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October 31, 1983


The opinion of the court was delivered by: SOFAER



 The federal courts enforce arbitration agreements in the wholehearted spirit intended by Congress. In considering a motion to compel arbitration or to stay judicial proceedings pending arbitration, a district court is limited to satisfying itself that the parties reached an agreement to arbitrate and that a party has failed to perform that agreement. The court may not even consider whether the nonperforming party has a valid defense to arbitration, such as laches; nor may it permit a party bound by an arbitration agreement to evade its obligations by attempting to enforce its rights through alternative remedial mechanisms. But the threshold inquiries allocated to the court must properly be performed, as they reflect the ultimate contractual source of the duty to arbitrate. A court may not force a party to arbitrate when ordinary contract principles indicate that it has not agreed to do so.

 In this case, the assignee of a receivable under a contract containing a broad arbitration provision is attempting to avoid arbitrating the account debtor's alleged right to set off against a conceded liabililty because of the assignor's default in a subsequent transaction. Whether the assignee has obligated itself to arbitrate this dispute turns upon the reach of the assignee's contractual obligations. Normally, the assignee is bound to arbitrate all disputes, if that is the remedial mechanism agreed upon by the assignor. Nevertheless, as explained below, the assignee of a security interest may be able to establish that it has refused to agree to arbitrate subsequent claims by giving proper notice of the limited nature of its involvement, or by obtaining a separate and legally sufficient agreement with the account debtor that the debtor will pay without asserting offsets or counterclaims. But the assignee in this case cannot establish that it gave proper notice or secured the necessary agreement, so it cannot avoid the normal contract rule requiring arbitration. The action must therefore be stayed pending arbitration.

 I. Factual Background.

 On June 3, 1981, defendant Amoco Oil Company ("Amoco") entered into an "exchange" agreement with Quasar Petroleum, Ltd. ("Quasar"), an independent oil trader. A telex dated May 9, 1981, embodies the two-part final agreement, which Amoco referenced as P/S-81-056X. (Exhibit 1, Composite of Affidavits and Exhibits.) Part I provided that Amoco would sell to Quasar a certain quantity of foreign crude oil at a specified price per barrel, while Part II provided that two months later Amoco would purchase from Quasar the same quantity of foreign crude oil at the same price. The arrangement enabled Amoco to show a stronger working capital position by shifting assets to cash from inventory and yet be assured of oil at a specific price during a specific period. At the same time, it enabled Quasar to assume the risks and potential benefits of price fluctuations during that period. For example, Quasar could profit by selling the first shipment to another buyer at a higher price than it had paid Amoco, or by repurchasing the second shipment at a lower price than it would receive from Amoco. Of course, Quasar also could lose on one or both parts of the contemplated transaction.

 The contract was one of a series between the companies, by each of which Quasar agreed to buy in excess of ten million dollars worth of oil. Since the purchases necessary to perform the contracts were several times greater than its net worth, Quasar required financing, which it often arranged to obtain from plaintiff Banque de Paris et des Pays-Bas ("Paribas").

 The terms of Part I of P/S-81-056X required Quasar to post a letter of credit in Amoco's favor before Amoco sold Quasar the first shipment of oil. When Amoco delivered the appropriate amount of foreign crude oil to Quasar, the companies completed the Part I exchange of funds for bills of lading without problem.

 Beginning in August 1981, however, communications between Amoco and Quasar evidence alterations in Part II of P/S-81-056X to allow Quasar to substitute domestic crude oil for foreign and to make delivery at a later date and for a different price.Nothing in the record makes clear how or why these changes were negotiated and adopted. At any rate, Quasar eventually delivered the oil in three monthly shipments commencing in March 1982. The payment terms of Part II, in which Quasar was seller and Amoco buyer, did not require a documentary exchange with payment on receipt of bills of lading but rather permitted Amoco to pay by telegraphic transfer on receipt of invoices. To finance its purchase of oil for resale to Amoco under the terms of Part II, Quasar obtained a loan from Paribas. The loan was secured by a preexisting assignment to Paribas of Quasar's accounts receivable on the exchange agreement, including the proceeds that would become due under Quasar's existing and future contracts for the sale of crude oil. General Security Agreement, Exhibit 9. Paribas also demanded of Quasar that Amoco either open a letter of credit in Quasar's favor or execute a separate document which Paribas called an "undertaking." This "undertaking" would take the form of a telex in which Amoco stated that it would pay immediately available funds into Paribas for the oil it received from Quasar.

 Prior to each resale of oil to Amoco by Quasar and each loan by Paribas to Quasar, Paribas received a separate "undertaking" from Amoco confirming the transaction and containing the words "payable by telegraphic transfer into Banque de Paris et des Pays-Bas." Exhibits 18, 19, 23.Indeed, because it failed to include these words, Amoco's first such telex had been deemed unsatisfactory by Paribas. Patterned on wording suggested by Paribas and Quasar, the replacement telex included the requisite phrase, but simultaneously deleted language in the first telex to the effect that payment would be made "without offset or counterclaim." Compare Exhibits 16 & 18, with Exhibit 17.

 Quasar completely performed its obligations under the altered 1981 exchange agreement. Later, however, financial difficulties forced Quasar to advise Amoco that it would be unable to perform according to a subsequent exchange agreement executed by them on April 16, 1982, and referenced by Amoco as P/S-82-036X.In response, Amoco withheld $3,804,000 due Quasar on its May 1982 oil shipment as a setoff against damages Amoco claimed to have suffered because of Quasar's anticipatory breach of P/S-82-036X. Quasar subsequently defaulted on its loan from Paribas, which then initiated this action.

 Paribas seeks to recover the $3,804,000 from Amoco either as an assignee of Quasar's accounts under Section 9-318 of the Uniform Commercial Code, or because of the "undertakings" executed by Amoco, which Paribas construes as separate and direct promises to pay Paribas for the oil received from Quasar.Amoco denies having made any direct promise to Paribas, and argues that in any event all of Paribas's claims are subject to an arbitration provision contained in the original exchange agreement, P/S-81-056X. Amoco therefore moves to dismiss, or alternatively to stay the present action and compel arbitration.

 The Federal Arbitration Act applies to federal adjudication of controversies arising out of contracts evidencing transactions in interstate or international commerce. 9 U.S.C. §§ 1, 2; Bernhardt v. Polygraphic Co. of America, Inc., 350 U.S. 198, 100 L. Ed. 199, 76 S. Ct. 273 (1955). The Amoco-Quasar agreement is plainly such a contract. The Act directs that:

 If any suit or proceeding be brought in any of the courts of the United States upon any issue referable to arbitration under an agreement in writing for such arbitration, the court in which such suit is pending, upon being satisfied that the issue involved in such suit or proceeding is referable to arbitration under such an agreement, shall on application of ...

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