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A man who alleged that he was defrauded in the sale of his $8.4 million life insurance policy can’t be forced into arbitration under the terms of the contract, the Third Circuit has ruled.

Lincoln T. Griswold had filed suit against Pennsylvania-based Coventry First, which had purchased his policy through a broker appointed by his agent, Mid-Atlantic Financial, because of the alleged fraud in that deal. Coventry had paid a kickback to the broker, Kevin McGarrey, in order to rig the bidding process in its favor, Griswold alleged.

The district court had rejected Coventry’s effort to enforce the arbitration clause in the contract for the sale of the policy. The U.S. Court of Appeals for the Third Circuit agreed.

“Here, what ‘saves the day’ for Griswold is the fact that the alleged ‘secret McGarrey agreement’ took place prior to and apart from the execution of the purchase agreement. Of course, that alleged fraud was related to the purchase agreement—it set the purchase price and, allegedly, the inflated, undisclosed broker’s commission. But that alone is not sufficient to compel arbitration under the equitable estoppel doctrine: The claims must be based directly on the agreement,” Judge Thomas Hardiman said in the opinion he wrote on behalf of the unanimous three-judge panel.

Coventry had argued that the contract principle of equitable estoppel would trigger the standard arbitration clause that was included in the sales agreement, even though Griswold wasn’t a signatory. Both Georgia, where Griswold had established the trust that was to be the beneficiary of the policy, and Pennsylvania, where Coventry is based, recognize that principle and allow for nonsignatories to a contract to still be bound by an arbitration clause if it is included in the relevant contract, according to the Third Circuit’s opinion.

“Estoppel ‘can bind a nonsignatory to an arbitration clause when that nonsignatory has reaped the benefits of a contract containing an arbitration clause,’” Hardiman said, quoting from the Third Circuit’s 2010 opinion in Invista S.A.R.L. v. Rhodia.

If a party hasn’t signed a contract but still benefits from it and enforces some of its terms, that party can be held to the contract’s arbitration clause, according to the opinion.

“Equitable estoppel thus prevents a nonsignatory from ‘”cherry-picking” the provisions of a contract that it will benefit from and ignoring other provisions that don’t benefit it or that it would prefer not to be governed by (such as an arbitration clause),’” Hardiman said, again quoting from Invista.

“A nonsignatory cannot knowingly embrace the contract only to later ‘turn its back’ on other provisions in the contract, such as an arbitration clause,” Hardiman said, citing to another Third Circuit opinion, E.I. du Pont de Nemours & Co. v. Rhone Poulenc Fiber and Resin Intermediates, which was issued in 2001.

Hardiman held that the issue in the DuPont case was substantially similar to the one presented in the current case, Griswold v. Coventry First. The DuPont case had involved an arbitration clause in a contract between that company’s subsidiary and two other parties. When the underlying joint venture failed and DuPont sued the parties, the Third Circuit had held that it couldn’t be held to the arbitration clause because its claim—breach of an oral contract—didn’t hinge on the written contract that included the arbitration clause, but, rather, on an oral agreement made outside of, although was related to, the written contract, Hardiman said.

“Here, appellees’ amended complaint sufficiently alleged their injury without mention of the purchase agreement,” Hardiman said. “Put simply, appellees do not allege breach of the purchase agreement; they allege fraud antecedent to the purchase agreement.”

Griswold alleged that when McGarrey approached Coventry about buying the policy in 2008, “Coventry rigged the bidding process by having McGarrey sign a written producer agreement—the ‘secret McGarrey agreement’—promising to refrain from seeking any further bids and to report any competing offers and their material terms to Coventry. In exchange, Coventry allegedly allowed McGarrey to ‘self-determine’ his commission to the tune of $145,000, which was $61,000 more than what he was entitled to,” according to the opinion.

Since that alleged agreement was made before the contract was created and wasn’t included in it when the contract was created, the district court had found that Griswold would have a claim even if the final contract were void, according to the opinion. The appellate court agreed.

“Because the ‘secret McGarrey agreement’ was not incorporated into the purchase agreement, appellees’ claims do not allege a breach of that agreement and they are not bound by its terms. Therefore, Coventry cannot compel arbitration against appellees, who never consented to the purchase agreement,” Hardiman said.

He was joined by Third Circuit Judges Thomas Ambro and Joseph Greenaway Jr.

Ronald Mann of Mitts Law in Philadelphia represented Griswold, and Kannon Shanmugam of Williams & Connolly in Washington, D.C., represented Coventry. Neither could be reached for comment.

Saranac Hale Spencer can be contacted at 215-557-2449 or sspencer@alm.com. Follow her on Twitter @SSpencerTLI.

(Copies of the 22-page opinion in Griswold v. Coventry First, PICS No. 14-1257, are available from The Legal Intelligencer. Please call the Pennsylvania Instant Case Service at 800-276-PICS to order or for information.)