Opinion ID: 1160537
Heading Depth: 3
Heading Rank: 1

Heading: Arbitrability of Fraud Claims Under Prima Paint

Text: GWFSC contends plaintiffs' declarations are legally insufficient to raise a nonarbitrable issue because their claims of fraud, even if believed, are not directed specifically at the arbitration clauses. GWFSC relies on Prima Paint v. Flood & Conklin (1967) 388 U.S. 395, 404 [18 L.Ed.2d 1270, 1277-1278, 87 S.Ct. 1801] ( Prima Paint ), in which the high court held that under the USAA, unless the parties have agreed otherwise, claims of fraud in the inducement of the contract generally, that is, fraud claims not going to the `making' of the agreement to arbitrate, are to be decided by the arbitrator rather than the court. We have interpreted section 1281.2 to embody the same standard of enforceability. ( Ericksen, Arbuthnot, McCarthy, Kearney, & Walsh, Inc. v. 100 Oak Street (1983) 35 Cal.3d 312, 322-323 [197 Cal. Rptr. 581, 673 P.2d 251] ( Ericksen ).) [8] To consider GWFSC's Prima Paint argument, we must separate out the two fraud theories upon which plaintiffs have relied to avoid enforcement of the arbitration agreements: fraud in the execution of the client agreements, and fraud permeating the agreements. (6) California law distinguishes between fraud in the execution or inception of a contract and fraud in the inducement of a contract. In brief, in the former case `the fraud goes to the inception or execution of the agreement, so that the promisor is deceived as to the nature of his act, and actually does not know what he is signing, or does not intend to enter into a contract at all, mutual assent is lacking, and [the contract] is void. In such a case it may be disregarded without the necessity of rescission.' ( Ford v. Shearson Lehman American Express, Inc. (1986) 180 Cal. App.3d 1011, 1028 [225 Cal. Rptr. 895].) Fraud in the inducement, by contrast, occurs when `the promisor knows what he is signing but his consent is induced by fraud, mutual assent is present and a contract is formed, which, by reason of the fraud, is voidable. In order to escape from its obligations the aggrieved party must rescind. ...' ( Ibid. ) (7) GWFSC asserts Prima Paint mandates arbitration of any fraud claim, even one going to the execution of the contract, except an independent or separate and distinct challenge to the arbitration clause itself. Statements to that effect appear in some decisions applying Prima Paint. (See, e.g., Rowland v. Paine Webber, Inc. (1992) 4 Cal. App.4th 279, 285 [6 Cal. Rptr.2d 20] [independent challenge]; Union Mutual Stock Life Ins. v. Beneficial Life. (1st Cir.1985) 774 F.2d 524, 529 [same]; see also R.M. Perez & Associates, Inc. v. Welch (5th Cir.1992) 960 F.2d 534, 537-538 [holding fraud in the factum, as well as in the inducement, subject to Prima Paint ].) [9] We do not believe, however, the language or logic of Prima Paint compels such a reading. To the contrary, we conclude claims of fraud in the execution of the entire agreement are not arbitrable under either state or federal law. If the entire contract is void ab initio because of fraud, the parties have not agreed to arbitrate any controversy; under that circumstance, Prima Paint does not require a court to order arbitration. (Accord, Rice v. Dean Witter Reynolds, Inc., supra, 235 Cal. App.3d at p. 1024; Strotz v. Dean Witter Reynolds, Inc., supra, 223 Cal. App.3d at pp. 217-218; Three Valleys Mun. Water Dist. v. E.F. Hutton, supra, 925 F.2d at pp. 1140-1141; Cancanon v. Smith Barney, Harris, Upham & Co. (11th Cir.1986) 805 F.2d 998, 999-1000; see also Rush v. Oppenheimer & Co., Inc. (S.D.N.Y. 1988) 681 F. Supp. 1045, 1049 [allegations of fraud need not be directed exclusively at the arbitration clause].) The central rationale of the high court's decision in Prima Paint was that arbitration clauses must, under federal law established in the USAA, be viewed as `separable' from other portions of a contract ( Prima Paint, supra, 388 U.S. at p. 402 [18 L.Ed.2d at pp. 1276-1277]); hence, fraud in the inducement relating to other contractual terms does not render the arbitration agreement unenforceable, even when it might justify rescission of the contract as a whole. By entering into the arbitration agreement, the parties established their intent that disputes coming within the agreement's scope be determined by an arbitrator rather than a court; this contractual intent must be respected even with regard to claims of fraud in the inducement of the contract generally. Where, however, a party's apparent assent to a written contract is negated by fraud in the inception, there is simply no arbitration agreement to be enforced. As one Court of Appeal recently explained, Prima Paint does not require allegations directed specifically and solely at the agreement to arbitrate. Prima Paint, rather, requires some allegation [and, as we held earlier, evidence] from which it may be determined that the parties in fact did not intend to arbitrate the issues set forth in the pleadings. The allegation may be directed solely at the `making' of the agreement to arbitrate or, as recognized by the doctrine of fraud in the inception, it may be directed at the `making' of the contract as a whole. ( Hayes Children Leasing Co. v. NCR Corp. (1995) 37 Cal. App.4th 775, 784 [43 Cal. Rptr.2d 650].) In the absence of a contrary agreement, parties to a predispute arbitration agreement are presumed to have intended arbitration of controversies, including allegations of fraud in the inducement of the contract generally, that may allow rescission or reformation of the contract or part of it. They cannot, however, have intended arbitration under a contract wholly void for fraud in its execution. We therefore conclude Prima Paint does not preclude the court from deciding claims of fraud in the execution of the entire contract. The same is true of California law under our decision in Ericksen, supra, 35 Cal.3d 312, in which we explicitly distinguished cases where the party opposing arbitration `denied ever agreeing to anything.' ( Id. at p. 323, fn. 8.) Although the question of fraud in the execution is for the trial court to decide, we reach a different conclusion on plaintiffs' second theory, fraud permeating the agreements. The permeation doctrine has developed in California courts as an ill-defined exception to the Prima Paint rule of arbitrability. (See Strotz v. Dean Witter Reynolds, Inc., supra, 223 Cal. App.3d at pp. 212-217 ( Strotz ) [tracing origins of the doctrine and ultimately rejecting it as vague and potentially inconsistent with Prima Paint ].) After examining various statements of the doctrine, we conclude it conflicts with Prima Paint and, thus, is not a ground for avoiding arbitration. In Main v. Merrill Lynch, Pierce, Fenner & Smith, Inc., supra, 67 Cal. App.3d at page 27 ( Main ), the court, having reviewed Prima Paint and several of its federal and state progeny, concluded, where it is alleged that fraud either induced the arbitration clause itself, or permeated the entire agreement including the arbitration clause, that issue will be determined judicially and not by arbitration. (Italics added.) The court then found the plaintiff's allegations sufficient to show constructive fraud, in that defendants gained an advantage over plaintiff by inclusion, in the lending agreement, of the provision to arbitrate. ( Id. at p. 31; but see Strotz, supra, 223 Cal. App.3d at p. 216 [persuasively criticizing Main's conclusion on the last point].) In Ericksen, supra, 35 Cal.3d at page 323, footnote 8, this court mentioned Main's analysis briefly, but with apparent approval. In doing so, however, we apparently understood the permeation doctrine to be identical or very similar to fraud in the inception or execution of a contract: we held it inapplicable because `this is not a case ... where the defendant denied ever agreeing to anything.' ( Ibid. ; see also Hayes Children Leasing Co. v. NCR Corp., supra, 37 Cal. App.4th at p. 784 [ Ericksen treated permeation as identical to the doctrine of fraud in the inception]; Herman Feil, Inc. v. Design Center of Los Angeles (1988) 204 Cal. App.3d 1406, 1416 [251 Cal. Rptr. 895] [As was observed in Ericksen, however, the `permeation' claim is applicable only where the party seeking to avoid arbitration denies having agreed to anything. ].) The permeation doctrine received its broadest application in Ford v. Shearson Lehman American Express, Inc., supra, 180 Cal. App.3d at pages 1019-1028 ( Ford ). The court there interpreted Prima Paint as requiring arbitration only when the fraud claim goes to the performance under a contract; claims of fraud going to the making or procurement of a contract are to be decided by the trial court. ( Id. at p. 1022.) In the case before it, the court concluded, arbitration could be avoided on a theory of fraud permeating the contract because the plaintiff had alleged a grand scheme of fraud which permeated the entire relationship and transactions perpetrated by all defendants. ( Id. at p. 1027.) Thus, the plaintiff sufficiently alleged the fraud practiced on him pertained to the `making' of the agreements containing the arbitration clause. ( Id. at p. 1023.) As another Court of Appeal has since explained, the Ford court appears to have ignore[d] the rule in Prima Paint that the arbitration agreement is severable from the principal contract. [¶] The Supreme Court in Prima Paint did not hold that fraud which goes to the making of the contract is for the court and fraud related to the performance of the contract is for the arbitrator. Rather, the court specifically and expressly made a distinction between fraud which is directed at the arbitration agreement and fraud directed at the principal contract. The court quite clearly held that only fraud directed at the making or performance of the arbitration agreement is to be determined by the court. ( Prima Paint Corp. v. Flood & Conklin, supra, 388 U.S. 395, 403-404 [18 L.Ed.2 1270, 1277-1278].) ( Strotz, supra, 223 Cal. App.3d at p. 217.) Thus, the permeation doctrine conflicts with Prima Paint to the extent it indicates that an agreement to arbitrate may be found invalid simply because the contract as a whole was induced by fraud. ( Hayes Children Leasing Co. v. NCR Corp., supra, 37 Cal. App.4th at p. 784.) To the extent, on the other hand, the permeation doctrine is merely another name for fraud in the execution of a contract, it is unnecessary. Seeing, therefore, no legally valid use for the theory, we decline further to recognize it. Claims that a party has employed fraud in inducing consent specifically to the arbitration agreement (e.g., by actively concealing its existence or misrepresenting its meaning or value) are, under Prima Paint, to be decided by the court, because they go to the validity of the making of the arbitration clause itself. Claims that, due to fraud in the execution of the agreement as a whole, the parties reached no contract containing an arbitration clause, are also to be decided by the court. But claims that the contract as a whole was obtained through fraud in the inducement are, in the absence of evidence of the parties' contrary intent, arbitrable under Prima Paint. Included in this rule of arbitrability are claims of a grand scheme of fraud, or fraud permeating the transaction.