Leo Middle East FZE v. Zhang

Background

Leo Middle East FZE agreed to purchase shares of Series A Preferred Stock in Hyperloop Transportation Technologies, Inc. from Edgewater HTT III, LLC for $5 million. The agreement made Leo ME a limited partner and EWI Capital, LLC a general partner responsible for managing the investment. Zhe Zhang signed the agreement for EWI. The agreement required disputes relating to it to be resolved through arbitration before the Hong Kong International Arbitration Center.

The plaintiffs and cross-defendants sued EWI, Zhang, and others in federal court, asserting contract, fiduciary-duty, and fraud claims. EWI and Zhang filed crossclaims alleging that the cross-defendants breached the contract and the duty of good faith and fair dealing. The plaintiffs and cross-defendants moved to compel arbitration of those crossclaims after the court had ruled on their earlier motion to dismiss.

Issue and governing standard

The court considered whether the plaintiffs and cross-defendants had waived their contractual right to arbitration by participating in the federal litigation. Waiver means giving up a known right through conduct. Under Ninth Circuit law, waiver based on litigation conduct requires knowledge of the arbitration right, conduct inconsistent with that right, and prejudice to the party opposing arbitration.

The court also considered whether an arbitrator or the court should decide the waiver question. Questions about whether a party waived arbitration through litigation conduct are for the court unless the agreement clearly and unmistakably assigns that issue to an arbitrator.

Reasoning

The court held that it had to decide waiver. The agreement broadly required arbitration of disputes arising from or relating to the agreement, but it did not specifically state that an arbitrator would decide waiver based on participation in litigation. The court found that this language was not clear and unmistakable enough to transfer the waiver question to an arbitrator.

The court found all three waiver factors satisfied. First, the plaintiffs and cross-defendants attached the investment agreement, including its arbitration clause, to their original complaint. The court therefore found it likely that they knew about the arbitration clause when they filed suit.

Second, the court found that they acted inconsistently with arbitration. They filed their claims in federal court, moved to dismiss the crossclaims without requesting arbitration, and participated in discovery. They moved to compel arbitration only after losing their motion to dismiss.

Third, the court found prejudice to EWI and Zhang. The parties incurred litigation and discovery costs that would not have occurred had arbitration been sought initially. The plaintiffs and cross-defendants also litigated their claims and sought discovery under the federal court’s procedures, potentially obtaining information unavailable in arbitration. The court reasoned that allowing arbitration after the unsuccessful court motions would give the plaintiffs and cross-defendants another opportunity to pursue the dispute.

The court rejected the argument that the possibility of parallel proceedings and inconsistent rulings required arbitration. It stated that the plaintiffs and cross-defendants had created that situation by filing in federal court, challenging the crossclaims there, and using court discovery.

Disposition

The court denied the motion to compel arbitration. The opinion does not state that the motion was denied with or without prejudice.