Heads up, sureties!  (And all other contracting parties.)  Incorporation by reference of the terms of one agreement into another is a classical common law basis for binding the incorporating parties to the incorporated terms.  As a performance bond surety recently learned, the rule is little different when the terms of a commercial agreement containing an arbitration clause are incorporated by reference into the terms of a bond.  The surety may become subject to the arbitration agreement as well.  See, Federal Ins. Co. v. Metropolitan Transp. Authority, No. 18-3664, 2019 U.S. App. LEXIS 26361 (2d Cir. Aug. 30, 2019).

In December 2014, Lanmark Group contracted with New York’s Metropolitan Transportation Authority (“MTA”) (acting by and through the New York City Transit Authority (“NYCTA”)) to do some rehabilitating and renovating of NYCTA’s headquarters in Brooklyn (the “Contract”).  See Fed. Ins. Co. v. Metro. Transp. Auth., 2018 U.S. Dist. LEXIS 183352 (S.D.N.Y. Oct. 25, 2018) at *2.  Federal Insurance, as surety, provided a performance bond on behalf of Lanmark in favor of NYCTA/MTA (the “Bond”).  The Bond “attached a copy of the Contract and incorporated it ‘as though herein set forth in full.’”  Id. at *3.

The Contract, which was governed by New York law (Art. 8.05(B)), included what amounted to an arbitration clause (Art. 8.03).  The ADR provision stated in pertinent part that

[t]he parties to this Contract hereby authorize and agree to the resolution of all Disputes arising out of, under, or in connection with, the Contract in accordance with the [arbitration procedures described later in the provision].”  2019 U.S. App. LEXIS 26361 at *3.

“Disputes” was defined as “any . . . challenge or assertion” by Lanmark having anything to do with the Contract.  Id. 

In late November 2016, NYCTA notified Lanmark and Federal regarding 10 alleged events of default by Lanmark.  Lanmark soon responded, denying any material breach.  In April 2017, NYCTA notified Lanmark that it was terminating the Contract, and demanded that Federal complete the Contract pursuant to the Bond terms.  2018 U.S. Dist. LEXIS 183352 at *3.  However, Federal advised NYCTA that no one could perform the Contract as written because its specifications did not comply with applicable New York City and State building code requirements.  See id. at *3-*4.  Lanmark filed a dispute notice with NYCTA, in effect commencing an arbitration pursuant to Art. 8.03 of the Contract; Federal, however, filed suit in U.S. District Court in late May 2017, seeking a declaration that it had no obligation to complete the Contract, as well as an injunction against NYCTA/MTA’s compelling Federal to complete the Contract.  See id. at *4.  NYCTA/MTA countered with a motion to dismiss Federal’s claim against them.  See id. at *4-*5.

The defendants in the District Court case moved to dismiss under both FRCP 12(b)(1) and 12(b)(6) in recognition that the law concerning the correct legal rubric for seeking dismissal based on the existence of an arbitration agreement is unsettled.  See 2018 U.S. Dist. LEXIS 183352 at *6.  (The court declined to resolve that procedural issue in the circumstances because the result in the case before it would be same under either analysis, see id.)

The District Court found that the Contract arbitration provision had clearly been incorporated by reference in the Bond, but that a non-signatory like Federal “still cannot be compelled to arbitrate unless the arbitration clause itself contains language broad enough to allow nonsignatories’ disputes to be brought within its terms.”  2018 U.S. Dist. LEXIS 183352 at *10 (emphasis omitted).  In that regard, the court opined that an arbitration agreement restricted to disputes among the immediate parties does not bind a non-signatory notwithstanding the incorporation by reference of such an arbitration clause in a contract by which the non-signatory is bound, but a broadly worded arbitration clause “which is not restricted to the immediate parties” may be effectively incorporated by reference into another agreement.  See id. at *10.  In the case at bar, the Contract arbitration provision was the only means provided to resolve “all Disputes arising out of, under, or in connection with, the Contract.”  See id. at *11.  That was sufficient, and Federal Insurance was thus subject to the Contract arbitration clause.

The next question concerned whether Federal’s claim was subject to arbitration, and more specifically whether the court or the arbitrator should decide that issue of arbitrability.  In that regard, the District Court found that the scope of the arbitration provision -- “all Disputes arising out of, under, or in connection with, the Contract” -- was “exactly the sort of language that subjects any and all controversies to arbitration.”  Id. at *12.  Thus the arbitrability question was for the arbitrator, rather than for the court.  See id. at *13.

The Second Circuit Court of Appeals, reviewing the District Court’s order de novo, issued only a Summary Order, affirming the District Court’s order and judgment.  It opined that “a broadly-worded arbitration clause which is not restricted to the immediate parties may be effectively incorporated by reference into another agreement.”  2019 U.S. App. LEXIS 26361 at *2.  The Court of Appeals found that the Contract’s arbitration clause language was sufficiently broad for those purposes, and thus bound Federal despite its having not been a signatory to the Contract.  See id.

Furthermore, the Court of Appeals recognized that arbitrability is an issue for judicial determination “unless the parties clearly and unmistakably provide otherwise,” id. at *4, but it pointed out that the arbitration provision in question uses “any and all” language with reference to the controversies to be arbitrated when it states

parties to this Contract hereby authorize and agree to the resolution of all disputes arising out of, under, or in connection with the Contract” by arbitration.  See id.  (emphasis in original).

The Court took this to be a clear and unmistakable indication that the parties to the Contract terms, now including Federal, “require the issue of arbitrability to be decided by the arbitrator, not the court.”  Id. at *4.

The lesson for surety companies, among others, is clear -- be aware of this law, determine your preferred dispute resolution method, and tailor the terms of your bond accordingly.