Leafguard of Kentuckiana, Inc. v. Leafguard of Kentucky, LLC

Citations: 138 F. Supp. 3d 846; 2015 U.S. Dist. LEXIS 138551; 2015 WL 5923554Docket: Civil Action No. 5: 15-237-DCR

Court: District Court, E.D. Kentucky; October 9, 2015; Federal District Court

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Defendant Englert Inc. filed a motion to compel arbitration and stay the action pending arbitration regarding a dispute with Plaintiff LeafGuard of Kentuckiana. Englert, a New Jersey corporation, manufactures the "Englert LeafGuard Gutter System," while the plaintiff, a Kentucky corporation, had a Distributor Agreement with Englert since January 1, 2003, for specific sales territories. The agreement was renewed multiple times but faced issues when Englert raised concerns about LeafGuard of Kentuckiana's sales performance and royalty payments in 2014. 

In 2015, John Conley of LeafGuard of Kentuckiana discussed selling his franchise to John Chambers, who owned LeafGuard of Kentucky, unaware of the ongoing disputes with Englert. On March 12, 2015, a Purchase Agreement was signed for the sale of assets to LeafGuard of Kentucky for $520,000. The parties disagreed on whether Englert's consent was necessary for this sale. Englert offered conditional consent, requiring the payment of overdue royalties and indicated it would not renew the Distributor Agreement after January 2017. However, on June 25, 2015, Chambers withdrew from the purchase deal and requested a return of the escrow deposit. Subsequently, Englert terminated the Distributor Agreement on July 14, 2015, due to LeafGuard of Kentuckiana's failure to accept or counter Englert's offer.

On August 4, 2015, LeafGuard of Kentuckiana initiated a lawsuit against Englert, Chambers, and LeafGuard of Kentucky in the Fayette Circuit Court, which was subsequently removed to federal court. The plaintiff alleges breaches of the Distributor Agreement and the Purchase Agreement, specifically claiming that Englert failed to act in good faith and interfered with the sale of the Distributor Agreement. Additionally, breach of contract claims were made against LeafGuard of Kentucky and Chambers, along with a request for injunctive relief to enforce both agreements. However, on September 2, 2015, the court denied the request for injunctive relief.

On the day the case was removed, Englert sought to compel arbitration and stay the proceedings, referencing arbitration provisions in the Distributor Agreement. These provisions require parties to attempt good faith resolution of disputes, followed by binding arbitration if unresolved within ten days. If the parties cannot agree on an arbitrator within thirty days after a request for arbitration, each party must appoint one, leading to the selection of a third arbitrator if necessary. Arbitration is to follow the Commercial Rules of the American Arbitration Association, with confidentiality mandated and costs shared. Importantly, the arbitrators cannot award punitive or exemplary damages, and any decisions made will be binding and enforceable in New Jersey courts. The plaintiff argues that this arbitration provision is unconscionable and thus unenforceable.

The plaintiff argues that a specific provision in the Distributor Agreement demonstrates its one-sided nature, particularly regarding Englert's right to seek injunctive relief in cases of breach by the Distributor related to confidentiality or non-competition. The agreement acknowledges that such breaches would cause serious and irreparable harm, making legal remedies inadequate. 

There is also a dispute over the enforceability of the agreement's choice-of-law provision, which stipulates that New Jersey law governs the agreement and that any lawsuits must be filed in New Jersey courts. Englert seeks to stay the entire action pending arbitration, which the plaintiff supports. In contrast, LeafGuard of Kentucky and Chambers oppose the stay, asserting they are not bound by the arbitration clause and wish to file motions for summary judgment based on a consent requirement in the Purchase Agreement. Englert does not oppose these motions concerning the condition precedent.

Both parties recognize that their dispute is partially governed by the Federal Arbitration Act (FAA), which establishes a strong federal policy favoring arbitration agreements. To evaluate a motion to compel arbitration, the Court will assess whether the parties agreed to arbitrate, the scope of the arbitration agreement, the presence of any non-arbitrable federal claims, and whether to stay non-arbitration proceedings. While state law applies to the interpretation of the arbitration agreement, the FAA's pro-arbitration stance remains influential in the analysis.

Doubts about the parties' intentions should favor arbitration, as established in Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, Inc. The Court will first address a jurisdictional issue raised by Englert, who argues that the arbitration agreement's validity should be settled in arbitration. LeafGuard of Kentuckiana contests the arbitration agreement's validity, allowing the Court jurisdiction over this specific issue. The Distributor Agreement stipulates that arbitration follows the Commercial Rules of the American Arbitration Association, which grants arbitrators authority to rule on their own jurisdiction, including the arbitration agreement's validity. However, under Section 4 of the FAA, challenges to the arbitration clause must be decided by the court, not the arbitrator, as clarified in Buckeye Check Cashing, Inc. v. Cardegna. While arbitrators can rule on the validity of the entire contract, the Court must apply state law to verify agreement to arbitrate if the arbitration agreement's validity is questioned.

LeafGuard claims the arbitration clause is unconscionable, suggesting a challenge to the entire contract, but it specifically targets the arbitration clause, maintaining the breach of contract claim against Englert. Consequently, the Court will apply state law to assess the arbitration agreement's validity. On the choice-of-law issue, LeafGuard cites Kentucky law, while Englert argues for New Jersey law based on the Distributor Agreement's choice-of-law provision. Kentucky choice-of-law rules dictate that federal courts in diversity cases must adhere to the state's conflict of law principles, confirming Englert's position. Traditionally, Kentucky courts exhibit a protective stance on choice of law matters.

Kentucky generally applies its own law unless there are compelling reasons to apply another jurisdiction's law, as established in Harris Corp. v. Comair, Inc. The Kentucky Supreme Court in Breeding v. Mass. Indem. and Life Ins. Co. opted for Kentucky law despite a Delaware choice-of-law provision in an insurance contract, utilizing the most significant relationship test from the Restatement Second of Conflict of Laws. In contrast, Wallace Hardware Co., Inc. v. Abrams upheld a Tennessee choice-of-law provision, emphasizing the enforcement of such provisions under § 187 of the Restatement, which encourages honoring parties' choices unless a case presents significant differences. The court noted that Breeding did not prevent parties from choosing applicable law, as the circumstances were distinct—specifically, the policy in Breeding was not negotiated or disclosed to Mr. Breeding. Furthermore, in Geico Indem. Co. v. Crawford, the court applied § 187 to enforce an Ohio choice-of-law clause, asserting that the Kentucky Supreme Court had not explicitly rejected its application. This analysis will guide the current case in determining whether New Jersey or Kentucky law applies, utilizing the significant relationship test from § 188, which considers factors such as the places of contracting, negotiation, performance, and the parties' domiciles. The evidence regarding the place of contracting and negotiation is ambiguous, with a notarization in New Jersey but an affidavit from the plaintiff indicating no business conducted in New Jersey.

The original agreement, signed in 2003 and automatically renewed every two years until 2014, includes a Distributor Agreement designating sales territories in Indiana and Kentucky, along with provisions for training at Englert’s New Jersey headquarters. Englert is incorporated and has its principal place of business in New Jersey, while LeafGuard of Kentuckiana is incorporated and operates in Kentucky. Under § 187(2) of the Restatement Second, New Jersey law governs the contractual rights and duties since there is a substantial relationship between the parties and no fundamental policy of Kentucky law would be undermined by its application. The sophisticated nature of the parties and the clear choice-of-law provision in the agreement support the enforcement of New Jersey law. The plaintiff’s claim that Englert waived the choice-of-law clause is dismissed, as Englert acted promptly following the filing of the Complaint. Regarding the arbitration agreement, the burden of proof rests on the party opposing arbitration. LeafGuard of Kentuckiana contends that the arbitration clause is unenforceable due to claims of being an adhesion contract obtained through economic duress and procedural unconscionability.

The plaintiff claims the agreement is substantively unconscionable due to a waiver of the right to seek injunctive relief, as well as exemplary and punitive damages. Despite this assertion, the court will enforce the arbitration clause because the plaintiff has not provided sufficient evidence to support the unconscionability claim. Under New Jersey law, unconscionability requires proof of significant imbalance in bargaining power or overt unfairness in the contract terms. This involves two aspects: procedural and substantive unconscionability.

Procedural unconscionability pertains to the fairness of the contract formation process. Factors considered include the age, literacy, and sophistication of the parties, the complexity of contract terms, and the tactics used during negotiation. In this case, the court found no evidence supporting procedural unconscionability. The plaintiff, Conley, is a seasoned businessman with over 22 years of experience running his business, LeafGuard of Kentuckiana. There is no indication that he lacks the capability to make informed decisions or that improper tactics were used by Englert to secure his signature on the Distributor Agreement. The arbitration clause is clearly labeled and understandable, not concealed in fine print.

Conley’s affidavit, which claims the agreement was presented as a take-it-or-leave-it document and that he faced economic duress, attempts to argue that the contract is an adhesion contract. However, the court determined that the evidence presented does not meet the necessary threshold to classify the contract as unconscionable.

Economic duress in New Jersey is defined as a wrongful act or threat that undermines a victim's free will. In Quigley v. KPMG Peat Marwick, the court ruled against a plaintiff's economic duress claim due to a lack of evidence demonstrating significantly egregious circumstances beyond typical job-related pressure and the absence of deception in signing agreements. The court also noted the plaintiff's continued employment for twelve years post-agreement. Similarly, in the current case, Conley has not shown that Englert applied improper economic pressure; the mere prospect of continuing a distributorship does not constitute duress. Conley allowed the Distributor Agreement to renew automatically for over a decade. 

The concept of adhesion contracts, which are take-it-or-leave-it agreements with limited negotiation opportunities, does not inherently render a contract unconscionable. Factors for determining unconscionability include the contract’s subject matter, the parties' bargaining power, economic compulsion, and public interest implications. LeafGuard's argument relies on Conley’s unsubstantiated claims regarding the adhesion nature of the Distributor Agreement, but even if it is classified as such, it does not automatically imply unconscionability. Evidence does not support that Conley was coerced into signing; he operates several businesses and could have declined this venture. 

The case aligns more with Martindale v. Sandvik, where arbitration agreements were upheld due to the absence of public policy violations, as opposed to Muhammad, where a class-arbitration waiver was deemed unconscionable. The arbitration agreement in this case, involving two businesses with knowledgeable representatives, is not procedurally unconscionable based on the analysis.

Substantive unconscionability is not present in the Distributor Agreement, as the plaintiff's waiver of punitive, exemplary damages, and injunctive relief does not create a one-sided obligation that would shock the court’s conscience, per New Jersey law. The waiver applies equally to both parties, and the court cites a prior case where a similar arbitration clause was upheld. The plaintiff failed to provide legal authority supporting its claim of unconscionability regarding these waivers. Additionally, the agreement allows Englert to seek injunctive relief, which does not prevent LeafGuard of Kentuckiana from pursuing similar remedies. Consequently, the court enforces the arbitration clause and grants Englert’s motion to compel arbitration.

Regarding the stay of proceedings, the Federal Arbitration Act (FAA) mandates a stay on arbitrable claims while arbitration is ongoing. As all claims against Englert are subject to arbitration, the court grants the motion for a stay on those claims but denies Englert’s request for a complete stay of the entire action, including claims involving non-parties to the Distributor Agreement. The court acknowledges that district courts have discretion to stay non-arbitrable claims but will only do so if the resolution of these claims depends on the arbitrator’s decision. Since LeafGuard of Kentucky and Chambers argue that their claims are not dependent on the arbitration outcome, they are allowed to pursue motions for summary judgment while arbitration is pending.

The plaintiff, LeafGuard of Kentuckiana, Inc., filed a motion for leave to submit a sur-reply concerning the choice-of-law issue after Englert Inc. had already filed its reply. Although the plaintiff was not entitled to a sur-reply since it could have addressed the issue in its original response, the Court chose to consider the sur-reply in its deliberations. The Court issued several orders: 

1. Englert Inc.'s motion to compel arbitration is granted.
2. Englert Inc.'s motion to stay the action pending arbitration is partially granted and partially denied, resulting in a stay of LeafGuard's claims against Englert until arbitration is complete.
3. LeafGuard must pursue all claims related to the Distributor Agreement in line with the arbitration provision. Claims and counterclaims involving LeafGuard, Defendant LeafGuard of Kentucky, LLC, and Defendant John Chambers will continue in Court until the motions for summary judgment are resolved.
4. Both Englert and LeafGuard are required to submit status reports on the arbitration every 60 days and upon its completion.
5. The plaintiff's motion for leave to file a sur-reply is granted, and the Clerk is instructed to file the sur-reply submitted by LeafGuard. Additionally, LeafGuard has sought injunctive relief from the Court.