795 F. 2d 1111 - Mowbray v. Moseley Hallgarten Estabrook & Weeden Inc

This action was brought below by plaintiffs-appellants, Robert M. Mowbray and Rose A. Mowbray, against their former stockbroker Michael French, and his employer, a Burlington, Vermont stock brokerage firm known as Moseley, Hallgarten, Estabrook & Weeden, Inc. ("Moseley"). Plaintiffs' basic claim below was for alleged excessive trading or "churning" of their accounts by defendants. Plaintiffs also alleged fraudulent misrepresentation by defendant French in recommending particular investments. Plaintiffs sought to recover damages pursuant to Rule 10b of the Securities Act of 1934 and Rule 10b-5 promulgated thereunder, and pursuant to several state statutory and common law causes of action.

After discovery was completed and less than two months before trial, defendants, citing the Supreme Court decision in Dean Witter Reynolds, Inc. v. Byrd, 470 U.S. 213, 105 S.Ct. 1238, 84 L.Ed.2d 158 (1985), moved to compel arbitration on all plaintiffs' claims and for a stay of district court proceedings. The district court allowed the motion without opinion, and this appeal followed.

Five issues are raised on appeal, but only two of these are necessary for our decision today. First, defendants-appellees question this court's jurisdiction, arguing that the district court order compelling arbitration is not an appealable order. For the reasons stated below, we disagree and find that appellate jurisdiction exists. Second, plaintiffs-appellants argue that the district court erred in finding defendants to be the beneficiaries of an arbitration agreement signed between plaintiffs and Securities Settlement Corporation, a "clearing house" broker not a party to this suit. For the reasons stated below, we agree with appellants that appellees were not parties to the arbitration agreement, and hence, could not invoke it. Thus, on this ground alone, we find that the district court erred in compelling arbitration and remand for trial to proceed on the merits.1

The motion filed by defendants-appellees below was brought pursuant to the Federal Arbitration Act, 9 U.S.C. Secs. 3 and 4.2 Specifically, the motion requested "that plaintiffs be ordered to arbitrate all claims set forth in their complaint ... and that further proceedings in this action be stayed pending such arbitration." Thus, defendants below sought, and were granted, both a Sec. 4 order to compel arbitration and a Sec. 3 order to stay proceedings pending such arbitration.

On appeal, defendants-appellees assert that the "mixed" Sec. 3 and Sec. 4 order below was not a "final" order, and hence, is not appealable. To support this claim of lack of appellate jurisdiction, defendants-appellees make the following three-step argument: (1) that despite the explicit request and granting of a stay under Sec. 3 of the Arbitration Act, the "thrust" of the motion below was to compel arbitration under Sec. 4 of the Act; (2) that, under Hartford Financial Systems, Inc. v. Florida Software Services, Inc., 712 F.2d 724 (1st Cir.1983), Sec. 4 orders to compel arbitration are generally not appealable; and (3) that because the motion and order below is "essentially" a Sec. 4 motion and order, it cannot be appealed.

Appellees misconstrue both the law and the nature of the order below. First, we do not accept appellees' contention that the motion and order below "essentially" involved Sec. 4. Rather, the explicit request, as granted, was for an order to compel and a stay. Thus, the current appeal involves a "mixed" Sec. 3 and Sec. 4 order both compelling arbitration and staying district court proceedings.

Second, as a matter of law, and given the fact that plaintiffs-appellants' underlying action is "legal" rather than "equitable" in nature, the characterization of the order below as "essentially" a Sec. 4 order or as a Sec. 4 order joined to a Sec. 3 order is immaterial. As plaintiffs-appellants note, Sec. 4 orders can always be appealed under 28 U.S.C. 1292(a)(1)--whether standing alone, "embedded" to ongoing litigation, or joined to Sec. 3 orders--where the Sec. 4 order fits within the "Enelow-Ettelson " exception, i.e., where the underlying action rests in law and not in equity. See Hartford Financial Systems, supra at 729; Langley v. Colonial Leasing Co. of New England, 707 F.2d 1, 5 (1st Cir.1983); see also Ettelson v. Metropolitan Life Insurance Co., 317 U.S. 188, 63 S.Ct. 163, 87 L.Ed. 176 (1942); Enelow v. New York Life Insurance Co., 293 U.S. 379, 55 S.Ct. 310, 79 L.Ed. 440 (1935).3 Thus framed, the issue of our appellate jurisdiction over the order below--whether viewed as a Sec. 4 order standing alone or as a Sec. 4 order joined to a Sec. 3 order--turns on whether plaintiffs-appellants' action lies in law or in equity.

To determine whether an action is brought in law or in equity, courts have applied either a "historical" or "dominant purpose" test. See 16 Wright, Miller, Cooper & Gressman, Federal Practice and Procedure, Sec. 3923, pp. 61-63, n. 36-38, and cases cited therein. The historical test involves an inquiry as to whether, given the prayers in the complaint, the action historically could have been brought as an action in equity. Id. Thus, if due to prayers for equitable relief, the suit originally could have been brought in equity, then an "equitable" characterization of the underlying suit would be proper, and appellate jurisdiction would not exist. See USM Corporation v. GKN Fasteners, Ltd., 574 F.2d 17, 22 & n. 10 (1st Cir.1978). Moreover, the presence of legal along with equitable prayers in the complaint would not be fatal to the "equitable" characterization of the action, since equity courts presumably would exercise jurisdiction over the legal claims under the doctrine of "equitable clean-up." Id.

Despite our intimations in USM Corporation, supra at 22, that the historical test may be necessary, we are reluctant to apply it in this case and instead, along with every other circuit that has addressed the matter, opt to apply the "dominant purpose" test initially announced by Judge Friendly in Schine v. Schine, 367 F.2d 685, 688 (2d Cir.1966) (Friendly, J., concurring). Under this test, while "any fair doubt [should be] resolved against the claim that the action was predominantly one at law," id., a "legal" characterization of the underlying action (and hence, appellate jurisdiction) is permissible where the complaint is "wholly or basically and predominantly an action at law," Alexander v. Pacific Maritime Ass'n, 332 F.2d 266, 277 (9th Cir.1964), and where the prayers for equitable relief, if present, are "merely incidental." Standard Chlorine of Delaware, Inc. v. Leonard, 384 F.2d 304, 309 (2d Cir.1967); Medtronic, Inc. v. Intermedics, Inc., 725 F.2d 440, 444-445 (7th Cir.1984) (Posner, J.) ("the equitable relief sought [must be] more than merely incidental" to preclude appellate jurisdiction); Lee v. Ply*Gem Industries, Inc., 593 F.2d 1266, 1269 (D.C.Cir.), cert. denied, 441 U.S. 967, 99 S.Ct. 2417, 60 L.Ed.2d 1073 (1979) (the "presumption [is] that the pending action is equitable, but that may be overborne if the request for equitable relief is incidental or clearly subordinate to essentially legal claims"); Thompson v. House of Nine, Inc., 482 F.2d 888, 890 (5th Cir.1973) (same); Chapman v. International Ladies' Garment Workers' Union, 401 F.2d 626, 629 (4th Cir.1968) (same).4

Applying the dominant purpose test to the instant case, we first note that plaintiffs case is brought as a declaratory judgment, "a chameleon-like statutory remedy which is neither 'legal' nor 'equitable'," Hartford Financial Systems, supra at 727, and that courts faced with requests for declaratory relief in these circumstances have sought to determine whether, in the absence of the Declaratory Judgment Act, the suit brought would have been legal or equitable in nature. See Diematic Manufacturing Corp. v. Packaging Industries, Inc., 516 F.2d 975, 978 (2d Cir.), cert. denied, 423 U.S. 913, 96 S.Ct. 217, 46 L.Ed.2d 141 (1975); Wallace v. Norman Industries, Inc., 467 F.2d 824, 827 (5th Cir.1972); American Safety Equipment Corp. v. J.P. Maguire & Co., 391 F.2d 821, 824 (2d Cir.1968).

As we now enter the "Serbonian Bog" imposed by Enelow-Ettelson,5 our inquiry is whether, absent the availability of declaratory relief, the action brought would have been legal in nature, and also, whether the prayers for equitable relief are "merely incidental" in an action that is "wholly or basically and predominantly one at law." See Langley v. Colonial Leasing Co. of New England, 707 F.2d 1, 6 (1st Cir.1983). Applying these tests, we find, for the reasons stated below, that plaintiffs-appellants' action is "legal" under Enelow-Ettelson, and accordingly, conclude that appellate jurisdiction exists.

Plaintiffs' complaint contains nine relevant prayers for relief, eight of which seek damages from the defendants upon a district court finding of violations of Rule 10b-5 under the federal securities law as well as breaches of fiduciary duty under plaintiffs' common law fraud and state law claims.6 Plaintiffs' only prayer for equitable relief was that the district court "issue a permanent injunction against the [defendants], enjoining them from violating Rule 10b-5 of the Securities and Exchange Commission, Title 9, Sec. 2453 and Title 9, Sec. 4224 of the laws of the State of Vermont."

Following the mandate that we resolve "any fair doubt against the claim that the action was predominantly one at law," Schine, supra at 688, and viewing the complaint "with an eye toward a finding of nonappealability," Mellon Bank, supra at 1249, we do not find plaintiffs' isolated plea for an injunction against future securities law violations by defendants as overriding the clear goal of plaintiffs' complaint for a legal remedy, i.e., damages. In short, we do not regard plaintiffs' complaint as generating any fair doubt that the action below was in law. Finally, because the crux of plaintiffs' action was allegations of federal securities law violations, we also note that, absent the availability of declaratory relief, the action filed would have been a legal one seeking damages, invoking federal jurisdiction under the Securities Act of 1934. Thus, because the underlying action was basically and predominantly one at law, and because, absent the availability of declaratory relief, the action brought would have been legal in nature, we conclude that appellate jurisdiction exists to review the Sec. 3 and Sec. 4 orders below.

II. Whether the Defendants-Appellees Could Invoke the Arbitration Agreement Signed Between Plaintiffs and Securities Settlement Corporation

The arbitration clause at issue in this case is part of a Customer Agreement ("Agreement") signed by plaintiffs and Securities Settlement Corporation ("SSC"), a "clearing house" broker not a party to this suit. While the Agreement tangentially refers to defendants in their "introducing firm" role, the clause providing for compulsory arbitration does not mention defendants and defendants did not in fact sign the Agreement.7

On appeal, plaintiffs-appellants argue for a literal and hence narrow construction of the parties to the arbitration clause and to the Agreement generally. Thus, appellants assert that the agreement can only be invoked by its signatory, SSC, and not by defendant Michael French nor defendant Moseley, each a nonsignatory. To support their conclusions, plaintiffs-appellants assert that the continued reference in the Agreement to defendants reveals that "the drafters knew full well how to include [defendants] ... when that was the intention." Thus, appellants suggest that the omission of defendants from the clause allowing arbitration and as signatories should be regarded as purposeful.

Defendants-appellees offer two grounds upon which we can find a "meetings of the minds" between plaintiffs and defendants below on the issue of compulsory arbitration. First, citing Okcuoglu v. Hess, Graut & Co., Inc., 580 F.Supp. 749 (E.D.Pa.1984), defendants assert that the conduct of the parties below render defendants the "agents" of the signatory SSC; thus, as agent of SSC, defendants argue that they can invoke SSC's contingent right to have disputes regarding it subject to arbitration. Second, citing Cauble v. Mabon Nugent & Co., 594 F.Supp. 985 (S.D.N.Y.1984), defendants-appellees argue that they, as the introducing brokers, are third party beneficiaries of the arbitration provisions of the Agreement signed between plaintiffs and SSC, the clearing house broker.

For reasons stated more fully below, we find each of these cases distinguishable on their facts, and therefore, because we are unable to find any other theory supporting a contract between plaintiffs and defendants on the issue of arbitration, we conclude that the district court's order to compel arbitration must be vacated and that trial below must proceed.

As the defendants-appellees note, Okcuoglu, supra, involved a claim that options transactions had taken place where not authorized, and that when transactions were authorized, the buy or sell would not occur. Similar to the instant case, the defendants in Okcuoglu were introducing brokers who, although not explicitly made parties to a customer agreement signed between plaintiffs and a clearing house broker, sought to invoke the compulsory arbitration provision of that agreement. Plaintiffs opposed arbitration on the ground that the defendant introducing broker was not a party to the agreement.

In holding that the defendant introducing brokers could invoke the arbitration provisions of the agreement, the court in Okcuoglu adopted the following four-step analysis: (1) since the transactions sued upon related to unauthorized or unexecuted trades, the possibility remained that the clearing house could be joined as a necessary party; (2) so long as the possibility existed of joining the clearing house, such clearing house had the right to have all disputes as to transactions it handled submitted to arbitration; (3) the course of dealings between the parties indicates that the introducing broker acted both as the customer's and the clearing broker's agent; and (4) therefore, the introducing broker, as the clearing broker's agent, could enforce the latter's contingent right to compel arbitration. Id. at 750-752.

The above result, stressed the court, did not alter the customer's clear understanding that any dispute involving the clearing broker--either directly or indirectly--would be subject to arbitration. Id. at 752. The problem in applying Okcuoglu, therefore, is the extent to which the case is distinguishable due to the directness or indirectness of a particular clearing broker's involvement in the transactions sued upon. In short, it follows from Okcuoglu that, if there were no possibility of joining the clearing house broker to the introducing broker-customer dispute, the introducing broker accordingly could not invoke the customer-clearing house contract.

This is such a case. On the state of the pleadings before us, where the case was slated to go to trial in less than two months, no claim has been asserted by either party which intimates even a potential involvement of SSC, the clearing house. Thus, because SSC's involvement in the dispute before us cannot be characterized as even indirect, we conclude that SSC was not subject to the dispute and hence no contingent right existed for SSC (through its "agents" defendants-appellees) to invoke the arbitration agreement. Accordingly, because we find the agency theory of Okcuoglu to be inapposite to the facts of this case, we turn to defendants-appellees next asserted ground for finding a meeting of the minds on the issue of arbitration, i.e., Cauble, supra and the third party beneficiary theory.

In Cauble, the court held that an introducing commodities broker was the third party beneficiary of, and thus able to independently enforce, the liquidation (not arbitration) provisions of a customer-clearing house agreement. As the Cauble court noted, the Restatement of Contracts provides that a party can be considered a third-party beneficiary where " 'recognition of a right to performance is appropriate to effectuate the intention of the parties' " and where " 'the circumstances indicate that the promisee intends to give the beneficiary the benefit of the promised performance.' " 594 F.Supp. at 991, citing Restatement (Second) of Contracts Sec. 302.

The crux in third-party beneficiary analysis, then, is the intent of the parties. In Cauble, the court noted that the course of dealings between the parties indicated that performance of the client's contractual obligations under the agreement with the clearing broker was to be monitored and controlled by the introducing broker. Id. at 991. This fact of supervisory powers exercised by the introducing broker over the customer's account, combined with the "central position" of the introducing broker in the customer-clearing house relation, led the Cauble court to conclude that the introducing broker "should be" recognized as a third party beneficiary of the customer-clearing broker agreement. Id. at 992.

Despite Cauble, we decline, on the facts before us, to find an intent on the part of both plaintiffs and the clearing broker to allow defendants, the introducing brokers, to invoke the arbitration clause. Granted, it is undisputed that the agreement between plaintiffs and SSC was signed in connection with the opening of plaintiffs' accounts with the defendants introducing brokers. Moreover, we are willing to assume that, as in Cauble, the defendants below exercised supervisory powers and stood in a "central position" between plaintiffs and the clearing house. But the difference between this case and Cauble is that, unlike the liquidation provisions at issue there, it does not follow from the introducing broker's de facto control over a client's account that the client originally or subsequently intended that the introducing broker be able to invoke SSC's power to compel arbitration. In short, while the power to liquidate can be characterized as an "obvious" (and hence, intended) incident of an introducing broker's administrative or supervisory powers over a customer's account, id., we do not regard it as obvious that a customer intended or agreed to have all disputes with an introducing broker arbitrated merely because the introducing broker exercises certain supervisory powers over an account or its margin requirements. Thus, because it is not clear on the record before us that plaintiffs intended defendants, the introducing brokers, to invoke the arbitration clause of the agreement between plaintiffs and SSC, we decline to adopt the third-party beneficiary theory of Cauble.

Finally, our conclusion--that defendants-appellees, the introducing brokers, are not intended beneficiaries of the arbitration clause--is bolstered by the language of the agreement itself. The agreement, drafted in letter form, refers throughout to three parties: (1) "you," i.e., SSC, the clearing house broker; (2) "the undersigned," i.e., plaintiffs-appellants, the customers; and (3) "the introducing firm," i.e., defendants-appellees, the introducing brokers. The agreement goes on to selectively include, and exclude, the introducing firm from certain provisions. Specifically, the introducing broker is not included in the clause providing for compulsory arbitration: "Any controversy between you and the undersigned arising out of or relating to this contract, or the breach thereof, shall be settled by arbitration...." (Emphasis supplied).

On appeal, the appellants urge us to take note of the probable sophistication of the drafters of the agreement, and argue that therefore the omission of defendants from the arbitration clause must be regarded as purposeful. We agree. Thus, because the drafters specifically included the introducing firm in certain provisions, and because the introducing firm was not included in the arbitration clause, we believe the reasonable inference to be that the parties did not intend defendants-appellees, the introducing firm, to be a beneficiary of the arbitration clause. Rather, the plain meaning of a well-drafted contract suggests that defendants-appellees could not compel arbitration, and the facts as pleaded by defendants do not persuade us otherwise. Thus, because we cannot find convincing support for a conclusion that defendants-appellees are parties to the arbitration clause, and because we therefore cannot find a contract between plaintiffs and defendants on the issue of compulsory arbitration, we conclude that the granting below of defendants' motion to compel arbitration was error. The order of the district court is therefore vacated and the case remanded for trial to proceed on the merits.