The Massachusetts Appeals Court recently applied the doctrine set forth in the seminal case of Machado v. System4 LLC, 471 Mass. 204 (2015), to require arbitration even though the defendant did not sign an arbitration agreement and was not otherwise compelled to arbitrate the dispute.

In Silverwood Partners LLC v. Wellness Partners LLC, No. 16-P-1174 (July 25, 2017), the Appeals Court affirmed the decision of the Superior Court to compel arbitration in the following situation: two broker-dealers, Nicolas McCoy and Michael Burgmaier, left the employ of Silverwood Partners LLC, also a broker-dealer, to secretly create a competing firm, the defendant Wellness Partners LLC doing business as Whipstitch Capital. In the process, as alleged by Silverwood, defendants stole Silverwood’s clients and diverted Silverwood’s business opportunities to Whipstitch. Following certain procedural wrangling, what came before the Court was an Amended Complaint by Silverwood against only Whipstitch asserting, among other things, claims for aiding and abetting the individuals in breaching their fiduciary duties, conversion, and tortious interference.

As a broker-dealer registered with the SEC, Silverwood was required to arbitrate any claims among any Financial Industry Regulatory Authority (FINRA) members or associated persons, including McCoy and Burgmaier. It appears as though by dropping McCoy and Burgmaier from the case in its Amended Complaint, Silverwood attempted to avoid the arbitration requirement and pursue its claims directly against Whipstitch in court rather than through arbitration.¹ It was conceded that Whipstitch, unlike McCoy and Burgmaier, is not a member or associated person within the meaning of the FINRA requirement of arbitration. The only issue before the court was whether Whipstitch could compel Silverwood to pursue any claim it had against Whipstitch in arbitration instead of in court.

In the Machado case, the SJC stated that courts have recognized six theories for binding non-signatories to arbitration agreements: incorporation by reference, assumption, agency, veil piercing/alter ego, equitable estoppel, and third party beneficiary. Machado at 210. In order to bind a non-signatory under a theory of equitable estoppel, the court noted that Machado requires one of two circumstances: “(1) when a signatory ‘must rely on the terms of the written agreement in asserting its claims against the non-signatory’ or (2) when a signatory ‘raises allegations of substantially interdependent and concerted misconduct by both the non-signatory and one or more of the signatories to the contract’.” Machado at 211.

In applying that principle, the court in Silverwood held that “the second circumstance emphatically applies in this case.” The Court at some length demonstrated and concluded that the allegations by Silverwood against Whipstitch were substantially interdependent with the allegations against McCoy and Burgmaier which were required to be, and in fact were, arbitrated pursuant to FINRA requirements. In so concluding, the Court rejected Silverwood’s argument that the doctrine of equitable estoppel has never been applied to compel FINRA arbitration as opposed to contractual arbitration. Acknowledging that that was in fact the case, the Court observed that while a FINRA member could not compel a non-member such as Whipstitch to submit to FINRA arbitration, the question before the court was whether the non-member, Whipstitch, could compel a FINRA member to submit to FINRA arbitration. The court concluded that since Silverwood did agree to subject itself to such arbitration and since Silverwood’s dispute with Whipstitch was substantially intertwined with the arbitrated dispute between Silverwood and McCoy and Burgmaier, the application of estoppel was appropriate.

¹ Footnote 4 of the decision explains that McCoy and Burgmaier prevailed in an arbitration proceeding brought by Silverwood.