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Current Developments in the Commercial Divisions of the
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Posted: August 25, 2015

Contract’s Arbitration Clause Enforced Despite Alleged Fraud Relating to Contract

On August 19, 2015, the Second Department issued a decision in Ferrarella v. Godt, 2015 NY Slip Op. 06571, enforcing an arbitration clause in a contract notwithstanding allegations that the contract had been fraudulently induced.

In Ferrarella, the the plaintiff brought an action relating to a stock purchase agreement. The defendant moved to compel arbitration. The Second Department affirmed the trial court’s order granting the motion, explaining:

[A]n arbitration clause is generally separable from substantive provisions of a contract, so that an agreement to arbitrate is valid even if the substantive provisions of the contract are induced by fraud. However, if a party can demonstrate that the alleged fraud was part of a grand scheme that permeated the entire contract, including the arbitration provision, the arbitration provision should fall with the rest of the contract. To demonstrate that fraud permeated the entire contract, it must be established that the agreement was not the result of an arm’s length negotiation or the arbitration clause was inserted into the contract to accomplish a fraudulent scheme.

(Internal quotations and citations omitted) (emphasis added). Applying this standard, the Second Department agreed with the trial court that the arbitration clause should be enforced, although a dissenter argued “that [the] arbitration be temporarily stayed pending an evidentiary hearing . . . to determine whether a valid arbitration agreement” existed.

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