Transfers and Assignments During Litigation and Arbitration

August 21, 2020Articles The Legal Intelligencer

Did you ever think you were pursuing one company and then another acquires the assets during the litigation? I have a case against a franchise company, but the franchise agreement was assigned during the dispute to another with a similar name, and without formal notice of assignment. Maybe something similar has happened to you.

After discovery was substantially completed, you learn that the defendant or its assets have been sold. You are naturally concerned for your client. Will you obtain an empty judgment? The case management order says the deadline for amendments has passed. How do you explain that you might need to amend, but you don’t even have enough information whether the named defendant has assets, or whether the transferee has assets?

These transfers during dispute resolution very often may be strategic. Sometimes, the client even is notified of the transaction but is not aware of the significance of the transaction to the litigation. Not surprisingly, the real party in interest rule does not require the litigant to affirmatively notify anyone that the transfer occurred. The real party in interest rule, such as Federal Rule Civil Procedure 17, does not really address the issue of whether the transferee should be added to a case.

Naturally, the transferee has not given any discovery regarding the transaction because it is not a party. Moreover, the discovery is stymied because of the confidentiality provision in the asset purchase agreement or the assignment document. You think, but you are not sure whether this is a sham transaction, but you cannot reasonably ask to investigate that now. The client wants to know what to do, and you need a solution for the tribunal.

Litigation Solutions for Transfers During the Case

Federal Rule of Civil Procedure 25 provides for substitution of parties. Hidden within the rule is a joinder provision:

(c) Transfer of interest. If an interest is transferred, the action may be continued by or against the original party unless the court, on motion, orders the transferee to be substituted in the action or joined with the original party. The motion must be served as provided in Rule 25 (a) (3).

I added the italics because the rule is titled “Substitution of Parties” but has a joinder provision. When is it proper to keep both the transferee and the transferor in the case? State law determines whether the liability of the transferor is extinguished and the transferee accepts all of the liability. But if the transferee has no assets, or the transaction is a sham, it seems appropriate that both transferor and transferee be named defendants.

Case law supports joinder of transferor and transferee where the transferee retains some reversionary interest, even a security interest, in the transferred assets. See, e.g, Burka v. Aetna Life Insurance,87 F.3d 478, 479 (D.C. Cir. 1996)(party to whom real property was transferred could be joined along with transferee, because transferee continued to hold security interest in property); Federal Deposit Insurance v. Tisch,89 F.R.D. 446, 448 (E.D.N.Y. 1981) (when plaintiff assigned its claims but retained interest in outcome of litigation, joinder rather than substitution was appropriate, because both assignor and assignee were still real parties in interest, and participation by both was most efficient way to insure that all issues would be fully litigated); DVI Financial Services v. Bay Area Regional Cancer Center,237 Fed. Appx. 721, 722–723 (3d Cir. 2007) (unpublished) (“U.S. Bank possessed a transferable interest in the action by virtue of its power of attorney and its contractual obligations to DVI Receivables XV. In addition, DVI remained a party to the action and was subject to Bay Area’s counterclaims. The district court did not abuse its discretion when it permitted U.S. Bank to join the action as an additional plaintiff.”); Burka v. Aetna Life Inusurance, 87 F.3d 478, 479 (D.C. Cir. 1996) (party to whom real property was transferred could be joined along with transferee, because transferee continued to hold security interest in property).

How is the court to determine whether the transferee should still be in the case? This is a matter of state law liability. The decision on who is liable may transcend the conveyance document. There may be joint and several liability either directly, or as a result of the transferee’s indemnification obligations. At a minimum, you will need the conveyance document at least to screen the issue, and possibly the relative solvency of both the transferor and transferee. This information is unlikely to be readily available and probably will require more discovery and motion practice than is practicable. My suggested solution is to move to join the transferee, and let them try to explain to the court how this stealth transaction was not a sham transaction. My experience is that the transferee would rather be joined than explain to the court how and why this happened. Often the conveyance document will have sensitive information, and particularly, about your litigation. The defendants may not want to be forthcoming about some of the thought process once the transfer is highlighted.

Solutions for Transfers During Arbitration

The issue is not as simple in arbitrations. The rules governing commercial arbitration in the United States have not caught up with this issue, as international arbitration tribunals have. Commercial arbitration is a creature of contract, and if a new entity acquires an interest, it is not necessarily bound to arbitrate at all. Even if it is, it may not be obligated to arbitrate in the existing case.

For example, Rule 22 of the Commercial Rules of the American Arbitration Association, empowers the panel in the interests of efficiency and economy to order production of any conveyance document, which may help resolve this issue. Rule 32 instructs us that the panel “shall conduct the proceedings with a view to expediting resolution of the dispute.” See Parker v. Dimension Services, 2018-Ohio-5248 (Ct. App. 2018) regarding authority of arbitrators. The argument is that the acquisition of the contact with the arbitration clause is binding on the transferee, and typically this is an express provision under the arbitration clause.

Joinder is less of a problem in international arbitration. See UNCITRAL Rule 17(5), which would allow joinder of a transferee, consistent with the goals of arbitration to provide efficient resolution of disputes. Joinder also so advances the goal of arbitration as it could prevent serial arbitrations in the future.

Joinder is salutary because you obtain two possible entities for payment rather than the one you originally named. In federal court, you have an easy-to-apply rule. In arbitration, you can argue the analogous federal rule, the goal of efficient dispute resolution, and the analog in international arbitration, should allow the arbitrators to order joinder.

Next time you see a transfer during dispute resolution, see how it can be to your advantage.

Reprinted with permission from the August 21 issue of The Legal Intelligencer. (c) 2020 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.