United States District Court, S.D. New York
June 14, 2004.
THOMAS DENNEY, R. THOMAS WEEKS, NORMAN R. KIRISITS, KATHRYN M. KIRISITS, TD CODY INVESTMENTS, L.L.C., RTW INVESTMENTS, L.L.C., NRK SYRACUSE INVESTMENTS, L.L.C., DKW PARTNERS, DKW LOCKPORT INVESTORS, INC., DONALD A. DESTEFANO, PATRICIA J. DESTEFANO, DD TIFFANY CIRCLE INVESTMENTS L.L.C., TIFFANY CIRCLE PARTNERS, DIAMOND ROOFING COMPANY, INC., JEFF BLUMIN, JB HILLTOP INVESTMENTS L.L.C., KYLE BLUMIN, KB HOAG LANE INVESTMENTS, L.L.C., L. MICHAEL BLUMIN, MB ST. ANDREWS INVESTMENTS, L.L.C., FAYETTEVILLE PARTNERS, and LAUREL HOLLOW INVESTORS, INC., on their own behalf and on behalf of all others similarly situated, Plaintiffs,
JENKENS & GILCHRIST, a Texas Professional Corporation, JENKENS & GILCHRIST, an Illinois Professional Corporation, BDO SEIDMAN, L.L.P., PASQUALE & BOWERS, L.L.P., CANTLEY & SEDACCA, L.L.P., DERMODY, BURKE, AND BROWN, CERTIFIED PUBLIC ACCOUNTANTS, PLLC, PAUL M. DAUGERDAS, PAUL SHANBROM, EDWARD SEDACCA, DEUTSCHE BANK AG, and DEUTSCHE BANK SECURITIES, INC., d/b/a DEUTSCHE BANK ALEX BROWN, A DIVISION OF DEUTSCHE BANK SECURITIES, INC., Defendants.
The opinion of the court was delivered by: SHIRA SCHEINDLIN, District Judge
MEMORANDUM OPINION AND ORDER
By Opinion & Order dated April 30, 2004 (the "April 30
Opinion"), I denied defendants' motion to compel arbitration on
the ground that the contracts containing the arbitration clauses
were mutually fraudulent.*fn1 See Denney v. Jenkens &
Gilchrist, No. 03 Civ. 5460, 2004 WL 936843, at *6 (S.D.N.Y. Apr.
30, 2004) ("Denney I"). I did not reach the question of whether
the arbitration clauses encompassed the underlying dispute.
Thereafter, all defendants other than the Jenkens and Cantley
Defendants filed a notice of appeal pursuant to section 16 of the
Federal Arbitration Act, 9 U.S.C. § 16. They now move to stay
this action pending appeal.
Ordinarily, when a party appeals an order denying a motion to
compel arbitration, the district court should stay the action
pending appeal. See In re Winimo Realty Corp., 270 B.R. 99, 105
(S.D.N.Y. 2001); Satcom Int'l Group PLC v. Orbcomm Int'l
Partners, L.P., 55 F. Supp.2d 231, 236 (S.D.N.Y. 1999); and
Bradford-Scott Data Corp. v. Physician Computer Network, Inc.,
128 F.3d 504, 505 (7th Cir. 1997). However, the posture of this
action creates a unique situation that demands that this Court
reach the question of the scope of the arbitration agreements before entering a stay. Specifically, defendants'
pending appeal may take many months to resolve. In the event that
the Court of Appeals reverses and remands Denney I, this Court
will be required to consider the issue of whether the arbitration
agreements encompass the underlying litigation. And if the Court
again refuses to compel arbitration, on the ground that the
contracts do not govern this dispute, defendants will likely
Thus, it may be two years before the parties have a final
resolution from the Court of Appeals regarding whether this
action is subject to arbitration. This result is untenable
because such a delay will obviously prejudice plaintiffs.
Moreover, two separate appeals of a single question would be a
waste of resources, particularly given that the Second Circuit
can easily consider both the validity of the contracts, and their
scope, in a single appeal.
Under these circumstances, it would be inappropriate to grant
the stay without first considering the scope of the agreements
because the potential prejudice to plaintiffs is too great. Thus,
before entertaining defendants' stay application, the Court must
protect plaintiffs' interests by considering the scope of the
arbitration agreements. Viewed together, the decisions in Denney
I and this Memorandum Opinion & Order will allow the parties to
obtain complete resolution from the Court of Appeals in a single
appeal, without undue delay. I. FACTS
The factual allegations giving rise to this litigation are set
forth in detail in the April 30 Opinion, and familiarity with
that opinion is presumed. In brief, plaintiffs purport to
represent the class of investors who, between 1999 and 2001,
engaged in a tax strategy known as Currency Options Bring Reward
Alternatives, or "COBRA." The strategy was developed by the
Jenkens Defendants, and marketed by the BDO Defendants*fn2
to the wealthy clients of Pasquale & Bowers ("Pasquale") and
Dermody, Burke, and Brown ("Dermody"). The Jenkens Defendants,
and later the Cantley Defendants, wrote legal opinion letters
attesting to COBRA's validity and legality. The securities
transactions underlying COBRA were carried out by the Deutsche
Bank Defendants,*fn3 with whom plaintiffs opened accounts at
the recommendation of the Jenkens Defendants.
On December 27, 1999, and again in August, 2000, the IRS issued
notices indicating that losses arising from COBRA-like
transactions are not properly allowable for Federal income tax purposes. Nonetheless,
the Jenkens Defendants and the Cantley Defendants continued to
issue opinion letters stating that COBRA was a valid, legal tax
strategy, and Paquale and Dermody prepared plaintiffs' tax
returns utilizing the COBRA losses to offset plaintiffs' capital
Plaintiffs are presently defending federal and state tax audits
as a result of COBRA. In addition to the financial losses
plaintiffs incurred in carrying out the transactions underlying
COBRA, plaintiffs have incurred and will continue to incur
substantial damages in the form of fees paid to attorneys and
accountants retained to address the audits. Based on these facts,
plaintiffs allege that defendants violated the Racketeer
Influenced and Corrupt Organizations Act, 18 U.S.C. § 1962, and
are liable for damages and other relief arising from unjust
enrichment, breach of contract, breach of the duty of good faith
and fair dealing, breach of fiduciary duties, fraud, negligent
misrepresentation, professional malpractice, "unethical,
excessive and illegal fees," and conspiracy.
B. The Contracts
On October 8, 1999, plaintiff L. Michael Blumin, on behalf of
Jefyle Equipment Corp., Inc., entered into a consulting agreement
with BDO (the "Blumin Agreement"). The Blumin Agreement was
effective through September 30, 2000, and required BDO to provide
Jefyle Equipment Corporation with "assistance in financing business, real estate ventures and
financing corporation activities, assistance with like kind
exchanges, assistance with leasing transaction issues, assistance
in planning the Expansion, and assisting [Jefyle Equipment Corp.]
and/or its advisors in determining tax treatments of the
transactions associated with the Expansion." Consulting Agreement
between BDO and Jefyle Equipment Corp., Ex. 4 to the Affidavit of
Michael R. Young ("Young Aff."), counsel to the BDO Defendants, ¶
On October 12, 1999, Thomas Denney, R. Thomas Weeks, Norman R.
Kirisits, and BDO executed a consulting agreement (the "Denney
Agreement"). The Denney Agreement expired on December 31, 1999,
and required BDO to provide consulting services, include tax
treatment advice, in connection with Denney's, Weeks's, and
Kirisits's transfer of their business operations, "by sale, lease
or otherwise." Consulting Agreement between BDO and Denney,
Weeks, and Kirisits, Ex. 2 to the Young Aff., at "whereas"
clauses and ¶ 2.
Finally, on November 2, 1999, plaintiff Diamond Roofing Co.,
Inc. entered into a consulting agreement with BDO (the "DeStefano
Agreement"). The DeStefano Agreement was effective through
September 30, 2000, and required BDO to provide services to
Diamond Roofing Company in connection with the expansion of its
business operations. Specifically, BDO was to provide the same services to Diamond Roofing Company that it was providing to
Jefyle Equipment Corporation pursuant to the Blumin Agreement.
See Consulting Agreement between BDO and Diamond Roofing Co.,
Inc., Ex. 3 to the Young Aff., at "whereas" clauses and ¶ 2.
All three agreements contained identical, mandatory arbitration
If any dispute, controversy or claim arises in
connection with the performance or breach of this
Agreement and cannot be resolved by facilitated
negotiations (or the parties agree to waive that
process) then such dispute, controversy or claim
shall be settled by arbitration in accordance with
the laws of the State of New York, and the then
current Arbitration Rules for Professional Accounting
and Related Disputes of the American Arbitration
Association ("AAA") except that no pre-hearing
discovery shall be permitted unless specifically
authorized by the arbitration panel, and shall take
place in the city in which the BDO office providing
the relevant Services exists, unless the parties
agree to a different locale.
Blumin Agreement ¶ 7(d); Denney Agreement ¶ 8(d); DeStefano
Agreement ¶ 7(d).
C. The April 30 Opinion
In support of their motion to compel arbitration, defendants
argued that the consulting agreements were entered into in
connection with plaintiffs' COBRA transactions, and that the
mandatory arbitration clauses therefore required plaintiffs to arbitrate their claims. Plaintiffs countered by
arguing that the plain language of the contracts makes clear that
the agreements govern consulting services wholly unrelated to
In the course of considering the parties' arguments, I asked
counsel for BDO and counsel for plaintiffs whether BDO provided
consulting services to plaintiffs for anything other than COBRA.
See 3/14/04 Transcript ("Tr.") at 6. Counsel for both BDO and
plaintiffs acknowledged that the only work BDO did on plaintiffs'
behalf was in connection with COBRA. Moreover, counsel informed
the Court that although the Blumin and DeStefano Agreements
obligated BDO to assist Jefyle Equipment and Diamond Roofing,
respectively, with their expansions, BDO provided no such
services. Similarly, though the Denney Agreement stated that BDO
would assist Denney, Weeks, and Kirisits with the transfers of
their businesses, the transfers had already occurred at the time
the Denney Agreement was executed, and BDO provided no work in
connection with those transfers. See id. at 6, 10.
Based on these facts, I concluded that the agreements between
BDO and plaintiffs were mutually fraudulent because they were
intended to conceal the nature of the work that BDO was
performing, and described work that was never performed and that
the parties never intended be performed. See Denney I, 2004 WL 936843, at *6. Because the contracts are mutually fraudulent,
the arbitration clauses contained therein cannot be enforced.
Having concluded that the contracts were invalid, I did not
address whether the arbitration clauses contained therein
encompass plaintiffs' underlying claims.
A. Scope of the Arbitration Clauses
1. Legal Standard
The determination of whether a dispute is arbitrable under the
FAA comprises two questions: "(1) whether there exists a valid
agreement to arbitrate at all under the contract in question . . .
and if so, (2) whether the particular dispute sought to be
arbitrated falls within the scope of the arbitration agreement."
Hartford Acc. and Indem. Co. v. Swiss Reinsurance Amer. Corp.,
246 F.3d 219, 226 (2d Cir. 2001) (quoting National Union Fire
Ins. Co. v. Belco Petroleum Corp., 88 F.3d 129, 135 (2d Cir.
1996)). In Denney I, I concluded that no valid agreement to
arbitrate exists between plaintiffs and BDO. However, for the
reasons set forth above, see supra Part II.A, I will assume,
arguendo, that the agreement is valid, and address whether the
parties' underlying dispute falls within the scope of the
Because there is "a strong federal policy favoring arbitration
. . . doubts as to whether a claim falls within the scope of that
agreement should be resolved in favor of arbitrability." Ace
Capital Re Overseas Ltd. v. Cent. United Life Ins. Co.,
307 F.3d 24, 28 (2d Cir. 2002) (internal quotation marks and citations
omitted). Although federal policy favors arbitration, the Federal
Arbitration Act has been interpreted to require consent before a
party can be compelled to arbitrate. "[A] party cannot be
required to submit to arbitration any dispute which he has not
agreed so to submit." Louis Dreyfus Negoce S.A. v. Blystad
Shipping & Trading Inc., 252 F.3d 218, 224 (2d Cir. 2001)
(quoting AT & T Techs., Inc. v. Communications Workers of Am.,
475 U.S. 643, 648 (1986)).
The Second Circuit has established a three-part inquiry for
determining whether a particular dispute falls within the scope
of the arbitration agreement. See id. First, "a court should
classify the particular clause as either broad or narrow." Id.
Second, if the clause is narrow, "the court must determine
whether the dispute is over an issue that `is on its face within
the purview of the clause,' or over a collateral issue that is
somehow connected to the main agreement that contains the
arbitration clause." Id. (quoting Rochdale Vill., Inc. v.
Public Serv. Employees Union, 605 F.2d 1290, 1295 (2d Cir.
1979)). "Where the arbitration clause is narrow, a collateral
matter will generally be ruled beyond its purview." Id. Third,
if the arbitration clause is broad, "`there arises a presumption of arbitrability' and arbitration of even a collateral matter
will be ordered if the claim alleged `implicates issues of
contract construction or the parties' rights and obligations
under it." Id. (quoting Collins & Aikman Prods. Co. v. Bldg.
Sys., Inc., 58 F.3d 16, 23 (2d Cir. 1995)). "In the end, a court
must determine whether, on the one hand, the language of the
clause, taken as a whole, evidences the parties' intent to have
arbitration serve as the primary recourse for disputes connected
to the agreement containing the clause, or if, on the other hand,
arbitration was designed to play a more limited role in any
future dispute." Id. at 225.
2. The Arbitration Clauses Do Not Encompass the Underlying
The language of the arbitration clauses is broad because it
covers "any dispute, controversy or claim [that] arises in
connection with the performance or breach of this Agreement."
However, this dispute is not subject to arbitration because
plaintiffs' allegations do not arise in connection with the
performance or breach of the contracts. While broad arbitration
clauses create a presumption of arbitrability and subject
collateral matters to arbitration, the underlying dispute here is
wholly unrelated to the obligations encompassed by the contracts,
and does not constitute even a collateral matter. Specifically,
the plain language of the contracts demonstrates that certain
plaintiffs (as well as at least one non-party) retained BDO to provide consulting services in connection with
Jefyle Equipment's and Diamond Roofing's expansions, and the sale
or transfer of businesses owned by Denney, Weeks, and Kirisits.
Nothing contained in the contracts relates to BDO advising
plaintiffs with respect to tax shelters, foreign investments, and
accounting.*fn4 Indeed, the Blumin Agreement was made with
Jefyle Equipment Corporation, non-party, and the effective dates
of all three of the contracts do not correspond to the time
periods during which BDO provided consulting advice regarding tax
shelters to plaintiffs.
Is essence, defendants seek to apply the arbitration clauses to
a dispute that arises entirely outside the scope of the
agreements. While the plaintiffs who signed the written
agreements consented to arbitrate disputes arising from the
services provided pursuant to the contracts, they did not agree
to arbitrate disputes generated by other, unrelated services.
Because the underlying action arises from unrelated services,
plaintiffs cannot be compelled to arbitrate. See Louis Dreyfus,
252 F.3d at 224; see also Lewis v. New Jersey Sports
Productions, Inc., No. 02 Civ. 6505, 2003 WL 1090279 (S.D.N.Y.
Mar. 12, 2003) (arbitration clause contained in one agreement cannot be applied to conduct
encompassed by a separate agreement where agreement covering the
disputed conduct contains no arbitration clause).
C. The Stay Application
Having addressed the validity of the contracts in Denney I,
and the scope of the arbitration clauses contained in the
agreements in this Memorandum Opinion & Order, I have
sufficiently protected plaintiffs' interest in avoiding undue
delay during the appeal, and a stay is warranted. Therefore, for
the reasons set forth in In re Winimo Realty Corp., 270 B.R. at
105; Satcom Int'l, 55 F. Supp.2d at 236; and Bradford-Scott
Data Corp., 128 F.3d at 505, defendants' motion for a stay is
For the foregoing reasons, defendants' motion to stay is
granted. This action is stayed with respect to all defendants other than
Jenkens & Gilchrist, a Texas Professional Corporation, Jenkens &
Gilchrist, an Illinois Professional Corporation, and Paul M.
Daugerdas during the pendency of defendants' appeal.