COA: Participating in Discovery May Waive Right to Arbitration

In HCW Retirement and Financial Services, LLC v. HCW Employee Benefit Services, LLC, COA11-1479, the North Carolina Court of Appeals recently held that asking a deponent about facts and circumstances relating to a claim potentially subject to an arbitration clause may waive the right to have that claim submitted to arbitration.

In that case, Plaintiffs HCW Retirement & Financial Services, LLC and HCWRFS, LLC were limited liability companies and Plaintiff Wilton Drake was a financial planner who offered retirement planning services. Defendants Frank S. Woody, III and Todd T. Yates were financial advisers who offered investment and insurance services. Between the late 1990s until 2010, the parties were involved in various collaborative ventures focusing on the provision of financial or investment advice. In 2003, Defendants and Drake formed Prescott Office Management, LLC, for the purpose of entering into an office sharing arrangement pursuant to which Prescott would purchase part of an office condominium. At the time they organized Prescott, the parties executed and signed an Operating Agreement that governed their rights and responsibilities with respect to Prescott and included an arbitration provision.

In 2011, Plaintiffs filed suit against Defendants seeking damages for, among other things, breach of fiduciary duty and breach of the duty of good faith and fair dealing. Defendants filed an answer and then a motion to stay the litigation and refer the claims of breach of good faith and fair dealing and breach of fiduciary duty to arbitration pursuant to the Operating Agreement. The trial court denied the motion to compel arbitration, holding that these claims fell outside the substantive scope of the arbitration provision, and further, that Defendants had impliedly waived any right to arbitration by participating in discovery procedures which would not have necessarily been available in arbitration.

On appeal, the Court of Appeals held that although the trial court had incorrectly concluded that the claims were outside the scope of the arbitration provision, the trial court had correctly held that Defendants had waived their right to arbitration by utilizing discovery procedures that would not necessarily have been available in arbitration. The Court explained that although public policy favors arbitration clauses, arbitration is a contractual right that may be waived by the conduct of the party seeking to enforce its right. A party must show prejudice to defeat an attempt to compel arbitration on the grounds of waiver. A party may be prejudiced by its opponent's delay in seeking arbitration if (1) it is forced to bear the expense of a long trial, (2) it loses helpful evidence, (3) it takes steps in litigation to its detriment or expends significant amounts of money on the litigation, or (4) its opponent makes use of judicial discovery procedures not available in arbitration.

The Court then held that Plaintiffs had sufficiently demonstrated the prejudice required to defeat Defendants’ motion to compel arbitration. The trial court found that Defendants had asked Drake in his deposition about facts relating to the claims for breach of fiduciary duty and breach of good faith and fair dealing, that Plaintiffs had incurred expenses in connection with that deposition, that this discovery would be available in arbitration only if permitted by the arbitrator, and that Defendants had refused to respond to Plaintiffs’ discovery requests relating to those claims on the grounds that they were subject to arbitration. The Court of Appeals agreed that the record contained facts to support each of these findings, and that these findings supported the conclusion that Defendants had waived the right to arbitration. The Court’s decision affirming the lower court can be found here.