Main v. Merrill Lynch, Pierce, Fenner & Smith, Inc.

• Decision Date: 10 February 1977
• Court: California Court of Appeals Court of Appeals
• Parties: Edith E. MAIN, Plaintiff and Respondent, v. MERRILL LYNCH, PIERCE, FENNER & SMITH INC. and Jack Smith, Defendants and Appellants. Civ. 38083.

Page 378

136 Cal.Rptr. 378

67 Cal.App.3d 19

Edith E. MAIN, Plaintiff and Respondent, v. MERRILL LYNCH, PIERCE, FENNER & SMITH INC. and Jack Smith, Defendants and Appellants.

Civ. 38083.

Court of Appeal, First District, Division 1, California.

Feb. 10, 1977.

Orrick, Herrington, Rowley & Sutcliffe, W. Reece Bader, Laird H. Simons III, San Francisco, for defendants and appellants.

Cullinan, Burns & Helmer, Vincent Cullinan, Robert C. Schubert, San Francisco, for plaintiff and respondent.

MOLINARI, Presiding Justice.

Defendant Merrill Lynch, Pierce, Fenner & Smith Inc. ('Merrill Lynch'), a stock brokerage firm, and its 'account executive,' defendant Jack Smith, had been engaging in interstate securities transactions for the account of a customer, plaintiff Edith Main. At defendant Smith's suggestion she signed a writing called a 'Lending Agreement' which permitted Merrill Lynch to make discretionary sales and purchases of securities. The writing contained the following provision:

'It is agreed that any controversy between us (plaintiff and Merrill Lynch) arising out of your business or this agreement, shall be submitted to arbitration conducted under the provisions of the Constitution and Rules of the Board of Governors of the New York Stock Exchange, . . .'

Thereafter plaintiff commenced the instant action against defendants Merrill Lynch and Smith. She alleged, among other things, that pursuant to the writing Merrill Lynch had made improvident purchases and sales for her account, resulting in losses and damages to her totaling $83.750. And she alleged that she was induced to sign the writing as a result of the 'fraud' and 'undue influence' of defendants.

Following service upon them of the complaint, defendants filed a petition in the superior court to compel arbitration. A hearing was held after which the court ordered that 'defendants' petition to compel arbitration is denied.' Defendants have appealed from that order.

I. The first contention of defendants is that the Federal Arbitration Act, title 9, sections 1--14, United States Code ('Arbitration Act'), was applicable to their petition to compel arbitration, 'as a matter of federal substantive law.'

1] The Arbitration Act is similar in many respects to the provisions of California's Code of Civil Procedure, part 3, title 9, entitled 'Arbitration' (§§ 1280--1294.2). Each contemplates a special proceeding, affording a judicial remedy where a party to an agreement to arbitrate a dispute elects for one reason or another not to do so. Ordinarily it is an original judicial proceeding, but sometimes it will be brought by a party, as was done here, in the course of an existing action. The issue is usually whether there is a Valid written agreement to arbitrate. If such an agreement is found to exist, arbitration will be ordered, and if the motion to compel arbitration is made in the course of an existing action the action will be stayed. If no valid arbitration agreement is found, the requested relief will be denied and, if a related action on the basic agreement is pending, it will proceed to trial.

The Arbitration Act is applicable to a 'written provision in . . . a contract evidencing a transaction involving (interstate) commerce . . ..' (See 9 U.S.C.A. § 2). Plaintiff appears to concede that hers was such a transaction.

2] The Arbitration Act provides for a 'trial,' by jury if requested, of the issue whether a Valid agreement to arbitrate the subject dispute is existent (see 9 U.S.C.A § 4); the issue to be resolved does not concern 'the merits of the controversy as to which arbitration is sought.' (Aberthaw Construction Co. v. Centre County Hospital (D.C.1973) 366 F.Supp. 513, 515, affd. 503 F.2d 1398 (3 Cir. 1974).) The issue 'should not be determined on affidavits, but rather a full trial should be had.' (A/S Custodia v. Lessin International, Inc. (2 Cir. 1974) 503 F.2d 318, 320; El Hoss Engineer. & Transport Co. v. American Ind. Oil Co. (2 Cir. 1961) 289 F.2d 346, 351, cert. den., 368 U.S. 837, 82 S.Ct. 51, 7 L.Ed.2d 38.)

3] The Arbitration Act also expressly relates to petitions in 'any United States district court . . ..' (See 9 U.S.C.A. § 4). But it has now been widely held that the act is equally applicable to such proceedings brought in state courts arising out of transactions involving interstate commerce, or admiralty.

'4] The Federal Arbitration Act, declaring arbitration agreement affecting (interstate) commerce or maritime affairs to be valid, enforceable, and irrevocable, is a declaration of national law equally applicable in state or federal courts.' (REA Express v. Missouri Pacific Railroad Co. (Tex.Civ.App.1969) 447 S.W.2d 721, 726; see also Matter of Rederi (Dow Chem. Co.) (1970) 25 N.Y.2d 576, 584, 307 N.Y.S.2d 660, 255 N.E.2d 774, cert. den., 398 U.S. 939, 90 S.Ct. 1844, 26 L.Ed.2d 272; Cooper v. Computer Credit Systems, Inc. (1972) 40 A.D.2d 692, 336 N.Y.S.2d 380, 381; Aerojet-General Corp. v. Non-Ferrous Metal Refin. (1971) 37 A.D.2d 531, 322 N.Y.S.2d 33, 34; Miller v. Puritan Fashions Corp. (Tex.Civ.App.1974) 516 S.W.2d 234, 238; Mamlin v. Susan Thomas, Inc. (Tex.Civ.App.1973) 490 S.W.2d 634, 637; West Point-Pepperell, Inc. v. Multi-Line Indus., Inc. (1973) 231 Ga. 329, 201 S.E.2d 452, 453; Pathman Const. Co. v. Knox County Hospital Ass'n (Ind.App.1975) 326 N.E.2d 844, 851; Pinkis v. Network Cinema Corp. (1973) 9 Wash.App. 337, 512 P.2d 751, 755--756; Robert Lawrence Co. v. Devonshire Fabrics, Inc. (2 Cir. 1959) 271 F.2d 402, 404--407; American Airlines, Inc. v. Louisville & Jefferson C.A.B. (6 Cir. 1959) 269 F.2d 811, 815--816; Litton RCS, Inc. v. Pennsylvania Turnpike Commission (D.C.1974) 376 F.Supp. 579, 585--586, affd. 511 F.2d 1394 (3 Cir. 1975); Aberthaw Construction Co. v. Centre County Hospital, supra, 366 F.Supp. 513, 514--515.) We are advised of no contrary authority.

,6] We find this authority compelling, and hold the Arbitration Act to be applicable to California's courts in the case of a contract evidencing a transaction involving interstate commerce to settle by arbitration a controversy thereafter arising out of such contract or transaction. The proceedings below, as contended by defendants, were controlled by the Arbitration Act, and its authoritative interpretations.

II. We construe defendants' next appellate contention in this manner. They appear to concede that specific allegations and proof of fraud or undue influence in the inducement of an arbitration clause (as distinguished from the inducement of the contract in which it appears) would compel a determination of the clause's invalidity. But they argue that where as in the instant case, the allegations and proof relate to the inducement of the contract in which the arbitration clause is found, federal law requires that the issue of the contract's validity be arbitrated.

The leading case on the subject is undoubtedly Moseley v. Electronic Facilities (1963) 374 U.S. 167, 83 S.Ct. 1815, 10 L.Ed.2d 818. Electronic Facilities sought a judicial decree that certain of its subcontracts with Moseley be arbitrated in accordance with provisions of the subcontracts. Mosely responded by attacking 'not only the subcontracts, but also the arbitration clauses contained therein, as having been procured through fraud.' The high court opined: '(I)t seems clear that the issue of fraud should first be adjudicated before the rights of the parties under the subcontracts can be determined. . . . If this issue is determined favorably to the petitioner (Moseley), there can be no arbitration under the subcontracts.' (374 U.S., pp. 170--171, 83 S.Ct., pp. 1817--1818).

Another relevant high court decision is found in Prima Paint v. Flood & Conklin (1967) 388 U.S. 395, 87 S.Ct. 1801, 18 L.Ed.2d 1270. There also, the parties' agreement contained a clause providing for arbitration of disputes. Prima Paint, in the United States District Court, sought rescission of the agreement 'on the basis of . . . alleged fraudulent inducement.' It alleged only that it had been "fraudulently induced to accelerate the execution and closing date of the . . . agreement herein, . . ." No contention was made that the arbitration clause had been fraudulently induced. The Prima Paint court held (pp. 403--404, 87 S.Ct.p. 1806) that 'consistent both with the decision in Moseley v. Electronic Facilities (supra) 374 U.S. 167, 171, 172, 83 S.Ct. 1815, 1817, 1818, 10 L.Ed.2d 818 (1963), and with the statutory scheme,' 'if the claim is fraud in the inducement of the arbitration clause itself--an issue which goes to the 'making' of the agreement to arbitrate--the federal court may proceed to adjudicate it.' Concluding that the claimed fraud did not affect the arbitration clause, but instead the inducement of the contract generally, i.e., the acceleration of its 'execution and closing date,' the court held that issue subject to arbitration, as had been agreed by the parties.

Moseley and Prima Paint have been consistently followed by other federal and state courts of review.

Comprehensive Merch. Cat., Inc. v. Madison Sales Corp. (7 Cir. 1975) 521 F.2d 1210, 1213: '(I)f the alleged fraud was part of a grand scheme that permeated the entire contract, including the arbitration provision, the arbitration provision should fall with the rest of the contract. (See Moseley v. Electronic, etc., Facilities, 374 U.S. 167, 83 S.Ct. 1815, 10 L.Ed.2d 818; Housekeeper v. Lourie, 39 A.D.2d 280, 333 N.Y.S.2d 932, Supra.)'

Robert Lawrence Co. v. Devonshire Fabrics, Inc., supra, 271 F.2d 402, 411: Here the court was considering the Arbitration Act, and whether a contract was subject to arbitration thereunder. It said: '(T)his is not a case . . . where the defendant denied ever agreeing to anything. Naturally such a question had first to be settled before arbitration could be directed.'

Kulukundis Shipping Co. v. Amtorg Trading Corp. (2 Cir. 1942) 126 F.2d 978, 986: 'The Arbitration Act does not cover an...