Portfolio Hotels, LLC v. 1250 North SD, LLC et al
Filing
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Order Granting Petition to Compel Arbitration (ECF No. 1 ). The parties are ordered to submit the dispute regarding the Management Agreement only for arbitration. The Court defers to the parties if they choose to put out Arbitration to a later date. Case administratively closed. Signed by Judge Cynthia Bashant on 9/8/21. (jmo)
Case 3:21-cv-00314-BAS-MSB Document 19 Filed 09/09/21 PageID.589 Page 1 of 12
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UNITED STATES DISTRICT COURT
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SOUTHERN DISTRICT OF CALIFORNIA
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PORTFOLIO HOTELS, LLC,
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v.
Case No. 21-cv-00314-BAS-MSB
Petitioner, ORDER GRANTING PETITION TO
COMPEL ARBITRATION
(ECF No. 1)
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1250 NORTH SD, LLC; SAN DIEGO
HOTEL CIRCLE OWNER, LLC,
Respondents.
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Portfolio Hotels, LLC brings this Petition to Compel Arbitration (ECF No. 1
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(“Petition”)). Respondents 1250 North SD, LLC and San Diego Hotel Circle Owner, LLC
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oppose the Petition (ECF No. 11 (“Opposition”)).
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(“Reply”)). Following oral argument and for the reasons stated below, the Court GRANTS
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the Petition and orders the parties to arbitration.
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I.
Petitioner replies (ECF No. 13
STATEMENT OF FACTS
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The Respondents in this matter, San Diego Hotel Circle Owner, LLC (“SDHCO”)
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and 1250 North San Diego, LLC (“1250 North”) operated the DoubleTree by Hilton, San
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Diego in Mission Valley (the “Hotel”). (Pet. ¶ 9.) According to Petitioner’s counsel at
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oral argument, Oak Coast was an 80% owner of the Hotel. The Respondents entered into
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a Management Agreement with Petitioner Portfolio Hotels, LLC (“Portfolio”) to manage
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the Hotel. (Pet. ¶¶ 10–11; Ex. A to Pet. (“Management Agreement”).)1 The Management
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Agreement is summarized below.
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Ladder Capital Finance, LLC (“Ladder”) lent money to related entities, San Diego
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Hotel Circle Mezzanine, LLC (“SDHC Mezzanine”) and 1250 North San Diego
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Mezzanine, LLC (“1250 North Mezzanine”) pursuant to a loan agreement. As part of that
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loan agreement, Respondents, Portfolio, and Ladder entered into a Subordination
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Agreement under which Respondents assigned the Management Agreement between
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Respondents and Portfolio to Ladder and agreed that Portfolio would “subordinate its
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interest in the Management Fees” to the liens and security interests created for the benefit
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of Ladder. (Ex. B to Opp’n.) 2 The terms of the Subordination Agreement are set out
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below.
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At some point, Ladder declared the parties were in violation of the loan agreement
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because the Hotel had been transferred to CHRG Perillo and Ladder declared the parties to
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be in default. The Hotel, which had been offered as collateral for the loan, was bought at
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auction by Ladder’s affiliate LSDDT, LLC. (Pet. ¶ 16.) Portfolio demanded unpaid
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management fees and payroll-related expenses for the time period before Ladder had
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defaulted on the property, and LSDDT, LLC terminated Portfolio as the property manager
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of the Hotel.
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Ladder and SDHCO filed a lawsuit in the Supreme Court of New York. The first
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cause of action was for declaratory judgment, requesting that the court declare that any
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amounts due to Portfolio under the Management Agreement are subordinate to the lender’s
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rights under the Subordination Agreement. The second cause of action was for breach of
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the Management Agreement, alleging Portfolio mismanaged the Hotel. The New York
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judge granted Portfolio’s motion to dismiss the second cause of action for lack of subject
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matter jurisdiction.
The judge found that the Management Agreement and the
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All exhibits to the Petition are attached in a single docket entry. (See ECF No. 1-2.)
All exhibits to the Opposition are attached in a single docket entry. (See ECF No. 11-1.)
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Subordination Agreement were separate agreements and that the Management Agreement
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was required to be heard in California court. That ruling is currently on appeal.
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A.
Management Agreement
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The Management Agreement was entered into on March 23, 2015 between SDHCO
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and 1250 North (the “Owners”) and Portfolio (the “Manager”) for a term of ten years and
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concerned the management of the Hotel, including how it would operate, calculation of
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management fees, expenditures for the Hotel, and insurance and indemnification, among
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other issues. The Management Agreement stipulated that it would be governed in all
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respects by the laws of the State of North Carolina. (Management Agreement § 20.) It
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further has a forum selection clause requiring that “any action brought to enforce any of
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the provisions of the agreement shall be instituted in a court of competent jurisdiction in
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Ssan [sic] Diego, California.” (Id.)
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Of particular relevance to this lawsuit, the Management Agreement stipulated that
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“[t]he parties shall submit any dispute concerning this Agreement, including the
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interpretation of or the enforcement of rights and duties hereunder to final and binding
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arbitration by a licensed attorney . . . who has had at least 15 years of experience in
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negotiating, drafting and/or interpreting hotel management agreements.” (Management
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Agreement § 14.) The Management Agreement outlined the method for choosing an
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arbitrator: “In the event the parties cannot mutually agree on an Arbitrator within five
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business days, the Manager shall select one Arbitrator and Oak Coast shall select one
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Arbitrator within five business days thereafter.” (Id.) The Management Agreement further
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provided that “[t]he arbitration shall be held at 10:00 am on the 10th Business Day after
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the arbitrator is selected at the office of the Arbitrators unless the parties agree in writing
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to a different time or date.” (Id.) “There will be no discovery prior to the arbitration.”
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(Id.) “The Arbitrator will have three business days after arbitration to issue a decision as
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to whether consent was reasonably withheld.” (Id.)
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The Management Agreement was signed by Graham Hershman on behalf of
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Portfolio, by Graham Hershman as President of SDHCO, and by Phillip Nahas as President
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of 1250 North. 3 (Id.)
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B.
Subordination Agreement
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The Subordination Agreement (“a Conditional Assignment of Management
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Agreement and Subordination of Management Fees”) was entered into four days later
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between Ladder, SDHCO, 1250 North, and Portfolio. In the Subordination Agreement,
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SDHC Mezzanine and 1250 North Mezzanine agreed to a Promissory Note indebted to
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Ladder in the amount of $5,750,000. (Subordination Agreement, Recitals C.) In exchange,
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Ladder required that the borrowers assign the previously described Management
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Agreement to Ladder, and that Portfolio agree to subordinate its interest in the management
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fees to the loan amount. As additional collateral for the Loan, the borrowers agreed to
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conditionally transfer and assign to Ladder all of the Borrower’s rights, title, and interest
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in the Management Agreement. (Id. § 1.) Furthermore, Portfolio agreed it “shall . . . not
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contest or impede the exercise by [Ladder] of any right it has under or in connection with
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this Assignment.” (Id. § 7.)
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Portfolio agreed that the Management Agreement, fees, liens, rights, and interests it
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held are “subordinate and inferior to the liens and security interests” created for the benefit
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of Ladder. (Subordination Agreement § 2.) Upon default, Ladder may terminate the
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Management Agreement. (Id. § 4.) Finally, “[i]n the event of any inconsistency between
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the terms and conditions hereof and the terms and conditions of the Management
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Agreement,” the parties agreed that “the terms and conditions set forth in this Assignment
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shall govern.” (Id. § 22.)
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According to Petitioner’s counsel at oral argument, Portfolio and SDHCO were both owned by
related LLCs, and ultimately by the same individuals including Graham Hershman. Portfolio owned 20%
of the Hotel. Oak Coast and 1250 North were owned by different LLCs and individuals than Portfolio
and SDHCO and owned 80% of the Hotel.
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The parties agreed that any dispute involving the Subordination Agreement would
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be governed by New York law, and they agreed that any lawsuit would be filed in federal
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or state court in the City of New York. (Subordination Agreement § 13b.)
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The Subordination Agreement was signed by “Borrowers” Phillip Nahas as
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President of 1250 North Mezzanine; Graham Hershman as President of SDHC Mezzanine;
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Mark Ableman as Executive Director of Ladder; and Graham Hershman on behalf of
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Portfolio.
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II.
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ANALYSIS
A.
Choice of Law
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“In a diversity case, the district court must apply the choice-of-law rules of the state
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in which it sits.” Abogados v. AT&T, Inc., 223 F.3d 932, 934 (9th Cir. 2000) (citing Klaxon
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Co. v. Stentor Elec. Mfg. Co., 313 U.S. 487, 496 (1941); Ledesma v. Jack Stewart Produce,
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Inc., 816 F.2d 482, 484 (9th Cir. 1987)). California law “reflects a strong policy favoring
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enforcing [choice-of-law] provisions” in contracts negotiated at arm’s length. Nedlloyd
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Lines B.V. v. Superior Court, 3 Cal. 4th 459, 465 (1992). Thus, the choice-of-law provision
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in the Management Agreement should be enforced unless the chosen state, North Carolina,
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“has no substantial relationship to the parties or the transaction or there is no other
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reasonable basis for the parties’ choice.” Id. Alternatively, the choice-of-law provision in
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a contract should not be enforced if “application of the law of the chosen state would be
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contrary to the fundamental policy of a state which has a materially greater interest than
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the chosen state in the determination of a particular issue” and which “would be the state
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of the applicable law in the absence of an effective choice of law by the parties.” Id.
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Although the parties dispute whether North Carolina law or California law should
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be applied in this case, they both conceded at oral argument that the ultimate choice-of-law
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likely has no effect on the ultimate issue, since the laws on arbitration in both jurisdictions
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are the same.
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In this case, the Management Agreement clearly has a choice-of-law provision that
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specifies North Carolina law should be applied. Respondents argue this provision should
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not be enforced because there is no substantial relationship between North Carolina and
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the parties or the transaction and there is no other reasonable basis for this choice.
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Petitioner counters that the original parties to the Management Agreement owned three
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hotels with similar management agreements, one of which was in North Carolina.
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Ultimately, the Court finds that there is a sufficient relationship with North Carolina
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to apply the choice-of-law provision in the Management Agreement. But, as laid out
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below, the Court finds no distinguishable differences between the law of the two
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jurisdictions.
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B.
Colorado River Doctrine
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Respondents ask this Court to stay or dismiss the action under the “Colorado River
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doctrine” because of the pending state court matter in New York. Colorado River Water
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Conservation Dist. v. United States (“Colorado River”), 424 U.S. 800 (1976). “Abstention
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from the exercise of federal jurisdiction is the exception not the rule.” Seneca Ins. Co.,
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Inc. v. Strange Land, Inc., 862 F.3d 835, 841 (9th Cir. 2017) (quoting Colorado River, 424
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U.S. at 813). “[F]ederal courts have a ‘virtually unflagging obligation . . . to exercise the
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jurisdiction given them.’” Id.; see also Smith v. Cent. Ariz. Water Conservation Dist., 418
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F.3d 1028, 1033 (9th Cir. 2005) (holding that a stay under the Colorado River doctrine
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occurs only in “exceedingly rare” circumstances).
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“Nevertheless, abstention is considered appropriate in a few well-defined areas to
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ease friction between federal and state sovereigns.” American Intern. Underwriters
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(Philippines), Inc. v. Cont’l Ins. Co., 843 F.2d 1253, 1257 (9th Cir. 1988). Thus, when
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allowing a state court to construe state law or to address difficult questions of state law
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involving policy issues, or where federal jurisdiction has been invoked to restrain state
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criminal proceedings, Colorado River may be applicable. Id. Factors to consider include:
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(1) which court first assumed jurisdiction over any property at stake; (2) the
inconvenience of the federal forum; (3) the desire to avoid piecemeal
litigation; (4) the order in which the forums obtained jurisdiction; (5) whether
federal law or state law provides the rule of decision on the merits; (6) whether
the state court proceedings can adequately protect the rights of the federal
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litigants; (7) the desire to avoid forum shopping; and (8) whether the state
court proceedings will resolve all the issues before the federal court.
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Seneca Ins., 862 F.3d at 841–42. “These factors are not a ‘mechanical checklist.’” Id.
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(quoting Moses H. Cone Mem’l Hosp. v. Mercury Construct. Corp., 460 U.S. 1, 16 (1983)).
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“Rather . . . we examine them in ‘a pragmatic, flexible manner with a view to the realities
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of the case at hand.’” Id. (quoting Moses H. Cone, 460 U.S. at 2).
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With respect to the final factor, the question “is whether the state court proceeding
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sufficiently parallels the federal proceedings. Although we have not always required ‘exact
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parallelism,’ the two actions must be ‘substantially similar.’” R.R. Street & Co., Inc. v.
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Transport Ins. Co., 656 F.3d 966, 982 (9th Cir. 2011) (quoting Nakash v. Mariciano, 882
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F.2d 1411, 1416 (9th Cir. 1989)). “‘[T]he existence of a substantial doubt as to whether
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the state proceedings will resolve the federal action precludes’ a Colorado River stay or
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dismissal.” R.R. Street, 656 F.3d at 982 (quoting Cent. Ariz. Water Conservation Dist.,
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418 F.3d at 1028); see also Intel. Corp. v. Advanced Micro Devices, Inc., 12 F.3d 908, 913
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(9th Cir. 1993). “When a district court decides to dismiss or stay under Colorado River, it
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presumably concludes that the parallel state-court litigation will be an adequate vehicle for
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the complete and prompt resolution of the issues between the parties. If there is any
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substantial doubt as to this, it would be a serious abuse of discretion to grant the stay or
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dismissal at all.” Intel Corp., 12 F.3d at 913 (quoting Moses H. Cone, 460 U.S. at 28)
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In this case, there is a substantial doubt as to whether the litigation in New York state
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court will resolve the federal action. The State Court Judge has already refused to rule on
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the Management Agreement, finding that the issue should be litigated in California.
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Although that issue is currently on appeal, the Court finds it likely that the appellate court
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will find, as this Court does below and as the New York Supreme Court already found, that
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the Management Agreement is separate and distinct from the Subordination Agreement.
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Thus, the likelihood of inconsistent or piecemeal litigation is remote. Furthermore, the
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Hotel at issue is in California, and ruling on the Management Agreement does not impact
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any New York state policy questions. Therefore, the Court declines to apply the Colorado
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River doctrine to this case.
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C.
Precedence of Subordination Agreement
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Respondents next argue that the Petition should be denied “because it violates
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Portfolio’s explicit agreement in the Subordination Agreement to not contest any exercise
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by Lender of its rights thereunder.” (Opp’n at 18–21.) Ladder points out that the
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Subordination Agreement, by its terms, takes precedence over the Management
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Agreement. (Subordination Agreement § 22.)
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However, the fact that Portfolio is seeking fees allegedly due under the Management
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Agreement is not contesting the right of Ladder to subordinate any fees owed to the
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underlying debt. The two agreements are separate: one concerns whether Portfolio is
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entitled to management fees at all and the other concerns who gets the money that is owed
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first. There is no inconsistency between Portfolio seeking a declaration that it is owed fees
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and its agreement to allow Ladder to get paid first.
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Agreement does not control the issue raised by this petition: whether Portfolio is owed fees
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at all.
Therefore, the Subordination
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D.
Unconscionability of Arbitration Provision
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Respondents argue that even if this Court refuses to stay or dismiss the Petition
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pursuant to the Colorado River doctrine and finds the Subordination Agreement is not
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controlling, it should still refuse to enforce the arbitration provision in the Management
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Agreement because the provision is unconscionable.
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If a party challenges the validity of an arbitration provision as unconscionable, the
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federal court must consider the challenge before ordering compliance with the term. Rent-
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a-Center, West, Inc. v. Jackson, 561 U.S. 63, 71 (2010). “[Q]uestions of arbitrability must
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be addressed with a healthy regard for the federal policy favoring arbitration.” Moses H.
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Cone, 460 U.S. at 24. “[A]ny doubts concerning the scope of arbitrable issue should be
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resolved in favor of arbitration.” Id. at 25.
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“While federal policy favors arbitration agreements, federal courts rely on state law
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when addressing issues of contract validity and enforceability.” Laster v. T-Mobile, 407
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F. Supp. 2d 1181, 1186 (S.D. Cal. 2005) (citing Ticknor v. Choice Hotels Int’l, Inc., 265 F.
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3d 931, 936–37 (9th Cir. 2001)). “North Carolina has a strong public policy favoring
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arbitration.” Crossman v. Life Care Ctrs. of Am., Inc., 225 N.C. App. 1, 4 (2013) (quoting
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Raper v. Oliver House, LLC, 180 N.C. App. 414, 419 (2006)); see also Bigler v. Harker
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School, 213 Cal. App. 4th 727, 735 (2013) (“‘California courts have uniformly
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acknowledged that there is a strong public policy in favor of arbitration.’ Thus, ‘doubts
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concerning the scope of arbitrable issues are to be resolved in favor of arbitration.’”)
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(quoting Young Seok Suh v. Super. Ct., 181 Cal. App. 4th 1504, 1511–12 (2010)).
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However, “as a general rule, [North Carolina] courts will not enforce unconscionable
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contracts.” Rite Color Chem. Co., Inc. v. Velvet Textile Co., Inc., 105 N.C. App. 14, 18
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(1992); see also Armendariz v. Found. Health Psychcare Servs., Inc., 24 Cal. 4th 83, 114
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(2000) (“[A] [California] court can refuse to enforce an unconscionable provision in a
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contract.”).
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“[U]nconscionability is an affirmative defense,” and “the party asserting the defense
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has the burden of establishing that the agreement was unconscionable.” Westmoreland v.
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High Point Healthcare, Inc., 218 N.C. App. 76, 80 (2012) (citing Tillman v. Com. Credit
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Loans, 362 N.C. 93, 101 (2008) (plurality opinion)); Rite Color Chem., 105 N.C. App. at
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20; see also Bigler, 213 Cal. App. 4th at 735 (noting that the party opposing arbitration has
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the burden of proving the defense of unconscionability). To establish unconscionability, a
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party
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unconscionability. Westmoreland, 218 N.C. App. at 80.; see also Armendariz, 24 Cal. 4th
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at 114. “[B]oth elements must be present, but a court may rule a contract is unconscionable
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when the contract presents pronounced substantive unfairness and a minimal degree of
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procedural unfairness or vice versa.” Westmoreland, 218 N.C. App. at 80; see also
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Armendariz, 24 Cal. 4th at 114.
must
demonstrate
both
procedural
unconscionability
and
substantive
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“Procedural unconscionability” arises when the bargaining that led to the contract
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involved “unfair surprise, lack of meaningful choice and inequality of bargaining power.”
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Westmoreland, 218 N.C. App. at 80; see also Bigler, 213 Cal. App. 4th at 736 (procedural
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unconscionability “focuses on oppression, surprise and the manner in which the agreement
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was negotiated”).
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oppressive contract terms.” Westmoreland, 218 N.C. App. at 84; see also Bigler, 213 Cal.
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App. 4th at 736 (finding that substantive unconscionability “focuses on ‘the actual terms
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of the agreement and evaluates whether they create such overly harsh or one-sided results
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as to shock the conscience’” (quoting Young Seok Suh, 181 Cal. App. 4th at 1514)). “A
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court will generally refuse to enforce a contract on the ground of unconscionability only
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when the inequality of the bargain is so manifest as to shock the judgment of a person of
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common sense and where the terms are so oppressive that no reasonable person would
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make them on the one hand, and no honest and fair person would accept them on the other.”
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Brenner v. Little Red School House, Ltd., 302 N.C. 207, 214 (1981); see also Bigler, 213
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Cal. App. 4th at 736.
“Substantive unconscionability” “refers to harsh, one-sided and
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Respondents have failed to demonstrate that either procedural or substantive
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unconscionability exists in this case. All parties are legal entities, not individuals, with
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equal bargaining power. There is no evidence that there was any “unfair surprise” or “lack
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of meaningful choice.” Respondents argue that the parties to the Management Agreement
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were all “owned and controlled by the same individuals.” (Opp’n at 22.) And since “the
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parties were affiliates,” they “had no interest in ensuring that the various provisions of the
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Management Agreement would be fair and reasonable.” (Id. at 23.) The Court disagrees.
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First of all, assuming that a unity of interest when executing the contract can rise to the
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level of procedural unconscionability—a questionable supposition—there is insufficient
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evidence that all parties to the Management Agreement were “owned and controlled by the
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same individuals.” Although it appears there was a unity of interest between Portfolio and
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SDHCO, there is no claim that 1250 North or Oak Coast, also parties to the negotiation,
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were owned or controlled by the same individuals.
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Nor is there any evidence that the agreement was “one-sided” or “oppressive.” The
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arbitration agreement is not one that “shocks the conscience.” Respondents argue that five
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provisions make the agreement substantively unconscionable: (1) the agreement that the
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arbitration must occur within ten days; (2) the prohibition on discovery; (3) the rule that
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the Arbitrator much reach a decision within three days; (4) the limited pool of Arbitrators;
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and (5) the rule that the parties must choose an Arbitrator within five days. With respect
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to the timing of the Arbitration and Arbitrator’s decision, the Agreement actually provides
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that the parties can agree in writing to a different date, so the ten days is not set in stone.
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Additionally, there is no provision that requires the Arbitrator to reach a decision in three
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days. Instead, the Agreement provides that the Arbitrator will reach a decision on whether
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consent was reasonably withheld within three days. Again, this is presumably so the
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Arbitration can take place as quickly as possible. Neither of these provisions “shock the
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conscience.” Additionally, although Respondents argue that there is a limited pool of
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Arbitrators, the qualifications requirement does not seem unreasonable, and Respondents
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do not argue that Arbitrators that fit these qualifications do not exist. See, e.g., AT&T v.
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Mobility, LLC v. Concepcion, 563 U.S. 333, 344 (2011) (noting an arbitration agreement
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may specify “that the decisionmaker be a specialist in the relevant field”) Furthermore,
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providing that the parties have five days to attempt to reach a mutual agreement as to the
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designated Arbitrator and, if that is not possible, giving another five days for each party to
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designate their selected Arbitrator, does not seem overly harsh or oppressive.
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The limitation on discovery does give this Court pause. California has held, in the
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employer-employee context, that “[a]dequate discovery is indispensable for the vindication
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of statutory claims” to ensure the minimum standards of fairness. Fitz v. NCR Corp., 118
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Cal. App. 4th 702, 716 (2004) (citing Armendariz, 24 Cal. 4th at 104). But the concern in
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Fitz was the unequal position between the bargaining parties. In this case, the parties
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involved LLC entities with equal bargaining positions. As pointed out by the Fourth
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Circuit, “[w]hen the contracting parties stipulate that disputes will be submitted to
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arbitration, they relinquish the right to certain procedural niceties which are normally
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associated with a formal trial. One of these accoutrements is the right to pre-trial
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discovery.” Burton v. Bush, 614 F.2d 389, 390 (4th Cir. 1980). To the extent California
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holds to the contrary, as discussed above, the Court finds upholding the parties’ choice of
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law provision in the Agreement is appropriate. The difference in the law does not
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contravene a fundamental policy in the state of California given the relatively equal
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bargaining positions of the parties.
Therefore, the Court finds that the arbitration agreement is neither substantively nor
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procedurally unconscionable.
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III.
CONCLUSION AND ORDER
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For the reasons stated above, the Court GRANTS the Petition to Compel
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Arbitration. (ECF No. 1.) The parties are ordered to submit the dispute regarding the
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Management Agreement only for arbitration.
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Although at oral argument the parties suggested that this Court may wish to stay its
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ruling pending decision by the New York appellate court, the Court finds the arbitration
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clause in the Management Agreement allows the parties to agree in writing to delay the
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arbitration, so the Court defers to the parties if they choose to put out Arbitration to a later
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date. The Clerk of the Court is directed to administratively close this case.
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IT IS SO ORDERED.
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DATED: September 8, 2021
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