A familiar scenario: After an intensive mediation, the parties draft a term sheet intended to be binding and to replace their existing contract which included an arbitration clause. A formal settlement agreement cannot be reached, however, and the parties disagree on the legal effect of the term sheet. What now? Is the dispute for the court or arbitrators to decide? This scenario was presented to the First Circuit in McKenzie v. Brannan.
During the 1960s U.S. Pop Art Movement, artist Robert Indiana produced renderings of the word “love” featuring all capital letters arranged in a square, with the L and a tilted O resting on the V and E. Indiana’s “LOVE” has been depicted on prints, sculptures and even a postage stamp, and it is one the most famous images of the Pop Art Movement. Upon his death, Indiana’s artistic endeavors left him with an estate valued at nearly $90 million.
Indiana had collaborated with Michael McKenzie, an art publisher, on the commercialization of images of his HOPE artwork. Their ensuing HOPE collaboration was codified in a 2008 publishing agreement permitting McKenzie to sell various items with the HOPE image. The 2008 agreement included a standard American Arbitration Association (AAA) arbitration clause. When Indiana died in 2018, his rights under the 2008 agreement passed to his estate, the sole beneficiary of which was the Star of Hope, a non-profit arts institution based in Maine.
Various disagreements arose among entities affiliated with the artist. The Morgan Art Foundation filed a federal lawsuit against McKenzie and Indiana (and later his estate) in New York for breach of contract, and McKenzie and the estate exchanged crossclaims. The estate moved to compel arbitration on McKenzie’s claims under the 2008 agreement, and McKenzie consented to arbitration.
Concerned that the New York proceedings were depleting funds that should be going to the non-profit Star of Hope, the attorney general of Maine fostered an agreement between McKenzie and the estate to mediate their disagreements. In 2019, after a two-day mediation, the parties executed a “Term Sheet” “intended to be binding” that would be replaced by a “more formal Settlement Agreement.” That more formal agreement did not materialize, so the estate recommenced the arbitration. McKenzie quickly filed suit in Maine seeking a declaration that the term sheet was binding and enjoining the arbitration. The estate argued that the term sheet was not binding because it was subject to further negotiation. It moved to enforce the arbitration clause in the 2008 agreement and argued that any doubt about arbitrability should be decided by the arbitrators.
The district court agreed with the estate and ruled that if the “AAA Panel determines that the dispute is arbitrable and proceeds to the merits, the Court will likely dismiss the case without prejudice …” The AAA panel ruled that the enforceability of the term sheet should be decided in arbitration, the district court dismissed McKenzie’s action, and McKenzie appealed.
The First Circuit focused on the question of who holds the authority to decide arbitrability, and it applied the presumption that the court must decide that gateway issue unless the parties have agreed by “clear and unmistakable evidence” to delegate that matter to the arbitrators. According to the court, McKenzie’s claim that the parties intended the term sheet to supersede and terminate the 2008 agreement and its broad arbitration clause meant that there was not sufficient clear and unmistakable evidence of such a delegation. And because McKenzie challenged the applicability and enforceability of the 2008 agreement’s arbitration clause, the court must resolve the disagreement as to whether the arbitration clause applies.
Ultimately, the First Circuit remanded the case for further proceedings to resolve whether the term sheet is a binding contract that terminated the 2008 agreement and extinguished its arbitration provision. And so, the LOVE story continues.
Practice Point
When crafting a term sheet that memorializes an agreement reached during a mediation, the parties need to focus on what happens if they fail to agree upon a formal written settlement agreement. It is not enough to say that the term sheet is intended to be an enforceable agreement; its enforceability may still be challenged in court. Just as important, the term sheet should specify who decides any future disagreements about the term sheet: the court or one or more arbitrators. As is clear from the LOVE festivities, a failure to specify who decides may lead to extensive legal wrangling and expense.
https://www.americanbar.org/groups/litigation/committees/alternative-dispute-resolution/practice/2022/mcKenzie-v-brannan-a-never-ending-love-story/ (February 23, 2022)
Published in Section of Litigation-Alternative Dispute Resolution Practice Point, February 23, 2022 © 2022 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
