribunal rejected the respondent’s challenge, holding that the arbitration agreement could be extended to the non-signatory claimants because the non-signatories had played a major role in the conclusion, performance and termination of the contracts containing the arbitration agreement.[46] In particular, the tribunal considered that 1) one of the non-signatory companies had performed under the requirements of the contract containing the arbitration agreement, particularly by making all deliveries to Isover-Saint-Gobain, and 2) the other non-signatory claimant was the parent company of one of the signatories, owned the trademarks under which the products under the contract were marketed, and had absolute control over the subsidiary signatory, which itself had a direct role in the conclusion, performance and termination of the contracts.[47]

The arbitral tribunal therefore found that, given the non-signatories’ role in the conclusion, performance, and termination of the contracts, they had demonstrated intent to be bound to the contract that contained the arbitration agreement itself. As a result, the non-signatories were de-facto parties to the contract, and could bring claims against the respondent under the arbitration clause in the respondents’ contracts.[48] The tribunal’s decision was upheld by the Paris Court of Appeals,[49] and continues to represent the French approach to binding third-party non-signatory companies to an arbitration agreement.   

As a result, under French law, the common-law notion that separate companies are also distinct separate legal entities, despite being part of a group of companies, has been limited to an extent by the group of companies doctrine.[50]  However, the group of companies doctrine will be used to bind a non-signatory under French law only upon a showing of clear intent by the parties to be bound by the arbitration agreement.  For example, in ICC Case No. 2138 of 1974, the group of companies doctrine could not be used to bind a non-signatory to an arbitration agreement, because it could not be shown that the non-signatory would have agreed to the arbitration agreement.[51] There, the tribunal noted that despite the fact that the non-signatory had taken part in the negotiation of the contract, and had signed the main provisions of the agreement, it had not signed the later contract that contained the arbitration clause.[52] Thus, despite the fact that the non-signatory had been involved in the negotiation, performance, and termination of the contract, the arbitration agreement could not be extended to the non-signatory, because there was no evidence that the non-signatory intended to be bound by the arbitration agreement.[53]

             II.     The Arbitrability of shareholder derivative suits

A.    Advantages and Disadvantages of Shareholder Derivative Arbitration

Scholars and jurists alike have debated the efficacy and justification of compelling shareholder derivative suits to arbitration. First, respecting a party agreement calling for the arbitration for shareholder derivative suits is in line with modern business law, which generally respects party autonomy in the formation of contracts.[54] By respecting clauses calling for the arbitration of derivative suits, commentators note that we may obtain a more accurate measure of shareholders' actual preferences with regard to these sorts of suits.[55] Further, the arbitration of shareholder derivative suits may prove to be the most cost-effective means to resolve such claims, since discovery costs of arbitration are generally lower than the discovery costs of litigation.[56] The parties to an arbitration proceeding may also be able to keep their dispute confidential, thus avoiding negative publicity that could harm the corporation and its chances of future success, an important consideration since shareholders in a derivative proceeding aim to protect their investment in the corporation.[57]

There are, however, several objections to submitting shareholder derivative disputes to arbitration. Arbitration has historically been viewed as an unacceptable means of resolving public shareholder derivative claims because of the theory that states must retain the power to oversee public corporations.[58] Shareholder derivative actions allow shareholders to bring suits against corporate directors and officers to enforce shareholders’ corporate rights, and further permit the judiciary to develop corporate rules of law to regulate public corporations and prevent fraudulent activity of their executives.[59] The confidential nature of arbitration means that arbitral decisions are generally unpublished, and do not create binding precedent on future derivative disputes.[60] Therefore, some commentators have argued that the precedential value of judicial decisions is too valuable in the context of developing the law of public corporations and management duties.[61]

Further, over the years, courts have developed extensive experience in shareholder derivative litigation. Panels of arbitrators expert in the securities industry are not likely to have familiarity in the manner in which this body of law has developed or the reasons for its development.[62]

In addition, a notable objection has been the reluctance to bind the shareholders of a public corporation to an arbitration agreement contained in the corporate charter or shareholder agreement.[63] Even if, arguendo, a corporate charter can be interpreted as a contract, the question remains whether shareholders may be deemed to have accepted an arbitration agreement contained in the charter simply by purchasing shares in the corporation.[64] In particular, shareholders of public corporations generally have only passive ownership of stock in the corporation, and may be unaware that an arbitration provision exists in the corporate charter when purchasing their shares.[65] As such, a great concern of shareholder arbitration is whether it can be said that a shareholder has assented to arbitration.[66] A shareholder derivative suit is an action brought by a shareholder on behalf of a corporation.[67] As such, in shareholder derivative disputes, if a corporation has signed an arbitration agreement, that agreement is binding on the shareholder that brings the dispute, even though the shareholder is simply the vehicle for initiating the suit.[68]

As a result, despite the recent increase in shareholder arbitration, the practice of arbitrating shareholder disputes remains a source of great critique. The perceived necessity of government oversight over corporate management, the binding nature of arbitration clauses on shareholders that have night signed such agreements, and the precedential value of such suits in national courts remain pivotal arguments against the arbitration of shareholder derivative suits. Despite this fact, legislation in many western nations, and particularly the U.S. and France, highly favor the arbitration of disputes. As a result, it remains to be seen whether the arbitrability of shareholder derivative suits will be reigned in by legislation.

B.    International approaches to shareholder derivative suits in national courts

Even shareholders or corporations pursue a derivative action in national courts rather than through arbitration, several challenges remain. The challenges result from numerous factors that contribute to how frequently shareholder derivative suits occur in various national jurisdictions. Scholars have pointed out that in Continental Europe, these factors include: minimum ownership requirements, the risks of litigation, access to information, and the possibility of including not only directors, but also controlling shareholders.[69] These challenges may provide incentive for shareholders or corporations to pursue commercial arbitration instead of filing a suit in national courts due to the advantages discussed above.

The minimum ownership requirement allows only shareholders with a minimum ownership interest in a corporation to bring a suit.[70] In theory, minimum ownership requirements may prevent frivolous lawsuits because they help ensure that shareholders filing suit have a significant interest in the outcome of the litigation.[71] On the other hand, at least one study concluded that these limits encourage corporations to “bribe” shareholders who fall above the limits in order to prevent lawsuits, while ignoring shareholders with smaller ownership interests.[72]  In Continental European countries with such requirements, mandatory minimum ownership percentages range from 1% (Belgium) to 20% (Italy), and may be accompanied by alternative minimum monetary totals (for example, 100,000 € in Germany).[73] If a shareholder cannot meet either the percentage ownership requirement or the minimum ownership value requirement, then the shareholder will be blocked from filing suit.[74] In comparison, France and Switzerland do not have such requirements and individual shareholders can file suits against directors of a corporation regardless of the percentage of their ownership interest.[75]  

Other laws that do not provide strong incentive for shareholders to file suits may also explain the small number of European shareholder derivative suits.[76] Unlike in the United States, where each party in a lawsuit must pay its own litigation costs (the so-called “American Rule”), in many European jurisdictions the losing party must cover both its own costs and costs of the other party.[77]  Due to this “English Rule,” shareholders may not wish to pursue a derivative suit that may entail high legal fees due to the complexity of a case.[78] At the same time, in some European countries, the law limits the scope of the “English Rule” to reimbursement of court fees and may not include lawyer fees.[79] For example, in France, the losing party in a corporate case typically does not pay the attorney fees of the winning party because an attorney is not mandatory in commercial courts.[80]    

In addition to the question of legal fees, the relative infrequency of derivative suits in Europe may be cause in part by the unavailability of contingency fees as well as the possibility of having to pay other litigation costs even if the suit is successful.[81] A contingency fee scenario reduces the risk for shareholder plaintiffs by basing payment of their attorney(s) entirely on the success of their suit.[82] Within the European Union, only England and Wales permit attorneys to use a contingency fee structure.[83] Even if the plaintiff does not have to pay high attorney fees, initial court fees may deter many plaintiffs from filing derivative suits.[84] For example, in Germany, plaintiffs can pay fees of a few thousand Euros (based on the amount in dispute, which is capped at 500,000 €) simply to commence an action.[85] This can make it difficult for shareholders with limited financial means to pursue a suit in the relevant national court, and may make arbitration a more appealing option if it is available based on the existing shareholder agreement or other corporate agreements.

Conclusion  

In conclusion, it is clear that shareholder derivative arbitration may provide an attractive alternative to derivative litigation in national courts. Based on agreements already in place between the corporation and its shareholders, it may in fact be the only option available. National legislatures may decide to limit the scope of shareholder derivative arbitration in the future, but in the meantime a party considering a derivative suit should consider the availability of arbitration and compare the benefits with options in national courts, or should consider whether it could be bound to arbitrate as a third-party signatory to an existing agreement. The generally favorable treatment of arbitration internationally, as seen in U.S. courts and in Europe, demonstrates that derivative arbitration as a subset of commercial arbitration may expand in the future.   

III.     Bibliography

Cases

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Camacho v. 1440 Rhode Island Ave. Corp., et al., 620 A.2d 242, 249 (D.C. App. 1993).

C.F. Trust, Inc. v. First Flight Ltd Partnership, et al., 111 F. Supp. 2d 734, 742 (E.D. Va. 2000.

Deloitte Noraudit A/S v. Deloitte Haskins & Sells, U.S., 9 F.3d 1060 (2d Cir. 1993).

Dow Chemical Group v. Isover-Saint-Gobain, ICC Case No. 4131

Gingiss Int'l, Inc. v. Bormet, 58 F.3d 328 (7th Cir. 1995).

Gvozdenovic v. United Air Lines, Inc., 933 F.2d 1100 (2d Cir. 1991).

ICC Case No. 2138 (1974).

In re Salomon Inc. Shareholders' Derivative Litig. 91 Civ. 5500 (RRP), 68 F.3d 554 (2d Cir. 1995).

Isover-Saint-Gobain v. Dow Chemical France, Cour d’appel de Paris, 21 oct. 1983.

Long v. Silver, 248 F.3d 309 (4th Cir. 2001).

McAuliffe v. C&K Builders, Inc., 142 A.2d 605, 607 (1958).

Mecos, S.r.L. v. Georal Intern., Ltd., 2005 WL 2046024 (E.D. N.Y. 2005).

Pritzker v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 7 F.3d 1110, 1112 (3d Cir. 1993).

Progressive Cas. Ins. Co. v. C.A. Reaseguradora Nacional De Venezuela, 991 F.2d 42 (2d Cir. 1993).

Articles and Treatises

Richard Bamforth & Irina Tymczyszyn, Joining non-signatories to an arbitration agreement: recent developments, in Dispute Resolution 2007/08 Vol. 2: Arbitration (2007) available at http://www.olswang.com/pdfs/arbitration_jun07.pdf. 

Tiffany Chieu, “Class Actions in the European Union?: Importing Lessons Learned from the United States' Experience into European Community Competition Law,” 18 Cardozo J. Int'l & Comp. L. 123 (2010).

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Oehmke & Brovins, “Binding Nonsignatories to Arbitration--Beware of the Foot in the Door,” 127 Am. Jur. Trials 107 (2012).

G. Richard Shell, Arbitration and Corporate Governance, 67 N.C. L. Rev. 517, 521 (1989).

Andrew J. Sockol, A Natural Evolution: Compulsory Arbitration of Shareholder Derivative Suits in Publicly Traded Corporations, 77 Tul. L. Rev. 1095 (2003).

Aubrey L. Thomas, Comment: Nonsignatories in Arbitration: A Good-Faith Analysis, 14 Lewis & Clark L. Rev. 953, 955 (2010).

United Nations Conference on Trade and Development, Dispute Settlement: International Commercial Arbitration, UNCTAD/EDM/Misc.232/Add.38, 2005.

E. Norman Veasey & Michael P. Dooley, The Role of Corporate Litigation in the Twenty-First Century, 25 Del. J. Corp. L. 131 (2000).

Robert A. Wells, The Use of Arbitration in Director and Officer Indemnification Disputes, 13 Ohio St. J. on Disp. Resol. 199 (1997).

What Arbitration Agreement? Compelling Non-Signatories to Arbitrate, Disp. Resol. J., JULY 2001, at 40, 42.

Dwayne E. Williams, Binding Nonsignatories to Arbitration Agreements, 25 Franchise L.J. 175, 182 (2006).

Williston on Contracts § 54:14 (4th ed.).