First Circuit vacates order compelling arbitration of a Law 75 impairment claim brought against a non-signatory subsidiary

It happens every once in a blue moon when a federal court vacates an order compelling arbitration. Air Con-Inc. v. Daikin Applied, 21 F. 4th 168 (1st Cir. 2021) is one of those rare instances. Air Con is a Puerto Rico distributor of branded air conditioners. Air Con sued Daikin Applied (the wholesaler-subsidiary) in federal district court for impairment under Law 75 alleging that it impaired an exclusive distribution relationship. Air Con and Daikin Applied’s parent company (Daikin Industries Ltd.) had a written non-exclusive distribution agreement with an arbitration provision that required the parties to arbitrate in Japan. But, the parent company, a non-party in the case, did not counter-sign the agreement. Air Con alleged that, since 2000 until the facts in 2015 leading up to the lawsuit, it had a separate exclusive distribution relationship with the subsidiary corroborated by a course of dealings but not memorialized by any written distribution agreement. The question was whether the district court erred in compelling arbitration of the Law 75 claim against the subsidiary with which no arbitration agreement existed. The First Circuit found it was error and reversed. Procedurally, the First Circuit joined the majority of sister circuits in holding that motions to compel arbitration under Section 4 of the FAA are subject to the standards of motions for summary judgment. Substantively, the decision is significant in several legal fronts. First, the district court erred in finding that the distributor’s contract with the parent was enforceable by the subsidiary. Even if there was any such enforceable contract, this was error because there is a legal presumption of corporate separateness that must be overcome by clear evidence that the parent in fact controls the activities of the subsidiary. The error was compounded by the district court’s imposition of the burden of disproving the existence of a valid arbitration agreement on the non-moving party. Second, there was error in discrediting the allegations that the distributor had a separate distribution relationship with the subsidiary governed by an “unwritten agreement” and that relationship had no arbitration mandate. Third, the subsidiary argued that the distributor’s placement of purchase orders under a “Daikin Sales Order” constituted an acceptance of arbitration. The Sales Order had an arbitration agreement with the locale in Miami, Florida, for all claims arising or relating to the contract or its breach. Significantly, the First Circuit held that the arbitration provision covered only disputes relating to each particular sale authorized by that contract. But its scope did not extend to the separate impairment claim for a “pattern of unfair practices” brought under Law 75. Daikin Applied not only recognizes the limits of how far arbitration can reach but also that arbitration is a creature of state or territorial contract law. And, there can be diverse but separate business relationships that define how products of one brand get from the supplier or manufacturer, to the wholesaler (the defendant subsidiary in this case), to the distributor (the plaintiff), and for sale to customers in the relevant market. What was at stake in this case was the distributor's claim that Law 75 protected its years-long exclusive distribution relationhip with a stateside wholesaler for the sale and distribution of products in Puerto Rico. It mattered to the court's holding that this separate commercial relationship, protected by Puerto Rico Law 75, did not have an arbitration mandate, so it was erroneous to compel it.