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February 6, 1996

AVIALL, INC., Plaintiff, against RYDER SYSTEM, INC., Defendant.

The opinion of the court was delivered by: MUKASEY


 Plaintiff Aviall, Inc., and its former corporate parent, Ryder System, Inc., dispute the allocation of pension-related balance sheet items set forth in the Distribution Agreement governing Ryder's December 1993 spin-off of Aviall. In accordance with that agreement, Aviall initially submitted the dispute to KPMG Peat Marwick ("KPMG") for arbitration, but now seeks to disqualify KPMG and asks the court to reform the contract and appoint a neutral arbitrator. Ryder moved to dismiss the complaint for failure to state a claim for relief, or in the alternative to stay the litigation until the conclusion of the arbitration. while Ryder's motion was pending, Aviall moved for summary judgment. Ryder then cross-moved for summary judgment. For the reasons that follow, Aviall's motion for summary judgment is denied, and Ryder's cross-motion for summary judgment is granted. The other motions are moot.


 The following facts are drawn from the complaint, affidavits, deposition testimony and documentary exhibits submitted by both parties. On cross-motions for summary judgment, the standard is the same as that for individual motions for summary judgment and the court must consider each motion independent of the other. When evaluating each motion, the court must consider the facts in the light most favorable to the non-moving party. Heublein, Inc. v. United States, 996 F.2d 1455, 1461 (2d Cir. 1993). Simply because the parties have cross-moved, and therefore have implicitly agreed that no material issues of fact exist, does not mean that the court must join in that agreement and grant judgment as a matter of the law for one side or the other. Id. The court may conclude that material issues of fact do exist and deny both motions.

 Prior to December 1993, Ryder operated a variety of logistics and transportation businesses, including Aviall, a subsidiary engaged primarily in aviation-related services. (Compl. P 6) In 1993, as part of a reorganization, Ryder decided to leave the aviation field and to distribute new shares in Aviall to Ryder's shareholders. (Id.) As a result of the spin-off, shareholders who previously had an interest in Aviall only by virtue of their ownership of Ryder stock, held stock in both Ryder and Aviall.

 To memorialize this transaction, Ryder drafted a Distribution and Indemnity Agreement (the "Agreement"), dated November 23, 1995. (Id. at P 1) The Agreement outlined several aspects of the new relationship between the companies, including the distribution of stock, tax-sharing, employee benefits, indemnification, access to corporate information, and pension-accounting treatment. (Id. at Ex. A) The Agreement also required Ryder to create a Distribution Statement recording the intracompany payments generated by the spin-off, and deliver it to Aviall at least three days before the effective date of the spin-off. (Id. at Ex. A § 3.03(a)) Section 3.03(c) of the Agreement governs any disputes between the parties relating to that Distribution Statement and states:

If there are any items related to the Distribution Statement which are in dispute, then such items shall be submitted to KPMG Peat Marwick ("Peat Marwick") for resolution.

 Section 3.03(c) was not the only dispute resolution provision, and KPMG was not chosen as arbitrator for all disputes. For example, § 3.11(n) provides that

In the event of any dispute between Ryder and Aviall regarding the amount of the Proceeds Payment and if, at the time of such dispute, Peat Marwick are the independent auditors for both Ryder and Aviall, Peat Marwick shall review the calculations of the Proceeds Payment submitted by each of Ryder and Aviall and shall act as arbitrator of any such dispute. If, at the time of such dispute, Peat Marwick are not the independent auditors for both Ryder and Aviall, then the parties shall select another nationally recognized certified public accounting firm, which does not serve as independent auditors for either Ryder or Aviall, to resolve any such dispute.

 Furthermore, § 5.04 of the Tax Sharing Agreement, executed in connection with and required by § 3.04 of the Distribution Agreement states that

any disputes between the parties with respect to this Agreement shall be resolved by a 'Big Six' public accounting firm or a law firm satisfactory to Ryder and Aviall.

 Finally, § 6.04 of the Agreement provides that it "shall be governed by and construed in accordance with the laws of the State of New York."

 One of the problems that arose during the structuring of the spin-off was how to divide the pension plans for Aviall and Ryder employees. Ryder originally planned to transfer to Aviall all of the pension assets and liabilities for employees going to Aviall (Huston Dep. pp. 61-62; Teneglia Dep. pp. 107-08), but the Pension Benefit Guaranty Corporation ("PBGC") objected to this plan out of concern that the obligations would not be met if they were transferred. The PBGC wanted Ryder to guarantee any payments for employees transferred to Aviall. (Huston Dep. pp. 62-66; Mojena Dep. Ex. 2) Ultimately, Ryder and the PBGC agreed that Ryder would retain the investments and pay the pensions of Aviall employees until the spin-off, and that Aviall would be responsible for all benefits earned by Aviall employees thereafter. (Murphy Dep. pp. 84-85; Mojena Dep. Ex. 2) As a result, Ryder had a large deferred cost associated with the Aviall employees prior to the spin-off, which took the form of a prepaid pension expense asset allocated to the Aviall balance sheet.

 During its negotiations with the PBGC, Ryder sought assistance on this matter from its accountant KPMG. In response to Ryder's inquiry, on November 3, 1993, several weeks before execution of the Agreement and the spin-off, KPMG issued a Record of Inquiry ("ROI") on the pension-accounting treatment, in which John R. Deming, a partner in KPMG's Department of Professional Practice, recorded that Ryder had inquired about the division of the pension plans, and approved Ryder's proposal for the pension accounting. (Deming Dep. pp. 4, 8 & Ex. 1) In the ROI, Deming remarked that Ryder's suggestion "appears to be . . . reasonable," but that "it is possible that others may insist on a more mechanical approach which could result in a larger proportion of the unrecognized net loss being retained by the client." (Id. at Ex. 1) Approximately two weeks later, on November 16, 1993, again prior to the Agreement and the spin-off, KPMG senior manager Hector Mojena wrote a memo in which he too approved Ryder's proposal. (Mojena Dep. Ex. 2) Finally, KPMG signed off on its audit of Ryder's and Aviall's 1993 year-end financial statements, which reflected the above-described pension-accounting treatment. (Huston Dep. pp. 32-33) Hamlin and Mojena of the Miami office performed Ryder's audit, and Bruce Piller of the KPMG's Dallas office handled the Aviall engagement. (Piller Dep. pp. 10-11) Some time after these audits, Aviall switched accountants.

 After execution of the Agreement, Aviall sought to reallocate the pension-related balance sheet items. It did so first through informal negotiations with Ryder. When these discussions broke down in November 1994, Aviall requested formal dispute resolution by KPMG pursuant to § 3.03(c) of the Agreement. (Def. Mem. to Dismiss Ex. C) Aviall knew then that KPMG had helped draft the Distribution Agreement and that KPMG was still Ryder's accountant.

 After learning of the dispute, Richard Hamlin, the KPMG partner in charge of the Ryder account, asked Andrew Capelli, a partner in the Department of Professional Practice who works in the New York office, to serve as arbitrator, and Capelli agreed. (Hamlin Dep. pp. 71-73; Capelli Dep. pp. 51-52) Capelli works closely and meets socially with John Deming, the partner who issued the ROI approving Ryder's proposed pension allocation prior to the Distribution Agreement and spin-off. (Capelli Dep. pp. 6, 26) Shortly after his appointment, Capelli, upon Hamlin's request, gave Hamlin the names of several employee benefits experts. (Hamlin Dep. pp. 85-87)

 Aviall then changed its mind about KPMG and commenced this action to disqualify KPMG and substitute a neutral arbitrator. Aviall contends that KPMG, regardless of who it designates to hear the case, is biased towards Ryder, and that Andrew Capelli has prejudged the case. Ryder argues that these issues are not ripe for decision prior to the ...

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