Inducement of a Contract

RICHARD K. PARSELL*

The Arbitration Law of New York provides that an agreement to arbitrate either an existing or future controversy is "valid, enforcible and irrevocable, save upon such grounds as exist at law or in equity for the revocation of any contract" and provision is made for compelling a recalcitrant party to proceed according to his contract. It is also provided that a party, before being compelled to arbitrate, be given the opportunity to have it summarily determined whether he has in fact agreed to arbitrate the question sought to be submitted to arbitration. A recent case has come before the Appellate Division in New York which calls upon the court to decide whether an issue of fraud in the inducement of a contract is a matter for arbitration and whether it is a matter which must be decided by the court before arbitration can be compelled according to the New York statute. If a party can have such an issue of fraud tried by the court before

*A graduate of the Cornell Law School engaged under the direction of the law faculty, in a study of Commercial Arbitration for the American Arbitration Association.

1L. 1920, ch. 275. § 2. "Validity of arbitration agreements. A provision in a written contract to settle by arbitration a controversy thereafter arising between the parties to the contract, or a submission hereafter entered into of an existing controversy to arbitration pursuant to title eight of chapter seventeen of the code of civil procedure, or article eighty-three of the civil practice act, shall be valid, enforcible and irrevocable, save upon such grounds as exist at law or in equity for the revocation of any contract."

28 3, "Remedy in case of default. A party aggrieved by the failure, neglect or refusal of another to perform under a contract or submission providing for arbitration, described in section two hereof, may petition the supreme court, or a judge thereof, for an order directing that such arbitration proceed in the manner provided for in such contract or submission. Eight days' notice in writing of such application shall be served upon the party in default. Service thereof shall be made in the manner provided by law for personal service of a summons. The court, or a judge thereof, shall hear the parties, and upon being satisfied that the making of the contract or submission or the failure to comply therewith is not in issue, the court, or the judge thereof, hearing such application, shall make an order directing the parties to proceed to arbitration in accordance with the terms of the contract or submission. If the making of the contract or submission or the default be in issue, the court, or the judge thereof, shall proceed summarily to the trial thereof. If no jury trial be demanded by either party, the court, or the judge thereof, shall hear and determine such issue. Where such an issue is raised, any party may, on or before the return day of the notice of application, demand a jury trial of such issue, and if such demand be made, the court, or the judge thereof, shall make an order referring the issue or issues to a jury in the manner provided by law for referring to a jury issues in an equity action. If the jury find that no written contract providing for arbitration was made or submission entered into, as the case may be, or that there is no default, the proceeding shall be dismissed. If the jury find that a written contract providing for arbitration was made or submission was entered into and there is a default in the performance thereof, the court, or the judge thereof, shall make an order summarily directing the parties to the contract or submission to proceed with the arbitration in accordance with the terms thereof.

being compelled to arbitrate, it offers ready means for delaying the proceedings and, therefore, to a certain extent enables the original purpose of expeditious settlement to be thwarted by one of the parties.

The case referred to is Matter of Cheney Brothers v. Joroco Dresses, Inc., 218 App. Div. 652, 219 N. Y. Supp. 96 (1st Dept. 1926). An examination of the facts3 shows that plaintiff sold some textiles to defendant under a contract containing a general arbitration clause and providing that the plaintiff would not sell the pattern selected to any other person. A dispute arose under the contract and plaintiff demanded arbitration. Defendant declined to proceed and thereupon plaintiff moved for an order compelling arbitration. Defendant then answered that the contract had been obtained by fraud and misrepresentation in that the salesman had not intended to and actually did not restrict the patterns to him. Upon reaching the Appellate Division the court, reversing the order of the Supreme Court, said, "that the question as to whether or not the contract was fraudulently induced raises an issue of fact which must be tried before the right to arbitration under the contract may be enforced. If the contract was voided by fraud, the arbitration provision therein falls." Three of the judges dissented.

Before commenting upon the holding of the court from a legal point of view, it may be well to examine various ways of dealing with fraud from an hypothetical standpoint. For the purpose of discussion, it is suggested that a contract containing a provision for arbitration be regarded as divided into two parts, one a contract for sale or for services or what not, which we shall call the first contract, and the other, which we shall call the second, a contract to submit to arbitration disputes as to the first contract.

Where fraud is alleged as to the second contract, i. e., the agreement for arbitration, the possible means for determining the issue are to have the question determined by the court before compulsion of arbitration, to have the arbitrators decide the matter, or to have it determined by the court after arbitration has been had and when it is sought to have the award enforced. It seems obvious that the validity of the agreement for arbitration should be determined before arbitration is compelled both from the point of view of the provisions in the Arbitration Law and from the point of fundamental justice."

'The report does not state the facts of the case.

"In Matter of Gresham & Co., Ltd., 202 App. Div. 211, 195 N. Y. Supp. 106 (1st Dept. 1922), it was held that the question whether there had been a valid signing of an agreement by the agent who signed the contract was one for summary determination under sec. 3. Similarly in Matter of Palmer & Pierce, Inc., 195 App. Div. 523, 186 N. Y. Supp. 369 (1st Dept. 1921), summary determination as to whether the arbitration agreement had been in fact made was held demandable prior to arbitration.

And further, as a practical matter, a party could well be deemed to waive questions of fraud of this type by not raising them at that time.

Where fraud is alleged as to the first contract, the contract to which the arbitration provision is appended, the same propositions may be put, i. e., whether the point should be determined by the court before arbitration is compelled, whether it should be settled by the arbitrators, or whether it should be determined after the arbitration when it is sought to have the award enforced. In this case, the answer is not so entirely obvious and requires somewhat detailed consideration.

In the Cheney Brothers case, the fraud was in the inducement of what we have called the first contract. (There was no fraud alleged as to the second.) The view of the Appellate Division was that the allegation of fraud, if made out, would invalidate the whole contract including the arbitration provision and on that ground the court decided that fraud as to the first portion of the contract had to be determined by the court before arbitration could be compelled under section 3 of the Arbitration Law. This decision seems convincing unless it can be shown that it is not necessary to consider a contract containing a provision for arbitration as an entirety, but that a contract containing an agreement for arbitration may be regarded as severable and as composed of a first contract and a second supplementary contract, somewhat as suggested above for discussion purposes. It becomes a question for consideration, therefore, to determine which view is preferable, and so for the moment it may be well to consider how such contracts have been regarded in dealing with other matters.

At common law a general provision in a contract for arbitration of disputes which might arise out of the contract in the future, is considered invalid in the sense that it will not bar an action brought on the principal contract. This shows at least that the provision for arbitration is not considered so tied up with the rest of the provisions of the contract as to permit its invalidity to affect the validity of the rest of the contract. But a suit thus brought is usually held

'In ELLIOTT, CONTRACTS, (1913) § 3655, an agreement for arbitration in a building contract is called a "supplementary contract."

"In United States Asphalt R. Co. v. Trinidad Lake P. Co., 222 Fed. 1006 (S. D. N. Y. 1915), there is an excellent discussion as to the various reasons assigned for this rule and their lack of conviction, and as to the way the authorities are established in this country. For an exhaustive review of the change of view of the English courts on this point and the precedent established in this country, see JULIUS HENRY COHEN, COMMERCIAL ARBITRATION AND the Law (1918).

to constitute a revocation of the arbitration agreement' and the fact that disputes arising out of the principal contract were settled in court, contrary to the agreement of the parties, may be made the basis of an action for damages for breach of the contract to arbitrate. This seems to infer separateness in the treatment of the arbitration provision.

Under the Arbitration Law, agreements to arbitrate are valid and can be made a bar to an action on the principal contract.10 Such provision for arbitration has peculiar significance, for where there is breach of contract, the arbitration provision is not subject to the usual rules as to right to rescind, absolution from obligation to perform, etc. For example, if, in the Cheney Brothers case, the Joroco Dresses, Inc., had merely sought to rescind the contract because Cheney Brothers had broken it in not giving them exclusive patterns, they would have been unable to rescind the arbitration agreement and would not be considered absolved from their duty to arbitrate. This vitality again seems to indicate that an arbitration agreement is regarded as distinct from the rest of the provisions of a contract and as standing upon an independent footing.

An agreement for arbitration is governed by the laws of contract and is in its nature a form of contract." A contract for arbitration refers, of course, to some particular subject matter about which there may be dispute, but it is equally clear that an arbitration contract may be executed independently and that it may be in and of itself a complete and distinct contract. The consideration for such an independent contract consists in the mutual promises to abide by the award. Where an agreement for arbitration is executed together with and as part of another contract, it does not necessarily follow that it loses its character as an independent agreement, for execution as one instrument is not a test of singleness of contractual obligation. Suppose the case where parties make the contract for arbitration at a time subsequent to the making of the contract to which it refers. In such case, its independent footing would seem quite clear, yet as a matter of fact there is little actual difference between that case and

"There is a good discussion of this point in Williams v. Branning Mfg. Co., 153 N. C. 7, 68 S. E. 902 (1910), annotated in (1911) 31 L. R. A. (N. s.) 679. For direct holdings on the point, see Paulsen v. Manske et al., 126 Ill. 72, 18 N. É. 275 (1888), and Crilly v. Philip Rinn Co., 135 Ill. App. 198 (1907).

Call v. Hagar, 69 Me. 521 (1879); Miller v. The President of Junction Canal Co., 41 N. Y. 98 (1869); Union Ins. Co. v. Central Trust Co., 157 N. Y. 633, 52 N. E. 671 (1899).

Supra, note 1.

10 5 of the Arbitration Law, L. 1920, ch. 275.

"District of Columbia v. Bailey, 171 U. S. 161, 43 L. Ed. 118, 18 Sup. Ct. 868 (1879).

the case where the agreement is executed as part of one instrument.12 It is not particularly helpful to consider the case where an agreement for arbitration is appended to an illegal contract. In such case, the arbitration agreement is ineffective. The ineffectiveness, however, is not necessarily due to the fact that the arbitration clause shares the illegality of the principal contract, but more probably is due to the fact that an arbitration and award cannot create a valid obligation out of something that is inherently illegal, even though the contract for arbitration itself may be valid. And even though illegality be the issue, an award as to it is not conclusive.13

It may be well to distinguish at this point between a distinct supplementary contract and a separable part of a divisible contract. The term divisible contract as generally used refers to apportioned contracts.14 Williston says, "A divisible contract, using that term properly, is always one contract and not several contracts. It differs in one respect only from other contracts-namely, that on performance on one side of each of its successive divisions, the other party becomes indebted for the agreed price of the division." It is obvious then that a contract containing an arbitration clause is not what is technically called a divisible contract and it is, therefore, not helpful to consider the law applicable to such contracts. There is one class of divisible contract, however, that may be referred to argumentatively, namely, where there is an agreement in restraint of trade which is unreasonable in part and reasonable in part. Such a contract is often upheld as to the reasonable part and only considered unenforcible as to the remainder.16 This might be the basis for arguing that a contract which is voidable on account of fraud in inducing one part of it, is unenforcible only as to the part concerning which the fraudulent representations are made.1

12In United States Asphalt R. Co. v. Trinidad Lake P. Co., supra note 6, one of the provisions of a charter party was an ordinary agreement for arbitration and the court in commenting upon it said at page 1007, "There can be no doubt but that this was a submission to arbitration, and for that reason was a contract between the parties to this action."

13There is a detailed consideration of contracts to arbitrate illegal matters in Benton v. Singleton, 114 Ga. 548, 40 S. E. 811 (1901).

14Woodward, The Doctrine of Divisible Contracts, (1900) 39 AM. L. Reg. (n.s.) 1. 162 WILLISTON, CONTRACTS (1920) 1648, § 861.

16Edgecomb v. Edminston, 153 N. E. 99 (Mass. 1926).

17Further cases of somewhat similar effect, namely, that a contract bad in part but separable will be enforced as to the valid part, the rule in such cases being that where there is no imputation of malum in se the bad parts do not affect the good, are Gelpcke v. Ĉity of Dubuque, 1 Wall. 221 (U. S. 1863) and Southwell v. Beazley, 5 Or. 458, (1875).

In Kahn v. Orenstein, 12 Del. Ch. 344, 114 Atl. 165 (1921), there was specific performance of part only of a divisible contract, the test for severability being stated as separateness of consideration.