Arbitration – First Impression – Corporate Principals – Piercing the Veil – Defunct Corporation – Breach of Contract Claim

Cold Springs Ventures, LLC v. Gilead Sciences, Inc. (Lawyers Weekly No. 14-15-0328, 21 pp.) (John Jolly Jr., Ch.J.) 2014 NCBC 10

Holding: In order to determine whether plaintiffs, as principals of a now-defunct corporation, will be required to arbitrate defendant Gilead Sciences, Inc.’s breach of contract claim, the court must make a summary determination as to whether Gilead may pierce the veil of the defunct corporation and require the principals of that corporation to arbitrate Gilead’s claim that the corporation breached a contract, which the principals did not sign.

The court declines to stay the arbitration pending a substantive ruling on whether plaintiffs may be found liable to Gilead under the instrumentality rule. However, the court stays arbitration until the court rules on the jurisdictional issue of whether plaintiffs may be compelled to be parties to the arbitration.

Background

Plaintiffs are former investors, shareholders, and directors of Old Kryo, Inc. Gilead had a contract with Old Kryo, which contained a mandatory arbitration clause.

Old Kryo sold its assets, purportedly including its contract with Gilead, to Kryosphere, Inc. Gilead contends that Old Kryo breached the contract by assigning it without obtaining prior written consent from Gilead.

Old Kryo was subsequently dissolved.

Gilead initiated an arbitration proceeding against Kryosphere and plaintiffs, alleging breach of contract. The parties agree that plaintiffs were not signatories to the Gilead contract and normally would not be bound by the contract’s arbitration clause.

Gilead contends that plaintiffs committed fraud and depletion of Old Kryo’s resources and that they are, in substance, the alter ego of Old Kryo. Gilead seeks to use the “instrumentality rule” first to require plaintiffs to arbitrate its breach of contract claim and then to hold plaintiffs liable.

Plaintiffs contend that Gilead has not alleged any misconduct on their part as investors and directors. Plaintiffs argue that Gilead’s “bare-bone, conclusory” allegations are insufficient to compel plaintiffs to participate in the arbitration proceeding.

Gilead argues that its stated intention “to recover from [plaintiffs] under a veil piercing theory” compels plaintiffs to participate in arbitration.

Analysis

Even though the Federal Arbitration Act applies in this case, state law fills procedural gaps in the FAA as it is applied in state courts. As such, G.S. § 1-569.7(b) requires this court to make a threshold determination of whether plaintiffs can be compelled to be parties in the arbitration.

The inquiry into whether a non-signatory is bound by an arbitration clause is one for judicial determination. Therefore, this court, rather than the AAA panel, must determine whether a valid agreement to arbitrate exists.

When assessing arbitrability, the merits of a dispute are beyond the scope of the court’s jurisdiction. Nevertheless, in this case, an inquiry into arbitrability is necessarily a coincidental inquiry into issues that underlie the substantive merits of Gliead’s claim against plaintiffs.

This appears to be an issue of first impression in North Carolina.

Gilead would have this court essentially hold that any shareholder or director of a corporate signatory to an arbitration clause can be compelled to arbitrate by way of a claimant’s bare allegation that the instrumentality rule applies.

However, the mere fact that certain issues could later be litigated substantively cannot on its own foreclose courts from assessing arbitrability. Courts must address those issues for the limited purpose of determining whether a claimant seeking to compel arbitration can sufficiently allege a basis for going forward against a responding party. Though this court cannot address the merits of claims that the parties have agreed to arbitrate, this court must decide the threshold issue of whether the parties consented to arbitration in the first place. That determination will ultimately depend upon whether Gilead can allege facts and offer evidence that plaintiffs are deemed to have consented to arbitration by virtue of the instrumentality rule. Accordingly, plaintiffs have met their burden of showing a likelihood of success on the merits of their contention that this court should decide the initial arbitrability issue.

Furthermore, forcing a party to arbitrate an issue absent an agreement to do so constitutes per se irreparable harm.

On the narrow question of whether Gilead can compel plaintiffs to be parties to the arbitration, plaintiffs are entitled to a preliminary injunction. Arbitration is stayed pending determination of whether plaintiffs can be compelled to be parties to the arbitration.

The court is sensitive to plaintiffs’ concerns that a preliminary determination that plaintiffs cannot be compelled to arbitration, without a corresponding resolution on the merits of the instrumentality rule issue, might put plaintiffs in an awkward “Catch-22” situation. For example, if the arbitration goes forward without plaintiffs as parties and results in a substantial judgment in favor of Gilead against Old Kryo, plaintiffs may later face – either in this action or another action – a claim at law by Gilead that pursuant to the instrumentality rule, plaintiffs are liable for that judgment. If this risk is a sufficient concern to plaintiffs, they are free to take a Rule 41 voluntary dismissal of their declaratory judgment claims and defend at the arbitration if they so choose. However, plaintiffs’ concerns, while potentially real, do not confer jurisdiction on this court that it otherwise lacks.

Motion granted in part.