Co. waived arbitration with ‘litigation conduct’

A defendant corporation that actively litigated its former CEO’s lawsuit for six months could not then compel arbitration after its motion to dismiss was denied in part, a Superior Court judge in Massachusetts has found.

The defendant, Arctic Sand Technologies Inc., alleged a contractual right to binding arbitration under its employment agreement with plaintiff Nadia Shalaby, and argued that any questions about the arbitrability of her claims should be determined by the arbitrator.

Judge Kenneth W. Salinger disagreed.

“The court finds that Arctic Sand waived any contractual right to arbitrate Dr. Shalaby’s claims by deliberately waiting six months before seeking to compel arbitration, and by actively litigating the case in Superior Court in the meantime,” the judge wrote. “It made no attempt to invoke its alleged contractual right to binding arbitration until after it learned that its motion to dismiss was not completely successful. Under the circumstances of the case, the Court finds that Arctic Sand has waived arbitration by its litigation conduct.”

The 16-page decision is Shalaby v. Arctic Sand Technologies Inc., et al.

‘Like a disingenuous diner’

Plaintiff’s counsel Ellen J. Zucker of Burns & Levinson in Boston said the decision offers a straightforward lesson.

“The decision should remind litigators that if a party believes a dispute is subject to arbitration, that argument needs to be made at the start of litigation,” she said.

Matthew J. Iverson of DLA Piper’s Boston office represented the defendants. Iverson did not respond to interview requests.

But Paul A. Finn, a Brockton mediator and arbitrator, said Salinger’s decision is troubling.

“If there’s a legal basis for the case to be dismissed [and] I’m advised by my attorneys there’s a way to get the case thrown out without spending money on arbitration, I’m going to take that shot,” he said. “If I’m not successful, why can I not then impose the terms of the contract?”

The issue by no means appears clear-cut. In a 2013 decision, for example, U.S. District Court Judge Nathaniel M. Gorton ruled in Bruck v. Morgan Stanley Smith Barney LLC, et al. that “[d]efendants’ limited involvement in this case is not sufficient to find waiver of the right to arbitrate.” As in Shalaby, the defendants in Bruck already had filed a motion to dismiss when they sought to compel arbitration.

“[I]t could hardly be said that the ‘litigation machinery has been substantially invoked’ nor that the parties were ‘well into preparation of a lawsuit by the time an intention to arbitrate was communicated,’” Gorton wrote.

C. Max Perlman, an employment lawyer at Boston’s Hirsch, Roberts, Weinstein, said it is common for a party to try to have claims dismissed prior to moving for arbitration and that, given the short amount of time a party has to answer a complaint, it is possible the defendants in Shalaby were still deciding how to proceed when they filed their motion to dismiss.

“A presumption that cases are arbitrable when parties agree will often overcome participating in the litigation process to some extent,” he said.

Perlman said Salinger’s decision, however, “indicates a reluctance to allow a party two bites at the same apple,” and suggests that if a defendant is inclined to arbitrate, a motion to compel arbitration should be the party’s first filing.

“The court, in essence, found that the defendant was like a disingenuous diner who complains about his meal after clearing his plate,” Perlman said. “The defendant was more than happy to be in Superior Court until they found out the Superior Court wasn’t going to rule in their favor on [the motion to dismiss]. They were more than happy to eat that meal until the bill came. What they were hoping to do was get the case dismissed, and if that didn’t work out, go to arbitration.”

Jaclyn L. Kugell, chairwoman of the employment law firm Morgan, Brown & Joy in Boston, said the defendants could have tried to file a single motion that sought the case’s dismissal or, in the alternative, to compel arbitration, but that Salinger may not have viewed that approach any more favorably than the one chosen.

While the judge appeared to view the defendants’ tactics as abusive forum shopping, Kugell said she sees nothing nefarious in their litigation conduct.

“We all make strategy calls that sometimes don’t work out,” she said.

Line in the sand

So what is the “point of no return” after which a party has waived its right to arbitration? Zucker said it is reasonable to draw a line once the jurisdiction of the court is invoked to address the merits of a dispute.

“You will not have much luck in compelling arbitration if you engage the machinery of the court in other respects, then seek to raise the issue,” she said. “Parties run a real risk if they wait and only press the point when things do not turn out as they might have hoped in court.”

But questions of whether there has been waiver of arbitration by litigation conduct will be decided on a case-by-case basis, and Kugell said preserving the right to arbitrate may simply come down to not crossing a point at which a judge thinks he has wasted his time if he allows a dispute to switch to arbitration.

Matthew J. Williams of Kennebunk, Maine, said a good rule of thumb is that waiver has probably occurred when litigation has progressed to a point that it would not have progressed in arbitration. He said the litigation of a motion to dismiss is a perfect example.

“Once you file a motion to dismiss and you force the other side to respond … you’ve now created some litigation activities that most certainly wouldn’t have occurred in the arbitration context,” said Williams, who recently prevailed in a case at the 1st U.S. Circuit Court of Appeals in which the court found the plaintiff could not be granted a stay to pursue arbitration eight months after filing suit.

Boston mediator and arbitrator Sarah E. Worley suggested a handful of ways defendants can try to avoid waiving their right to arbitrate by litigation conduct. She said they should assert their right to arbitrate in answers and affirmative defenses; move to stay the proceedings and compel arbitration in a timely manner; and notify opposing parties of arbitration agreements and put them on notice that the defense’s litigation conduct should not be considered a waiver.

Williams said judges may be particularly skeptical if a plaintiff, rather than a defendant, seeks to demand arbitration after engaging in litigation.

That is what happened in his 1st Circuit case, Joca-Roca Real Estate, LLC v. Brennan. In a Dec. 1 decision, Judge Bruce M. Selya wrote for a unanimous panel that the plaintiff could not be granted a stay to pursue arbitration eight months after filing a lawsuit.

“Here, the plaintiff commenced a civil action, vigorously prosecuted it, and then — after many months of active litigation — tried to switch horses midstream to pursue an arbitral remedy,” Selya wrote. “To make matters worse, it made this abrupt about-face in the absence of any material change in circumstances. … We are left to infer that the change in direction may well reflect the plaintiff’s dissatisfaction with the way the court case was proceeding — and we do not condone the use of an arbitration clause as a parachute when judicial winds blow unfavorably.”

Moves and countermoves

Artic Sand, cofounded by Shalaby in 2011 as a spinoff from the Massachusetts Institute of Technology, develops power conversion chips for electronic devices. The company raised $9.6 million in financing in 2012, when a board of directors was appointed to oversee the company.

Shalaby, who retained 18 percent of the company’s shares, alleges in her complaint that she began to experience sexism within the company at that time. She claims that discrimination toward her escalated after she complained about being treated more harshly than a male co-founder.

Shalaby was replaced as CEO in October 2013 and fired the following March.

She sued Arctic Sand, replacement CEO Gary Davison and board Chairman John Major in April in a nine-count complaint that principally concerned whether Arctic Sand had terminated her for cause and thus had a right to repurchase her stock.

The parties litigated Shalaby’s request for a preliminary injunction regarding the contents of a computer, cellphone and external hard drive.

Salinger considered the motion “a discovery dispute disguised as a motion for a preliminary injunction” and disposed of it with a protective order.

The defendants later succeeded in getting all the counts against Davison and Major thrown out, but four claims against Artic Sand itself survived a motion to dismiss.

Arctic Sand then moved to compel binding arbitration. Shalaby, in turn, filed a motion to amend her complaint to add claims of discrimination and retaliation.

“While she was willing to wait on filing her claims of discrimination and retaliation in hope that matters could get resolved amicably and in the best interests of all parties, she determined to timely file her claims of discrimination and retaliation and to request prompt removal of her Charge so that the motion to compel arbitration could be weighed by this court fairly, with an understanding — one the Defendants surely had — that this litigation involved concerns that the conduct at issue was animated by both discrimination and retaliation,” the motion to amend states.

‘Heads I win, tails you lose’

Salinger found Arctic Sand deliberately delayed moving to compel arbitration “because it first wanted to press its motion to dismiss in Superior Court.”

By filing that motion, the judge said, Arctic Sand made “a deliberate choice to seek ‘an immediate and total victory in the parties’ dispute’ in Superior Court, and ‘to see how the case was going in … court before deciding whether it would be better off there or in arbitration.’ … Arctic Sand was happy to litigate Shalaby’s claims in the Superior Court so long as it thought it could obtain a quick judgment in its favor on the merits.”

Salinger criticized Arctic Sand for wanting to play “heads I win, tails you lose” and for invoking the “litigation machinery” of the court with an “extensive and exhaustive” motion to dismiss.

Salinger also noted that Artic Sand filed a counterclaim and “invoked the court’s jurisdiction by asking it to resolve a discovery dispute.”

He went on to say that “Arctic Sand had no legitimate reason for asking the Superior Court to decide the legal merits of Dr. Shalaby’s claims before moving to compel arbitration. If Arctic Sand had wished, it could have first moved to compel arbitration and then, if successful, filed a motion to dismiss with the arbitrator.”

Concluding that Arctic Sand’s delay was “deliberate and tactical” and forced the plaintiff to incur unnecessary expense and delay, Salinger also granted Shalaby leave to amend her complaint to add claims of discrimination and retaliation against all three defendants.