General contractors appreciate the importance of understanding the provisions in their own contracts. However, understanding the provisions contained in other parties’ contracts on the same Project can be just as important at times.
For example, in some circumstances, a person or company that did not sign a contract with an arbitration clause may still be subject to that clause if certain conditions are met. This can happen under a legal principle known as “direct benefits estoppel.”[1] Under this theory, a non-party to a contract can still be held subject to certain terms of the contract, including arbitration provisions. As a general matter, this can occur when the non-signing party acts as if it was a party to that agreement—for example, by trying to direct work under that agreement—and does so directly for its own benefit. In other words, the non-signing party behaves as if it is actually a party to the contract in an effort to directly benefit from the terms of that contract.
This article discusses the implications and application of this theory to arbitration agreements, and it also provides several examples to better describe the application of this theory. It also gives guidance to general contractors on ways to potentially avoid unintentionally subjecting themselves to an arbitration provision they did not sign.
Direct Benefits Estoppel
The general, well recognized rule is that arbitration agreements only bind the parties that agreed in writing to submit their disputes to arbitration.[2] But direct benefits estoppel is an important exception to the general rule. The basic premise of this theory is that a non-party to a contract cannot directly insert itself into the execution of that contract in order to benefit itself, without otherwise being bound by the terms of that contract. Stated differently, if a non-signatory wants to enforce and benefit from certain terms of a contract signed by two other parties, it will essentially be bound to all parts of that contract—including, for example, arbitration provisions in that agreement.
Seeking Direct Benefits
When a non-signing party acts like, or otherwise directly demands to be treated like, a signing party during the life of the contract, it could be subject to the contract’s arbitration provision (as well as other provisions in the contract). Imagine this example: A general contractor hires a subcontractor. In that subcontract, there is no arbitration provision. Then, the subcontractor hires a sub-subcontractor. The sub-subcontract contains an arbitration provision. The general contractor is not a party to that sub-subcontract and generally would not be bound by its arbitration provision. However, the general contractor may assert a claim against the subcontractor. The subcontractor could then flow that claim down to the sub-subcontract, claiming that the sub-subcontractor is at fault. In that scenario, the general contractor could be tempted to demand that the sub-subcontractor pay the general contractor directly for those claims, including by citing (and seeking to enforce) certain provisions in the sub-subcontract. However, by trying to benefit directly from the sub-subcontract through direct enforcement of its terms, the general contractor could be bound to the sub-subcontract’s arbitration provision.
In this example, the general contractor sought to benefit directly from the sub-subcontract (and it was not otherwise a third-party beneficiary under that contract). And it sought to do so by trying to enforce, or otherwise direct performance pursuant to, the terms of that contract. Essentially, the general contractor sought to directly insert itself into someone else’s contract to directly benefit from it. This is different than simply benefiting, directly or indirectly, from the performance of the contract. The key is that the non-signatory behaves as if it is a signing party to the contract.
As a final note, the general contractor in our example does not receive a “direct benefit” from the sub-subcontract simply just by the sub-subcontractor performing work on the project.[3] The key distinction is that the general contractor inserts itself into the performance of the sub-subcontract, rather than sitting by while the subcontractor works to enforce the terms of the sub-subcontract.
In re Weekley Homes, L.P.—a 2005 Texas Supreme Court case—offers another good example of the application of this doctrine.[4] In this case, a father contracted with a homebuilder to build a home. The contract contained an arbitration provision. The father intended to live in the home with his daughter, who did not sign the contract. Even though the daughter did not sign the contract, she nonetheless directed the homebuilder’s work so that aspects of the home were constructed to her liking. She also made demands for repairs, and received reimbursements for expenses incurred during repairs, from the builder. The daughter and father then filed suit against the homebuilder. The daughter did not sue under a breach of contract theory (the father did sue for breach of contract). However, the court still compelled the daughter to arbitrate her claims, even though she was not a signatory to the contract and would not have otherwise been bound to the contract’s arbitration provision. The court did so because the daughter “deliberately sought substantial and direct benefits from the contract….”[5] The key is that the daughter acted like she was a party to the contract for her own benefit. And therefore, the court held her to that contract’s arbitration provision.
Benefits Must Be Directly From the Contract
For a non-party to be bound to an arbitration provision under this theory, the claim asserted must be rooted in the performance of the contract containing the arbitration provision—the claim cannot be “independent of the contract.”[6] And not all claims suffice to subject a non-party to an arbitration provision they did not sign. The claim asserted by the non-party must specifically seek to enforce the contract containing the arbitration agreement, like when a non-signing party joins in the breach of contract claims of a signing party.[7] Again, the non-signing party becomes subject to the arbitration provision by attempting to enforce other parts of the contract for its own benefit.
Conversely, a non-signing party will not be bound to an arbitration clause if it artfully couches its claims outside the direct performance of a specific contractual term. For example, if a homeowner’s association sues a builder for a breach of statutory warranty, the homeowner’s association is generally not bound to an arbitration agreement between the general contractor and developer.[8] This is because the statutory claim exists with or without the contract. Therefore, the claim does not depend on the contract.
Implications
Many general contractors may prefer arbitration over litigation. However, it is important to understand the applicable dispute resolution forum, including the impact that the direct benefits estoppel doctrine might have on this. For example, imagine a project and related arbitration between the general contractor and subcontractor is ongoing in Florida. Suddenly being subject to arbitration with a sub-subcontractor in Washington could be inefficient and expensive.
Additionally, there could be instances where a party has assessed the benefits and risks, and decides that it actually wants disputes to be litigated rather than arbitrated. In some cases, the implications of having to arbitrate in an unfamiliar or unfriendly forum could be significant enough to make asserting a claim untenable.
Tips/Conclusion
Not every jurisdiction applies this theory in the same way. For example, Illinois state courts have not applied the direct benefits estoppel theory.[9] However, other jurisdictions are much more willing to apply direct benefits estoppel (as noted above). It is important to recognize that there is not a universal application. And it also important to understand the applicable law.
Most general contractors are familiar with the potential benefits of including arbitration provisions in their contracts. When a project involves many subcontractors and sub-subcontractors, having an idea of what provisions are in other parties’ contract is just as critical. The direct benefits estoppel theory can be thought of as the “no cherry picking” theory. One cannot seek to directly enforce certain provisions of a contract while seeking to avoid an arbitration provision contained in that contract.
Overall, every arbitration provision, every jurisdiction, and every case are different. But knowing that there are times when you could be subject to an arbitration provision that you did not sign is an important step to avoiding unintended consequences.
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[1] While third-party beneficiary status adds another complex and important layer to this discussion, this article leaves that discussion for another day.
[2] AT&T Techs. v. Communs. Workers of Am., 475 U.S. 643, 648-49 (1986) (finding that “arbitrators derive their authority to resolve disputes only because the parties have agreed in advance to submit such grievances to arbitration.”).
[4] In re Weekley Homes, L.P., 180 S.W.3d 127, 129 (Tex. 2005).
[5] Id. at 134.
[6] Paquin v. Campbell, 378 So. 3d 686, 691 (Fla. Dist. Ct. App. 2024) (holding that direct benefits estoppel did not bind a non-signatory to an arbitration provision when the claims asserted were not breach of contract, but were tort claims and “actions independent of the contracts.”).
[7] In re FirstMerit Bank, N.A., 52 S.W.3d 749, 755-566 (Tex. 2001).
[8] R.J. Griffin & Co. v. Beach Club II Homeowners Ass’n., 384 F.3d 157, 159 (Fla. Dist. Ct. App. 2004).
[9] Schultz v. Sinav Ltd., 248 N.E.3d 10, 51 (Ill. App. Ct. 2024).