When entering into any type of business contract, “choice of law” is often critical in determining how and where an agreement is enforced. Each state has its own laws governing contracts. Additionally, certain federal laws apply to contracts affecting interstate commerce. This confusion often leads to litigation over which jurisdiction's laws apply in a given situation.
Matter of Flintlock Construction Services, LLC v. Weiss
Here is a recent example from a decision by the Appellate Division, First Department, of the New York Supreme Court. The case arose from a dispute between a woman and her two stepsons over a real estate investment gone bad. The stepmother invested $500,000 in two limited liability companies (LLCs) the stepsons established. In exchange for 25 percent ownership in each entity, the stepmother agreed to the terms of the LLCs' operating agreements, which contained identical terms regarding choice of law. In the event of a legal dispute, the operating agreement required the parties to submit to binding arbitration, and the agreements would be interpreted according to New York law.
The stepmother eventually sought arbitration against her stepsons and the two LLCs for breach of contract. She asked for punitive damages as compensation for the stepsons' alleged misconduct. In accordance with the operating agreements, she submitted the complaint to a private arbitration panel.
The stepsons asked the panel to dismiss the claim for punitive damages, but the panel refused. The stepsons then asked a Manhattan Supreme Court judge to stay the arbitration, arguing an arbitration panel cannot award punitive damages under New York law. When the Manhattan justice refused to stay the arbitration, the stepsons appealed to the First Department. In an opinion issued on August 14th, a divided First Department voted 3-2 to affirm the Manhattan justice's decision.
New York courts traditionally do not allow private arbitrators to award punitive damages. According to a 1976 decision by the New York Court of Appeals, “Punitive damages is a sanction reserved to the State, a public policy of such magnitude as to call for judicial intrusion to prevent its contravention.” But federal law, which applies to arbitration over interstate commerce disputes, allows a private arbitrator to award punitive damages when justified.
The issue before the First Department concerned whether the New York rule against punitive damages applied to this arbitration. The majority held it was too early to make that decision. The arbitration panel is yet to determine whether the dispute between the stepmother and her stepsons affects interstate commerce. If it does, she can seek punitive damages. The two dissenting justices argued punitive damages should be off the table altogether. They read the choice of New York law in the operating agreements as applying this state's rule against punitive damages, irrespective of federal law.
The disagreement among the appeals judges indicates how complex choice-of-law issues can be when dealing with contracts. That is why it is essential for the parties to any business agreement to make their intentions as clear as possible. If you need a New York business attorney to advise you on any contract or civil litigation matter, contact the Nisar & Mason, P.C. today.