Delaware Chancery Court Refers Issues of Arbitrability to Arbitrator in Officer Indemnification and Advancement Dispute

By: Shoshannah Katz and James Parks

In Meyers, et al. v. Quiz-Dia LLC, et al., C.A. No. 9878-VCL (Del. Ch. Ct. December 2, 2016), the Chancery Court referred the issue of arbitrability with respect to certain indemnification claims made by former officers of the Quiznos family of companies pursuant to their employment agreements to arbitration and stayed the proceedings as to those claims, while refusing to grant a stay of the proceedings with respect to separate claims for indemnification and advancement arising under a range of other agreements.

Greg MacDonald (“MacDonald”) and Dennis Smythe (“Smythe”) were officers of the principal operating entity of the Quiznos sandwich shops, QCE LLC (“OpCo”), and claim to have been officers of all of the other entities in the Quiznos family of companies. As part of a restructuring in 2012, ownership over OpCo and its subsidiaries passed to various investment funds (the “Funds”) that held a substantial amount of Quiznos’ debt. MacDonald and Smythe subsequently left Quiznos post-restructuring.

Quiznos’ position did not sufficiently improve as a result of the restructuring. In March 2014, OpCo and a number of other Quiznos entities filed a petition for bankruptcy, disclosing that the reorganized debtors and the Funds intended to pursue certain litigation claims against MacDonald and Smythe. In July 2014, after demanding indemnification and advancement from Quiznos for “all expenses incurred in connection with the threatened claims,” MacDonald and Smythe sued the Quiznos entities in the Delaware Chancery Court for indemnification and advancement under a range of agreements, but not under either of MacDonald or Smythe’s employment agreements.

Less than two weeks later, the Funds sued MacDonald, Smythe, and certain other individuals in federal district court in Colorado, alleging that MacDonald and Smythe induced them to participate in the restructuring by means of deceptive financial projections. In May 2016, MacDonald and Smythe amended their claims in the Delaware action to seek indemnification under their employment agreements. The Quiznos entities subsequently moved to dismiss the new claims in favor of arbitration and to stay the prior claims pending the outcome of the arbitration. MacDonald and Smythe responded that the defendants had waived their right to arbitrate.

In considering the question of arbitration with respect to the employment agreements, the court first analyzed the issue of substantive arbitrability, that is, “whether the issue of arbitrability should be decided by the court or the arbitrator.” Applying Colorado law (the governing law of the employment agreements), the court determined that whether a dispute is subject to arbitration is to be decided by the arbitrator, rather than the court, because the parties explicitly incorporated a set of rules into the arbitration provision of each employment agreement (in this case, the Commercial Arbitration Rules of the American Arbitration Association) that empower the arbitrator to determine arbitrability.

Assuming that the arbitrator was to hold the claims arbitrable, the court further held that questions of procedural arbitrability, such as “whether the invocation of arbitration was proper or timely” and the plaintiffs’ procedural defense of waiver of the right to arbitrate, are also within the scope of the arbitration. Accordingly, if the arbitrator were to hold the claims arbitrable, then the court indicated that it would defer to the arbitrator as to procedural arbitrability, including the plaintiffs’ defense of waiver of the right to arbitrate.

Pending the arbitrator’s decision as to arbitrability, the court applied the law of the forum, Delaware, in resolving to stay the proceedings with respect to the claims under the employment agreements, noting that if the arbitrator determines that the claims are arbitrable, then they will be dismissed in the present action for lack of jurisdiction.

The court refused to grant a stay of the prior claims for advancement and indemnification under the other agreements pending the arbitration of the claims arising under the employment agreements. The court acknowledged that a broader stay is appropriate in circumstances where the claims subject to arbitration and those in the court proceeding are so intertwined that arbitration of one would produce factual findings dispositive of the other. As the court viewed the indemnification provisions in the employment agreements as “materially different” from those in the other agreements, the court ultimately ruled that the issues in the instant case were not sufficiently intertwined to warrant a broader stay.

Meyers, et al. v. Quiz-Dia LLC, et al., C.A. No. 9878-VCL (Del. Ch. Ct. December 2, 2016)

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