Opinion
No. 04 Civ. 5496 (JSR).
September 20, 2004
MEMORANDUM ORDER
By its petition and corresponding motion, petitioner XL Capital, Ltd. seeks to stay or dismiss an arbitration that respondents William Kronenberg III, Frank A. Piliero, and David M. Rosenberg have commenced before the American Arbitration Association ("AAA") and to compel respondents to submit their disputes to the accounting firm of Ernst Young LLP.
The pertinent facts are as follows:
Petitioner XL Capital is a Cayman Islands corporation, with its principal place of business in Bermuda. Petition to Compel Arbitration dated July 15, 2004 ("Petition") at ¶ 2. Respondents are Pennsylvania residents who previously owned all outstanding capital stock of ECS, Inc., a Pennsylvania corporation engaged in the business of insuring environmental risks. Id. at ¶¶ 3-5; Exh. 1 (Stock Purchase Agreement between XL Capital Ltd. and Respondents); Response Opposing Petition to Compel Arbitration dated July 23, 2004 ("Response") at ¶ 8. By a Stock Purchase Agreement dated June 1, 1999 (the "Agreement"), respondents sold their ECS stock to petitioner. See Petition, Exh. 1 (the Agreement). Among other things, the Agreement provided that, depending on a number of variables, respondents might receive in the future additional consideration for their stock in the form of an "Earned Payout Amount." Id. at 2(e).
Regarding any disputes that might arise under the Agreement, Section 8(c) of the Agreement mandated that: "Except as provided as in Section 8(b) below, the Parties hereby agree that all questions, issues or disputes arising under this Agreement shall be resolved by arbitration, conducted before a panel of three arbitrators in New York, New York in accordance with the applicable rules and procedures of the American Arbitration Association then in effect." However, with respect to calculation of the Earned Payout Amount (as well as the calculation of a so-called "Cashout Payment" not here relevant), Section 8(b) of the Agreement provided that "Notwithstanding anything stated within the context of this Agreement to the contrary, all questions, issues or disputes arising under this Agreement with respect to the calculations of the Cashout Payment and the Earned Payout Amount shall be resolved in accordance with the procedures set forth in Annex III and Annex IV, respectively." Annex IV, in turn, provided that "In the event Sellers object to the Worksheet [specifying the calculation of the Earned Payout Amount] within such 30-day period, Sellers and Buyer shall attempt to resolve any such objections within 30 days of Buyer's receipt of Sellers' objections. If Sellers and Buyer are unable to resolve the matter within such 30-day period, Sellers and Buyer shall, within 15 days following the expiration of such 30-day period, engage Ernst Young LLP solely to determine whether the Worksheet to which Sellers have objected requires any restatements and Tillinghast-Towers Perrin solely to provide Ernst Young LLP with any necessary actuarial analysis and computations. . . ."
On April 30, 2003, petitioner provided respondents with a Worksheet calculating the Earned Payout Amount. Petition at ¶ 12. After some discussion, petitioner, on September 8-9, 2003, provided the respondents with access to the backup documentation that formed the basis of Worksheet calculations. Id. at ¶ 18. On September 30, 2003, respondents sent to petitioner, in writing, their objections to various calculations in the Worksheet. Id. at ¶ 19. When the parties were unable to resolve their differences, petitioner, on April 13, 2004, sent a letter advising respondents that petitioner intended to invoke Section 8(b) of the Agreement pursuant to which the dispute was to be resolved by Ernst Young. Response, Exh. 1 (Letter from David Januszewski to Bradley Massam).
Subsequently, however, respondents, on June 17, 2004, filed a formal demand for arbitration with the AAA, pursuant to section 8(a) of the Agreement, asserting claims of fraud and deceitful conduct, negligent misrepresentation, breach of contract, breach of the covenant of good faith and fair dealing, and the like. Response, Exh. 2 (Demand for Arbitration dated June 17, 2004). The arbitration demand did not challenge the Worksheet as a matter of accounting per se, but rather asserted that petitioner had made fraudulent misrepresentations in connection with the Agreement and the Earned Payout Amount, had breached the contract by adding unprofitable business lines and unnecessary expenses to ECS, and had engaged in other unlawful conduct, all of which had the effect of reducing the Earned Payout Amount to which respondents were entitled. Id.
Over the next few weeks, the contending parties attempted to pursue their respectively preferred avenues of resolving their disputes, i.e. before Ernst Young (as favored by petitioner) and before the AAA (as favored by respondents); but eventually something akin to impasse was reached and, on July 15, 2004, the instant lawsuit was filed.
After receiving written submissions, the Court heard oral argument on August 10, 2004. See transcript, 8/10/04. Initially, respondents argued that the very question of arbitrability should be referred to the AAA, but the Court rejected that view. Otherwise, however, the Court reserved judgment on petitioner's dual motion to stay or dismiss the AAA arbitration and to compel respondents to submit the disputes to Ernst Young.
The reasons for the Court's determination on the issue of arbitrability are set forth at pages 3-8 of the transcript of the oral argument on August 10, 2004, and need not be repeated here.
The Court now denies both prongs of the motion. The issues submitted to the AAA are not, in their essence, accounting issues, let alone issues that directly respect the "calculation" of the Earned Payout Amount, which is the subject matter of 8(b). Rather, they are essentially claims of fraud and breach of contract, thereby falling directly with the purview of Section 8(a). To be sure, the arbitrators' resolution of these issues will have an impact on the amount of the Earned Payout Amount; but if that were enough to trigger Section 8(b), then the contracting parties' intent (as evidenced by the plain language of Section 8) to submit all disputes to AAA arbitration except for a narrow exception relating to the calculation (from an accounting standpoint) of the Cashout Payment and Earned Payout Amount, would be turned on its head, and the narrow exception of Section 8(b) would effectively swallow the broader coverage of the general arbitration clause, Section 8(a). Moreover, it is apparent from the face of Section 8 that the parties plainly did not contemplate that non-accounting issues such as fraud and breach of contract would be submitted to an accounting firm, Ernst Young, rather than to the AAA. See, e.g., McDonnell Douglas Finance Corp. v. Pennsylvania Power Light Co., 858 F.2d 825, 833 (2d Cir. 1988). Here, although it may be that after the AAA arbitration is concluded, there may remain pure issues of accounting that must be referred to Ernst Young in order to make the final calculation, the arbitrators must first resolve the broader legal claims of fraud, breach of contract, and the like raised by respondents' demand.
Thus, this case is readily distinguishable from the case on which petitioner primarily relies, Campeau Corporation and Federated Department Stores, Inc. v. The May Department Stores Company, 722 F. Supp. 224 (S.D.N.Y. 1989), where only accounting issues were involved.
Accordingly, petitioner's motion to stay or dismiss the AAA arbitration and to compel the disputes that are the subject thereof to be referred to Ernst Young for resolution is denied, and the petition dismissed. Clerk to enter judgment.