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DENNEY v. JENKENS & GILCHRIST

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,
v.
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 appeal again.

  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

  A. Background

  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 gains.

  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, ¶ 2.

  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 clauses:
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 ...

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