Strotz v. Dean Witter Reynolds, Inc.

• Decision Date: 27 August 1990
• Docket Number: No. E006574,E006574
• Citation: Strotz v. Dean Witter Reynolds, Inc., 272 Cal.Rptr. 680, 223 Cal.App.3d 208 (Cal. App. 1990)
• Court: California Court of Appeals
• Parties: Linda STROTZ, Plaintiff and Respondent, v. DEAN WITTER REYNOLDS, INC. et al., Defendants and Appellants.

Page 680

272 Cal.Rptr. 680

223 Cal.App.3d 208

Linda STROTZ, Plaintiff and Respondent, v. DEAN WITTER REYNOLDS, INC. et al., Defendants and Appellants.

No. E006574.

Court of Appeal, Fourth District, Division 2, California.

Aug. 27, 1990.

Review Denied Nov. 14, 1990.

[223 Cal.App.3d 210] Jones, Bell, Simpson & Abbott, Michael J. Abbott and Donald C. Miller, Los Angeles, for defendants and appellants.

Covington & Crowe, Robert F. Schauer, Melanie Fisch and Wayne K. Baldwin, Ontario, for plaintiff and respondent.

OPINION

HOLLENHORST, Acting Presiding Justice.

Defendants Dean Witter Reynolds, Inc. (Dean Witter) and Craig Nelson (Nelson) appeal from an order denying their petition to compel arbitration. The trial court denied arbitration because of plaintiff's allegations in her complaint that defendants had fraudulently induced her to sign the contract which contained the agreement to arbitrate and that the fraud permeated the entire contract, including the agreement to arbitrate.

I FACTS ¹

In October of 1985, plaintiff went to the Dean Witter office in Upland and met with Nelson for the purpose of transferring her investment account from the Dean Witter office in Costa Mesa which had managed her investments since 1979. At the time of the transfer, Nelson had plaintiff sign a "Customer's Agreement" and an "Option Client Information" agreement. Both contracts include agreements to arbitrate any controversy arising out of or related to the contract. Additionally both contracts state that all terms of the agreement shall be included in any subsequent agreement. Plaintiff signed a second "Option Client Information" agreement in 1987 which contained the same terms. In 1988, plaintiff filed suit when she learned defendants had lost her $180,000 investment, contending that defendants had misrepresented the nature of the OEX index options in which she had invested by stating they were a low risk investment when in fact they were high risk, had concealed the full extent of her losses and had sold her stock to cover her losses.

When defendants demanded arbitration under the two contracts signed in 1985, plaintiff filed a first amended complaint wherein she alleged that at the time she signed the contracts in 1985, defendants told her that the contracts simply were documents necessary to open her account, that they did not affect her legal rights and that it was not necessary to read them. She contends she was not given the opportunity to read the documents and was not advised of the agreement to arbitrate. Additionally she alleges she was not told that the document entitled "Option Client Information" was actually a contract, the terms of which were set forth on the back of the form. Finally, plaintiff contends she did not know the true nature and effect of the documents and that had she known she would not have signed them. ²

Defendants filed their petition to compel arbitration wherein they alleged that both the contracts signed in 1985 and the "Option Client Information" contract signed in 1987 required plaintiff to submit her claims to arbitration. In opposition to the petition to compel arbitration, plaintiff filed a declaration which in essence repeated the allegations in the complaint. She also filed a supplemental declaration in which she stated that from time to time after she opened her account with defendants, she received documents or form letters from defendants. When she received such documents, she would call defendants and ask what the documents were. Each time, defendants would tell her that it was okay to sign the documents, that it wasn't necessary to keep copies and not to worry. She further stated that she signed such documents on defendants' assurances that they were simply standard documents defendants required. The 1987 "Option Client Information"s agreement was among the documents defendant told her were standard forms defendants required.

II PERMEATION DOCTRINE

In this case we are called upon to determine whether the federal Arbitration Act (9 U.S.C. § 1 et seq.) allows a party to avoid his agreement to arbitrate by use of what has been referred to by the parties as the "permeation doctrine." While the parties argue its applicability, they have not attempted to explain or define the doctrine. But then we find that the courts which have applied the permeation doctrine provide little guidance in its proper application as well. Therein lies the problem. Because the parameters of the doctrine have not been clearly defined in relation to the United States Supreme Court rule of severability under the federal Arbitration Act, we decline to rely on it. Nonetheless, as we explain, we find the trial court properly denied the petition to compel arbitration.

The federal Arbitration Act provides that, in contracts involving interstate commerce, a written arbitration agreement is valid and enforceable. ³ Accordingly, a trial court is required to order a matter of arbitration unless there are grounds for revocation of the arbitration agreement. Prior to 1967, the circuit courts of appeal had been divided on the issue of whether claims of fraud in the inducement of a contract which contained an agreement to arbitrate were subject to arbitration or were to be decided by the trial court. Some courts held as a matter of federal substantive law that the arbitration agreement was severable from the principal contract and therefore claims of fraud in the inducement of the principal contract did not invalidate the arbitration agreement. Others held that the issue of severability was to be determined under the applicable state law.

In Prima Paint Corp. v. Flood & Conklin Mfg. Co. (1967) 388 U.S. 395, 87 S.Ct. 1801, 18 L.Ed.2d 1270, the United States Supreme Court resolved this conflict and held that, as a matter of federal substantive law, an arbitration clause in a contract is severable from the principal contract in which it is located. Therefore, claims of fraud or other defenses which may vitiate the principal contract do not affect the agreement to arbitrate. Accordingly, in ruling on a petition to compel arbitration or an application for a stay of court proceedings pending arbitration, the trial "court may consider only issues relating to the making and the performance of the agreement to arbitrate" and may not "consider claims of fraud in the inducement of the contract generally." ⁴ (Id., 388 U.S. at p. 404, 87 S.Ct. at p. 1806.) These principles were later determined to apply to any contract governed by the federal Arbitration Act whether the issue is raised in state or federal courts. (Southland Corp. v. Keating (1984) 465 U.S. 1, 12, 104 S.Ct. 852, 859, 79 L.Ed.2d 1; Moses H. Cone Memorial Hosp. v. Mercury Const. (1983) 460 U.S. 1, 24-25, 103 S.Ct. 927, 941-942, 74 L.Ed.2d 765.)

In Prima Paint, the plaintiff alleged that it had been induced to enter a contract containing an arbitration agreement by the defendants' false representations and fraud regarding its ability to perform the contract. The court held that this fraud did not relate to the making or the performance of the agreement to arbitrate. As there was no evidence the parties intended to withhold legal issues regarding the validity of the contract from arbitration and no evidence the plaintiff was fraudulently induced to agree to arbitration, the fraud issue was to be decided by the arbitrator. ⁵

Although Prima Paint is clear in its directive that the trial court may decide only issues of fraud directed at the making and the performance of the arbitration agreement, the courts which have applied the permeation doctrine actually have relied more on an earlier Supreme Court decision in Moseley v. Electronic & Missile Facilities (1963) 374 U.S. 167, 83 S.Ct. 1815, 10 L.Ed.2d 818, rather than Prima Paint. In Moseley, two subcontractors filed an action in Georgia and sought, in addition to other relief, an injunction enjoining the prime contractor from proceeding with its arbitration efforts in New York, contending that the Miller Act (40 U.S.C. §§ 270a-270d) gave the subcontractors the right to sue in the district court where the subcontracts were performed. The Supreme Court did not decide that issue, stating that before the issue of the arbitrability of the disputes under the subcontracts could be reached, the district court must first decide the issue of fraud. In Moseley, the subcontractors alleged "that the subcontracts ... were a fraudulent scheme to obtain a great amount of work and material from petitioner and the other subcontractors without making payment therefor and to 'browbeat' petitioner and his fellow subcontractors into accepting much less than the value of their claims. One of the means used to effect such scheme was alleged to be the insertion in the subcontracts of an arbitration clause requiring arbitration of disputes in New York." (Id., at p. 171, 83 S.Ct. at p. 1817.) In finding "that the issue of fraud should first be adjudicated before the rights of the parties under the subcontracts can be determined," the court emphasized, "that, as alleged here, the issue goes to the arbitration clause itself, since it is contended that it was to be used to effect the fraudulent scheme." (Ibid., emphasis supplied.) The court later held that Moseley and Prima Paint were consistent. ( Prima Paint Corp. v. Flood & Conklin Mfg. Co., supra, 388 U.S. 395, 404, fn. 12, 87 S.Ct. 1801, 1806, fn. 12, 18 L.Ed.2d 1270.)

Thus, when Moseley and Prima Paint are read together, they hold that, under a broadly worded arbitration provision, fraud in the making or performance of a principal contract is to be decided by the arbitrator. The issue of fraud is to be decided by the court only where it is alleged the arbitration agreement itself was obtained by fraud or is part of a fraudulent scheme. It is not sufficient to allege simply that the arbitration agreement is located in a contract which was otherwise procured by fraud.

The ...