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Waiver Of The Contractual Right To Demand Arbitration

In HCW Retirement and Financial Services, LLC, et al. v. HCW Employee Benefit Services, LLC, et al., No. 384PA12, ___ N.C. ___, ___ S.E.2d ___, 2013 WL 4605443 (Aug. 28, 2013), the North Carolina Supreme Court held that the defendants did not waive their contractual right to demand arbitration by taking a deposition in which they asked the deponent questions about arbitrable claims. The dispute between the parties arose out of an amendment to the operating agreement of a limited liability company. The plaintiffs asserted numerous claims, including, that two of the defendants breached their duty of good faith as members of the LLC and their fiduciary duty to a minority member.

Those two defendants filed a motion to compel arbitration pursuant to the arbitration provision in the LLC’s operating agreement. The plaintiffs sought discovery from defendants during the time that motion was pending. The defendants objected on the grounds that the claims were subject to arbitration. While the motion was pending, the defendants nevertheless deposed the individual plaintiff, Wilton R. Drake. During that deposition, which lasted over ten hours, Drake was asked questions regarding the arbitrable claims for about an hour. The plaintiffs alleged that hour of deposition questions constituted the use of discovery procedures in a manner inconsistent with arbitration rights and that they had been prejudiced as a result.

The N.C. Supreme Court’s decision enumerated three important points regarding waiver of the right to demand arbitration:

  1. A party implicitly waives its right to compel arbitration when it takes actions inconsistent with arbitration that result in prejudice to the opposing side;
  2. A party opposing arbitration bears the burden of proving prejudice; and
  3. The use of judicial discovery procedures per se does not constitute prejudicial action; rather, the judicial discovery employed must be unavailable in arbitration.

The Court then addressed the plaintiff’s argument that “by spending an hour on the arbitrable claims during his deposition, defendants ‘engag[ed] in discovery that could occur in arbitration only at the discretion of the arbitrator.’” The court explained that the focus on discovery available in arbitration only at the discretion of the arbitrator is:

a subtle but important shift from the original … standard that the discovery employed be “unavailable in arbitration” to a standard requiring that the discovery employed be “available only at the discretion of the arbitrator” or “unavailable as a matter of right.” This varies from the standard this Court has previously endorsed for prejudice under these circumstances: prior case law requires that the discovery procedures employed be unavailable in arbitration, not just unavailable as a matter of right. If the arbitrator has discretion over the discovery procedures at issue, then they are not per se unavailable. Moreover, the opinion in Servomation [Corp. v. Hickory Construction Co., 316 N.C. 543, 342 S.E.2d 853 (1986)] suggests that discovery need not be exactly reciprocal.

The Court found that the plaintiffs presented no evidence that during arbitration they would be unable to question defendants about the arbitrable claims in either a formal deposition or “some equivalent interview or examination.” Because the plaintiffs failed to present any evidence in support of their contention that they had been prejudiced by the use of discovery procedures not available in arbitration, the Court concluded that that the plaintiffs failed to prove prejudice. Therefore, no waiver of defendants’ contractual right to arbitration occurred.

The Supreme Court’s decision in HCW Retirement and Financial Services serves as a reminder to carefully consider whether your actions could result in an unintended waiver of your contractual right to arbitration.

About the author: Andrew Flynt is a member of the firm’s litigation team who focuses on insurance coverage analysis, insurance bad faith litigation and business litigation. For questions about this article, please contact Andrew.