The so-called doctrine of severability as applied to agreements to arbitrate disputes is well-recognized. Basically, provisions that require disputes to be resolved by arbitration that are contained as part of broader contracts are viewed separately from any other provision of the contract for purposes of determining any challenge to arbitration based upon fraud or fraudulent inducement. Generally, if the alleged fraud did not particularly target the arbitration provision itself, courts will not allow a party to the broader contract in which that provision is contained to avoid arbitration based upon a claim of fraudulent inducement. I have written often about these concepts. See, e.g., Federal Court Rejects Challenge to Arbitration Clause Based Upon Alleged Fraudulent Inducement; Special Rules for Nullifying Arbitration Agreements for Alleged Fraud; Courts Reinforce Strict Standards for Nullifying Arbitration Provision Based Upon Fraud; Second Department Reinforces Vitality of Arbitration Clauses in Face of Fraud Claim.
Of course, if the broader contract is being challenged based upon the rarely-sustainable argument of fraud in the factum, which would make the entire contract void ab initio, that would potentially be decided by the court rather than in arbitration. See First Department Explains Distinction Between Void and Voidable Documents and Corresponding Fraud.
Given the rather consistent governing law, it is somewhat remarkable that parties continue to seek to circumvent arbitration provisions with nothing more than conclusory arguments of fraud in the inducement of the contract or unspecified assertions that the arbitration provision was used as part of a “grand fraudulent scheme.” A recent example of such ineffective arguments is reflected in the decision of the New York Supreme Court Commercial Division in Kings County in Gowanus Park LLC v. KSK Construction Group LLC, Index No. 517124/2022, Jan. 25, 2023 (Ruchelsman, J.).
Gowanus Facts
In Gowanus, the plaintiff property owner entered into a contract with defendant KSK Construction Group LLC for the construction of a four-story residential building. In connection with the promised construction, the parties entered into a standard AIA contract, which contained a broad arbitration provision requiring any disputes to be resolved by arbitration before the American Arbitration Association, under the Construction Industry Arbitration Rules. Those Rules broadly delegate questions of the arbitrator’s own jurisdiction and the existence, scope, or validity of the arbitration agreement to the arbitrator. See NYSCEF No. 7, pp.2-3.
The plaintiff instituted an action in court alleging, among other things, that defendant “made material representations and omissions regarding its experience and ability to manage and complete the construction project to induce [plaintiff] to enter into an agreement with [defendant]. [Plaintiff] relied on [defendant]’s representations and omissions and entered into the contract with [defendant]. In fact, however, [defendant] was wholly incapable of managing or completing the project and subsequently walked off the job. Moreover, most of the work performed by [defendant] was riddled with defects and had to be redone at significant cost to [plaintiff].” See NYSCEF No. 1.
Defendant moved to stay the action against it in view of and pending the arbitration that had already been commenced between the parties under the AIA contract.
In opposition to the motion to stay the pending arbitration, plaintiff claimed in rather conclusory fashion that defendant’s “fraudulent misrepresentations were part of a grand scheme that permeate[d] the entire” AIA contract. See NYSCEF No. 7.
The Commercial Division granted the motion to stay, enforced the arbitration provisions and rejected plaintiff’s conclusory assertions.
Arbitration is Upheld
The Court first acknowledged the public policy favoring arbitration and alternative dispute resolution mechanisms. The Court then explained the manner in which challenges to arbitration provisions is determined:
An allegation of fraud in the inducement only affects the arbitration clause when either the fraud relates to the arbitration clause itself or where the fraud was “part of a grand scheme that permeated the entire contract”(see, Anderson Street Realty. Corp., v. New Rochelle Revitalization LLC, 78 AD3d 972, 913 NYS2d 114 [2d Dept., 2010]). “To demonstrate that fraud permeated the entire contract, it must be established that the agreement was not the result of an arm’s length negotiation … or the arbitration clause was inserted into the contract to accomplish a fraudulent scheme” (id).
Thus, even 332 East 66 Street. Inc., v. Walker, 59 Misc3d 1216(A), 106 NYS34 727 (Supreme Court New York County 2018) cited by the plaintiff held that “generally, under a broad arbitration provision, the claim of fraud in the inducement of the agreement is deemed to be included as a matter for arbitrators to determine” (.id). The court did explain that to avoid arbitration the fraud had to relate to the arbitration clause itself or that “something greater than the substantive provisions of the agreement were induced by fraud” (id).
***
In this case the plaintiff alleges there was a grand scheme of fraud that permeated the entire contract. However, mere fraudulent inducement does not establish the fraud permeated the entire contract (Tiki Boatworks LLC v. Crusin’ Tikis LLC, 2021 WL1198256 [N.D.N.Y. 2021]). Consequently, without additional evidence that fraudulent inducement included something greater than the provisions of the agreement itself no such fraudulent scheme has been presented and there is no basis upon which to deny arbitration (see, Markowitz v. Friedman, 144 A.D.3d 993, 42 NYS3d 213 [2d Dept., 2016]). The plaintiff has failed to produce any evidence that the contract entered into between the parties was not an arms length negotiation or that any alleged fraud in the inducement was a scheme which permeated the entire contract.
Thus, the court granted the motion to stay the action pending the arbitration.