In the News: Arbitration and Regulation
Mandatory Arbitration Provisions: Will They Undermine the Benefits of Securities Law Regulation?
In the March 12, 2012 National Law Journal, Gonzaga University professor and former law school dean Daniel Morrissey uses the example of The Carlyle Group L.P., involved in a showdown with the SEC, as a springboard to launch his argument that mandatory arbitration provisions, if they are allowed to proliferate, will be fatal to shareholder litigation.
The Carlyle Group’s prospectus for an offering provided that purchasers of securities would agree to forego class actions involving their claims. The SEC refused to accelerate the effective date of Carlyle’s registration statement, and Carlyle blinked, withdrawing its mandatory arbitration provision.
Prof. Morrissey argues that the history of securities legislation, from the Securities Act of 1933 and the Securities Exchange Act of 1934 to the Private Securities Litigation Act, evinces “the implicit congressional finding that shareholder suits are better brought as class actions in court, not individual arbitrations.”
Of course, an explicit congressional intent to exempt securities litigation from mandatory arbitration would allow plaintiffs in securities class actions to escape the grip of the Federal Arbitration Act and mandatory arbitration provisions. Congress can create an escape hatch from the preemptive effects of the FAA. Because Prof. Morrissey points to an “implicit” congressional finding, we wonder just how much litigants can count on an implicit escape hatch if they are parties to an arbitration provision.
“Arbitration will result in more investment fraud,” Prof. Morrissey concludes. “And it probably won’t be long before another company, emboldened by the unfriendly attitude of some judges there toward SEC regulation, tries a like maneuver [to Carlyle’s] and pushes it all the way to the Supreme Court.”
Goldman Sachs Fights $20.6 Million Arbitration Award
FINRA – the Financial Industry Regulatory Authority – is a private company that is the largest regulator of securities firms doing business in the United States.
On March 12, 2012, Fox Business News reports that Goldman is seeking to overturn a $20.6 million arbitration award resulting from FINRA arbitration, and confirmed by Federal Judge Jed S. Rakoff in November 2010. The matter has been appealed to the 2nd Circuit.
Goldman disputes the claims of creditors of Bayou Group LLC, a failed hedge fund, that Goldman ignored suspicious signs that Bayou Group LLC made improper transfers of funds to its account at Goldman.
On the one hand, the award is being attacked as “unreasoned and patently indefensible.” On the other hand, it is argued that upholding the award could help raise standards for banks that clear trades for hedge funds. Samuel Israel III, the former hedge fund manager for Bayou Group LLC, surrendered to federal authorities on June 9, 2008. Mr. Israel has been sentenced to a total of 22 years (including two years for faking his own suicide).
Construction of Arbitration Clause: Clear Enough to Require Reversal of Order Denying Arbitration
First District, Division 3, Takes Practical Approach to Interpreting Arbitration Clause Between Two Merchants.
The next case is a fount of curious factoids – such as (1) there is an American Spice Trade Association (ASTA) with its own set of arbitration rules; and (2) in 2009 a multi-state outbreak of Salmonella Rissen was traced back to Union products that contained white pepper. The outbreak of Salmonella Rissen led to Union suing its supplier Harris Freeman & Co., Inc., and to Harris Freeman moving, unsuccessfully, in the trial court, to compel arbitration in New York under the rules of the ASTA. Union International Food Company v. Harris Freeman & Co., Inc., Case No. A132384 (1st Dist. Div. 3 March 8, 2012) (authored by Siggins, J.) (not for publication).
The trial court had denied the motion to compel arbitration on two grounds: “(1) Harris Freeman did not sufficiently advise Union of the specific terms and rules governing the proposed arbitration; and (2) the existence of a related third-party action raised the possibility of conflicting rulings and duplication of resources.”
The Court of Appeal, however, found overwhelming evidence of a course of dealing whereby Union for several years accepted ASTA contracts containing arbitration clauses – even though Union didn’t always sign the contracts. The clauses were never questioned, and they “clearly and unequivocally” incorporated ASTA arbitration rules.
Under Cal. Code of Civ. Proc. section 1281.2(c), a court may deny a request to arbitrate if “[a] party to the arbitration is also a party to a pending court action or special proceeding with a third party, arising out of the same transaction or series of related transactions and there is a possibility of conflicting rulings on a common issue of law or fact.” While there may have been legitimate concern that other litigation involving product liability could generate conflicting results here, that concern had ceased to be an issue, because the related litigation had been settled and dismissed.
The Court of Appeal has taken a pragmatic approach here to enforcing an arbitration clause between two merchants and holding them to it. Some of the considerations that are prominent in cases involving an employer and employee seem not to have troubled the Court, given that the contractual relationship was between two companies. Perhaps the Court would have been more troubled in an employee/employer context by the fact that some of the contracts were not signed, rules were not attached, there was an incorporation by reference, and the arbitration was to take place in New York. Indeed, the Court made short shrift of an unconscionability issue – the trial court “made no determination on whether Union met its burden of proof on the issue”, and besides, “Union’s evidence is far from overwhelming.”
In the News: Can Mediation Save Stockton From Fiscal Ruin?
AB 506: A Life Saver in a Fiscal Storm for Sinking City?
In the March 10, 2012 Los Angeles Times, Diana Marcum poignantly reports about the fiscal plight of the port city of Stockton, and its human cost. Stockton has descended from boom to the brink of bankruptcy. Thriving back in 2004, Stockton has been hit hard by the real estate crisis, the loss of municipal revenue, and extensive commitments, such as employee retirement benefits, that it struggles to meet.
There is an interesting mediation angle to the story.
The City of Stockton is taking advantage of a new state law, AB 506, to mediate with creditors. “Taking advantage” may overstate the case, because the new law actually requires municipalities to mediate or declare a fiscal emergency before they can go the bankruptcy route.
Above: “Farm Security clients during applications for aid under Tenant Purchase Act. Stockton, California. December, 1938.” Dorothea Lange, photographer. Library of Congress.
A city can file a petition for bankruptcy under Ch. 9 of the Bankruptcy Code. AB 506 adds another step by barring local government agencies from filing for bankruptcy until they undergo mediation or hold a public hearing and declare a fiscal emergency. Whereas in the past, California imposed no pre-conditions to filing bankruptcy, now filing bankruptcy is to be treated as a last resort. AB 506 passed the Assembly in September 2011 on a party-line vote, 50-24, with only one Republican voting for it.
Stockton will have to mediate with its creditors and municipal employees before it can play a bankruptcy card. Good luck to Stockton and its people.
Click here for text of AB 506.
Above: “Near Stockton, California. November 17, 1938. One of six successful applicants out of seventy-five. Purchasing farm under Bankhead Jones Act. "When a feller is in for himself, if he makes it, it’s his. If he don’t make it, it’s his fault alone." (Tenant Purchase).” Dorothea Lange, photographer. Library of Congress.
Arbitration: 2nd Dist. Div. 2 Holds That Arbitrator’s Award Regarding Attorney Fees Is Not Res Judicata In Subsequent Attorney/Client Dispute Over Fees
Attorney, Who Was Not an “Arbitral Party”, Could Not Take Advantage of Arbitrator’s Findings
Shumake v. Mirisola, Case No. B227383 (2nd Dist. Div. 2 March 5, 2012) (Boren, P.J.) (not certified for publication), is a good reminder of an elementary, but useful point, concerning arbitration. If you want to take advantage of the res judicata effect of an arbitrator’s award, it certainly helps if you are a party to the arbitration. Here, the attorney arguing for res judicata was not a party to the arbitration, nor was there evidence that the actual arbitral parties intended a res judicata effect to the arbitration in any subsequent lawsuit.
The case really is about a fee dispute between the attorney, Shumake, and his client, Mirisola. Mirisola was represented by attorney Treadwell in a contractor’s dispute. Some of the issues were resolved, and Mirisola terminated Treadwell, who moved on with attorney Shumake.
In an arbitration, where he was represented by Shumake, Mirisola obtained a favorable result against the contractor – including attorney’s fees in the amount of $40,125.
But in a subsequent lawsuit between Shumake and his client Mirisola in which the attorney sought to recover fees from Mirisola, the client claimed that he had never seen the cost memorandum that was the basis for the $40,125 award when it was submitted, and besides, it was all wrong. A jury awarded Shumake $29,625 in fees in his action against Mirisola – $10,500 less than he had obtained for Mirisola in the latter’s arbitration with his contractor.
In his appeal, Shumake argued for arbitral finality and the res judicata effect of the arbitrator’s award. No go – because Shumake was not himself a party to the arbitration, and there was no evidence that the parties to the arbitration intended the results to be binding in a subsequent judicial action involving Shumake and Mirisola.
Result: In all respects, the judgment was affirmed, except for a remand to determine litigation costs.
Miscellaneous: “Stuck in Arbitration” – Op-Ed Contribution of Prof. Amalia Kessler in the New York Times
Historical Perspective for the Privatization of Dispute Resolution
Last night we posted on Kilgore v. KeyBank, a March 7, 2012 Ninth Circuit opinion concerning the enforcement of an arbitration clause. Kilgore is part of the post-Concepcion trend (more like a juggernaut) to apply the Federal Arbitration Act and the Supremacy Clause so as to preempt state court efforts, grounded in public policy considerations, that would otherwise avoid enforcing arbitration clauses. This morning we read Prof. Amalia Kessler’s op-ed contribution to the March 6, 2012, NYT on-line edition, “Stuck in Arbitration.” Prof. Kessler’s contribution offers historical perspective to the use of private dispute resolution in the United States. Her contribution is also a pitch for proposed legislation, the Arbitration Fairness Act. Prof. Kessler is a professor of law and legal history at Stanford, working on a book about the origins of American adversarial legal culture.
Ninth Circuit Holds California Broughton-Cruz Rule That Claims For Public Injunctive Relief Cannot Be Arbitrated Is Preempted By Federal Arbitration Act
Court Also Lays Bare The Policy Consequences For The Privatization Of Consumer Justice
In Kilgore v. KeyBank, No. 09-16703 & No. 10-15934 (9th Cir. March 7, 2012) (authored by Judge Trott) (for publication), the Ninth Circuit resolves an FAA preemption issue dividing the district courts, lays bare the policy consequences for consumer justice, and provides a roadmap for drafting an arbitration clause that will survive claims of procedural unconscionability.
The named plaintiffs, who had been students of a private helicopter vocational school, sued the school on behalf of themselves and others similarly situated. Plaintiffs claimed that the school was a “sham aviation school” targeting limited-income individuals unable to pay for their training without student loans; that the school’s “preferred lender” provided the loans; that the school obtained the loan proceeds; that the school failed before the students could complete their training; and that the lender purportedly knew that aviation schools were “a slowly unfolding disaster”, yet continued to loan money to students. Because of a bankruptcy stay, the students could not prosecute their claims against the school, and so turned their attention to the lender.
Each of the lender’s Notes, however, contained an arbitration clause that the district court declined to enforce. In one interlocutory appeal (the second appeal was dismissed as moot), the Kilgore court considered whether, in light of AT&T Mobility, Inc. v. Concepcion, __ U.S. __ 131 S.Ct. 1740 (2011), the FAA “preempts California’s state law rule prohibiting the arbitration of claims for broad, public injunctive relief – a rule established in Broughton v. Cigna Health-Plans of California, 988 P.2d 67 (Cal. 1999), and Cruz v. Pacificare Health Systems, Inc., 66 P.3d 1157 (Cal. 2003).” Kilgore holds that the FAA does preempt the Broughton-Cruz rule.
What are the policy consequences of federal preemption of the Broughton-Cruz rule? Well, what did the rule protect? In Broughton, the California Supreme Court concluded that an agreement to arbitrate could not be enforced in a case where the plaintiff is “functioning as a private attorney general, enjoining future deceptive practices on behalf of the general public” to enforce the Consumers Legal Remedies Act (CLRA). The California court “noted that enforcement of an arbitrator’s injunction would require a new arbitration proceeding, but that a court retains jurisdiction and could more easily handled the ‘considerable complexity’ involved in supervising injunctions. . . . Further, judges ‘are accountable to the public in ways arbitrators are not.’”
In other words, Broughton found that there is a public benefit to not privatizing consumer justice in cases where a public injunction is sought under the CLRA. In Cruz, the California Supreme Court extended the Broughton rule to claims for public injunctive relief under the UCL. The court found that the “request for injunctive relief is clearly for the benefit of health care consumers and the general public . . . .” Hence, the “Broughton-Cruz rule.” That rule is what is lost through federal preemption.
We note the Kilgore court seems to be very aware of the cognitive dissonance that results when consumer claims affecting the public are dispatched to arbitration, for it cites Judge Carter’s statement in Ferguson v. Corinthian Colleges, ___ F.Supp.2d ___, No. 08:11-cv-00127-DOC-AJW, Dkt. 56, 2011 WL 4852339 (C.D. Cal. Oct. 6, 2011): “[b]ecause Plaintiffs’ injunctive relief claims seek to enforce a public right, there is an inherent conflict with sending these claims to an arbitrator.” But Kilgore holds that the Broughton-Cruz rule does not survive Concepcion because the rule “’prohibits outright the arbitration of a particular type of claim’ – claims for broad public injunctive relief. Concepcion, 131 S.Ct. at 1747.”
Now all the lender needed in Kilgore was a well-drafted arbitration clause that would withstand allegations that it was “unconscionable.” And the lender had such an arbitration clause: the clause was not buried in the document; it was conspicuous in bold, large font; it appeared in its own section of the Note; plain language in more than one place explained the consequences of not opting out of arbitration; the potentially higher costs of arbitration were pointed out; the borrower was given 60 days to opt out; the contract was clear and signed; and above the Plaintiff’s signature was a warning to read the contract before signing, “as well as a promise from the student that he would do so ‘even if otherwise advised’”. Thus, Kilgore provides a roadmap for drafting an arbitration clause.
Absent an unforeseeable interpretive tour de force, or unforeseeable legislative changes, a well-honed arbitration clause will increasingly be found in the legal arsenals of corporations that battle consumer, CLRA, and UCL claims in California. That’s bad news, or good news, depending on where you stand.