Key Decisions

May 2012 – Creditors Were Not Bound By An Arbitration Agreement

(filed under: | May 16, 2012)

Creditors Were Not Bound By An Arbitration Agreement In A Financial Advisor’s Contract With The Debtor Corporation Because They Were Not Third Party Beneficiaries Of That Contract

Epitech, Inc. v. Kann
(Cal. Ct. of App., 2d Dist.), filed April 16, 2012 

AutoLife Acquisition Corporation had substantial short-term secured debt obligations were soon to come due. It retained a financial advisor, Kann Capital, Ltd., through its principal, Garry Michael Kann, to help it to obtain long-term financing. This long-term financing would presumably have enabled it to pay off its short-term creditors.

The financing was never obtained, and AutoLife ultimately fell into bankruptcy. AutoLife’s short-term creditors sued Kann. They alleged that his fraudulent misrepresentations induced them to forbear from foreclosing on their security, to their ultimate financial detriment.

Kann filed a petition to compel arbitration. He asserted that the short-term creditors had been third-party beneficiaries of his contract with AutoLife, which contained an arbitration clause. He asserted that was because his performance of the contract with AutoLife would have benefited the short-term creditors.

The trial court denied the motion. Kann appealed.

The Court of Appeal affirmed. It ruled that the short-term creditors were not third-party beneficiaries of the contract between Kann and AutoLife.

The court reasoned that AutoLife’s pre-existing obligation to the secured creditors was to pay them the money that they were owed. However, Kann’s performance under the contract would not have discharged that obligation because Kann did not contract to pay the secured creditors any money at all. Additionally, under the terms of Kann’s engagement letter, Kann did not agree to obtain the financing. Rather, the agreement was only for him perform certain acts geared toward possibly obtaining financing.

Based on these factors, Kahn’s performance might have enabled AutoLife to pay the short-term creditors, but whether it did so was not under his control. If AutoLife had paid, that was only incidental to Kann’s performance.

Finally, the court noted that the short-term creditors were suing Kann for misrepresentations that allegedly occurred before AutoLife engaged Kann. Liability for those alleged misrepresentations could not be subject to an agreement that did not yet exist.