Opinion ID: 2382863
Heading Depth: 2
Heading Rank: 4

Heading: Fraud in the Inducement of the Contract or Fraud in the Inducement of the Arbitration Clause.

Text: In connection with the judicial policy which favors voluntary commercial arbitration and which seeks to constrain the ability of parties to circumvent arbitration agreements, the Supreme Court has held that a party seeking to avoid arbitration by raising a claim of fraudulent inducement must allege that the arbitration clause itselfrather than the contract as a whole was fraudulently induced. Prima Paint, supra, 388 U.S. at 402-04, 87 S.Ct. at 1805-06. Hercules seems to contest this proposition. It argues, based on Moseley v. Electronic & Missile Facilities, 374 U.S. 167, 171-72, 83 S.Ct. 1815, 1817-18, 10 L.Ed.2d 818 (1963), that an allegation in its complaint that the arbitration clause was part and parcel of a fraudulent scheme perpetrated by Shama and Rippeteau with respect to the contract as a whole is sufficient to avoid referral of the entire case to arbitration. We disagree. In Prima Paint, supra, the Supreme Court construed Moseley and the plain meaning of the United States Arbitration Act, as requiring a party who seeks to avoid arbitration on the grounds of fraudulent inducement to challenge the making of the arbitration clause itself, and not merely the making of the contract in which the arbitration clause is contained or the scheme by which both were allegedly negotiated. Prima Paint thus stands for the proposition that where a party to a contract containing a broad arbitration clause claims fraud in the inducement both of the arbitration clause itself and of the entire contract containing the arbitration clause, the court is to consider only the former claim. If the claim of fraud in the inducement of the arbitration clause proves meritless, then the court is foreclosed from considering the question of fraud in the inducement of the contract as a whole, but must leave that issue to be decided by the arbitrators. See CBS Employees Fed. Credit Union v. Donaldson, Lufkin & Jenrette Sec. Corp., 912 F.2d 1563, 1566-67 (6th Cir.1990); Rush v. Oppenheimer & Co., 681 F.Supp. 1045, 1048, 1050 n. 9 (S.D.N.Y.1988). This point was effectively made in Robert Lawrence Co., supra, 271 F.2d at 410-11: The issue of fraud seems inextricably enmeshed in the other factual issues of the case. Indeed, the difference between fraud in the inducement and mere failure of performance ... depends upon little more than legal verbiage and the formulation of legal conclusions. Once it is settled that arbitration agreements are valid, irrevocable, and enforceable, ... arbitration should not be denied or postponed upon the mere cry of fraud in the inducement, as this would permit the frustration of the very purposes sought to be achieved by the agreement to arbitrate, i.e., a speedy and relatively inexpensive trial before commercial specialists. ... If [an] arbitration clause was induced by fraud, there can be no arbitration; and if the party charging this fraud shows there is substance to his charge, there must be a judicial trial of that question before a stay can issue.... It is not enough that there is substance to the charge that the contract [as a whole] was induced by fraud. (Emphasis added). Similarly, in Haynes v. Kuder, supra note 6, 591 A.2d at 1290 & n. 6, we indicated that such a bifurcated proceeding is both obvious from and inherent in the structure and content of the District's Uniform Arbitration Act, D.C.Code § 16-4302 (1989) (quoted in full, supra note 8). In the present case, Hercules alleged in its complaint that the arbitration clause was a vehicle by which Rippeteau sought to perpetrate his fraud on Hercules and Shama. [10] Rippeteau intended that the arbitration clause ... would virtually preclude Hercules from `walking off the job' once the project was begun. Additionally, Rippeteau knew that under arbitration, he would be more likely to [be able to] conceal his fraud, for, as Shama has intimated, discovery is non-existent or limited in arbitration. [11] Hercules alleged that it was induced by the fraudulent representations to ... agree to the arbitration clause as it existed in the contract. The complaint thus does not contain an allegation that Shama made a misrepresentation to Hercules about the content of the arbitration clause. Hercules did allege, however, that the arbitration clause was a specific subject of its dealings with Shama, that it wanted the clause out, and that but for the fraudulent representations by Shama, it would not have agreed to a contract containing such a clause (even though it might have accepted the same contract if it were judicially enforceable). Hercules further alleged that it opposed the inclusion of an arbitration clause because, by insisting on resolution of disputes through arbitration, Shama could take advantage of the limitations on discovery to negate Hercules' opportunity to prove Shama's unfair dealings. Shama suggests, and Judge FARRELL in his concurring opinion concludes, that under any reasonable construction of Hercules' pleadings, the rule of Prima Paint effectively disposes of the case, because Hercules' only claim of fraud in the inducement applies to the contract as a whole and only incidentally to the arbitration clause itself. Hercules claims, on the other hand, that its complaint not only alleges fraud in the inducement of the entire agreement, but also contains sufficient independent averments focused on the arbitration clause in particular to entitle Hercules to an evidentiary hearing. Indisputably, under Prima Paint, if the claim of fraud in the inducement reaches the arbitration clause only insofar as that clause is alleged to be a part of the contract as a whole, then the entire case, including the issue of fraud, must be referred to arbitration. The question whether Hercules' pleading is sufficiently specific is not dispositive, however, for even if, as Hercules contends, the claim of fraud in the inducement is viewed as sufficiently focused on the arbitration clause, [12] we conclude, for reasons stated below, that the complaint cannot and does not sufficiently allege two essential elements of fraud, namely, materiality and reasonable reliance.