Michigan Appellate Court Rules That, Absent Proof of Prejudice, Defendant’s Filing of a Cross-Complaint Does Not Constitute a Waiver of Arbitration

Universal Acad. v. Berkshire Dev., 2017 Mich. App. LEXIS 975 (Ct. App. June 20, 2017)

The dispute arose out of an agreement between Universal Academy (“Universal”) and Berkshire Development (“Berkshire”), under which Berkshire agreed to provide demolition services to Universal and Hamadeh Education Services (“HES”).  The agreement also contained an arbitration provision which provided in part:

In the event of a dispute between Contractor and the Owner that cannot be resolved, the parties agree to binding arbitration with the American Arbitration Association in accordance with the Construction Industry’s Rules of the American Arbitration Association in effect as of the date of this Agreement.

The agreement was terminated by Universal, alleging material breaches by Berkshire.  Following termination, subcontractors for the project filed a complaint against Berkshire, Universal, and HES, requesting foreclosure of construction liens and payment for services.  In response, Berkshire filed a cross-complaint against Universal and HES, requesting foreclosure of its lien and asserting claims of promissory estoppel and fraudulent inducement.  Five months after it filed the cross-complaint, Berkshire filed a motion to enforce the arbitration agreement between it and Universal.

The trial court dismissed all of Berkshire’s claims in the cross-complaint and denied Berkshire’s motion to enforce the arbitration agreement, reasoning that Berkshire had no claims left against Universal to arbitrate.  Following dismissal, Berkshire filed a demand for arbitration with the American Arbitration Association to arbitrate its breach of contract claim against Universal.  In response, Universal sought to permanently enjoin arbitration of any claims arising out of the demolition project on the grounds that Berkshire had waived its right to arbitration upon filing the cross-complaint, and that res judicata and compulsory joinder barred such claims.

Berkshire failed to timely file an answer.  Nevertheless, the trial court denied Universal’s motion for entry of default judgment and dismissed Universal’s case.  The trial court found that Berkshire did not waive its right to arbitrate, and that the application of res judicata and compulsory joinder is for the arbitrator, not the trial court to decide.

On appeal, the Court of Appeals of Michigan affirmed the trial court’s judgment.  When determining whether the right to arbitration has been waived, Michigan law requires the moving party to bear the heavy burden of showing that the other party:  (1) had knowledge of an existing right to compel arbitration; (2) acted inconsistently with such right; and (3) prejudice resulted from such inconsistent acts.

The Court found that the first requirement had been shown, raised questions about the second requirement, but ultimately affirmed under the third requirement.

The Court held that Universal suffered no real prejudice from having to defend itself initially in court, as Berkshire’s cross-complaint was part of a suit that had already been initiated by the subcontractors against Universal.  Furthermore, Berkshire filed its motion to compel arbitration just five months after filing its cross-complaint, and demanded arbitration just one month after that, while Michigan courts have previously found prejudice where a party had to defend itself for some 18 months before the other party sought arbitration.

The Court also agreed that the questions of res judicata and compulsory joinder were for the arbitrator to decide.  The Court held that whether an agreement to arbitrate exists or a controversy is subject to the scope of an arbitration agreement are questions for the trial court, but an arbitrator should decide whether a condition precedent to arbitrability has been fulfilled and whether an agreement to arbitrate is enforceable.

To view the full text of the court’s decision, courtesy of Lexis®, click here.

Alex Corey, assisted by Jeffrey Hon*

*Mr. Hon is a 2017 Summer Associate in the Construction Practice of Pepper Hamilton LLP.  He is not admitted to practice law.

 

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