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CAMFERDAM v. ERNST & YOUNG INTERNATIONAL

United States District Court, S.D. New York


February 12, 2004.

HENRY CAMFERDAM, JR., JEFFREY M. ADAMS, JAY MICHENER, CAROL TRIGILIO, BAMC INC., CARMEL PARTNERS, HNC DITCH INVESTMENTS LLC, JMA SEDGEMOOR INVESTMENTS LLC, JM WALNUT INVESTMENTS, and CT OAK TREE INVESTMENTS LLC, Plaintiffs
v.
ERNST & YOUNG INTERNATIONAL, INC., ERNST & YOUNG LLP, BRIAN UPCHURCH, CARL RHODES, WAYNE T. HOEING, JENKINS & GILCHRIST, P.C., PAUL M. DAUGERDAS, SIDLEY AUSTIN BROWN & WOOD LLP, R.J. RUBLE, Defendants

The opinion of the court was delivered by: BARBARA JONES, District Judge

Opinion

Plaintiffs filed this action on December 20, 2002, alleging claims under RICO, breach of fiduciary duty, fraud, negligence, breach of contract constituting professional malpractice, conspiracy to breach fiduciary duty, and tortious interference with contract. The Plaintiffs seek in excess of $40 million in compensatory damages and $1 billion in punitive damages against their accountants and advisors, Ernst & Young and three of its partners, as well as two law firms, Jenkins & Gilchrist and Brown & Wood and two of their partners (collectively "Law Firm Defendants"), who acted in concert with Ernst & Young to Page 2 allegedly promote an unlawful and unregistered tax shelter, which they dubbed "COBRA."

On April 14, 2003, Defendants Ernst & Young LLP ("E&Y"), Ernst & Young International ("E&Y International"), Brian Upchurch, Carl A. Rhoades, and Wayne T. Hoeing (collectively the "E&Y Defendants") moved this Court (1) to stay litigation of Counts 1-7 of Plaintiffs' First Amended Complaint pending arbitration of such claims pursuant to the Federal Arbitration Act ("FAA"), 9 U.S.C. § 3, and (2) for dismissal of Counts 8 and 9 as relief in aid of arbitration. For the reasons set forth below, Defendants' motion is granted.

  Also before this Court are motions by the Law Firm Defendants to stay these proceedings pending arbitration. As explained below, these motions are also granted.

  FACTS

  The four individual plaintiffs — Henry A. Camferdam, Jr., Jeffrey M. Adams, Jay Michener, and Carol Trigilio (collectively, "the Individual Plaintiffs") — received tax advice from E&Y relating to certain capital gains incurred when they sold their business in 1999. (Am. Compl. ¶¶ 46, 48). Each Individual Plaintiff had his or her own engagement letter with E&Y (collectively "the Letter Agreements"). (Defs' Exs. 2, 3, 4, 5). Page 3

  The six entity plaintiffs are a corporation, a partnership and four limited liability companies ("the Entity Plaintiffs") created by the Individual Plaintiffs as part of the transactions contemplated by the Letter Agreements.*fn1 To effectuate the strategy outlined in the Letter Agreements, the Individual Plaintiffs established the Entity Plaintiffs and conducted certain additional transactions (the "1999 tax transactions"). (Am. Compl. at ¶¶ 21-26). All Plaintiffs now allege that as a result of advice they received from E&Y with respect to the 1999 tax transactions — advice indisputably rendered pursuant to the Letter Agreements — Plaintiff have been "exposed . . . to audits by the IRS [Internal Revenue Service] and [have been exposed to] substantial tax liability." (Am. Compl. at ¶ 4). Additionally, Plaintiffs allege that E&Y and Plaintiffs' tax counsel charged Plaintiffs excessive fees for their work on the 1999 tax transactions. (Am. Compl. at ¶ 2).

  The E&Y Defendants have moved to compel arbitration based on the Letter Agreements signed by the Individual Plaintiffs. According to each Letter Agreement:

  Any controversy or claim arising out of or relating to tax and tax-related services now or hereafter provided by us to you (including any such matter involving any parent, subsidiary, affiliate, successor in interest, or agent of Page 4 Ernst & Young LLP) shall be submitted first to voluntary mediation, and if mediation is not successful, then to binding arbitration, in accordance with the dispute resolution procedures set forth in the Attachment to this letter.

 (the "Arbitration clause")(Defs' Ex. 2-5). The E&Y Defendants have submitted to this Court each of Plaintiffs' signed two page Letter Agreements. In addition, they have submitted what they claim were the *Attachments" to the Letter Agreements referred in the above paragraph. Each "Attachment" is a two-page document, titled "Dispute Resolution Procedures." (Defs' Exs. 2-5). Wayne T. Hoeing, a partner at E&Y who was with Plaintiffs when they signed these Letter Agreements, has submitted a declaration in which he avers that the "Attachment" was attached to the Letter Agreements at the time that the Plaintiffs signed those contracts.

  DISCUSSION

  Plaintiffs contend that their claims are not subject to arbitration because the "Attachments," which the E&Y Defendants allege were attached to the Letter Agreements, were not actually attached. The Plaintiffs have each submitted affidavits in which they aver that the two-page Dispute Resolution Procedures, which E&Y has filed with the Court, were not attached the to Letter Agreements. (See, e.g., Trigilio Aff. at ¶ 25; Camferdam Aff. at 24). Moreover, the Plaintiffs contend that they were not aware that the Letter Agreement itself even contained an Page 5 agreement to arbitrate because Hoeing, the E&Y partner with them at the time that they signed the Letter Agreements, did not explain to them that the contract included an arbitration clause. Based on these factual assertions, Plaintiffs now claim that, as a matter of law, they cannot be found to have agreed to arbitration.

  Plaintiffs argue, in the alternative, even if an agreement to arbitrate existed, the E&Y Defendants have waived their right to demand arbitration due to their participation in related litigation in the Northern District of Illinois ("the Illinois Litigation"). The Illinois Litigation arose out of a subpoena that E&Y received from the IRS seeking disclosure of the identities of-E&Y clients who had participated in certain tax-related transactions. Several E&Y clients — not including any of the Plaintiffs in this matter — sought to enjoin this disclosure, and the matter was litigated before the district court and the Seventh Circuit. The Plaintiffs in the Illinois Litigation did not prevail and the identities of E&Y clients were disclosed pursuant to the IRS subpoena.

  The Plaintiffs also argue that the Entity Plaintiffs and the Law Firm Defendants are not subject to the arbitration agreement.

  The parties agree that Indiana law controls this case. Page 6

 1. The Letter Agreement Contains a Binding Contract to Submit Claims to Arbitration.

  The Letter Agreement signed by the Individual Plaintiffs states that:

Any controversy or claim arising out of or relating to tax and tax-related services now or hereafter provided by us to you (including any such matter involving any parent, subsidiary, affiliate, successor in interest, or agent of Ernst & Young LLP) shall be submitted first to voluntary mediation, and if mediation is not successful, then to binding arbitration, in accordance with the dispute resolution procedures set forth in the Attachment to this letter.
(Defs' Ex. 2-5). This statement indicates the clear intent of the parties to arbitrate claims such as those presented in this suit.

  Plaintiffs' argument that they are not bound to arbitrate because they allegedly did not read the arbitration provision and Mr. Hoeing did not advise them of it, is unavailing. These excuses do not relieve them of their duty to arbitrate under the signed Letter Agreement. "It is a basic tenet of [Indiana] contract law that a person is assumed to have read and understood documents that they sign; a lack of understanding or failure to read the contract's provisions does not relieve a party from the terms of that agreement." Flynn v. Aerchem, Inc., 102 F. Supp.2d 1055, 1060 (S.D. Ind. 2000).

  Plaintiffs also argue that the alleged failure to provide the parties with the Attachment" at the time the Letter Page 7 Agreements were signed precludes a finding of an agreement to arbitrate. This argument is not persuasive. The intent to arbitrate is clear from the text of the Letter Agreement, and whether the Attachment setting forth the specific procedures was actually included with the Letter Agreement has no bearing on this issue.

  Plaintiffs rely upon In re Salomon, 68 F.3d 554 (2d Cir. 1995), to argue that no agreement to arbitrate exists here; however, such reliance is misplaced.*fn2 The parties in Salomon had specifically agreed that "all disputes were to be arbitrated by the [New York Stock Exchange] and only the NYSE." Id. at 558. When the NYSE refused to arbitrate a dispute between the parties, the court refused to substitute arbitrators under § 5 of the Federal Arbitration Act, finding that the agreement to arbitrate was a specific agreement to arbitrate before the NYSE and that there was "no further promise to arbitrate in another forum." Id. Plaintiffs try to analogize this case to Salomon by stating that the parties agreed to arbitrate according to the "set of rules contained in the missing and disputed Attachment" and arguing that this Court cannot "sever the missing Attachment from the alleged agreement to arbitrate." (Pl. Post-Arg. Br. at Page 8 17). This is disingenuous. The Plaintiffs' contention is not that they agreed to a specific set of rules, but rather that, because the Attachment was not supplied to them when they signed the Letter Agreements, they never agreed to any specific arbitration procedures. Thus, Salomon is inapplicable.*fn3

  While there is an undeniable agreement to arbitrate, the Court is unable to determine either the appropriate arbitral forum or which procedures will govern the arbitration. Defendants urge that Plaintiffs should be required to arbitrate this dispute in accordance with the procedures set forth in the Attachment, which requires, inter alia, that the arbitration be conducted in accordance with AAA Rules, no damages be awarded in excess of actual damages, and no discovery be permitted unless expressly authorized upon a showing of substantial need. Page 9 Defendant's argue that because the Letter Agreement specifically incorporates the Attachment, the Plaintiffs are bound by the terms of the Attachment, regardless of whether they ever received it. The Court agrees that if the Attachment were incorporated by reference in the Letter Agreement, then Plaintiffs would be bound to arbitrate according to the terms of the Attachment. See, e.g., Dimick v. First USA Bank, N.A., 2000 U.S. Dist. LEXIS 20910 (D.N.J. Jan. 14, 2000); Hart v. Canadian Imperial Bank of Commerce, 43 F. Supp.2d 395, 400-01 (S.D.N.Y. 1999); see also Butvin v. DoubleClick, Inc., 2001 U.S. Dist. LEXIS 2318, at *16 (S.D.N.Y. Mar. 7, 2001) ("The law simply does not protect someone who willingly signs an agreement which references and incorporates other controlling documents which he or she has not seen."). However, the Court finds that the reference in the Letter Agreement to the Attachment is insufficient to incorporate the terms of the Attachment. See Advanced Display Systems, Inc. v. Kent State University, 212 F.3d 1272 (Fed. Cir. 2000) (whether material is incorporated by reference is a question of law).

  "Under general principles of contract law, a contract may incorporate another document by making clear reference to it and describing it in such terms that its identity may be ascertained beyond doubt." New Moon Shipping Co. v. MAN B&W Diesel AG, 121 F.3d 24, 30 (2d Cir. 1997) (citing 4 Williston on Contracts § 628, at 903-04 Page 10 (3d ed. 1961)); see also Lake County Trust Co. v. Wine, 704 N.E.2d 1035, 1039 (Ind. App. 1998) ("a contract may incorporate another unsigned writing when the contract expressly a incorporates the terms of the writing"). Here, if we assume — as we must — that the Attachment was not attached to the Letter Agreement at the time of signing, then the Letter Agreement fails to adequately describe the Attachment.*fn4 Without referring to the Defendants' affidavits, the Court would be unable to identify these Attachments as the Attachments identified in the Letter Agreements. Thus, the reference in the Letter Agreements is not specific enough to incorporate the Attachment supplied by the E&Y Defendants into the agreement between the parties.*fn5

  Because the Attachment was not incorporated into the Letter Agreements by reference, the Court is presently unable to resolve the factual dispute as to which arbitral forum or which procedures shall control the arbitration. A factfinder must determine either that no attachment was provided or that the Page 11 Attachment the E&Y Defendants claim was attached to the Letter Agreements was, in fact, attached. If there was no attachment — and therefore a failure to specify the mechanics of the arbitration — the Court would order the parties to arbitration pursuant to the FAA. See 9 U.S.C. § 5 (if there is "a lapse in the naming of an arbitrator . . . [then] the court shall designate and appoint an arbitrator or arbitrators or umpire, as the case may require"); CNA Reinsurance Co. v. Trustmark Ins. Co., 2001 WL 648948, at *5 (N.D.Ill. June 5, 2001) ("If the parties have agreed to arbitrate, but have not specified the location or mechanics of arbitration, the court may fill the gaps under the FAA."). If the Attachment submitted by E&Y was attached, its terms shall govern.

  To resolve this matter, the Court directs the parties to brief the issue of how this question of fact should be decided — e.g., a hearing before the Court, a jury trial, etc. The parties are directed to submit further briefing on this issue on or before March 4, 2004. If either party wishes to respond, any such response is due no later than March 11, 2004.

 2. Defendants Have Not Waived Their Right to Arbitrate These Claims

  In response to a subpoena by the IRS, E&Y engaged in litigation in the Northern District of Illinois on the issue of whether it was required to reveal the names of its clients to Page 12 the IRS. Although not a party to the Illinois Litigation, Plaintiffs argue that E&Y's participation in this litigation waives the right to arbitrate this claim. This Court does not find any waiver. "[T]here is a strong presumption in favor of arbitration and that waiver of the right to arbitration `is not to be lightly inferred.'" Cotton v. Slone, 4 F.3d 176, 179 (2d Cir. 1993) (citation omitted) (quoting Carcich v. Rederi A/B Nordie, 389 F.2d 692, 696 (2d Cir. 1968)). Here, Plaintiffs have failed to overcome this presumption.

  E&Y did not institute the Illinois Litigation — suit was filed against E&Y and they were bound to answer. Under the circumstances, E&Y's litigation of the IRS subpoena in a suit that did not involve Plaintiffs is not sufficient to find a waiver of their right to arbitrate claims against Plaintiffs. Perry v. ICN Pharmaceuticals, 866 F. Supp. 120, 121 (S.D.N.Y. 1994) ("Pendency of a suit by plaintiff against . . . others concerning overlapping subject matter cannot deprive the moving defendants of the benefit of their arbitration agreement with plaintiff; otherwise arbitration could be defeated at any time when related litigation with nonsignatories of the arbitration agreement was initiated. This would destroy the usefulness of arbitration in many complex commercial contexts, contrary to the objectives of the United States Arbitration Act."). Page 13

  Moreover, Plaintiffs have failed to demonstrate that the litigation in the Northern District of Illinois resulted in prejudice against them. Rush v. Oppenheimer & Co., 779 F.2d 885, 887 (2d Cir. 1985) ("waiver of the right to compel arbitration due to participation in litigation may be found only when prejudice to the other party is demonstrated."). Plaintiffs argue that they are prejudiced by E&Y's participation in the Northern District of Illinois litigation because E&Y now seeks to dismiss Counts 8 and 9 of the Complaint as moot based on the outcome of the Illinois litigation. However, even if E&Y had not litigated the subpoena issue in Illinois, Counts 8 and 9 would still be subject to dismissal because, as explained in Section 5 below, Plaintiffs have failed to demonstrate that they are entitled to the injunctive relief that they seek in Counts 8 and 9.

 3. The Agreement to Arbitrate Covers the Entity Plaintiffs

  The Entity Plaintiffs that did not sign the Letter Agreements are bound to arbitrate their claims against the Defendants. The Letter Agreement specifically states that E&Y provided advice and services for the benefit of the Individual Plaintiffs and one Entity Plaintiff, Carmel Partners, which was created by the Letter Agreement.*fn6 "A party is estopped from Page 14 denying its obligation to arbitrate when it receives a `direct benefit' from a contract containing an arbitration clause." American Bureau of Shipping v. Tencara Shipyard S.P.A., 170 F.3d 349, 353 (2d Cir. 1999). Plaintiff Carmel Partners is a partnership whose four general partners are other Entity Plaintiffs — HNC Ditch Investments LLC, Sedgemoor Investments LLC, JM Walnut Investments LLC, and CT Oak Tree Investments LLC — that are wholly owned by the Individual Plaintiffs. The remaining Entity Plaintiff, BAMC, Inc., is also controlled by the Individual Plaintiffs. All Entity Plaintiffs were created for the sole purpose of implementing the advice given by E&Y under the Letter Agreements

  Plaintiffs argue that the Entity Plaintiffs are not bound by the Letter Agreements — and, thus, not bound to arbitrate — because the Entity Plaintiffs did not exist at the time of contracting and did not sign the Letter Agreements. However, if the Entity Plaintiffs are not bound by the Letter Agreements, then they have no cause of action against the Defendants arising out of the Letter Agreements. Moreover, it would defeat the purpose of the Arbitration Clause and the strong federal policy favoring arbitration to allow the Entity Plaintiffs to litigate issues that the Individual Plaintiffs — who created and control the Entity Plaintiffs — clearly agreed to arbitrate. Page 15

 4. The Agreement to Arbitrate Covers the Law Firm Defendants

  Although the Law Firm Defendants entered into separate engagement letters with the Plaintiffs, they now seek a stay based upon the Arbitration Clause in the Letter Agreements. A signatory to an arbitration agreement may be estopped from avoiding arbitration with a non-signatory when the issues the non-signatory is seeking to resolve in arbitration are intertwined with the agreement containing an arbitration clause that the signatory has signed. Thomson-CSF, S.A. v. Am. Arbitration Assoc., 64 F.3d 773, 779 (2d Cir. 1995). Here, Plaintiffs' claims against the Law Firm Defendants are intertwined with their claims against the E&Y Defendants under the Letter Agreement, and a stay is therefore granted pending the arbitration of the claims between the Plaintiffs and the Law Firm Defendants.

  A non-signatory may be bound to an arbitration agreement under ordinary principles of contract and agency. The Second Circuit has recognized five theories for binding nonsignatories to arbitration agreements: 1) incorporation by reference; 2) assumption; 3) agency; 4) veil-piercing/alterego; and 5) estoppel. Thomson-CSF, S.A. v. American Arbitration Assoc., 64 F.3d 773, 776 (2d Cir. 1995). Many courts also recognize an alternative estoppel theory, under which a signatory may be Page 16 estopped from avoiding arbitration with a nonsignatory. Id. at 779 (collecting cases).

  Plaintiffs argue that the Law Firm Defendants are not a entitled to arbitrate their claims because they fail to meet the applicable two prong test for the alternative estoppel theory: (1) that there is a close relationship between the Law Firm Defendants and the E&Y Defendants, and (2) that Plaintiffs' claims be intimately founded in and intertwined with the written agreement between E&Y and Plaintiffs. See Fluor Daniel Intercontinental, Inc. v. General Elec. Co., 1999 WL 637236, at *6 (S.D.N.Y. Aug. 20, 1999). However, Plaintiffs' argument is defeated by their own Complaint. Plaintiffs themselves proclaim that an agency relationship existed between the Law Firm Defendants and E&Y. (Am. Compl. ¶ 125). An agency relationship is sufficient to satisfy the first prong of the alternative estoppel test. Plaintiffs also claim that the Law Firm Defendants and the E&Y Defendants conspired to devise and promote the COBRA transactions to the Plaintiffs and others. (Am. Compl. ¶ 107). "A civil conspiracy is a kind of partnership, in which each member becomes the agent of the other." Roberson v. Money Tree, 954 F. Supp. 1519, 1529 n.11 (M.D. Ala. 1997) (citing Reno-West Coast Distribution Co., Inc. v. Mead Corp., 613 F.2d 722, 725 n.3 (9th Cir.), cert. denied, 444 U.S. 927 (1979)). Page 17

  Plaintiffs' Complaint is also instructive on the second prong of the test. Plaintiffs seek to impose liability on the Law Firm Defendants for their own actions and the actions undertaken by the E&Y Defendants pursuant to its Letter Agreements with Plaintiffs. Plaintiffs' theory of liability can only succeed if they prove their allegation that all Defendants conspired and acted together to establish a scheme to devise and promote the COBRA transactions.

  The application of equitable estoppel is warranted here because the Plaintiffs — signatories to the Letter Agreements — have raised allegations of "substantially interdependent and concerted misconduct by both the non-signatory [the Law Firm Defendants] and one or more of the signatories to the contract [the E&Y Defendants]." MS Dealer Service Corp. v. Franklin, 177 F.3d 942, 947 (11th Cir. 1999) (citations omitted). If this Court were to force the Law Firm Defendants to engage in litigation on the very same issues that will be arbitrated by the Plaintiffs and the E&Y Defendants, "the arbitration proceedings between the two signatories would be rendered meaningless and the federal policy in favor of arbitration effectively thwarted." Id.

 5. Counts 8 and 9 of the First Amended Complaint Are Dismissed.

  In Counts 8 and 9 of the First Amended Complaint, Plaintiffs seek to enjoin E&Y from disclosing information, Page 18 communications, documents, or otherwise committing any act that might impair or violate any of Plaintiffs' confidentiality rights and privileges.*fn7 To the extent that these counts seek to enjoin E&Y from disclosing information to the IRS, the counts are dismissed as moot. E&Y has already made disclosures to the IRS, and the propriety of those disclosures was the subject of litigation in the Northern District of Illinois. There is no reason to believe that E&Y will make any further disclosures to the IRS or any other party. If Plaintiffs have reason to believe that E&Y will make any future disclosures, then they may seek a protective order from this Court. However, as Plaintiffs have failed to establish any real or immediate threat of irreparable harm, they are not entitled to injunctive relief. Counts 8 and 9 are therefore dismissed. Page 19

  CONCLUSION

  The E&Y Defendants' motion to stay litigation of Counts 1-7 of Plaintiffs' First Amended Complaint pending arbitration and to dismiss Counts 8 and 9 is granted. The motions by the Law Firm Defendants for a stay pending arbitration are also granted. The parties are directed to submit supplemental briefing on the issue of how the arbitration procedures are to be determined no later than March 4, 2004.


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