Opinion
Cause No. IP 00-1538-C H/G; Adversary Proceeding Number IP 99-00518; Bankruptcy Court Cause Number IP 98-13045-AJM-11
September 28, 2001
ENTRY ON APPEAL FROM BANKRUPTCY COURT
This action presents an appeal from a decision of the United States Bankruptcy Court denying a motion to compel arbitration of claims in an adversary proceeding. Plaintiffs Baker O'Neal Holdings, Inc. and American Public Automotive Group, Inc. petitioned for relief under chapter 11 of the bankruptcy code in October 1998. On December 7, 1999, they filed a complaint in an adversary action against defendants Ernst Young, LLP and Charles J. Roach. Plaintiffs' complaint sought to avoid allegedly fraudulent transfers and to recover property under federal bankruptcy and Indiana law; and to recover damages under Indiana law for constructive fraud, negligence, and breach of contract, as well as for pecuniary loss suffered as crime victims.
On February 23, 2000, Bankruptcy Judge Anthony J. Metz, III confirmed a joint chapter 11 reorganization plan. About two weeks later, defendants filed a motion to dismiss or stay the adversary proceeding pending arbitration. Judge Metz denied defendants' motion in its entirety and entered findings of fact and conclusions of law to support his ruling. Defendants appeal the denial. The interlocutory decision denying arbitration is appealable under the Federal Arbitration Act, 9 U.S.C. § 16(a)(1)(A). In re National Gypsum Co., 118 F.3d 1056, 1061 (5th Cir. 1997) (affirming denial of arbitration). For the reasons explained below, the court affirms Judge Metz's decision to deny arbitration.
The court denies plaintiffs' motion to dismiss the appeal as moot. There is plainly a live controversy between the parties over the arbitrability of the claims in the adversary proceeding.
Background
This court's review does not concern the merits of the claims before the bankruptcy court in the adversary proceeding. Facts that are not relevant to the disposition of defendants' motion for arbitration have been included to provide context and should not be treated as findings of this court relevant to the merits.Plaintiffs Baker O'Neal Holdings, Inc. ("Baker") and American Public Automotive Group, Inc. ("APAG") are Delaware corporations doing business in Indiana. From 1994 until 1998, Ernst Young performed various professional services for both Baker and APAG. During that time, James O'Neal served as Baker's president and chief executive officer. Charles J. Roach, a partner in Ernst Young, worked with O'Neal to arrange Ernst Young's services. Plaintiffs allege that Roach also assisted O'Neal in borrowing $3.7 million from Baker during his tenure as president and CEO. Second Am. Cplt. at 16. Baker now seeks to recover those sums, as well as others, from Roach and Ernst Young.
In October 1996 and August 1997, Ernst Young and plaintiffs entered into "Engagement Letters" that required arbitration of any "controversy or claim arising out of or relating to the services covered by this letter or hereafter provided by [Ernst Young]." Second Am. Cplt. Exs. Q R. Based on those letters, Ernst Young asserts a right to arbitrate the claims asserted in the adversary proceeding.
On October 30, 1998, Baker and APAG filed voluntary petitions for relief under chapter 11 of the bankruptcy code. On December 7, 1999, they filed a complaint stating the following claims against Roach and Ernst Young: (1) to avoid and recover fees paid to Ernst Young under sections 548(a) and 550(a) of the bankruptcy code, (2) to avoid and recover fees paid to Ernst Young under the Indiana Uniform Fraudulent Transfer Act, Ind. Code § 32-2-7-1 et seq., (3) for constructive fraud, (4) for recovery of pecuniary loss as a result of defendants' commission of criminal acts, under Ind. Code § 34-24-3-1, (5) for negligence, and (6) for breach of contract. The current version of the complaint is the second amended complaint, which includes the claims stated in the original complaint.
In conjunction with other interested parties, plaintiffs filed their First Amended Joint Chapter 11 Plan of Reorganization ("Plan") on December 13, 1999. Ernst Young filed an objection to the Plan on January 19, 2000. Ernst Young argued that a settlement agreement and release in the proposed Plan infringed its right to bring an action or assert a defense against third parties Patrick J. Baker and Penny Baker. EY Obj. at 7. Patrick J. Baker is the sole shareholder of Baker and the chairman of the boards of directors of both Baker and APAG.
At a confirmation hearing on February 11, 2000, Ernst Young withdrew its objection to the Plan after plaintiffs modified the settlement agreement and release to exclude Ernst Young. Conf. Hrg. Tr. at 8-9. The bankruptcy court entered an order confirming the Plan as modified on February 23, 2000. In section 8.1 of the Plan and paragraph 7 of the confirmation order, the bankruptcy court expressly retained jurisdiction to adjudicate any cases or controversies between parties to the Plan. About two weeks later, on March 10, 2000, defendants Ernst Young and Roach filed a motion to dismiss the adversary proceeding or in the alternative to stay the proceeding pending arbitration. Plaintiffs filed an objection on June 23, 2000, and the bankruptcy court denied defendants' motion in its entirety on September 21, 2000. This appeal followed.
Standard of Review
The standard for this court's review depends on whether the adversary proceeding should be deemed a "core" proceeding or a "non-core" proceeding under 28 U.S.C. § 157. Under 28 U.S.C. § 157(c)(1) and Bankruptcy Rule 9033, in a non-core proceeding, the district court reviews de novo the bankruptcy court's findings of fact and conclusions of law. On appeal of a core proceeding, however, the district court reviews conclusions of law de novo, but reviews findings of fact under a clearly erroneous standard. See 28 U.S.C. § 157(b)(1) 158(a); F. R. Bankr. P. 8013; In re Frain, 230 F.3d 1014, 1017 (7th Cir. 2000) (standard of review for decision on dischargeability of debts).
Federal statutes designate certain proceedings as core, including "proceedings to determine, avoid, or recover fraudulent conveyances" and the "confirmations of plans." 28 U.S.C. § 157(b)(2)(H) (L). If a proceeding does not fall under Section 157(b)(2), the core determination should be made considering the extent to which the proceeding affects the case, whether the proceeding is one which the bankruptcy court has traditionally been empowered to decide, and whether the proceeding arises under state or federal law. United States Aviex Co. v. Aviex International, Inc., 96 B.R. 874, 879 (N.D.Ind. 1989). The relevant inquiry has been described in tautological terms as whether the nature of the proceeding "falls within the core of federal bankruptcy power." Gulf States Exploration Co. v. Manville Forest Prods. Corp., 896 F.2d 1384, 1389 (2d Cir. 1990).
In this case, the bankruptcy court denied a motion to compel arbitration of claims asserted in an adversary proceeding. The issues at the core of that decision were certainly at the heart of the bankruptcy court proceedings. The bankruptcy court provided three grounds for its decision: (1) the terms of the reorganization plan, (2) waiver based on the course of proceedings before the bankruptcy court, and (3) judicial estoppel, also based on the course of proceedings before the bankruptcy court.
The bankruptcy court's confirmation of the reorganization plan was a core proceeding. See 28 U.S.C. § 157(b)(2)(L). After confirmation, the reorganization plan is binding on all parties to the bankruptcy, see In re Chicago, Milwaukee, St. Paul and Pacific Railroad Co., 891 F.2d 159, 161 (7th Cir. 1989), and operates as a contract between the debtor and creditors. See, e.g., In re Harvey, 213 F.3d 318, 321 (7th Cir. 2000).
Plaintiffs argue that the bankruptcy court's decision to deny arbitration should be treated as a core proceeding because the issue required the bankruptcy court to interpret and enforce the confirmed plan. Actions to enforce a discharge injunction, which is part of a confirmation plan, have been held to be core proceedings "because they call on a bankruptcy court to construe and enforce its own orders." In re National Gypsum Co., 118 F.3d 1056, 1063 (5th Cir. 1997), citing In re Polysat, 152 B.R. 886, 888 (Bankr.E.D.Pa. 1993) ("[a]s the instant proceeding concerns the scope of the discharge injunction arising from sections 524 and 1141 of the Code, it is a core proceeding"); In re Jacobs, 149 B.R. 983, 989 (Bankr.N.D.Okla. 1993) ("action before the Court which issued a discharge, for the purpose of determining the scope of said discharge under 11 U.S.C. § 524 . . . is not merely related to the bankruptcy, but arises under Title 11 and arises in a case under Title 11," is a proceeding that affects the debtor-creditor relationship, and therefore is a core proceeding under 28 U.S.C. § 157(b)(2)(O)). Authority to interpret and enforce a confirmed plan is a necessary corollary to the bankruptcy court's confirmation power. Without such authority, plaintiffs contend, the more deferential review to which the bankruptcy court's confirmation of the plan is entitled could be circumvented by merely violating its provisions and then challenging its enforcement.
Ernst Young argues that this analysis is wrong because it focuses on the bankruptcy court's ruling and its rationale rather than on the claims asserted in the adversary proceeding itself. The court is inclined to agree with Ernst Young on that score. The focus here must be on the nature of the claims for relief asserted in the adversary proceeding. See Ralls v. Docktor Pet Centers, Inc., 177 B.R. 420, 425 (D.Mass. 1995) ("the word `proceeding' must refer to the specific causes of action and grounds for relief sought by a party, and not to the entire action"); In re Best Reception Systems, Inc., 220 B.R. 932, 945-46 (Bankr. E.D. Tenn. 1998) (in deciding whether proceeding is core or non-core, "`proceeding' must refer to each cause of action or right of recovery pled," and court must consider each count or asserted right to relief separately to determine applicable standard of review).
The problem is that the adversary proceeding includes claims that are both core and non-core. The claims to avoid allegedly fraudulent and/or preferential transfers, for example, are core proceedings. 28 U.S.C. § 157(b)(2)(F), (H). The issue of arbitration applies to both the core and the non-core claims, so the applicable standard of review here varies among the different claims for relief in the adversary proceeding. Ultimately, however, the standard of review does not affect the bottom line. This court would affirm the bankruptcy court's decision to deny arbitration under either applicable standard.
Discussion
As noted, the bankruptcy court denied the motion to compel arbitration on three grounds. First, the court held that the terms of the Plan preclude arbitration of plaintiffs' claims against Ernst Young because the Plan provides that the bankruptcy court retained jurisdiction over such claims in Section 8.1 of the Plan. Order ¶ 66. Second, the bankruptcy court held that Ernst Young waived its right to arbitration by failing to object to the Plan's terms at confirmation. Order ¶ 75. Third, the bankruptcy court invoked the doctrine of judicial estoppel to preclude arbitration. The court held that judicial estoppel was appropriate because, when Ernst Young obtained modification of the Plan, it successfully asserted rights inconsistent with a right to arbitrate. Order ¶¶ 82-85. This court affirms the denial of arbitration because arbitration would be inconsistent with the terms of the confirmed Plan and because Ernst Young waived its right to seek arbitration. The court does not reach the issue of judicial estoppel.
A party can waive a contractual right to arbitrate, and can do so either expressly or implicitly. Grumhaus v. Comerica Securities, Inc., 223 F.3d 648, 650 (7th Cir. 2000). In the case of an implied waiver, the court must determine whether, based on all the circumstances, the party against whom the waiver is to be enforced has acted inconsistently with the right to arbitrate. Id. at 650-51, citing St. Mary's Medical Center of Evansville, Inc. v. Disco Aluminum Products Co., 969 F.2d 585, 588 (7th Cir. 1992).
The Seventh Circuit has held that a party's "election to proceed before a nonarbitral tribunal for the resolution of a contractual dispute is a presumptive waiver of the right to arbitrate." Cabinetree of Wisconsin, Inc. v. Kraftmaid Cabinetry, Inc., 50 F.3d 388, 390 (7th Cir. 1995). This presumption prevents parties from proceeding, "either simultaneously or sequentially, in multiple forums." Id. "Selection of a forum in which to resolve a legal dispute should be made at the earliest possible opportunity." Id. at 391. A party's delay in seeking arbitration will not be excused merely because it needed time "to weigh its options." Id.
The court should not find waiver, however, where special circumstances excuse the prior conduct of the party seeking arbitration. Id.; see also Iowa Grain Co. v. Brown, 171 F.3d 504, 510 (7th Cir. 1999) (affirming order compelling arbitration where party initially filed action in state court to obtain class status not available under arbitration agreement); Baltimore and Ohio Chicago Terminal Railroad Co. v. Wisconsin Central Ltd., 154 F.3d 404, 409 (7th Cir. 1998) (affirming order compelling belated arbitration where enforceability of contract containing arbitration clause was in question and party sought arbitration only after its opponent brought contract into case).
In this case, the terms of the Plan call for the bankruptcy court not merely to retain jurisdiction over the claims in the adversary proceeding, but to "adjudicate" those claims. A court may retain jurisdiction over a dispute while its merits are arbitrated, but "adjudication" of claims in the Plan plainly called for the bankruptcy court to decide the claims on their merits. Ernst Young did not object to the Plan, and the terms of the Plan therefore effectively superseded those arbitration rights. Ernst Young's failure to object to the Plan on this basis amounted to a waiver of its right to seek arbitration.
Ernst Young did not assert its right to arbitration at the earliest possible opportunity. Plaintiffs filed their original complaint against defendants on December 7, 1999. In that complaint, plaintiffs alleged that defendants secured a business relationship with them in spite of obvious conflicts of interest, and that defendants violated their duty to notify plaintiffs of serious financial problems, including O'Neal's mismanagement of Baker. Cplt. at 6-7. Further, plaintiffs alleged that defendants assisted O'Neal in taking fraudulent loans from Baker and disguising those loans as assets in Baker's records. Cplt. at 9.
Thus, as of December 7, 1999, Ernst Young was on notice that plaintiffs claimed damages arising out of the professional services it provided plaintiffs. Ernst Young also knew that such claims were subject to the arbitration provisions of their Engagement Letters.
Ernst Young filed an objection to plaintiffs' reorganization plan on January 19, 2000. In its objection to a proposed release term, Ernst Young did not assert a right to arbitration or refer to the arbitration provisions of the Engagement Letters. Instead, it sought to protect its rights against Patrick J. Baker and Penny Baker. At a hearing on February 11, 2000, proponents of the Plan agreed to exclude Ernst Young from the settlement agreement with the Bakers. The bankruptcy court confirmed the "immaterially modified" Plan on February 23, 2000. Conf. Order at 1. Ernst Young finally asserted its right to arbitration on March 10, 2000, almost 14 weeks after plaintiffs filed their original complaint. Most important, Ernst Young first asserted that right after confirmation of the Plan, under which the bankruptcy court retained jurisdiction over claims, including those asserted in the adversary proceeding against Ernst Young and Roach.
The Official Plan Committee has argued that Ernst Young should have pursued arbitration prior to confirmation of the Plan, and that objecting to the Plan solely with respect to the settlement agreement misrepresented Ernst Young's intentions to the court. Hrg. Trans. of Aug. 7, 2000, at 23-24, 28-30. In defense of its objection, Ernst Young told the bankruptcy court that it was "certainly entitled to protect its rights in the Adversary Proceeding in advance of any ruling by this Court on its Motion [for arbitration]; until this Court rules on EY's motion [for arbitration], EY cannot know whether or not it will be required to litigate in the Adversary Proceeding." Def. Resp. to Plan Comm. Obj. at 10.
The problem with this argument, however, is that Ernst Young did not move for arbitration and then seek to protect its rights in the Adversary Proceeding while awaiting a ruling from the bankruptcy court. Instead, Ernst Young chose not to pursue arbitration until after its objection to the Plan was resolved. The difference is significant.
The former path promotes an efficient use of resources by permitting the court to consider arbitration as a preliminary matter. An early determination that certain claims are arbitrable facilitates their removal before the court has invested undue time or effort considering their merits. On the latter path, the court must evaluate all claims with respect to confirmation of the reorganization plan. After confirmation, the court's consideration of an arbitration motion is complicated by the relationship between the arbitration agreement and the reorganization plan, as well as the fact that the court has already invested substantial resources into the case.
Ernst Young's election to pursue the latter course suggests that it wanted to weigh its options before pursuing arbitration, at the court's and plaintiffs' expense. The Seventh Circuit criticized this strategy in Cabinetree, 50 F.3d at 391, in affirming a finding of waiver.
Courts have excused delay where the party seeking arbitration was engaged in preliminary negotiations concerning a settlement, see Dickinson v. Heinold Securities, Inc., 661 F.2d 638, 641 (7th Cir. 1981), or was not yet a defendant on an arbitrable claim. See id. at 641-42; In re Hart Ski Mfg. Co., 22 B.R. 763, 765 (D.Minn. 1982), aff'd 711 F.2d 845 (8th Cir. 1983). In this case, there is no evidence of ongoing settlement negotiations to excuse the delay, and Ernst Young knew on December 7, 1999, that plaintiffs sought damages for acts covered by the Engagement Letters' arbitration provisions.
In Dean Witter Reynolds Inc. v. Byrd, 470 U.S. 213 (1985), the Supreme Court addressed the holding in Dickinson that a district court has discretion to stay arbitration in a case pending the adjudication of any nonarbitrable claims. The Seventh Circuit had written that the stay might be necessary to avoid the application of collateral estoppel to the nonarbitrable claims where arbitration involves claims that are factually intertwined with them. Dickinson, 661 F.2d at 643-44. The Supreme Court disagreed with the Seventh Circuit and held that a stay is not warranted in such a case because the district court can protect itself by determining the preclusive effect to be given the arbitration proceeding. Dean Witter, 470 U.S. at 223, citing McDonald v. West Branch, 466 U.S. 284 (1984). The Supreme Court did not address the Seventh Circuit's decision to excuse the defendant's delay in pursuing arbitration.
In Hart, the district court followed the rule in the Eighth Circuit that a right to arbitrate cannot be waived through delay unless there is prejudice to the party opposing arbitration. 22 B.R. at 764. In the Seventh Circuit, prejudice is a factor in considering waiver but is not necessarily dispositive. See Grumhaus, 223 F.3d at 653 (7th Cir. 2000); Cabinetree, 50 F.3d at 390.
There is nothing in this case comparable to the circumstances that justified delay in Iowa Grain and Baltimore and Ohio. Ernst Young has not delayed pursuing arbitration to take advantage of a procedural benefit unique to another forum. Cf. Iowa Grain, 171 F.3d at 510 (7th Cir. 1999) (excusing delay in pursuing arbitration while plaintiff sought to obtain class certification available only in judicial forum). Nor has Ernst Young suggested that the enforceability of its right to arbitrate was uncertain. Cf. Baltimore and Ohio, 154 F.3d at 408 (excusing delay where enforceability of arbitration clause was in question and party sought arbitration only after opponent brought contract into case). Ernst Young was certain of its arbitration right even before it filed its objection to the Plan. Hrg. Trans. of Aug. 7, 2000, at 51. See generally Def. Obj. to Den. Arb.
Because Ernst Young has no valid explanation for its failure to pursue arbitration earlier, this court cannot excuse its delay. If Ernst Young doubted its right to arbitrate, it should have raised those concerns prior to confirmation of the Plan. See In re Harvey, 213 F.3d 318, 322 (7th Cir. 2000) (creditor should seek to resolve any ambiguities at confirmation in view of the binding effect of confirmation plan).
The bankruptcy court also found that Ernst Young acted inconsistently with a right to arbitrate when it objected to the Plan. Ernst Young premised that objection on its right to pursue a third party action and to assert state law defenses against the Bakers in the adversary proceeding. The bankruptcy court found Ernst Young's effort to protect its rights in the adversary proceeding inconsistent with its later motion to arbitrate. Order ¶¶ 45-47.
The memorandum in support of Ernst Young's objection strongly suggested that it intended to bring an action in the adversary proceeding. Ernst Young's objection stated:
Ernst Young is a defendant in the Adversary Proceeding, which is still in the pleadings stage. Fed.R.Bank.P. 7014 and Fed.R.Civ.P. 14 permit Ernst Young to initiate a third party complaint in the Adversary Proceeding . . . but the entry of a nonconsensual release of the Bakers would purport to nullify Ernst Young's right to pursue a third party action against the Bakers in the Adversary Proceeding. Further, the Baker Release would purport to bar Ernst Young from pursuing any independent state law claims against the Bakers, whether in the Adversary Proceeding or outside of it, without regard to the state procedural and substantive law that would govern such an action.
* * * *
Finally, the broad sweep of the Baker Release suggests that the Debtors may also argue that the release bars Ernst Young's right under Indiana state law to assert a nonparty defense to the state law claims advanced by the Debtors in the Adversary Proceeding. Under Indiana law, Ernst Young may assert as a defense to the debtors' action claims that nonparties, such as the Bakers, are responsible for some or all of the damages alleged.
EY Obj. at 8-9. In this passage, Ernst Young emphasized the threatened impairment of its rights against the Bakers in the adversary proceeding. Given that emphasis, it was reasonable for the bankruptcy court to conclude that Ernst Young expected to resolve all the claims against it in the adversary proceeding. Ernst Young would not assert a defense against the Bakers in the adversary proceeding if all of the claims against Ernst Young were submitted to arbitration. It is also unlikely that Ernst Young would file a third party complaint against the Bakers under the same circumstances.
Conversely, Ernst Young cites the phrase "whether in the Adversary Proceeding or outside of it" in the excerpted passage to argue that it sought to preserve its rights against the Bakers "in any appropriate forum." EY Obj. at 7. That reference is too oblique to undercut the predominant thrust of the memorandum: Ernst Young intended to assert its rights against the Bakers in the adversary proceeding. In light of all of the circumstances, including that Ernst Young had yet to express any intent to pursue arbitration, the bankruptcy court did not err in finding that Ernst Young had acted inconsistently with its later-expressed desire to arbitrate.
Conclusion
This court affirms the bankruptcy court's denial of arbitration. Whether the bankruptcy court's factual findings are reviewed de novo or for clear error, its factual findings were correct and show that Ernst Young's arbitration rights had been waived and effectively superseded by the terms of the confirmed Plan of reorganization.