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Direct Benefits Estoppel -- Compelling Non-Signatories to Arbitrate

The Seventh Circuit recently ruled that a party was bound to an arbitration award despite not being a signatory to the agreement to arbitrate. The court based its decision on the doctrine of "direct benefits estoppel," ruling that, even though the plaintiff was a non-signatory to the franchise agreement that contained an arbitration clause, she had received a direct benefit from the franchise agreement, and thus was bound under the terms of the arbitration award.

The case, Everett v. Paul Davis Restoration, Inc., involved a franchise agreement between the plaintiff's corporation and Paul Davis Restoration, Inc. ("PDRI"). The corporation was jointly owned by the plaintiff and her husband, and the court later found that it was formed to get the benefit of the franchise agreement and its only business was to further the goals of the franchise agreement. After the franchise was terminated, PDRI began an arbitration for breach of a non-compete clause. An arbitral award was issued, but the plaintiff refused first to arbitrate, and then to recognize the decision as binding upon her, arguing that she had never signed the agreement to arbitrate. The district court found that she had merely received an indirect benefit and thus the agreement was not binding on her. The Court of Appeals for the Seventh Circuit reversed, holding that she did indeed receive a direct benefit from the franchise agreement and thus was bound under the terms of the agreement to arbitrate. Accordingly, she was bound to the terms of the arbitral award.

Although the court acknowledged that "the fact that [the plaintiff] never signed the franchise agreement would be the end of [the] discussion," the court found that "the obligation to arbitrate a dispute is not always limited to those who have personally signed an agreement containing such a provision." The court held that the doctrine of direct benefits estoppel, which stands for the proposition that a non-signatory party is estopped from avoiding arbitration if she "knowingly seeks the benefits of the contract containing the arbitration clause," applied here. The court further found that the plaintiff and her husband had colluded to transfer ownership to her in order to avoid the non-competition clause in the agreement, further bolstering the argument that she should be held to the terms of the agreement to arbitrate.

The notion that parties cannot be compelled to arbitrate unless they have agreed to arbitrate is almost foundational. Indeed, in but one of many examples the Massachusetts Appeals Court has held that courts will not compel a non-signatory to arbitrate because that party has not signed an agreement to arbitrate. Here, we have a different result, albeit in different circumstances. Without the doctrine of "direct benefits estoppel," it is possible, if not likely, that the case may have been decided in favor of the plaintiff. However, the fact that the plaintiff was found to have received a direct benefit from the defendant was sufficient for the court to rule that she indeed was under the purview of the agreement to arbitrate, and to create the surprising result that a non-signatory to an agreement to arbitrate can be compelled to arbitrate.

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