Second Circuit Holds Contractual Forum Selection Clause Supersedes FINRA Mandatory Arbitration Rule

By David L. Goldberg, Christian T. Kemnitz & John F. Anzelc on August 29, 2014

On August 21, the US Court of Appeals for the Second Circuit decided two closely watched appeals regarding the intersection of Financial Industry Regulatory Authority, Inc. rules regarding mandatory arbitration of disputes and contractual forum selection clauses providing for a judicial forum. Goldman, Sachs & Co. v. Golden Empire Schools Financing Authority, et al., Nos. 13-797-cv; 13-2247-cv (2d Cir. Aug. 21, 2014). The Second Circuit’s decision in Golden Empire provides important guidance for broker-dealers and institutional market participants in drafting and interpreting forum selection clauses.Golden Empire decided the appeal of two district court decisions, Goldman, Sachs & Co. v. Golden Empire Sch. Fin. Auth., 922 F. Supp. 2d 435 (S.D.N.Y. 2013) and Citigroup Global Mkts. Inc. v. N.C. E. Mun. Power Agency, No. 13 CV 1703 (S.D.N.Y. May 10, 2013). In each case, a municipal authority sought to issue debt in the form of auction rate securities (ARS) and engaged investment banks (Goldman, Sachs & Co. and Citigroup, respectively) to underwrite the issuances. The banks and municipal authorities entered into agreements containing substantially identical forum selection clauses governing broker-dealer services provided as an ancillary part of the transaction. The clauses provided that “all actions and proceedings arising out of this Broker‐Dealer Agreement or any of the transactions contemplated hereby shall be brought in the United States District Court in the County of New York and that, in connection with any such action or proceeding, submit to the jurisdiction of, and venue in, such court.” The ARS market sustained substantial liquidity disruptions during the financial crisis. ARS issuers, including the appellants in Golden Empire, commenced a series of FINRA arbitrations against the banks seeking compensation for alleged losses sustained during the market disruption. (These suits were separate and apart from litigations and arbitrations brought by ARS investors.) With regard to the issuer claims, the banks in Golden Empire argued that the forum selection clause excerpted above superseded FINRA Rule 12200, which provides for arbitration of customer disputes. The Second Circuit agreed, after reconciling two prior decisions in that circuit, Bank Julius Baer & Co. v. Waxfield Ltd., 424 F.3d 278, 284 (2d Cir. 2005) (holding forum selection clause did not supersede agreement to arbitrate) and Applied Energetics, Inc. v. NewOak Capital Mkts. LLC, 645 F.3d 522, 526 (2d Cir. 2011) (holding forum selection clause superseded FINRA Rule 12200). The Second Circuit noted that while the forum selection clause in Bank Julius only provided that a customer “submits to the jurisdiction of any New York State or Federal Court” and that “any Action may be heard” in such court, the clause in Applied Energetics provided that “[a]ny dispute arising out of this Agreement shall be adjudicated in” New York. The clause in Bank Julius was also “not exclusive of any rights or remedies provided under any other agreement,” while the one at issue in Applied Energetics provided that it “constitute[d] the entire understanding and agreement” of the parties. The Second Circuit held that the forum selection language in the Golden Empire broker-dealer agreements was “indistinguishable” from that in Applied Energetics because it was “all inclusive and mandatory,” whereas the Bank Julius clause “simply waived objection to jurisdiction in New York.”

For their part, the municipal issuers argued that the agreements did not cover their entire relationships with the banks and that, in any event, the phrase “all actions and proceedings” did not include arbitrations. The Second Circuit disposed of the first argument by pointing out that the forum selection clause provided for “all actions and proceedings arising out of . . . any of the transactions contemplated,” and that this clause “plainly include[s]” the ARS issuances made. As to the second argument, the Second Circuit interpreted the phrase “all actions and proceedings” based upon its “plain meaning as generally understood,” and noted that “[a]rbitrations are regularly described as ‘proceedings’ by the United States Supreme Court, our Circuit, New York state courts, the C.P.L.R., and the FINRA Rules.” Thus, the Second Circuit held that the phrase “actions and proceedings” included arbitrations even though “arbitrations” were not specifically mentioned as such “actions or proceedings,” despite a contrary holding by the US Court of Appeals for the Fourth Circuit. UBS Fin. Servs., Inc. v. Carilion Clinic, 706 F.3d 319 (4th Cir. 2013).

Practical Advice

The Second Circuit’s decision in Golden Empire provides guidance for the drafting of an enforceable forum selection clauses in a broker-dealer agreement:

Use “shall” and not “may.” The Second Circuit distinguished an earlier case (Bank Julius Baer & Co. v. Waxfield Ltd., 424 F.3d 278 (2d Cir. 2005)), in which a (weaker) forum selection clause stated that the bank’s customer “submits to the jurisdiction [of a Court]” and “agrees that any action may be heard [in such court].” The Second Circuit noted that such language did not “specifically preclude” arbitration.
Use a merger clause, such as “this constitutes the entire agreement between the parties related to the subject matter hereof.”
Do not use language such as “This agreement is not exclusive of any rights and remedies provided by any other agreement.” That language was used in Bank Julius to sustain a prior agreement to arbitrate.
While the Second Circuit does not require a specific preclusive reference to arbitration in the forum selection clause (“and precludes arbitration of such claims”), such a reference does not hurt, and could help in other circuits. In any event, make sure that the language conforms to the first three points above.
There is no presumption of arbitrability in disputes over whether an agreement to arbitrate has been made. The Second Circuit had previously said as much in Applied Energetics, but some lower courts continue to miss that point.
The Second Circuit held that arbitrations are “actions and proceedings.” The Second Circuit explicitly disagreed with the Carilion case from the Fourth Circuit on this point.

The decision is available here.