Chancery Court Reaffirms Arbitrability to be Decided by Arbitrator if Claims are Not Frivolous on their Face
By: Scott E. Waxman and Douglas Logan
In Angus v. Ajio, the Delaware Court of Chancery denied Bruce Angus’ preliminary injunction to block arbitration initiated by Members of MoGo Sport, LLC (“MoGo”), a Delaware sports equipment and injury prevention company organized as a Delaware limited liability company. The court held that the arbitrability of the claims in the arbitration demand must be decided by the arbitrator and not the court if the party opposing arbitration cannot show the arbitration demand to be frivolous.
MoGo sold flavored mouth guards for athletes. Members of MoGo claimed that a part of MoGo’s mission was athlete safety and concussion awareness. A member attended a production development meeting in December of 2011, where there was a discussion of “base-line” concussion testing for athletes and other preventative measures. At that meeting, one of the MoGo members introduced Angus, another member of MoGo, to Dr. Julian Bailes with the understanding that all concepts discussed between the two would be presented to MoGo as future business opportunities. Angus and Dr. Bailes discussed a concept Dr. Bailes helped to develop that was designed to reduce the risk of concussions among athletes.
According to the aggrieved members, after their initial meeting, Angus had frequent “secret” conversations with Dr. Bailes about the concussion prevention technology and did not disclose the information to MoGo. Angus, along with some other members of MoGo, then created a separate company using Dr. Bailes’ concepts. The new company entered into a multimillion-dollar licensing agreement with a third party. This agreement was not disclosed to the members of MoGo as a whole. Separately, MoGo’s members entered into a sale of the company without any knowledge of the other company or its new licensing deal.
When the MoGo members finally learned of the other shadow company and the licensing deal, they attempted to rescind their consent to the MoGo acquisition. After receiving no confirmation from MoGo regarding their rescission, the aggrieved members demanded arbitration against the members involved with the shadow company, including Angus.
After the aggrieved members demanded arbitration, the members who formed the new company filed for a preliminary injunction in the Court of Chancery to block the arbitration, claiming that it was improper. The aggrieved members subsequently filed a motion to dismiss the preliminary injunction. The court granted the injunction blocking the arbitration demand for all the members involved with the new company except for Angus. The members who did not have to arbitrate were not signatories to MoGo’s Operating Agreement containing the arbitration clause. However, Angus was a signatory to the Operating Agreement, and the court ultimately enforced the arbitration demand and denied Angus’ preliminary injunction.
The Court of Chancery concluded that, under Delaware law, the arbitrability of claims must be decided by the arbitrator unless the demanding party’s claims are frivolous. The Delaware Supreme Court previously held that Delaware courts should not presume that parties agreed to arbitrate the issue of arbitrability unless there is clear and unmistakable evidence of an agreement to do so. The intent to arbitrate arbitrability is determined by a two-part test. First, there must be an arbitration clause generally providing for arbitration of all disputes. Second, there must be a reference to a set of arbitration rules that gives the arbitrators the power to decide arbitrability. Further, unless all claims by the party seeking arbitration are frivolous, the Court of Chancery has held that parties must settle arbitrability claims before an arbitrator and not in court. The court may conduct only a limited analysis to determine whether a claim is non-frivolous.
In this case, the court determined that there was an arbitration clause generally providing for arbitration of all disputes in the Operating Agreement and that the Operating Agreement did reference rules allowing an arbitrator to decide issues of arbitrability (the American Arbitration Association (“AAA”) guidelines).
The Members demanding arbitration raised three specific claims: first, that Angus breached his fiduciary duties to MoGo; second, that Angus committed fraud; and third, that Angus breached several provisions of the MoGo Operating Agreement. The court concluded that the Members raised at least one non-frivolous claim and therefore the court should not rule on arbitrability but rather defer the matter for arbitration.
In summary, the court held that Angus failed to meet the standard for a successful preliminary injunction, because he was a party to the Operating Agreement that contained a mandatory arbitration provision that, through its adoption of the AAA guidelines, gave the arbitrator the power to determine the arbitrability of the matter. Further, the court determined it could not grant the injunction because Angus could not show the aggrieved Members’ claims to be frivolous.