Air Conditioning Distribution Dispute Frozen Out of Arbitration

Air-Con and Daikin enjoyed a cooperative business relationship for the better part of 15 years. Beginning in 2000, Air-Con signed a written distribution agreement with Daikin Industries to be a “non-exclusive authorized distributor” in Puerto Rico and the Virgin Islands. The agreement contained an arbitration provision requiring arbitration of any dispute or controversy arising between the parties in relation to the agreement.

Around the same time, Air-Con established a distribution relationship with Daikin Applied. Daikin Industries is the parent company of Daikin Applied. No written document memorialized Air-Con and Daikin Applied’s relationship, but Air-Con allegedly gained rights for exclusive sale and distribution of Daikin-branded air conditioners and equipment in Puerto Rico and the Caribbean.

All was well until 2015, when Air-Con purportedly learned Daikin Applied not only sold Daikin products to other Puerto Rico distributors but did so at a dramatically lower price than they offered Air-Con, enabling other distributors to sell products for less than Air-Con paid for the same product. Air-Con also alleged Daikin Applied experienced serious delivery and inventory issues beginning around this time. In 2018, Air-Con sued Daikin Applied in Commonwealth court (the equivalent of Puerto Rican state court) under Puerto Rico’s Dealer Protection Act. Daikin Applied removed to federal court and then filed a motion to compel arbitration based on the arbitration provision in the written agreement between Air-Con and Daikin Industries. The District Court agreed with Daikin Applied and compelled arbitration. Air-Con appealed to the First Circuit.

The First Circuit reversed and first clarified the standard of review of a motion to compel arbitration. Because § 4 of the Federal Arbitration Act (FAA) commands the court to “hear the parties,” it contemplates the submission and consideration of materials beyond the pleadings, which best aligns with the summary judgment standard, not Rule 12’s plausibility standard. This interpretation is consistent with most other federal circuits.

Then, reviewing the district court opinion de novo, the First Circuit identified a fatal issue: The court improperly put the burden of disproving an arbitration agreement on Air-Con, the non-moving party. The burden must be on the party moving to compel arbitration to affirmatively demonstrate the existence of a binding arbitration agreement. While the FAA embodies a general policy of support for arbitration, arbitration can only be compelled if the parties so agreed. The lower court misconstrued portions of the complaint as an admission that Air-Con and Daikin Applied operated under the guidelines of the agreement between Air-Con and Daikin Industries — thus compelling arbitration. Finding no admission in the complaint, the First Circuit analyzed the written agreement between Air-Con and Daikin Industries to determine if Air-Con and Daikin Applied agreed to arbitrate. This agreement included a non-assignability clause. Without written consent of the other party, the agreement and all rights, duties, and obligations within may not be assigned or otherwise transferred. The agreement also disallowed any revision, modification, or amendment unless agreed to in writing and signed by both parties. Daikin Applied produced no evidence of a written assignment or modification of the agreement and thus failed to meet its burden of affirmatively establishing a binding written arbitration provision.

Daikin Applied made one last attempt to establish a binding arbitration agreement. For each accepted delivery from Daikin Applied, Air-Con signed a sales contract containing an arbitration clause. Daikin Applied argued that these sales contracts compelled arbitration of the entire dispute. However, returning again to the contract language, the Court determined the sales contract arbitration provisions applied only to disputes arising out of each particular sale authorized by each particular contract, not disputes regarding the entire distribution relationship.

Ultimately, the First Circuit denied all of Daikin’s attempts to compel arbitration and remanded to the district court for further proceedings.

Key Takeaway

The FAA’s threshold questions should not be given short shrift. While the FAA embodies a liberal policy favoring arbitration, arbitration remains a contract-based philosophy, and courts strictly construe the contract requirement. The party seeking to compel arbitration cannot succeed without clearing the FAA’s threshold questions by demonstrating that: