* District Judge of the Western District of Louisiana,

sitting by designation. 

IN THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

 

No. 97-20279 

 

NAURU PHOSPHATE ROYALTIES, INCORPORATED, (Texas),

Plaintiff - Appellee

versus

DRAGO DAIC INTERESTS, INCORPORATED,

Defendant - Appellant

 

Appeal from the United States District Court

for the Southern District of Texas

 

March 31, 1998

 

Before HIGGINBOTHAM and STEWART, Circuit Judges, and WALTER*,

District Judge.

PATRICK E. HIGGINBOTHAM, Circuit Judge:

Drago Daic Interests, Inc. appeals a district court order

confirming the award granted to Nauru Phosphate Royalties (Texas),

Inc. in an arbitration proceeding. The arbitration panel

determined that DDI materially breached the Development Agreement

between Nauru and DDI and held the beneficiaries of the agreement,

Drago Daic, Trustee, and Montgomery-666, bound by its award. This
2

case asks us to determine whether Nauru’s liability on the

Promissory Note was properly before the arbitration panel. We hold

that the arbitration panel did not exceed its authority in ruling

on Nauru’s liability on the Promissory Note and AFFIRM the district

court’s judgment. We reject any suggestion that because Daic

Trustee and M-666 were not parties to the arbitration or to this

case, the breach of the Development Agreement and Nauru’s

consequent non-liability on the Promissory Note were beyond the

reach of the arbitration. Finally, the district court did not err

in concluding that DDI was responsible for Nauru’s loss of

reimbursement funds for 122 lots and for cost overruns incurred in

excavating a drainage ditch.

I.

In 1990, Nauru Phosphate Royalties, Inc., a Delaware

corporation, entered into a sale and development agreement with

three parties - (i) Drago Daic Interests, Inc., (ii) Drago Daic,

Trustee, and (iii) Montgomery 666, Ltd. Nauru purchased 668 acres

in Montgomery County, Texas, from Daic Trustee and M-666 for $5

million in cash and an $8 million Promissory Note. The Promissory

Note was secured by a Deed of Trust lien on the land being sold.

Nauru agreed to retain DDI, as developer, to develop the land into

an up-scale residential housing subdivision, called Bentwood, with

a country club, golf course and the like.

The Development Agreement and Promissory Note, when read

together, set up the following arrangement: Nauru was to fund all
3

monies necessary for the development project and be reimbursed for

all of its expenditures in a given calendar year from that year’s

revenue. If expenditures exceeded revenues, no payments would be

made other than to Nauru. Only if revenues exceeded expenditures

would payment be made on the Promissory Note. This was to continue

until the Promissory Note was fully paid or the project sold,

whichever came first. Stated directly, in the event that revenues

did not exceed expenditures, the noteholders, Daic Trustee and M666, would not be entitled to payment on the Promissory Note.

The project began in 1990 and continued into 1995. The

property never achieved enough cash flow to pay current expenses,

much less reimburse Nauru or make any payments on the Promissory

Note. DDI was dissatisfied with Nauru’s timeliness of funding,

Nauru was unhappy about the costs and expenses, and the

noteholders, Daic Trustee and M-666, were unhappy about not being

paid. Eventually, Nauru gave notice of intent to terminate DDI as

developer and instituted an arbitration proceeding.

In the arbitration, Nauru claimed DDI fraudulently induced

Nauru to enter into the transaction and to continue development

with various cost overruns. In addition, Nauru claimed that DDI

materially breached the Development Agreement and sought

indemnification from DDI for any liability on the contingent, nonrecourse Promissory Note to Daic Trustee and M-666. DDI

counterclaimed that Nauru’s actions caused the project to fail.

DDI also sought to recover “profits” which assertedly were due.
4

In 1996, the arbitration panel (2-1) determined that DDI had

committed thirteen material breaches of the Development Agreement

between the parties, and Nauru had committed three non-material

breaches of the Development Agreement. The panel responded to

Nauru’s claim for indemnification of any liability on the

Promissory Note by deciding that Nauru had no further liabilities

to DDI under the Development Agreement and that Nauru had no

liability for payment of the $8 million Promissory Note. This Note

was executed by Nauru and payable to the noteholders, Drago Daic,

Trustee and Montgomery-666, who were not parties to the arbitration

proceeding. Finally, the panel decided that DDI was liable to

Nauru for over $1.8 million as a result of DDI’s material breaches

of the Development Agreement.

Nauru then filed an action in district court to confirm the

arbitration award. DDI moved to dismiss for lack of jurisdiction

and also moved to vacate or modify the award. The district court

denied the motion to dismiss and referred the matter to a

magistrate judge, who recommended that the award be confirmed. In

1997, the district court accepted the magistrate judge’s findings

and recommendations and confirmed the arbitration award. This

appeal followed.

II.
 

2 It is well-established that the Federal Arbitration Act

does not create federal jurisdiction. Some independent

jurisdictional basis, either diversity or federal question, must be

shown. See, e.g., Baltin v. Alaron Trading Corp., 128 F.3d 1466,

1469 (11th Cir. 1997). 

5

We must first determine if there is federal jurisdiction. DDI

contends that the district court erred in sustaining federal

jurisdiction on the basis of diversity of citizenship2.

DDI is a Texas corporation with its principal place of

business in Texas and Nauru is a Delaware corporation. Complete

diversity turns here on the location of Nauru’s principal place of

business. Nauru argues that its principal place of business is in

Australia or Nauru, a small island republic in the south Pacific.

DDI argues Nauru’s principal place of business is in Texas.

This court applies a “total activity” test to determine the

principal place of business. J.A. Olson Co. v. City of Winona,

Miss., 818 F.2d 401, 411-12 (5th Cir. 1987). We look to the

nature, location, importance, and purpose of a corporation’s

activities and the degree to which those activities bring the

corporation into contact with the local community. Id. Three

general principles drawn from the insights of Professor Wright

guide the inquiry (see Wright, Federal Courts § 27, at 167-68 (5th

ed. 1994)):

(1) when considering a corporation whose operations are far

flung, the sole nerve center of that corporation is more

significant in determining principal place of business; (2)

when a corporation has its sole operation in one state and

executive offices in another, the place of activity is

regarded as more significant; but (3) when the activity of a

corporation is passive and the “brain” of the corporation is

in another state, the situs of the corporation’s brain is

given greater significance.
6

Olson, 818 F.2d at 411 (citations omitted).

DDI asserts that the second Olson principle is applicable and

locates Nauru’s principal place of business in Texas because, even

if its offices are in Nauru, its sole operations are in Texas.

Nauru contends the third Olson principle is applicable and

establishes its principal place of business in Nauru or Australia

because its investment in Bentwood is passive and the bulk of the

corporation’s activities involve managing its affairs from its

nerve center in Nauru or Australia. Thus, the critical inquiry

involves the nature and quality of Nauru’s activities with regard

to Bentwood.

The district court determined that at the time this action was

filed Nauru was a passive investor in land and its primary

activities were management-oriented. This determination is

supported by the record which indicates that Nauru’s nerve center

or “brain” is in Nauru or Australia, not in Texas. Bentwood is the

only investment asset of Nauru, which was formed for the sole

purpose of acquiring this asset. Nauru had four members on its

board of directors, each of whom is a citizen of and resides in

Nauru. Nauru has three officers - a president, a treasurer/

secretary and an assistant secretary. The president resides in

Nauru, the treasurer/secretary resides in Australia, and the

assistant secretary resides in Houston, Texas. Nauru maintains its

offices and staff in Nauru and Australia. The assistant secretary

functioned as a conduit of information to the directors and other
7

officers in Australia and Nauru, and the Nauru Board and its

officers made substantive and managerial-level decisions.

The single exception to the lack of significant operations at

Bentwood is the Bentwood Country Club which includes the golf

course and restaurant/bar and generates a significant amount of

gross revenue. The country club is operated by two wholly-owned

subsidiaries of Nauru - the Bentwood Country Club, Inc. and

Bentwood Private Club, Inc. 

Other circuits have held that the operations of a subsidiary

are not to be imputed to a parent company for purposes of locating

the parent’s principal place of business, at least so long as the

subsidiary is not the alter ego of the parent. Taber Partners, I

v. Merit Builders, Inc., 987 F.2d 57, 61-63 (1st Cir.) cert.

denied, 510 U.S. 823 (1993); Danjaq S.A. v. Pathe Comm. Corp., 979

F.2d 772, 774-76 (9th Cir. 1992); Pyramid Sec. Ltd. v. IB

Resolution, Inc., 924 F.2d 1114, 1120 (D.C. Cir.), cert. denied,

502 U.S. 822 (1991). This court has attributed a subsidiary’s

citizenship to its parent company in alter ego situations where the

subsidiary’s wrongful conduct is at issue. Kuehne & Nagel (AG &

Co.) v. Geosource, Inc., 874 F.2d 283, 290-91 (5th Cir. 1989).

There is no evidence that the corporate form of Nauru’s

subsidiaries should be disregarded and the subsidiaries treated as

alter egos of Nauru.

The district’s court determination that Nauru’s principal

place of business is not in Texas is amply supported by the record

and hence is not clearly erroneous.
8

III.

A court “may not reconsider an award based on alleged errors

of fact or law or misinterpretation of the contract.” Exxon Corp.

v. Baton Rouge Oil & Chemical Workers Union, 77 F.3d 850, 853 (5th

Cir. 1996) (citing United Paperworkers Int’l Union v. Misco, Inc.,

484 U.S. 29, 36 (1987)); Executone Info. Sys., Inc. v. Davis, 26

F.3d 1314, 1320 (5th Cir. 1994) (“We must sustain an arbitration

award even if we disagree with the arbitrator’s interpretation of

the underlying contract as along as the arbitrator’s decision

‘draws its essence’ from the contract.”) (citations omitted). As

long as an arbitration award “is rationally inferable from the

letter or purpose of the underlying agreement,” the award should be

upheld regardless of alleged errors of law or fact. Executone, 26

F.3d at 1320. 

A.

DDI contends that the arbitration panel’s decision regarding

Nauru’s liability on the Promissory Note was not enforceable since

the panel exceeded its authority. DDI urges that Daic Trustee and

M-666 signed the Development Agreement only with respect to Section

3.7 and Article 5, and the applicability of the Development

Agreement to them is limited to these provisions. Relatedly, DDI

contends that Daic Trustee and M-666 were not parties to the

arbitration, and the issue of Nauru’s liability on the Promissory

Note could not be decided in their absence. 
9

Their arguments are not persuasive. At the outset, the

provisions of both the Development Agreement and the Promissory

Note reveal that the two documents are inextricably intertwined.

The first paragraph in the Promissory Note states in relevant part:

The terms of the Earnest Money Contract and the Development

Agreement are hereby incorporated into this Note as if fully

set forth in this Note.

Not only does it fully incorporate by reference the Development

Agreement, the Promissory Note is explicitly referenced throughout

the Development Agreement. 

The arbitration clause in the Development Agreement provides:

Any dispute, controversy or claim arising out of or in

connection with or relating to this Agreement or any breach or

alleged breach hereof, shall, upon the request of any party

involved, be submitted to and settled by arbitration in

Houston, Texas pursuant to the rules then in effect of the

American Arbitration Association.

As this court has noted, “[w]hen parties include such a broad

arbitration clause, they intend the clause to reach all aspects of

the relationship.” Valentine Sugars, Inc. v. Donau Corp., 981 F.2d

210, 213 n.2 (5th Cir.), cert. denied, 509 U.S. 923 (1993). Here,

Nauru’s demand for arbitration states that DDI’s failure to perform

pursuant to the Development Agreement affects its liability on the

Promissory Note. Thus, DDI knew that Nauru’s liability on the

Promissory Note was indeed an issue before the arbitration panel.

Further, by virtue of the two agreements, the Development

Agreement had to be performed without material breach by DDI in

order for the noteholders to be paid. Nauru’s duty to make payment

pursuant to the Promissory Note was a “conditional obligation,” and

Nauru had “certain set-off rights” against its obligation to pay
10

which were specified in the Development Agreement. By the very

terms of the Promissory Note, any material breach of the

Development Agreement by DDI would put payment on this Note at

risk. The evidence on record shows that Mr. Drago Daic wanted DDI

to be the developer of Bentwood pursuant to the Development

Agreement to ensure that the Promissory Note would be paid. Thus,

the Development Agreement and the Promissory Note were intimately

related to one another, and the district court did not err in

finding that the arbitration panel had the authority to rule on

Nauru’s liability on the Promissory Note since it was intimately

”related to” the Development Agreement. Indeed, it goes to the

heart of the dispute over DDI’s performance of the Development

Agreement.

The contention that the arbitration panel exceeded its

authority in finding no liability on the Promissory Note because

Daic Trustee and M-666 are not bound by the panel’s findings fails

in its premise. As effective third-party beneficiaries, the

noteholders may be precluded from litigating the issue of breach of

the Development Agreement in any subsequent proceeding and may be

bound by the panel’s finding of non-liability on Nauru’s part for

the Promissory Note. Guscott et al. v. City of Boston, 958 F.2d

361, 1992 WL 55889, at *3 (1st Cir. Mar. 25, 1992) (noting that

third-party beneficiary lacked right to enforce a contract for its

own benefit when contracting party breached a contractual condition

that had to be satisfied for third-party beneficiary to receive

payment); Restatement (Second) of Judgments § 56, cmt. a (“When a
 

3 The evidence on record establishes the following: 

Mr. Drago Daic is the sole owner of DDI. 

Mr. Drago Daic, as Trustee, represents the 3-D Trust, a verbal

trust established by Mr. Drago Daic for his children and

grandchildren. 

11

judgment is entered in an action between the promisee and the

promisor that terminates the obligation so far as the promisee is

concerned..., it... discharges the obligation in favor of the

beneficiary.”); 18 Wright, Miller & Cooper, Federal Practice and

Procedure: Jurisdiction § 4460, at 530 (1981) (“Substantive rules

governing the rights of third-party beneficiaries ... shape

preclusion rules. So long as the promisee retains the power to

discharge the obligation of the promisor, the third-party

beneficiary is precluded by litigation between the promisee and

promisor.”); Restatement (Second) of Contracts § 309(2) & § 309(2)

cmt. b (“If a contract ceases to be binding in whole or in part

because of ... present ... failure of performance, the right of any

beneficiary is to that extent discharged or modified.” “Where

there is a contract, the right of a beneficiary is subject to any

limitations imposed by the terms of the contract.”).

Our decision to hold that the arbitration award effectively

decides any “right” of Daic Trustee and M-666 to be paid under the

Promissory Note is also supported by the district court’s findings.

The district court noted that DDI, which did participate in the

arbitration, had the same interests at stake as Daic Trustee and M666. The record in this case demonstrates that the man behind all

three entities - Daic Interests, Daic Trustee and M-666, - Mr.

Drago Daic3, fully participated in the arbitration proceedings.
Fifty-five percent of M-666 is effectively controlled by Mr.

Drago Daic. Another company owned and controlled by Mr. Drago

Daic, Imperial Marketing, owns another 19.33 % of M-666.

Mr. Drago Daic, individually, or in his capacity as Trustee,

owns a 75% interest in the Promissory Note.

The land which was sold to Nauru for the Bentwood development

was initially purchased by Mr. Drago Daic in 1983 for approximately

$3.8 million. Within 30 days of purchasing the land, Mr. Drago

Daic sold the land at a substantial profit in equal 50% shares to

Drago Daic, Trustee and M-666. Drago Daic, Trustee and M-666

entered into a joint venture agreement with respect to the land,

with Mr. Drago Daic acting as managing joint venturer.

12

The district court concluded that the two noteholders had notice

that liability on the Promissory Note would be resolved by the

arbitration panel since Nauru in its arbitration complaint

contested the demands made by Daic Trustee and M-666 for payment

pursuant to the Promissory Note. Thus, the record establishes that

there was sufficient identity of interests among the three

entities, DDI, Daic Trustee and M-666, that it would be fair and

appropriate to hold the noteholders bound by the panel’s finding of

non-liability on the Promissory Note. 

It bears mention that an arbitration award may be enforced in

a subsequent proceeding against parties that did not participate in

an arbitration in circumstances when the parties to the arbitration

had related and congruent interests which were properly advanced

during the arbitration. See, e.g., Isidor Paiewonsky Assocs., Inc.

v. Sharp Properties, Inc., 998 F.2d 145, 155 (3d Cir. 1993)

(holding non-parties to arbitration clause since they have “related

and congruent interests” with the principals); Cecil’s, Inc. v.

Morris Mechanical Enters., Inc., 735 F.2d 437, 439-40 (11th Cir.

1984) (enforcing indemnification agreement between general
13

contractor and subcontractor even though underlying liability was

determined by arbitration to which subcontractor was not a party);

In re Oil Spill by the “Amoco Cadiz”, 659 F.2d 789, 795-96 (7th

Cir. 1981) (binding plaintiff to outcome of arbitration between its

principal and defendant even though plaintiff would be non-party to

arbitration proceedings).

We are cautious in concluding that an arbitration panel can

effectively determine the “rights” of the noteholders when they

were not formal parties to the arbitration. See First Options,

Inc. v. Kaplan, 115 S.Ct. 1920, 1924 (1995) (noting that “[c]ourts

should not assume that the parties agreed to arbitrate

arbitrability unless there is ‘clear and unmistakable’ evidence

that they did so”) (citations omitted). As a general matter, the

interests of judicial economy ought not to be furthered by drawing

non-parties within the gravitational force of an arbitration by

shortchanging their legitimate wish to pursue their claims in

court. That is not the case here. The non-parties to the

arbitration, Daic Trustee and M-666, were third-party beneficiaries

of the contract between the parties in arbitration with an interest

contingent upon faithful performance of the contract by DDI. When

DDI breached the Development Agreement, the noteholders’ interests

were necessarily at risk. The interests of DDI, Daic Trustee and

M-666 were identical and adequately represented by a party in

arbitration, DDI, and Daic Trustee and M-666 undoubtedly attempted

to enforce the Development Agreement against Nauru. The heart of

the matter is that the value of the Promissory Note depended
14

entirely upon performance by others over whom the noteholders had

no legal control -- not in the sense that their asset was

determinable by external market forces -- but by the very terms of

the Promissory Note they held. In these circumstances, the

district court did not err in finding a failure of a condition for

liability upon the Promissory Note, a decision that forecloses Daic

Trustee and M-666.

Finally, that the arbitration award effectively binds Daic

Trustee and M-666 preventing them from relitigating the breach of

the Development Agreement works no injustice. While Daic Trustee

and M-666 were not formal parties to the arbitration, they were

parties to the agreement to arbitrate. Since the Promissory Note

incorporated the Development Agreement by reference, the sweeping

arbitration clause in the Development Agreement bound both Daic

Trustee and M-666. Heinhuis v. Venture Assoc., Inc., 959 F.2d 551,

553-54 (5th Cir. 1992) (holding that parties to an excess insurance

policy, which incorporated by reference the underlying insurance

policy, were bound by the arbitration clause contained in the

underlying insurance policy). Indeed, in a letter dated February

9, 1995, Daic Trustee and M-666 attempted to enforce sections of

the Development Agreement, other than Sections 3.7 and 5, against

Nauru. An entity’s attempt to enforce an agreement that contains

an arbitration clause provides clear and unmistakable evidence that

the entity regards itself bound by the arbitration clause. See

Hughes Masonry Co. v. Greater Clark County Sch. Bldg. Corp., 659

F.2d 836, 839 (7th Cir. 1981); Sunkist Soft Drinks, Inc. v.
15

Sunkist Growers, Inc., 10 F.3d 753, 757-58 (11th Cir. 1993), cert.

denied, 513 U.S. 869 (1994); J.J. Ryan & Sons, Inc. v. Rhone

Poulenc Textile, S.A., 863 F.2d 315, 319-21 (4th Cir. 1988); McBro

Planning & Dev. Co. v. Triangle Elec. Constr. Co., 741 F.2d 342,

344 (11th Cir. 1984); Sam Reisfeld & Son Import Co. v. S.A. Eteco,

530 F.2d 679, 681 (5th Cir. 1976).

B.

The arbitration panel concluded that DDI was responsible for

Nauru’s loss of reimbursement funds for 122 lots located in the

Porter Municipal Utility District, which was calculated by the

panel to be $477,000.

DDI contends that the Development Agreement did not allow for

loss of reimbursement funds, but rather provided for an offset

against other amounts due under the Development Agreement and

Promissory Note. The Development Agreement provided with respect

to this expected MUD reimbursement expense:

It is anticipated that certain drainage, waste-water

treatment, water purification and other utility facilities

(the “Utility Improvement”) will be required to be constructed

on the Property in connection with the Project. Developer

expects that the Municipal Utility District (“M.U.D.”) to be

formed to operate such Utility Improvements will purchase the

Utility Improvements at a price equal to seventy percent (70%)

of the cost incurred in constructing such Utility

Improvements.

The arbitration record shows that some of the development property

was located in an existing MUD, the Porter MUD, while the rest of

the property was in a MUD created specifically for the development,

the Bentwater MUD. 
16

DDI argues that the arbitration panel did not apply the proper

contractual remedy and miscalculated the amount of the award. We

are not persuaded. The arbitration panel’s implicit assumption

that this Section, which allowed for offsets of reimbursement

losses, did not apply to reimbursement losses associated with an

existing MUD, the Porter MUD, but rather was directed at a MUD to

be formed in the future, is an interpretation of this Section that

the arbitration panel was allowed to make. See Executone, 26 F.3d

at 1320.

The arbitration panel also concluded that DDI was responsible

for cost overruns incurred in excavating a large drainage ditch.

DDI contends that the arbitration panel’s decision that it should

reimburse Nauru for cost overruns on the drainage ditch is contrary

to principles of waiver under Texas law. DDI argues that Nauru

waived any right to complain about cost overruns since it failed to

object to a management decision made by DDI regarding the

excavation.

There is no evidence from the award itself that the

arbitration panel ignored Texas law on waiver. On the contrary,

the panel might reasonably have attributed the cost overruns to

DDI, which was found to have mismanaged the development project in

several material respects, and, under Section 6.1(c) of the

Development Agreement, DDI could be held responsible for these cost

overruns. The district court correctly confirmed the arbitration

award regarding the Porter MUD and the drainage ditch.
17

IV.

We hold that the district court had jurisdiction and did not

err in confirming the arbitration award.

AFFIRMED.