In states like California where pre-dispute jury trial waivers are not enforceable, (see Grafton Partners v. Superior Court (2005) 36 Cal.4th 944), and lessors and lenders are generally facing a hostile environment before juries, using enforceable forum selection and arbitration clauses contained in loan and lease documents to position litigation away from juries is vitally important. Another alternative in California is to use California’s “judicial reference” procedure where the parties can select a judge outside of court and have the case heard by a judge and not a jury. The selected judge has essentially the same powers as would a judge sitting in court. (See California Code of Civil Procedure, §638 et seq.)

However, if a lessor or lender has not drafted a judicial reference clause in its loan or lease documents, and instead chooses to enforce a well-drafted forum selection clause or its right to arbitration, the lessor or lender cannot then extensively litigate the matter in a California court and later attempt to enforce a forum selection or arbitration clause without the possibility of waiving its right to litigate in the forum it selected in its loan or lease documents.

This article will discuss a recent case involving a forum selection clause where the court held that although a forum selection clause was enforceable, nevertheless when a party extensively litigates its case in court, it cannot attempt to later enforce the forum selection clause after many months of litigation and attempt to move the case to a different forum. In addition, this article will discuss similar situations involving arbitration clauses where lenders and lessors that have chosen to litigate in court may have waived their right to proceed with arbitration if they later choose to go arbitration to avoid a particular judge or a jury.

Forum Selection Clauses

In most courts throughout the country, forum selection clauses are presumed to be valid and will be given effect in the absence of a showing that enforcement of such a clause would be unreasonable (M/S Bremen v. Zapata Offshore Co. 407 U.S. 1, 92 S. Cto. 1907 (1972); Smith, Valentino & Smith, Inc. v. Superior Court 17 Cal.3d 491 (1976); Furda v. Superior Court 161 Cal.App.3d 418 (1984); IFC Credit Corp. v. Rieker Shoe Corp. 881 N.E.2d 382 (Ill. Ct. of App. 2007). However, there are times where they may not be enforced.

In the very recent California case of Trident Labs, Inc. v. Merrill Lynch Commercial Finance Corp. (filed on October 26, 2011, 2nd District, Division 8 2011, S.O.S. 5755), Merrill Lynch Commercial Finance Corp. (lender) made a loan to Trident Labs, Inc. (borrower) and the lender contended the loan was in default. The borrower preemptively filed a lawsuit against the lender in California alleging unfair business practices, fraud and deceit, and breach of contract. The loan documents stated that the borrower waived any rights to commence any action against the lender in any jurisdiction except in the county of Cook and state of Illinois. In the meantime, the lender ultimately filed an answer to the complaint including an affirmative defense of “waiver/improper forum” and a counterclaim against the borrower and the guarantor.

The case was extensively litigated for 19 months in both federal and state court, and then the lender filed a motion to enforce the forum selection clause and moved to dismiss or stay the lawsuit requiring the borrower to sue in Illinois. The court held that although forum selection clauses are valid and enforceable, a lender that extensively litigates a case cannot later choose “in its sole discretion” to litigate in a different forum. In other words, the defendant cannot change its mind mid- or late-stream in litigation and decide to proceed elsewhere. Under the circumstances of the case, a delay of more than 19 months, for which no justification is offered and during which the party that sought to change venue has repeatedly invoked the rights available to California litigants, did not survive a test of reasonableness.

Thus, the court would not allow enforcement of the forum selection clause because it was unreasonable to do so after 19 months of litigation as a matter of law. This is certainly an extreme case, but lenders and lessors cannot simply rely on an affirmative defense in an answer of waiver/improper jurisdiction and wait for trial or some other distant date and then attempt to rely on a forum selection clause to later attempt to dismiss or stay the case. Instead, the motion to dismiss or stay should be made at the earliest opportunity to avoid a court holding that enforcement of the clause is unreasonable under the circumstances.

Arbitration

There is a similar rule with respect to arbitration clauses but it is not a reasonableness standard but instead is a prejudice standard. Many arbitration provisions state that all claims between the parties, including without limitation, contract and tort disputes, shall be arbitrated pursuant to the rules of the American Arbitration Association in effect at the time the claim is filed, upon request of either party and the Federal Arbitration Act (FAA) shall apply to construction, interpretation and enforcement of the arbitration provision. The Federal Arbitration Act embodies a strong federal policy favoring arbitration. See Southland Corp. v. Keating, 465 U.S. 1, 104 S. Ct. 852 (1984). Thus, waiver of a contractual right to arbitrate under the FAA is disfavored and any examination of whether there has been a waiver must be “conducted in light of the strong federal policy favoring enforcement of arbitration agreements.” See Fisher v. A.G. Becker Paribas Inc., 791 F.2d 691 (9th Cir. 1986); St. Agnes Medical Center v. Pacificare of California, 31 Cal.4th 1187 (2003).

It is the burden on the party claiming any waiver of an arbitration clause to prove the waiver by clear and convincing evidence and that party must show 1.) the movant’s knowledge of an existing right to compel arbitration; 2.) acts inconsistent with invoking that right; and 3.) prejudice to the non-moving party. Likewise, simply participating in litigation of an arbitrable claim does not in and of itself waive a party’s right later to seek arbitration. See ATSA of California Inc. v. Continental Insurance Co., 702 F.2d 172 (9th Cir. 1983); Groom v. Health Net, 82 Cal.App.4th 1189 (2nd App. Dist. 2000). Furthermore, most courts hold that simply incurring legal fees is not sufficient to show prejudice. There must be more than incurring legal fees and costs to demonstrate prejudice.

However, there are situations where prejudice does exist. For example in Christensen v. Dewor Developments, 33 Cal.3d 778 (1983), a defendant made a showing that a delay in exercising an arbitration clause by the party requesting arbitration resulted in lost evidence. This was considered to be prejudice resulting in a waiver of the right to arbitrate. In Guess?, Inc. v. Superior Court, 79 Cal.App.4th 553 (2000), a court held that the defendant waived its right to compel arbitration because it failed to explain why it deferred seeking arbitration for three months, failed to raise the affirmative defense of arbitration in its answer, and participated in the discovery process by objecting to propounding party’s interrogatories and document requests.

Likewise, in Adolph v. Coastal Auto Sales, Inc. 184 Cal.App.4th 1443 (2010), a court found that an automobile dealership’s participation in the judicial process and six-month delay in seeking arbitration prejudiced the car buyer and thus constituted a waiver of the dealership’s rights to arbitrate the buyer’s claims. In Sobremonte v. Superior Court, 61 Cal.App.4th 980 (1998), a court held that the defendants engaged in discovery procedures that were more expansive than those available through arbitration and the defendant moved to compel arbitration only a month before trial and six months after answering the complaint. Therefore, the court held that the arbitration clause was waived by the defendants’ conduct.

In contrast to those cases, there are many cases that hold that there must be substantial prejudice above and beyond mere participation in the litigation to support the waiver of an arbitration clause. See e.g., Creative Telecommunications Inc. v. Breeden, 120 F.Supp.2d 1225 (D. Haw. 1999); Global Security & Communications Inc. v. AT&T, 1999 U.S. App. LEXIS 16955 (9th Cir. 1999); Lake Communications Inc. v. ICC Corp., 738 F.2d 1473 (9th Cir. 1984); Merrill Lynch Pierce Fenner & Smith, Inc. v. Lecopulos, 553 F.2d 842 (2nd Cir. 1977).

The bottom line is that the situations where conduct has resulted in the waiver of an arbitration clause are very fact specific and courts have a considerable amount of discretion as to whether there has been a waiver of the right to arbitration, even though there is a strong presumption in favor of no waiver of arbitration if a party elects to arbitrate despite its initial election to commence litigation.

Conclusion

Based on the foregoing, if a lessor or lender wants to either proceed with arbitration or chooses to enforce a forum selection clause, this decision should be made at the earliest time possible in order to avoid claims of waiver, estoppel or having a court rule that it is unreasonable to enforce the provision because of extensive litigation in court and, as a result, the other party has been prejudiced by the conduct.

In today’s economy, it is not surprising that a jury will rule against a financial institution simply because of the negative perception of financial institutions, which may have absolutely nothing to do with the case before the court. Therefore, careful drafting and use of judicial reference, arbitration, jury trial waivers (where they are enforceable) and forum selection clauses placing the lender or lessor in a more creditor friendly environment should be used whenever possible.

Andrew K. Alper is a partner with the law firm of Frandzel Robins Bloom & Csato, LC in Los Angeles. Alper has been representing equipment lessors, funding sources and other financial institutions since 1978. Alper obtained his Bachelor of Arts degree in Political Science, magna cum laude, from the University of California at Santa Barbara, and received his Juris Doctor from Loyola Marymount University School of Law making the Dean’s List. Alper’s practice emphasizes the representation of equipment lessors and funding sources in all aspects of equipment leasing including litigation, documentation, bankruptcy and transactional matters. Besides representing equipment lessors and funding sources, Alper represents banks and other financial institutions in the area of commercial litigation, insolvency, secured transactions, banking law, real estate and business litigation.