Business Law Legal Topics

Post-Dispute Adoption of Arbitration Bylaw Fails

466168267The following is a guest blog post by Richard G. Burt. Mr. Burt provides legal services to new and established businesses, including forming business entities, negotiating and drafting agreements, and advising clients on business law issues.

Recent court decisions in other states allowing enforcement of certain “forum selection” clauses in corporate bylaws has sparked much discussion on the scope of such clauses. A California court has just weighed in and made it clear that a forum selection clause in corporate bylaws can’t simply be amended to require arbitration of a dispute that’s already pending in court.

In Cobb v Ironwood Country Club (2015) 233 CA4th 960, the plaintiff members of the defendant country club filed a declaratory relief action, alleging that a dispute had arisen between them and the club over a financial matter. When the plaintiffs filed their complaint, the club’s bylaws contained no arbitration provision, but four months later the club adopted a bylaw that required arbitration of “any claim … by a Member past or present….” Following that convenient amendment, the club moved to compel arbitration. It didn’t fly with either the trial court or the court of appeal.

The court of appeal agreed with the club that its bylaws constituted a contract between the club and each of its members, but it parted ways with the club on whether a bylaw provision allowing the club to amend the bylaws meant that the members were deemed to have agreed to whatever amendments were made. Such an interpretation, the court said, would make the contract illusory and thus unenforceable.

The implied covenant of good faith and fair dealing restricts what might otherwise be a party’s unfettered power to amend or terminate an agreement governing the parties’ relationship. And there’s case law providing that the implied covenant of good faith and fair dealing prohibits a party from unilaterally changing the terms of an arbitration agreement “that apply retroactively to ‘accrued or known’ claims.” Because the dispute was already being litigated, the arbitration bylaw was beyond the club’s amendment power.

So it’s now clear that amending corporate bylaws to require arbitration of a dispute already pending in court doesn’t create an enforceable agreement to arbitrate that dispute. But what about for partnership agreements and LLC operating agreements that contain clauses allowing the agreement to be amended? Cobb suggests that the covenant of good faith and fair dealing can also limit the scope of amendments to those agreements without the consent of an adversely affected party.

For more on enforceability of arbitration provisions, illusory contracts, and the covenant of good faith and fair dealing, turn to CEB’s California Law of Contracts. On corporate bylaws, check out CEB’s Organizing Corporations in California.

Other CEBblog™ posts you may find interesting:

© The Regents of the University of California, 2015. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited.

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