IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT
No. 97-20279
NAURU PHOSPHATE ROYALTIES, INCORPORATED, (Texas),
Plaintiff - Appellee
versus
DRAGO DAIC INTERESTS, INCORPORATED,
Defendant - Appellant
Appeal from the United States District Court for the Southern District of Texas
March 31, 1998
Before HIGGINBOTHAM and STEWART, Circuit Judges, and WALTER*, District Judge.
PATRICK E. HIGGINBOTHAM, Circuit Judge:
Drago Daic Interests, Inc. appeals a district court order
confirming the award granted to Nauru Phosphate Royalties (Texas),
Inc. in an arbitration proceeding. The arbitration panel
determined that DDI materially breached the Development Agreement
between Nauru and DDI and held the beneficiaries of the agreement,
Drago Daic, Trustee, and Montgomery-666, bound by its award. This
* District Judge of the Western District of Louisiana, sitting by designation. case asks us to determine whether Nauru’s liability on the
Promissory Note was properly before the arbitration panel. We hold
that the arbitration panel did not exceed its authority in ruling
on Nauru’s liability on the Promissory Note and AFFIRM the district
court’s judgment. We reject any suggestion that because Daic
Trustee and M-666 were not parties to the arbitration or to this
case, the breach of the Development Agreement and Nauru’s
consequent non-liability on the Promissory Note were beyond the
reach of the arbitration. Finally, the district court did not err
in concluding that DDI was responsible for Nauru’s loss of
reimbursement funds for 122 lots and for cost overruns incurred in
excavating a drainage ditch.
I.
In 1990, Nauru Phosphate Royalties, Inc., a Delaware
corporation, entered into a sale and development agreement with
three parties - (i) Drago Daic Interests, Inc., (ii) Drago Daic,
Trustee, and (iii) Montgomery 666, Ltd. Nauru purchased 668 acres
in Montgomery County, Texas, from Daic Trustee and M-666 for $5
million in cash and an $8 million Promissory Note. The Promissory
Note was secured by a Deed of Trust lien on the land being sold.
Nauru agreed to retain DDI, as developer, to develop the land into
an up-scale residential housing subdivision, called Bentwood, with
a country club, golf course and the like.
The Development Agreement and Promissory Note, when read
together, set up the following arrangement: Nauru was to fund all
2 monies necessary for the development project and be reimbursed for
all of its expenditures in a given calendar year from that year’s
revenue. If expenditures exceeded revenues, no payments would be
made other than to Nauru. Only if revenues exceeded expenditures
would payment be made on the Promissory Note. This was to continue
until the Promissory Note was fully paid or the project sold,
whichever came first. Stated directly, in the event that revenues
did not exceed expenditures, the noteholders, Daic Trustee and M-
666, would not be entitled to payment on the Promissory Note.
The project began in 1990 and continued into 1995. The
property never achieved enough cash flow to pay current expenses,
much less reimburse Nauru or make any payments on the Promissory
Note. DDI was dissatisfied with Nauru’s timeliness of funding,
Nauru was unhappy about the costs and expenses, and the
noteholders, Daic Trustee and M-666, were unhappy about not being
paid. Eventually, Nauru gave notice of intent to terminate DDI as
developer and instituted an arbitration proceeding.
In the arbitration, Nauru claimed DDI fraudulently induced
Nauru to enter into the transaction and to continue development
with various cost overruns. In addition, Nauru claimed that DDI
materially breached the Development Agreement and sought
indemnification from DDI for any liability on the contingent, non-
recourse Promissory Note to Daic Trustee and M-666. DDI
counterclaimed that Nauru’s actions caused the project to fail.
DDI also sought to recover “profits” which assertedly were due.
3 In 1996, the arbitration panel (2-1) determined that DDI had
committed thirteen material breaches of the Development Agreement
between the parties, and Nauru had committed three non-material
breaches of the Development Agreement. The panel responded to
Nauru’s claim for indemnification of any liability on the
Promissory Note by deciding that Nauru had no further liabilities
to DDI under the Development Agreement and that Nauru had no
liability for payment of the $8 million Promissory Note. This Note
was executed by Nauru and payable to the noteholders, Drago Daic,
Trustee and Montgomery-666, who were not parties to the arbitration
proceeding. Finally, the panel decided that DDI was liable to
Nauru for over $1.8 million as a result of DDI’s material breaches
of the Development Agreement.
Nauru then filed an action in district court to confirm the
arbitration award. DDI moved to dismiss for lack of jurisdiction
and also moved to vacate or modify the award. The district court
denied the motion to dismiss and referred the matter to a
magistrate judge, who recommended that the award be confirmed. In
1997, the district court accepted the magistrate judge’s findings
and recommendations and confirmed the arbitration award. This
appeal followed.
II.
4 We must first determine if there is federal jurisdiction. DDI
contends that the district court erred in sustaining federal
jurisdiction on the basis of diversity of citizenship2.
DDI is a Texas corporation with its principal place of
business in Texas and Nauru is a Delaware corporation. Complete
diversity turns here on the location of Nauru’s principal place of
business. Nauru argues that its principal place of business is in
Australia or Nauru, a small island republic in the south Pacific.
DDI argues Nauru’s principal place of business is in Texas.
This court applies a “total activity” test to determine the
principal place of business. J.A. Olson Co. v. City of Winona,
Miss., 818 F.2d 401, 411-12 (5th Cir. 1987). We look to the
nature, location, importance, and purpose of a corporation’s
activities and the degree to which those activities bring the
corporation into contact with the local community. Id. Three
general principles drawn from the insights of Professor Wright
guide the inquiry (see Wright, Federal Courts § 27, at 167-68 (5th
ed. 1994)):
(1) when considering a corporation whose operations are far flung, the sole nerve center of that corporation is more significant in determining principal place of business; (2) when a corporation has its sole operation in one state and executive offices in another, the place of activity is regarded as more significant; but (3) when the activity of a corporation is passive and the “brain” of the corporation is in another state, the situs of the corporation’s brain is given greater significance.
2 It is well-established that the Federal Arbitration Act does not create federal jurisdiction. Some independent jurisdictional basis, either diversity or federal question, must be shown. See, e.g., Baltin v. Alaron Trading Corp., 128 F.3d 1466, 1469 (11th Cir. 1997).
5 Olson, 818 F.2d at 411 (citations omitted).
DDI asserts that the second Olson principle is applicable and
locates Nauru’s principal place of business in Texas because, even
if its offices are in Nauru, its sole operations are in Texas.
Nauru contends the third Olson principle is applicable and
establishes its principal place of business in Nauru or Australia
because its investment in Bentwood is passive and the bulk of the
corporation’s activities involve managing its affairs from its
nerve center in Nauru or Australia. Thus, the critical inquiry
involves the nature and quality of Nauru’s activities with regard
to Bentwood.
The district court determined that at the time this action was
filed Nauru was a passive investor in land and its primary
activities were management-oriented. This determination is
supported by the record which indicates that Nauru’s nerve center
or “brain” is in Nauru or Australia, not in Texas. Bentwood is the
only investment asset of Nauru, which was formed for the sole
purpose of acquiring this asset. Nauru had four members on its
board of directors, each of whom is a citizen of and resides in
Nauru. Nauru has three officers - a president, a treasurer/
secretary and an assistant secretary. The president resides in
Nauru, the treasurer/secretary resides in Australia, and the
assistant secretary resides in Houston, Texas. Nauru maintains its
offices and staff in Nauru and Australia. The assistant secretary
functioned as a conduit of information to the directors and other
6 officers in Australia and Nauru, and the Nauru Board and its
officers made substantive and managerial-level decisions.
The single exception to the lack of significant operations at
Bentwood is the Bentwood Country Club which includes the golf
course and restaurant/bar and generates a significant amount of
gross revenue. The country club is operated by two wholly-owned
subsidiaries of Nauru - the Bentwood Country Club, Inc. and
Bentwood Private Club, Inc.
Other circuits have held that the operations of a subsidiary
are not to be imputed to a parent company for purposes of locating
the parent’s principal place of business, at least so long as the
subsidiary is not the alter ego of the parent. Taber Partners, I
v. Merit Builders, Inc., 987 F.2d 57, 61-63 (1st Cir.) cert.
denied, 510 U.S. 823 (1993); Danjaq S.A. v. Pathe Comm. Corp., 979
F.2d 772, 774-76 (9th Cir. 1992); Pyramid Sec. Ltd. v. IB
Resolution, Inc., 924 F.2d 1114, 1120 (D.C. Cir.), cert. denied,
502 U.S. 822 (1991). This court has attributed a subsidiary’s
citizenship to its parent company in alter ego situations where the
subsidiary’s wrongful conduct is at issue. Kuehne & Nagel (AG &
Co.) v. Geosource, Inc., 874 F.2d 283, 290-91 (5th Cir. 1989).
There is no evidence that the corporate form of Nauru’s
subsidiaries should be disregarded and the subsidiaries treated as
alter egos of Nauru.
The district’s court determination that Nauru’s principal
place of business is not in Texas is amply supported by the record
and hence is not clearly erroneous.
7 III.
A court “may not reconsider an award based on alleged errors
of fact or law or misinterpretation of the contract.” Exxon Corp.
v. Baton Rouge Oil & Chemical Workers Union, 77 F.3d 850, 853 (5th
Cir. 1996) (citing United Paperworkers Int’l Union v. Misco, Inc.,
484 U.S. 29, 36 (1987)); Executone Info. Sys., Inc. v. Davis, 26
F.3d 1314, 1320 (5th Cir. 1994) (“We must sustain an arbitration
award even if we disagree with the arbitrator’s interpretation of
the underlying contract as along as the arbitrator’s decision
‘draws its essence’ from the contract.”) (citations omitted). As
long as an arbitration award “is rationally inferable from the
letter or purpose of the underlying agreement,” the award should be
upheld regardless of alleged errors of law or fact. Executone, 26
F.3d at 1320.
A.
DDI contends that the arbitration panel’s decision regarding
Nauru’s liability on the Promissory Note was not enforceable since
the panel exceeded its authority. DDI urges that Daic Trustee and
M-666 signed the Development Agreement only with respect to Section
3.7 and Article 5, and the applicability of the Development
Agreement to them is limited to these provisions. Relatedly, DDI
contends that Daic Trustee and M-666 were not parties to the
arbitration, and the issue of Nauru’s liability on the Promissory
Note could not be decided in their absence.
8 Their arguments are not persuasive. At the outset, the
provisions of both the Development Agreement and the Promissory
Note reveal that the two documents are inextricably intertwined.
The first paragraph in the Promissory Note states in relevant part:
The terms of the Earnest Money Contract and the Development Agreement are hereby incorporated into this Note as if fully set forth in this Note.
Not only does it fully incorporate by reference the Development
Agreement, the Promissory Note is explicitly referenced throughout
the Development Agreement.
The arbitration clause in the Development Agreement provides:
Any dispute, controversy or claim arising out of or in connection with or relating to this Agreement or any breach or alleged breach hereof, shall, upon the request of any party involved, be submitted to and settled by arbitration in Houston, Texas pursuant to the rules then in effect of the American Arbitration Association.
As this court has noted, “[w]hen parties include such a broad
arbitration clause, they intend the clause to reach all aspects of
the relationship.” Valentine Sugars, Inc. v. Donau Corp., 981 F.2d
210, 213 n.2 (5th Cir.), cert. denied, 509 U.S. 923 (1993). Here,
Nauru’s demand for arbitration states that DDI’s failure to perform
pursuant to the Development Agreement affects its liability on the
Promissory Note. Thus, DDI knew that Nauru’s liability on the
Promissory Note was indeed an issue before the arbitration panel.
Further, by virtue of the two agreements, the Development
Agreement had to be performed without material breach by DDI in
order for the noteholders to be paid. Nauru’s duty to make payment
pursuant to the Promissory Note was a “conditional obligation,” and
Nauru had “certain set-off rights” against its obligation to pay
9 which were specified in the Development Agreement. By the very
terms of the Promissory Note, any material breach of the
Development Agreement by DDI would put payment on this Note at
risk. The evidence on record shows that Mr. Drago Daic wanted DDI
to be the developer of Bentwood pursuant to the Development
Agreement to ensure that the Promissory Note would be paid. Thus,
the Development Agreement and the Promissory Note were intimately
related to one another, and the district court did not err in
finding that the arbitration panel had the authority to rule on
Nauru’s liability on the Promissory Note since it was intimately
”related to” the Development Agreement. Indeed, it goes to the
heart of the dispute over DDI’s performance of the Development
Agreement.
The contention that the arbitration panel exceeded its
authority in finding no liability on the Promissory Note because
Daic Trustee and M-666 are not bound by the panel’s findings fails
in its premise. As effective third-party beneficiaries, the
noteholders may be precluded from litigating the issue of breach of
the Development Agreement in any subsequent proceeding and may be
bound by the panel’s finding of non-liability on Nauru’s part for
the Promissory Note. Guscott et al. v. City of Boston, 958 F.2d
361, 1992 WL 55889, at *3 (1st Cir. Mar. 25, 1992) (noting that
third-party beneficiary lacked right to enforce a contract for its
own benefit when contracting party breached a contractual condition
that had to be satisfied for third-party beneficiary to receive
payment); Restatement (Second) of Judgments § 56, cmt. a (“When a
10 judgment is entered in an action between the promisee and the
promisor that terminates the obligation so far as the promisee is
concerned..., it... discharges the obligation in favor of the
beneficiary.”); 18 Wright, Miller & Cooper, Federal Practice and
Procedure: Jurisdiction § 4460, at 530 (1981) (“Substantive rules
governing the rights of third-party beneficiaries ... shape
preclusion rules. So long as the promisee retains the power to
discharge the obligation of the promisor, the third-party
beneficiary is precluded by litigation between the promisee and
promisor.”); Restatement (Second) of Contracts § 309(2) & § 309(2)
cmt. b (“If a contract ceases to be binding in whole or in part
because of ... present ... failure of performance, the right of any
beneficiary is to that extent discharged or modified.” “Where
there is a contract, the right of a beneficiary is subject to any
limitations imposed by the terms of the contract.”).
Our decision to hold that the arbitration award effectively
decides any “right” of Daic Trustee and M-666 to be paid under the
Promissory Note is also supported by the district court’s findings.
The district court noted that DDI, which did participate in the
arbitration, had the same interests at stake as Daic Trustee and M-
666. The record in this case demonstrates that the man behind all
three entities - Daic Interests, Daic Trustee and M-666, - Mr.
Drago Daic3, fully participated in the arbitration proceedings.
3 The evidence on record establishes the following: Mr. Drago Daic is the sole owner of DDI. Mr. Drago Daic, as Trustee, represents the 3-D Trust, a verbal trust established by Mr. Drago Daic for his children and grandchildren.
11 The district court concluded that the two noteholders had notice
that liability on the Promissory Note would be resolved by the
arbitration panel since Nauru in its arbitration complaint
contested the demands made by Daic Trustee and M-666 for payment
pursuant to the Promissory Note. Thus, the record establishes that
there was sufficient identity of interests among the three
entities, DDI, Daic Trustee and M-666, that it would be fair and
appropriate to hold the noteholders bound by the panel’s finding of
non-liability on the Promissory Note.
It bears mention that an arbitration award may be enforced in
a subsequent proceeding against parties that did not participate in
an arbitration in circumstances when the parties to the arbitration
had related and congruent interests which were properly advanced
during the arbitration. See, e.g., Isidor Paiewonsky Assocs., Inc.
v. Sharp Properties, Inc., 998 F.2d 145, 155 (3d Cir. 1993)
(holding non-parties to arbitration clause since they have “related
and congruent interests” with the principals); Cecil’s, Inc. v.
Morris Mechanical Enters., Inc., 735 F.2d 437, 439-40 (11th Cir.
1984) (enforcing indemnification agreement between general
Fifty-five percent of M-666 is effectively controlled by Mr. Drago Daic. Another company owned and controlled by Mr. Drago Daic, Imperial Marketing, owns another 19.33 % of M-666. Mr. Drago Daic, individually, or in his capacity as Trustee, owns a 75% interest in the Promissory Note. The land which was sold to Nauru for the Bentwood development was initially purchased by Mr. Drago Daic in 1983 for approximately $3.8 million. Within 30 days of purchasing the land, Mr. Drago Daic sold the land at a substantial profit in equal 50% shares to Drago Daic, Trustee and M-666. Drago Daic, Trustee and M-666 entered into a joint venture agreement with respect to the land, with Mr. Drago Daic acting as managing joint venturer.
12 contractor and subcontractor even though underlying liability was
determined by arbitration to which subcontractor was not a party);
In re Oil Spill by the “Amoco Cadiz”, 659 F.2d 789, 795-96 (7th
Cir. 1981) (binding plaintiff to outcome of arbitration between its
principal and defendant even though plaintiff would be non-party to
arbitration proceedings).
We are cautious in concluding that an arbitration panel can
effectively determine the “rights” of the noteholders when they
were not formal parties to the arbitration. See First Options,
Inc. v. Kaplan, 115 S.Ct. 1920, 1924 (1995) (noting that “[c]ourts
should not assume that the parties agreed to arbitrate
arbitrability unless there is ‘clear and unmistakable’ evidence
that they did so”) (citations omitted). As a general matter, the
interests of judicial economy ought not to be furthered by drawing
non-parties within the gravitational force of an arbitration by
shortchanging their legitimate wish to pursue their claims in
court. That is not the case here. The non-parties to the
arbitration, Daic Trustee and M-666, were third-party beneficiaries
of the contract between the parties in arbitration with an interest
contingent upon faithful performance of the contract by DDI. When
DDI breached the Development Agreement, the noteholders’ interests
were necessarily at risk. The interests of DDI, Daic Trustee and
M-666 were identical and adequately represented by a party in
arbitration, DDI, and Daic Trustee and M-666 undoubtedly attempted
to enforce the Development Agreement against Nauru. The heart of
the matter is that the value of the Promissory Note depended
13 entirely upon performance by others over whom the noteholders had
no legal control -- not in the sense that their asset was
determinable by external market forces -- but by the very terms of
the Promissory Note they held. In these circumstances, the
district court did not err in finding a failure of a condition for
liability upon the Promissory Note, a decision that forecloses Daic
Trustee and M-666.
Finally, that the arbitration award effectively binds Daic
Trustee and M-666 preventing them from relitigating the breach of
the Development Agreement works no injustice. While Daic Trustee
and M-666 were not formal parties to the arbitration, they were
parties to the agreement to arbitrate. Since the Promissory Note
incorporated the Development Agreement by reference, the sweeping
arbitration clause in the Development Agreement bound both Daic
Trustee and M-666. Heinhuis v. Venture Assoc., Inc., 959 F.2d 551,
553-54 (5th Cir. 1992) (holding that parties to an excess insurance
policy, which incorporated by reference the underlying insurance
policy, were bound by the arbitration clause contained in the
underlying insurance policy). Indeed, in a letter dated February
9, 1995, Daic Trustee and M-666 attempted to enforce sections of
the Development Agreement, other than Sections 3.7 and 5, against
Nauru. An entity’s attempt to enforce an agreement that contains
an arbitration clause provides clear and unmistakable evidence that
the entity regards itself bound by the arbitration clause. See
Hughes Masonry Co. v. Greater Clark County Sch. Bldg. Corp., 659
F.2d 836, 839 (7th Cir. 1981); Sunkist Soft Drinks, Inc. v.
14 Sunkist Growers, Inc., 10 F.3d 753, 757-58 (11th Cir. 1993), cert.
denied, 513 U.S. 869 (1994); J.J. Ryan & Sons, Inc. v. Rhone
Poulenc Textile, S.A., 863 F.2d 315, 319-21 (4th Cir. 1988); McBro
Planning & Dev. Co. v. Triangle Elec. Constr. Co., 741 F.2d 342,
344 (11th Cir. 1984); Sam Reisfeld & Son Import Co. v. S.A. Eteco,
530 F.2d 679, 681 (5th Cir. 1976).
B.
The arbitration panel concluded that DDI was responsible for
Nauru’s loss of reimbursement funds for 122 lots located in the
Porter Municipal Utility District, which was calculated by the
panel to be $477,000.
DDI contends that the Development Agreement did not allow for
loss of reimbursement funds, but rather provided for an offset
against other amounts due under the Development Agreement and
Promissory Note. The Development Agreement provided with respect
to this expected MUD reimbursement expense:
It is anticipated that certain drainage, waste-water treatment, water purification and other utility facilities (the “Utility Improvement”) will be required to be constructed on the Property in connection with the Project. Developer expects that the Municipal Utility District (“M.U.D.”) to be formed to operate such Utility Improvements will purchase the Utility Improvements at a price equal to seventy percent (70%) of the cost incurred in constructing such Utility Improvements.
The arbitration record shows that some of the development property
was located in an existing MUD, the Porter MUD, while the rest of
the property was in a MUD created specifically for the development,
the Bentwater MUD.
15 DDI argues that the arbitration panel did not apply the proper
contractual remedy and miscalculated the amount of the award. We
are not persuaded. The arbitration panel’s implicit assumption
that this Section, which allowed for offsets of reimbursement
losses, did not apply to reimbursement losses associated with an
existing MUD, the Porter MUD, but rather was directed at a MUD to
be formed in the future, is an interpretation of this Section that
the arbitration panel was allowed to make. See Executone, 26 F.3d
at 1320.
The arbitration panel also concluded that DDI was responsible
for cost overruns incurred in excavating a large drainage ditch.
DDI contends that the arbitration panel’s decision that it should
reimburse Nauru for cost overruns on the drainage ditch is contrary
to principles of waiver under Texas law. DDI argues that Nauru
waived any right to complain about cost overruns since it failed to
object to a management decision made by DDI regarding the
excavation.
There is no evidence from the award itself that the
arbitration panel ignored Texas law on waiver. On the contrary,
the panel might reasonably have attributed the cost overruns to
DDI, which was found to have mismanaged the development project in
several material respects, and, under Section 6.1(c) of the
Development Agreement, DDI could be held responsible for these cost
overruns. The district court correctly confirmed the arbitration
award regarding the Porter MUD and the drainage ditch.
16 IV.
We hold that the district court had jurisdiction and did not
err in confirming the arbitration award.
AFFIRMED.