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BLYTHE v. DEUTSCHE BANK AG

United States District Court, S.D. New York


January 7, 2005.

FRANKLIN W. BLYTHE, et al., Plaintiffs,
v.
DEUTSCHE BANK AG; DEUTSCHE BANK SECURITIES, INC., d/b/a DEUTSCHE BANK ALEX BROWN, a DIVISION of DEUTSCHE BANK SECURITIES, INC.; CRAIG BRUBAKER; DAVID PARSE; TODD CLENDENING; BDO SEIDMAN LLP; CHRISTOPHER TRUIT; MORRY GOTTLIEB; PAUL SHANBROM; ROBERT GREISMAN; THOM TAYLOR; and CHARLES McNEALY, Defendants.

The opinion of the court was delivered by: SHIRA SCHEINDLIN, District Judge

OPINION AND ORDER

I. INTRODUCTION

  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 duty, fraud, negligent misrepresentation, professional malpractice, and civil conspiracy.*fn1 BDO now moves to compel arbitration with respect to certain plaintiffs, and to stay the proceedings with respect to the remaining plaintiffs.*fn2 Deutsche Bank moves to stay the proceedings with respect to all plaintiffs.*fn3 II. BACKGROUND

  This case arises out of tax and consulting services marketed by defendants. The Complaint alleges that defendants defrauded plaintiffs through the marketing and sale of a tax shelter (a strategy involving digital options or swaps on foreign currency sometimes known as "COBRA") which they knew or should have known the IRS would challenge as lacking economic substance.

  Plaintiffs allege that the tax shelter scheme was developed by Deutsche Bank in concert with the law firm of Jenkens & Gilchrist, P.C. ("Jenkens").*fn4 Deutsche Bank agreed to act as the counter-party to the tax shelter transactions. Jenkens and Deutsche Bank recruited BDO and others to market the schemes to high net-worth clients, including plaintiffs.

  The Blythe Plaintiffs were introduced to the scheme through their longtime accountant Christopher Truitt, an employee of BDO. The Ramsey Plaintiffs were introduced to the scheme by their accountant, Charles McNealy, also an employee of BDO. The Zimmerman Plaintiffs were introduced to the scheme through their accountant Morry Gottlieb, an employee of BDO. The Baker, Ekaireb and Mosley Plaintiffs contacted Jenkens and/or Deutsche Bank directly to learn about COBRA, without dealing with BDO. All individual plaintiffs in this case are members of a putative settlement class with Jenkens in Denney v. Jenkens & Gilchrist,*fn5 also before this Court. The Jenkens settlement class has been preliminarily certified.*fn6 Plaintiffs are also members of other putative classes in Denney that have not yet been preliminarily certified. None of the plaintiffs in this case have opted out of the Jenkens class.*fn7 Deutsche Bank AG, Deutsche Bank Securities, and BDO Seidman are named as defendants in Denney. The individual defendants in this case are not named as defendants in Denney. Some, but not all, of the claims asserted by plaintiffs here are encompassed by Denney.*fn8

  A. BDO's Motion to Compel Arbitration and Stay the Proceedings

  1. The Blythe/BDO Agreement

  On June 30, 1998, Luther J. Blythe entered into a consulting agreement with BDO. This agreement contained the following language:

WHEREAS, Mr. Blythe is interested in transferring, by sale, lease or otherwise, an interest in certain investments, primarily investments in entities owning various golf properties;
WHEREAS, BDO is in the business of providing accounting and consulting services; and
WHEREAS, Mr. Blythe desires BDO to provide certain Consulting services in connection with any potential transactions, and BDO desires to provide such services . . .*fn9
The consulting agreement requires BDO to provide the following services:
consulting services in conjunction with any potential transaction, including assistance in determination of sales price and allocations thereof, assistance in structuring the Transaction, assisting Mr. Blythe and/or its advisors in structuring a reorganization qualifying as a nontaxable merger, income and estate planning for Mr. Blythe, and assisting Mr. Blythe in discussions and/or negotiations with potential purchasers of the golf course investments, on a specifically requested basis. For purposes of this Agreement, (i) the term "Transaction" shall mean the transfer, whether by sale, merger or otherwise, of all or any portion of the golf course investments.*fn10
  The Blythe/BDO Agreement also contains a mandatory arbitration clause, providing for arbitration of "any dispute, controversy or claim [that] arises in connection with the performance or breach of this Agreement."*fn11

  2. The Zimmerman/BDO Agreement

  On September 30, 1999, Jordan B. Zimmerman entered into a consulting agreement with BDO. This agreement contains the following language:

WHEREAS, [Zimmerman] is interested in transferring, by sale, lease or otherwise, any or all of his business operations (. . . such transfer [is referred to as] the "Transaction");
WHEREAS, BDO is in the business of providing accounting and consulting services; and
WHEREAS, [Zimmerman] desires BDO to provide certain tax and business consulting services in connection with the Transaction, and BDO desires to provide such services . . .*fn12
The consulting agreement requires BDO to provide the following services:
consulting services in connection with the Transaction, including assistance in structuring the Transaction, assisting the client in determining a tax treatment for the Transaction, and the preparation of 1999 and 2000 income tax returns that would reflect the Transaction.*fn13
The Zimmerman/BDO Agreement also contains a mandatory arbitration clause identical to that in the Blythe/BDO Agreement.
3. The Unsigned Ramsey/BDO Agreement
  BDO has submitted an unsigned consulting agreement between BDO and, among others, Barnwell S. Ramsey. The agreement appears to be in draft form. Its provisions are similar to those of the Blythe and Zimmerman Agreements, and it contains an identical arbitration clause.

  On the basis of the Blythe and Zimmerman Agreements, BDO moves to compel the Blythe and Zimmerman Plaintiffs to arbitrate their claims. Having been unable to locate a signed agreement with the Ramsey Plaintiffs, BDO does not seek to compel that group to arbitrate, but requests that the Court stay their claims pending certification of the class in Denney, on the ground that if the class action in Denney is certified, it will encompass the Ramsey Plaintiffs' claims.

  B. Deutsche Bank's Motion to Stay the Proceedings

  The Baker, Mosley and Ekaireb Plaintiffs opened brokerage accounts with DB Alex. Brown in 2000. Through individual members or entities within each group, these plaintiffs signed Account Agreements.*fn14 Each Account Agreement contains an identical arbitration clause: I agree to arbitrate with you any controversies which may arise, whether or not based on events occurring prior to the date of this agreement, including any controversy arising out of or relating to any account with you, to the construction, performance or breach of any agreement with you, or to transactions with or through you, only before the New York Stock Exchange or the National Association of Securities Dealers Regulation, Inc., at my election.

 However, the clauses go on to provide that:

No person shall bring a putative or certified class action to arbitration, nor seek to enforce any pre-dispute arbitration agreement against any person who has initiated in court a putative class action; or who is a member of a putative class who has not opted out of the class with respect to any claims encompassed by the punitive [sic] class action until (1) the class certification is denied; or (2) the class is decertified; or (3) the customer is excluded from the class by the court.*fn15
  This Class Action Provision is based on NASD Rule 10301(d)(3), which provides that:

 

No member or associated person shall seek to enforce any agreement to arbitrate against a customer, other member or person associated with a member who has initiated in court a putative class action or is a member of a putative or certified class with respect to any claims encompassed by the class action unless and until: (A) the class certification is denied; (B) the class is decertified; (C) the customer, other member or person associated with a member is excluded from the class by the court; or (D) the customer, other member or person associated with a member elects not to participate in the putative or certified class action or, if applicable, has complied with any conditions for withdrawing from the class prescribed by the court.*fn16
  The Blythe, Zimmerman and Ramsey Plaintiffs executed transactions with Deutsche Bank in 1999. The Account Agreements signed by these plaintiff groups did not contain arbitration clauses.

  Deutsche Bank argues that it will be entitled to compel the Baker, Mosley and Ekaireb Plaintiffs to arbitrate. However, Deutsche Bank concedes that, because these plaintiffs are members of the putative class in Denney, it cannot, pursuant to the Class Action Provision and NASD Rule 10301(d)(3), presently compel them to arbitrate any claims encompassed by Denney; rather, Deutsche Bank argues that it will be able to compel the Baker, Mosley and Ekaireb plaintiffs to arbitrate if and when class certification in Denney is denied or those plaintiffs are excluded from the class.

  Although Deutsche Bank has no arbitration agreement with the Blythe and Zimmerman Plaintiffs, Deutsche Bank argues that it is entitled to compel those plaintiffs to arbitrate through their arbitration agreements with BDO, because plaintiffs allege that BDO acted in concert with Deutsche Bank. However, in light of NASD Rule 10301(d)(3), Deutsche Bank does not seek to compel arbitration against these plaintiffs at this time. Deutsche Bank argues that it is entitled to compel arbitration now as to all claims that are not encompassed by Denney. However, Deutsche Bank does not (yet) seek to do so, recognizing that it would be "wasteful and inefficient."*fn17 Instead, Deutsche Bank asks that the Court stay the Blythe, Zimmerman, Baker, Mosley and Ekaireb Plaintiffs' claims pending certification of the class in Denney. Deutsche Bank argues that, if the Denney class is certified, and those plaintiffs do not opt out of it, then their claims will be resolved as part of the Denney class action; or, if the Denney class is not certified or those plaintiffs opt out, then Deutsche Bank will be entitled to compel arbitration as to all of their claims. Deutsche Bank argues that there is no scenario in which those plaintiffs' claims will ever proceed in this action.

  Finally, although neither Deutsche Bank nor BDO appears to have an arbitration agreement with the Ramsey Plaintiffs, Deutsche Bank asks the Court to stay the Ramsey Plaintiffs' claims. Deutsche Bank argues that "the fact that the Ramsey Plaintiffs may still choose to opt into [sic] any certified Denney litigation class warrants a stay of their claims until they make such a decision. It makes no sense to litigate these claims in an individual lawsuit if they eventually will be resolved as part of such a class action."*fn18

  III. 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."*fn19 To find a valid agreement to arbitrate, a court must apply the "generally accepted principles of contract law."*fn20 "[A] party is bound by the provisions of a contract that he signs, unless he can show special circumstances that would relieve him of such obligation."*fn21 A court should consider only "whether there was an objective agreement with respect to the entire contract."*fn22

  Because there is "a strong federal policy favoring arbitration . . . where ? the existence of an arbitration agreement is undisputed, doubts as to whether a claim falls within the scope of that agreement should be resolved in favor of arbitrability."*fn23 Thus, the Second Circuit has emphasized that

any doubts concerning the scope of arbitrable issues should be resolved in favor of arbitration. Accordingly, [f]ederal policy requires us to construe arbitration clauses as broadly as possible. We will compel arbitration unless it may be said with positive assurance that the arbitration clause is not susceptible of an interpretation that covers the asserted dispute.*fn24
  However, although federal policy favors arbitration, it is a matter of consent under the FAA, and "a party cannot be required to submit to arbitration any dispute which he has not agreed so to submit."*fn25

  The Second Circuit has established a three-part inquiry for determining whether a particular dispute falls within the scope of the arbitration agreement.*fn26 First, "a court should classify the particular clause as either broad or narrow."*fn27 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."*fn28 "Where the arbitration clause is narrow, a collateral matter will generally be ruled beyond its purview."*fn29 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.'"*fn30 "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."*fn31

  IV. DISCUSSION A. BDO's Motion to Compel Arbitation*fn32

  In Denney, BDO sought to compel arbitration of the Denney plaintiffs' claims on the basis of consulting agreements almost identical to those at issue here (the "Denney Agreements"). In an Opinion and Order dated April 28, 2004, I denied BDO's motion to compel arbitration, finding that the Denney Agreements were mutually fraudulent, because they were intended to conceal the nature of the work BDO was performing.*fn33 In a subsequent Opinion and Order, dated June 14, 2004, I found, as an additional ground for denying BDO's motion to compel arbitration, that the Denney Agreements did not encompass the Denney plaintiffs' dispute.*fn34

  Like the Denney Agreements, the consulting agreements here contain misleading language, from which "[i]t appears that neither plaintiffs nor BDO wanted any third party to know the nature of the contracts into which they entered, or that BDO had contracted with plaintiffs to provide tax shelter advice. As a result, they entered into agreements that described consulting work that was never performed and was different from the consulting services that were actually provided."*fn35

  The Denney Agreements, like those at issue here, described services in connection with the sale of plaintiffs' business operations, rather than the tax shelter services actually provided. As an indication of the fraudulent nature of the Denney Agreements, I noted that plaintiffs had in fact already sold their business operations before they entered into consulting agreements, and so the services described were never performed. Similarly, here, Zimmerman had already sold his business operations prior to the time he and BDO entered into the consulting agreement, and the services described were never performed.*fn36

  Moreover, since my decision in Denney, new evidence of the fraudulent nature of BDO's consulting agreements has come to light. In a recently discovered internal memorandum ("the Kerekes Memorandum"), dated August 11, 2000,*fn37 Michael Kerekes, a principal at BDO and a member of the committee at BDO responsible for tax shelters, states that the agreements "have been structured not to make clear exactly what services we were providing in return for our fee."*fn38 This memorandum strongly supports my finding of mutual fraud.

  Because the consulting agreements containing the arbitration clauses are mutually fraudulent, the contracts cannot be enforced.*fn39 Therefore, there is no valid agreement to arbitrate. BDO's motion to compel arbitration must be denied.

  BDO argues that "even evidence of `mutual fraud' would not render the arbitration agreements inoperative, for arbitration agreements are separable from the underlying agreements in which they are embedded."*fn40 BDO relies on Prima Paint, in which the Supreme Court "announced what has become known as the severability doctrine — that `arbitration clauses as a matter of federal law are `separable' from the contracts in which they are embedded, and that where no claim is made that fraud was directed to the arbitration clause itself, a broad arbitration clause will be held to encompass arbitration of the claim that the contract itself was induced by fraud.'"*fn41 BDO's reliance on Prima Paint is misplaced.

  The Second Circuit elucidated the holding of Prima Paint in Sphere Drake. Where the underlying contract in which an arbitration clause is contained is void, arbitration may not be compelled; where the underlying contract is merely voidable, the arbitration clause is severable from the contract, and arbitration may be compelled unless the arbitration clause itself is voidable.*fn42 The Sphere Drake court offered "a good example of a void contract[:] when parties fail to agree to essential contract terms, the agreement does not come into existence — it is void and wholly unenforceable."*fn43 By contrast, where a party alleges fraud in the inducement, the contract is merely voidable, not void, and arbitration must be compelled.*fn44

  Because they are mutually fraudulent, the consulting agreements are not merely voidable, but void ab initio. The consulting agreements describe services that were (with the exception of limited services performed for Blythe) never rendered nor intended to be rendered, and conceal the real substance of the parties' agreement — the provision of tax shelter advice. The consulting agreements do not represent a meeting of the minds of the parties, but are merely a sham or cover for their real agreement.*fn45 The consulting agreements are therefore void, and the arbitration clauses are not enforceable.*fn46

  Moreover, the consulting agreements do not cover the tax shelter services at issue here. 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. The underlying dispute here is wholly unrelated to the obligations encompassed by the contracts, and does not constitute even a collateral matter. The consulting agreements only involve services in connection with the transfer of assets and investments; they do not relate in any way to the tax shelter transactions which are at issue here. Plaintiffs' claims do not implicate issues of the construction of the consulting agreement or the parties' rights and obligations under it. As in Denney, the consulting agreements simply do not cover the plaintiffs' claims.*fn47

  I note again that, since my opinion in Denney, new evidence has come to light supporting my findings. The Kerekes Memorandum makes it clear that BDO deliberately drafted its agreements so as not to cover the tax shelter services that are at issue here. Instead, the tax shelter services appear to have been provided pursuant to oral understandings between the parties, which do not, of course, contain arbitration clauses.

  For the foregoing reasons, BDO's arbitration agreements are void, and inapplicable to this dispute. There is therefore no need to consider the argument that Deutsche Bank is entitled to compel arbitration pursuant to these agreements.

  B. The Motions to Stay

  A district court has discretion to stay a case pursuant to "the power inherent in every court to control the disposition of the causes on its docket with economy of time and effort for itself, for counsel, and for litigants."*fn48 However, such a stay is appropriate only in "rare circumstances."*fn49 "[T]he burden of making out the justice and wisdom of a departure from the beaten track l[ies] heavily on the [party seeking a stay in favor of another action] and discretion [is] abused if the stay [is] not kept within the bounds of moderation."*fn50

  BDO argues that the Ramsey Plaintiffs' claims should be stayed pending resolution of class certification issues in Denney, to conserve judicial and party resources.*fn51 Deutsche Bank argues that the entire case "should be stayed pending resolution of the class issues in Denney. It simply makes no sense for Plaintiffs to be permitted to litigate their case on both a class-wide basis and in a separate, individual action simultaneously."*fn52 I am not persuaded that the drastic remedy of a stay is justified here. Denney is at an early stage; it is unlikely, although possible, that class certification issues in Denney will be resolved within a year. It is important to note that Blythe includes claims that are not encompassed by Denney. Plaintiffs in this case should not be required to wait for a year, and perhaps more, for their individual claims — those not encompassed in Denney — to advance.

  Indeed, at defendants' urging, pre-trial proceedings in Denney as to BDO and Deutsche Bank have been stayed by orders of the Second Circuit, pending appeal of my decisions in Denney I & II.*fn53 It would be entirely improper to stay plaintiffs' claims against BDO and Deutsche Bank in favor of Denney, while the Denney plaintiffs are barred from proceeding as to those defendants. Moreover, while proceedings in Denney as to those defendants are stayed, the class issues in Denney cannot be resolved; Denney is effectively dead in the water. Contrary to Deutsche Bank's argument, therefore, plaintiffs are not presently able to litigate their case in Denney and in Blythe simultaneously, even insofar as those cases overlap. Once all appeals from my decisions here and in Denney I & II are complete, it is likely that some or all of the claims of the plaintiffs in both cases will proceed in this Court.*fn54 At that time, there will be no great hardship to defendants, nor any untoward drain on judicial resources, in allowing Blythe to proceed alongside Denney.*fn55 To the extent that Blythe and Denney overlap, the Court has the power to manage the two cases so as to avoid duplication of efforts. Defendants' motion to stay is therefore denied.

  V. CONCLUSION For the foregoing reasons, defendants' motions to compel arbitration and for a stay are denied. The Clerk of the Court is directed to close these motions [#10, 21]. A conference is scheduled for January 17, 2005 at 4:00 p.m.

  SO ORDERED.


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