Delaware, Confidential Arbitration and the Risk to Investors (Part 2)

We are discussing the system of confidential arbitrations for business disputes that was recently put in place in Delaware. 

To take advantage of the system of confidential arbitration, the parties must consent, one must be a "business entity," a party must be organized under the laws of Delaware or have their headquarters in the state, and, where the action is seeking only monetary damages, must allege an amount of at least $ 1 million.  In addition, the provision does not apply to actions involving consumers.  Consumer includes "an individual who purchases or leases merchandise primarily for personal, family or household purposes." 6 Del. C. § 2731. 

Rule 96 defines "consent to arbitrate" as "a written or oral agreement to engage in arbitration in the Court of Chancery and shall constitute consent to these rules."  The definition also provides magic language that will trigger application of the system of confidential arbitration.  According to the Rule:  "[A] consent to arbitrate is acceptable if it contains the following language:  The parties agree that any dispute arising under this agreement shall be arbitrated in the Court of Chancery of the State of Delaware". 

Parties seeking to invoke confidential arbitration may, presumably, consent to do so at any time.  Consent may also appear in an agreement.  See COMPREHENSIVE SETTLEMENT AGREEMENT Between Versata  and Selectica, Sept. 2011 ("Any and all disputes between the Parties, whether arising out of the Agreement or otherwise, shall be submitted to binding arbitration in Delaware under the auspices of the Delaware Chancery Court pursuant to 10 Del. C. Section 349, with the proviso that the arbitration be heard before a current judge who shall render an opinion in accordance with the law."). 

There is nothing in the statute or rules that requires the consent to be in an agreement executed by two businesses.  Indeed, the provisions require that only one of the parties be a business.  Consents, therefore, may appear in agreements that involve individual investors or shareholders (although not consumers).  Moreover, these types of consents are beginning to appear in LLC operating agreements.  According to one Limited Liability Agreement:  

The Members hereby agree that any dispute among the Members or Committee Representatives as to how to proceed under this Section 7.4 shall be arbitrated in the Court of Chancery of the State of Delaware, pursuant to 10 Del. C. § 349 and the Rules of the Delaware Court of Chancery. The parties hereby submit to the exclusive jurisdiction of the Delaware Court of Chancery in connection with any action to compel arbitration, in aid of arbitration, or for provisional relief to maintain the status quo or prevent irreparable harm prior to the appointment of the arbitrator. 

Similarly, another Limited Liability Company Agreement provided that:  

Any dispute, claim or controversy arising out of or relating to this Agreement that cannot be resolved amicably by the parties, including the scope or applicability of this agreement to arbitrate, shall be determined by binding arbitration pursuant to Section 349 of the Rules of the Court of Chancery of the State of Delaware if it is eligible for such arbitration.

In other words, members of LLCs with disputes arising from their ownership interest may find themselves subjected to mandatory confidential arbitration in Delaware.  We will discuss why this matters in the next post.

Primary materials are located at the DU Corporate Governance web site.