By John Butzer.
Can an individual who is not a party to a contract be bound to a limitation provision of that contract? In Arizona, the answer is no. Recently, the Arizona Supreme Court unanimously decided in JTF Aviation Holdings, Inc. v. CliftonLarsonAllen LLP that the closely related party doctrine does not extend to this scenario.
The Original Dispute
In December 2013, JTF Aviation, Inc. (JTF) hired CliftonLarsonAllen LLP (CLA) to conduct an audit of JTF’s consolidated financial statements. The primary purpose of the audit was to ensure that JTF’s financial information was presented in accordance with Generally Accepted Accounting Principles, known as GAAP. JTF and CLA documented their relationship with an Engagement Letter, which was signed by JTF’s Chief Financial Officer, Dick Larson and Chad Kunze, a principal with CLA. The Engagement Letter contained a provision stating that any litigation regarding the audit must be brought within twenty-four months from the delivery of the final audit report. Notably, JTF’s founder, President, and sole shareholder, Jeremy Freer did not sign the Engagement Letter.
The audit report was delivered to JTF in February 2014. In June 2014, Freer negotiated an agreement to sell JTF to Vistria Group for $80,000,000. In this agreement, JTF warranted that their financial statements “were prepared in accordance with GAAP consistently applied and present fairly the financial position and result of operations.” Three months later, Vistria commenced a lawsuit against JTF, Freer, and Larson. Vistria alleged that the financial statements did not conform to GAAP and that, due to this error, the earnings before interest, taxes, depreciation, and amortization (EBITA) of JTF were significantly inflated. As a result, Vistria argued the defendants fraudulently induced them to purchase JTF. Freer and the other defendants settled this lawsuit in September 2016.
In April 2017, well after the twenty-four-month period required by the Engagement Letter, Freer sued CLA. Freer alleged that CLA’s professional negligence, negligent misrepresentation, and breach of fiduciary duty gave rise to Vistria’s claims against him. In response, CLA argued that the limitation provision in the Engagement Letter barred Freer’s claim. Freer countered that he did not sign that Engagement Letter, and therefore was not bound by its terms. The trial court agreed with CLA and ruled that, even though Freer did not sign the Engagement Letter, he was bound by the limitations provision given how “closely related” he was to JTF and the surrounding events. The trial court found support for their decision in the Ninth Circuit’s opinion in Manila Indus., Inc. v. Ondova, Ltd. Co. In this case, the Ninth Circuit held that a nonparty’s alleged conduct, if it is “closely related” to the contractual relationship, can be used to enforce a forum selection clause against that nonparty.
Freer appealed, but the court of appeals affirmed the trial court decision. The appeals court also relied on prior case law involving the application of the doctrine to forum selection clauses. The court noted that Freer was the sole owner of JTF, was part of the relationship between JTF and CLA, and was involved in the negotiations between the parties. Due to these factors, the court reasoned that Freer was “closely related” to the contract. The court of appeals also discussed a separate element of “foreseeability” in regard to this doctrine. Referencing In re McGraw-Hill Glob. Educ. Holdings LLC, the court took into account whether enforcement of the clause against the non-signatory would be foreseeable. The court concluded that based on his close relation to the company and the events, enforcement of this provision against Freer would be foreseeable. As a result, the appeals court affirmed the trial court decision.
The Court’s Decision
The lower courts’ reasoning did not persuade the Arizona Supreme Court. First, the Court distinguished this limitation clause from forum selection clauses and treated it as a matter of first impression. Second, the Court used this opportunity to reaffirm the strength of the corporate veil under Arizona law.
The Court distinguished the case law cited by the lower courts. The cases cited allowed the closely related party doctrine to bind “closely related” nonparties to forum selection clauses. The Court distinguished the present case because it involved a limitation on “when a claim may be brought, not where it may be brought.” To the Court, this distinction shows that the closely related party doctrine has only been accepted for a limited purpose—therefore the extension of the doctrine to limitation provisions would be improper. Due to this decision, the Court did not address the foreseeability component that was raised by the court of appeals. The Court therefore did not provide any further guidance or clarification on which factors may be used to determine if a party is “closely related” to a contract.
The Court also discussed the tension between the closely related party doctrine and Arizona corporate law. The Court explained that by considering an individual’s ownership of a company as a strong indication that the owner is “closely related,” the doctrine essentially allows a party to pierce the corporate veil. The Court noted that under Arizona law, piercing of the corporate veil requires far more than proof of the existence of an ownership relationship. The Court held that these considerations weigh heavily against adopting the closely related party doctrine in this situation.
With these considerations in mind, the Arizona Supreme Court declined to apply the closely related party doctrine to nonparties in situations involving contractual provisions that limit when a party can bring a claim.
Impact on Arizona Businesses
This decision will directly impact companies that do business in Arizona, particularly those that provide professional services. Lengthy contracts govern the relationships between these businesses and their clients. Businesses cannot rely on the assumption that someone is sufficiently “closely related” to the transaction and will therefore be bound by provisions of the contract. Going forward, these businesses must ensure that their contracts include language that expressly binds all signatories and ensure that all relevant parties are signatories to the contract.