Nauru Phosphate Royalties, Incorporated, (Texas) v. Drago Daic Interests, Incorporated
Docket: 97-20279
Court: Court of Appeals for the Fifth Circuit; April 29, 1998; Federal Appellate Court
Drago Daic Interests, Inc. (DDI) appeals a district court order confirming an arbitration award in favor of Nauru Phosphate Royalties, Inc. (Nauru), which found that DDI materially breached their Development Agreement. The arbitration panel also determined the beneficiaries of the agreement, Drago Daic, Trustee, and Montgomery 666, Ltd., were bound by this award. The central issue on appeal was whether Nauru's liability concerning a Promissory Note was properly within the arbitration panel's jurisdiction. The court affirmed that the panel acted within its authority regarding Nauru's liability on the Promissory Note, rejecting claims that the non-parties to the arbitration could limit the scope of the panel's decision. Furthermore, the district court found DDI responsible for Nauru’s financial losses related to reimbursement for 122 lots and additional excavation costs. In 1990, Nauru entered into a sale and development agreement with DDI and the other parties, purchasing land with an $8 million Promissory Note secured by a Deed of Trust. The Development Agreement specified that Nauru would fund development costs, reimbursed only if revenues exceeded expenditures, which never occurred. DDI became dissatisfied with Nauru's funding delays, while Nauru was concerned about rising costs, leading to the arbitration initiated by Nauru, which accused DDI of fraud and breach of contract, while DDI counterclaimed for lost profits.
In 1996, an arbitration panel ruled 2-1 that DDI had committed thirteen material breaches of the Development Agreement, while Nauru had committed three non-material breaches. The panel found that Nauru had no further liabilities to DDI under the Development Agreement, including no obligation to pay an $8 million Promissory Note, which was executed by Nauru and payable to non-party noteholders. Additionally, the panel determined that DDI owed Nauru over $1.8 million due to DDI's breaches. Nauru subsequently sought confirmation of the arbitration award in district court. DDI moved to dismiss for lack of jurisdiction and to vacate or modify the award, but the district court denied the dismissal and referred the case to a magistrate judge, who recommended confirming the award. In 1997, the district court confirmed the award, leading to DDI's appeal.
The appeal hinges on federal jurisdiction, specifically the diversity of citizenship between DDI, a Texas corporation, and Nauru, which claims to be a Delaware corporation. The determination of Nauru's principal place of business is contested; Nauru argues it is in Australia or Nauru, while DDI claims it is in Texas. The court applies a "total activity" test based on factors such as the nature and location of corporate activities. DDI argues for the second principle from J.A. Olson Co. v. City of Winona, asserting that Nauru's sole operations are in Texas, while Nauru argues for the third principle, emphasizing its nerve center is in Nauru or Australia due to the passive nature of its activities. The key issue is the characterization of Nauru's activities related to its investment in Bentwood.
The district court found that Nauru was a passive investor primarily engaged in management activities, with its nerve center located in Nauru or Australia rather than Texas. Nauru's sole investment asset is Bentwood, and its board consists of four members, all citizens and residents of Nauru. Nauru has three officers, with the president in Nauru, the treasurer/secretary in Australia, and the assistant secretary in Houston. The assistant secretary relayed information among the board and officers, who made all significant decisions. The only notable operational exception is the Bentwood Country Club, run by two wholly-owned subsidiaries of Nauru, which generates considerable revenue. Legal precedent indicates that a subsidiary's operations are not attributed to the parent company unless the subsidiary is deemed an alter ego, a determination that has not been supported in this case. The court upheld the district court's finding that Nauru's principal place of business is not in Texas. It emphasized that arbitration awards cannot be revisited for alleged factual or legal errors, and must be upheld if they rationally derive from the underlying contract. DDI argued that the arbitration panel overstepped its authority regarding Nauru's liability on the Promissory Note, asserting that Daic Trustee and M-666 were only bound by specific provisions of the Development Agreement and were not parties to the arbitration, making the decision on Nauru's liability invalid without their presence.
The Development Agreement and the Promissory Note are closely interconnected, as evidenced by the Promissory Note's incorporation of the Development Agreement's terms. The arbitration clause within the Development Agreement mandates that any disputes related to the agreement be settled through arbitration in Houston, Texas, indicating a broad scope intended to cover all aspects of their relationship. Nauru's request for arbitration highlights DDI's failure to perform under the Development Agreement, impacting its liability under the Promissory Note. DDI was aware that Nauru's obligations under the Promissory Note were contingent upon DDI's performance, which needed to be without material breach for payments to be made to noteholders. Nauru's payment obligation is classified as conditional, with specific set-off rights outlined in the Development Agreement. Any material breach by DDI would jeopardize the Promissory Note payments. The evidence suggests that the development of Bentwood by DDI was crucial for ensuring Promissory Note payments. The district court correctly determined that the arbitration panel could address Nauru's liability on the Promissory Note as it is closely linked to DDI's performance under the Development Agreement. The argument that the arbitration panel overstepped its authority fails, as the noteholders, as effective third-party beneficiaries, could be bound by the arbitration panel's findings regarding Nauru's non-liability for the Promissory Note, preventing them from pursuing litigation on the breach of the Development Agreement in the future.
A judgment in an action between a promisee and promisor discharges the obligation to a third-party beneficiary, as long as the promisee can still discharge the promisor's obligation. If a contract becomes non-binding due to failure of performance, the rights of any beneficiary are modified or discharged correspondingly. In this case, the arbitration award determined the rights of Daic Trustee and M-666 concerning payment under the Promissory Note. The district court found that DDI, which participated in the arbitration, had aligned interests with Daic Trustee and M-666. Mr. Drago Daic represented all three entities and took part in the arbitration. The court noted that the noteholders were aware their claims would be addressed in arbitration, as Nauru contested their payment demands. This established a sufficient identity of interests to bind the noteholders to the arbitration panel's finding of non-liability. The document references case law affirming that arbitration awards can bind non-parties when their interests are related to those of the parties involved in arbitration. However, caution is advised in assuming arbitration can determine the rights of non-parties without clear evidence of consent to arbitrate. In this instance, Daic Trustee and M-666, as third-party beneficiaries, had contingent interests affected by DDI's contract performance. Their interests were adequately represented in arbitration, and they sought to enforce the Development Agreement against Nauru.
The value of the Promissory Note was contingent upon the performance of third parties, which the noteholders could not control. The district court correctly determined that a condition for liability under the Promissory Note failed, thus barring claims from Daic Trustee and M-666. Despite not being formal parties to the arbitration, Daic Trustee and M-666 were bound by the arbitration clause in the Development Agreement, which the Promissory Note referenced. Their attempts to enforce parts of the Development Agreement indicated their recognition of this binding arbitration clause. The arbitration panel found DDI liable for Nauru's loss of reimbursement funds amounting to $477,000, despite DDI's claim that the Development Agreement only allowed offsets against other amounts owed. The agreement anticipated that a Municipal Utility District (MUD) would purchase utility improvements at 70% of construction costs, and the arbitration record reflected some development property was within an existing MUD. DDI contested the arbitration panel's decision regarding reimbursement for cost overruns on a drainage ditch, arguing that Nauru waived any complaints by not objecting to DDI's management decisions. However, the panel appropriately attributed the overruns to DDI's mismanagement, affirming that DDI could be held liable under the Development Agreement. The district court's confirmation of the arbitration award concerning the Porter MUD and drainage ditch was upheld.
The district court's jurisdiction was affirmed in confirming the arbitration award. It is clarified that the Federal Arbitration Act does not establish federal jurisdiction; an independent jurisdictional basis, such as diversity or federal question, must be demonstrated. The evidence shows that Drago Daic is the sole owner of DDI and serves as Trustee of the 3-D Trust for his family. He effectively controls 55% of M-666 and also owns 19.33% of M-666 through another company, Imperial Marketing. Individually or as Trustee, he holds a 75% interest in the Promissory Note. The land sold to Nauru for the Bentwood development was initially purchased by him in 1983 for approximately $3.8 million and was subsequently sold for a profit to himself (as Trustee) and M-666. A joint venture agreement regarding the land was established, with Mr. Daic as the managing joint venturer.
