Volume 10, Issue 1 - October 2011

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VOLUME 10, ISSUE 1: CASE SUMMARY

Khan v. BDO Seidman, LLP, 404 Ill. App. 3d 892, 935 N.E.2d 1174, 343 Ill. Dec. 946 (Ill. App. 4 Dist. 2010)

The question of arbitrability arises whenever one disputant, who is a party to an arbitration agreement, moves a court to compel arbitration of the entire dispute or a specific issue within the case. Usually, a motion to compel arbitration is accompanied by a motion to stay judicial proceedings while the arbitration proceeds. Historically, the United States Supreme Court has presumed that most disputes arising out of a contract that contains an arbitration agreement should be arbitrated, even holding that a challenge to the application of a statute of limitations (which would have barred one party’s claim) was an issue for the arbitrator rather than a court. See Howsam v. Dean Witter Reynolds, Inc., 537 U.S. 79 (2002). This case raises the question whether an arbitrator or the court should decide arbitrability of a claim when the parties disagree about whether the arbitration agreement covers the particular claim.

The Khans (plaintiffs) sued their accounting firm, BDO Seidman, LLP (BDO), and several other parties when the Khans learned that BDO’s proposed investment strategy was illegal. “The upshot is that the Khans lost a lot of money, not only the fees and premiums they paid to defendants to carry out the “investment strategies,” but also the back taxes, interest, and penalties they had to pay to the Internal Revenue Service (IRS)…” See Khan v. BDO Seidman, LLP, 404 Ill. App. 3d 892, 894 (Ill. App. 4 Dist. 2010). The trial court granted BDO’s motion to compel arbitration and held that all of the plaintiffs’ claims fell within the scope of the arbitration agreement. Plaintiffs appealed.

The Appellate Court disagreed with the trial court’s grant to compel arbitration in regards to all of the claims asserted. The court relied on contractual language for its determination. “According to the contractual language, a claim is subject to arbitration only if it relates to, or arises from, BDO’s “performance” of the contract.” Id. at 894; see also id. at 897. Most of the plaintiffs’ claims, according to the court, fell into categories “expressly excluded from BDO’s promised performance.” Id. at 894; see also id. at 896-898. The contract stipulated that BDO would not provide “investment advice or services”; BDO would only provide “consulting services” which included “determining the sales price of investments, structuring the sale or making of investments, and negotiating with potential buyers or sellers of investments. Nevertheless, BDO will not provide ‘investment advice or services.’” Id. at 898. Those claims that that are part of the excluded category are not subject to the arbitration agreement, while the breach of contract claim would fall within the scope of the arbitration agreement. Id. at 895. The court, therefore, affirmed in part, reversed in part, and remanded the case for further proceedings. Id. at 895.

The Appellate Court held that: (1) whether claims were subject to arbitration was a question for the court, (2) claims based on alleged negligent and fraudulent investment advice fell outside the scope of the arbitration agreement, and (3) the claim that BDO conspired with other defendants to issue sham legal opinions regarding legality of investment strategy fell outside the scope of the arbitration agreement. “We find no evidence, in the text of the contract, that plaintiffs ever agreed to arbitrate [these] claims…for breach of fiduciary duty, negligent misrepresentation, fraud, and civil conspiracy.” Id. at 894. The Appellate Court did find that the breach of contract issue was arbitrable.

The Appellate Court denied a request for rehearing in October 2010, and an appeal to the Illinois Supreme Court was denied in January 2011. BDO and the other defendants filed a petition for certiorari to the United States Supreme Court in April 2011; the case was scheduled for conference on September 26, 2011. In its petition, BDO presented two questions for review:

 

  1. Whether, on a motion to compel arbitration, the Prima Paint doctrine of “separability” should be extended to gateway challenges to arbitrability on the basis of the scope, as opposed to the validity, of an arbitration clause?
  2. Whether, on a motion to compel arbitration, a court, in classifying the general scope of an arbitration clause, is restricted to the two categories of broad and narrow, as articulate by the majority of the United States Courts of Appeal?

 

Petition for certiorari at i. The case and updates may be found on the website of the Supreme Court of the United States (www.supremecourt.gov) under docket number 10-1331.

If the Supreme Court were to grant certiorari and reinstate the trial court’s ruling, the issue of the scope of the arbitration agreement would be for the arbitrator to decide. The arbitrator, then, would decide whether claims that may fall outside of the contract and arbitration agreement are within the scope of the arbitration agreement and therefore arbitrable. In this scenario, the arbitrator would decide the arbitrability of a claim and then arbitrate that claim if the arbitrator found the claim to be arbitrable. In this case, if the Illinois Appellate Court were reversed, an arbitrator would decide if a claim of civil conspiracy, among other claims, is arbitrable and falls within the scope of an arbitration agreement designed to resolve claims arising from a contract between the parties; that same arbitrator would then arbitrate the claim itself if the arbitrator decided it was arbitrable.

If, by contrast, the Supreme Court upheld the Illinois Appellate Court, then courts would decide the issue of the scope of an arbitration agreement and the arbitrability of claims, potentially causing some cases to be split between arbitration and court. Instead of permitting two separate procedures deciding related claims arising from the same basis of operational fact, the Court should grant certiorari and reverse the lower court. Failure to do so would defeat the purpose of arbitration—namely, to increase efficiency and decrease time and cost to resolve the dispute. Some observers may find this result troublesome because there is typically no appeal from an arbitrator’s decision and no way to guarantee that an arbitrator is well-suited to decide the issue of scope. Parties may guard against these concerns, however, by selecting an arbitrator with expertise in contract interpretation; such an arbitrator would be capable of deciding whether a claim fell under the terms of a contract or not, thereby alleviating the concerns discussed.

Summary written by Jennifer Herman, Moritz class of 2012

Posted in: Volume 10, Issue 1

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