Court Compels Arbitration of Non-Compete Claim Based on Arbitration Clause in Separate Agreement

Non-Compete, Non-Solicit, Arbitration Provision, DTSA, Illinois

A federal court, in a non-competition setting, had to untangle the relationship between three separate agreements. One contained an arbitration provision but the others did not. Ultimately, the court determined that some parties had to arbitrate some claims but that others did not have to arbitrate. 

The Purchase Agreement, the Employment Agreement, and the Non-Competition Agreement

Applications Software Technology LLC (“AST”) and Serene AST, LLC (Serene”) provide information technology solutions through both cloud- based and traditional software applications.

AST entered into acquisition discussions with Serene’s predecessor, Serene Corporation. Paresh Kapadia was one of Serene Corporation’s four shareholders. Following those negotiations, AST agreed to purchase all of Serene’s equity. AST purchased all of Serene’s equity securities (through a corporation called VANP, Inc., of which Kapadia owns 46.7 percent). Kapadia executed the Purchase Agreement in his individual capacity as a stockholder of VANP.

Serene and Kapadia also entered into an Employment Agreement that contained a mandatory arbitration provision:

7.9 Arbitration. Except as provided in Section 7.1 above with respect to injunctive relief, any controversy or claim arising out of or relating to this Agreement, the breach hereof or [Kapadia]’s employment by [Serene], including without limitation wrongful termination or discrimination claims, shall be settled by binding arbitration held in Chicago, Illinois in accordance with the rules of the American Arbitration Association’s (“AAA”) Model Employment Dispute Arbitration Procedures then in effect, and judgment upon the award rendered may be entered in any court having jurisdiction thereof…The award of the arbitrator shall be binding and final on all parties…

Kapadia entered into a separate Non-Competition Agreement with AST. Neither the Purchase Agreement nor the Non-Competition Agreement contained an arbitration provision.

AST and Serene’s Lawsuit again Kapadia

In a lawsuit, AST and Serene alleged that Kapadia created a new corporation, Suavis Corporation, and began competing directly with the business of AST and Serene in violation of various covenants in the agreements mentioned above.

Plaintiffs alleged that while employed by Serene, Kapadia misappropriated plaintiffs’ client relationships and trade secrets and “poached” AST and Serene’s employees to leave plaintiffs’ employment and work for Suavis. They also alleged that Kapadia converted plaintiffs’ property.

Among other things, Plaintiffs alleged that Kapadia and Suavis violated 1) the Federal Defend Trade Secrets Act, 2) the Illinois Trade Secrets Act, 3) the Employment Agreement, 4) the Non-Competition Agreement, and 5) a duty of loyalty to Serene. Plaintiffs’ raised claims against Suavis for tortious interference with contract and prospective economic advantage.

Defendants’ Motion to Compel Arbitration

Defendants moved the Court to compel arbitration based on the mandatory arbitration provision in the Employment Agreement. In response, Plaintiffs contended that there was no valid agreement to arbitrate because, in contrast to the Employment Agreement, the Purchase Agreement and the Non-Competition Agreement did not contain arbitration provisions, but did contain forum- selection clauses that provided for the exclusive jurisdiction of courts in Chicago.

Analyzing the situation, the District Court noted that the Purchase Agreement conditioned AST’s obligations to purchase Serene’s equity on the satisfaction of several conditions, including the execution and delivery of Kapadia’s Employment Agreement and Non-Competition Agreement.

Whether the parties have agreed to arbitrate is a question normally answered by the court, and the issue is governed by state-law principles governing contract formation.

Illinois Law Regarding the Issue

Under Illinois law, where two or more instruments are executed by the same contracting parties in the course of the same transaction, the instruments will be considered together and construed with reference to one another because they are, in the eyes of the law, one contract.

If possible, effect must be given to all of the language so that provisions which appear to be conflicting or inconsistent may be reconciled and harmonized. Furthermore, where one intention is expressed in one provision of a contract and a possibly conflicting intention appears in another provision, full effect should be given to the more principal and specific provision, and the general provision should be subjected to such modification or qualification as the specific provisions make necessary.

Prevailing of the Mandatory Arbitration Provision

These legal principles pointed to enforcement of the mandatory arbitration provision in the Employment Agreement. While it might appear that the arbitration provision conflicted with the forum-selection clauses, courts have reconciled such provisions by interpreting a forum-selection clause as dictating the location of any action that might be necessary after arbitration to enforce any arbitration award. The court concluded that the arbitration provision should be enforced, as it was more principal and specific.

Additionally, the forum-selection clauses of the Purchase Agreement and Non-Competition Agreement did not specifically preclude– or even mention– arbitration.

Plaintiffs argued that even if the arbitration clause in the Employment Agreement was enforceable, some of their claims did not fall within its scope.

The parties to the Employment Agreement are Serene and Kapadia, who agreed to arbitrate “any controversy or claim arising out of or relating to” that Agreement, its breach, or Kapadia’s employment by Serene.

Plaintiffs contended that they could not be compelled to arbitrate any claims that related to or arose from the Purchase Agreement or the Non-Competition Agreement, but the Court disagreed.

All of Serene’s claims against Kapadia related to the Employment Agreement or Kapadia’s employment (or both) and accordingly had to be arbitrated.

The complication, however, was a non-signatory to the Employment Agreement on each side of the case (AST and Suavis).

The Complication: Non-Signatory Parties

Generally, under Illinois law, only signatories to an arbitration agreement can move to compel arbitration. But some Illinois courts have recognized contract-based theories under which a non-signatory to an agreement may be bound by the arbitration agreement of others, such as 1) incorporation by reference, 2) assumption, 3) agency, 4) veil-piercing or alter ego, 5) estoppel, and 6) third-party-beneficiary status.

Defendants invoked an estoppel theory. They maintained that even though AST was not a party to the Employment Agreement, it was estopped from opposing arbitration because it had knowingly sought the direct benefits of the Employment Agreement by relying on it as a basis for its allegations and requested relief in all of its claims. Also, defendants contended that Suavis could enforce the arbitration clause against plaintiffs because plaintiffs referred to the terms of the Employment Agreement in asserting their claims against Suavis

However, Illinois courts have rejected the “expanded interpretation of equitable estoppel” on which defendants relied.

Defendants did not present any argument regarding estoppel in the event that Illinois law applied, nor did they argue that plaintiffs did or said anything when Serene entered into the Employment Agreement with Kapadia that would have led Suavis to rely to its detriment upon plaintiffs’ action or statement. Therefore the arbitration agreement between Serene and Kapadia was not enforceable by Suavis or against AST.

The Court’s Conclusion

The court concluded that only Serene’s claims against Kapadia had to be arbitrated. Suavis could not compel plaintiffs to arbitrate their claims against it, nor could defendants compel AST to arbitrate its claims against either defendant.

Thus, arbitration was ordered on the claims of Serene against Kapadia. The remainder of plaintiffs’ claims were stayed, pending completion of arbitration. Applications Software Technology LLC and Serene AST, LLC v Paresh Kapadia and Suavis Corporation, 2018 WL 3122173 (N.D. Il. June 26, 2018).

Michael R. Lied is a partner at Howard & Howard’s Peoria, Illinois office. He concentrates his practice in the areas of labor & employment law, and related litigation and immigration law, representing employers.

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