BDO Wins Arkansas Supreme Court Appeal to Arbitrate Fraud Allegations

Monadnock Research (Vol V, No 1) - 14 January 2012

LITTLE ROCK, Ark. - BDO Seidman has won an appeal against Straits Steel & Wire, forcing the client's allegations of fraud to be heard by arbitrators and not the courts.

The Supreme Court of Arkansas has reversed a ruling of Arkansas' Sebastian County Circuit Court, which had denied a motion by BDO LLP, Mark Puckett, and James Cross (BDO) to compel arbitration against Straits Steel & Wire, Co. Inc., SSW Holding Co. and Straits Diversification, LLC (SSW).

BDO Wins Arkansas Supreme Court Appeal to Arbitrate Fraud Allegations

BDO successfully argued on appeal that the circuit court erred in denying arbitration because SSW's claim of fraud had to be resolved through arbitration and not the courts because it was the venue of choice in agreements signed by the parties. SSW attempted to get around the venue choice of the agreements it had signed by claiming unconscionability of the fraud allegedly perpetrated by BDO.

Background

SSW filed suit in Arkansas against BDO claiming breach of fiduciary duty, negligence and professional malpractice, negligent misrepresentation, disgorgement of excessive and illegal fees, fraudulent inducement, fraudulent concealment, declaratory judgment, fraud, civil conspiracy, and breach of contract.

The case involves tax consulting services provided by BDO to create allegedly fraudulent tax shelter schemes employed by SSW in its Federal Tax filings for 2001 through 2005. SSW says that BDO devised a scheme and advised it to execute a "distressed debt strategy" (DDS), claiming it would be highly profitable and would minimize the company's tax liability. SSW asserted that BDO, at the time it marketed the DDS, either knew or should have known that the DDS would not yield the results promised and that US authorities were investigating the legality this type of tax shelter at the time.

Consulting Agreement Terms

BDO and SSW had signed two agreements - one in 2001 and the other in 2003. The relevant language in those two agreements regarding dispute resolution venue was as follows:

2001Consulting Agreement

8. (d) 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.

11. Governing Law. This agreement shall be governed and construed in accordance with the laws of the State of New York, except for its conflict of law principles.

2003 Consulting Agreement

12. Governing Law and Severability. This Agreement, shall be governed by, and construed in accordance with, the laws of the State of Michigan (without giving effect to the choice of law principles thereof).

SSW and BDO Arguments

The lower court agreed with SSW's argument that under New York law, the arbitration provision was invalid and unenforceable because fraud permeated the entire consulting agreement. SSW also asserted that the allegations against BDO were outside the scope of both arbitration provisions of the 2001 and 2003 agreements, since those provisions only covered disputes arising "in connection with the performance or breach" of the Consulting Agreements, which stated that they did apply to investment advice and services.

SSW also asserted, and the lower court agreed, that the arbitration provision in the 2001 consulting agreement was "procedurally and substantively unconscionable" under New York law, and that the arbitration provision in the 2003 agreement was "substantively unconscionable" under Michigan law because (1) the arbitration provisions violate public policy as they were part of a conspiracy to commit criminal fraud; (2) BDO was the sole creator of the provisions; (3) the provisions contain unreasonable and impermissible limits on discovery; and (4) the provisions impermissibly preclude SSW Holding's right to recover punitive damages.

BDO argued that all claims raised in the complaint related to services that it agreed to provide pursuant to the two consulting agreements, each of which contained broad provisions mandating arbitration of any dispute, controversy or claim arising in connection with performance or breach of the agreement.

The Arkansas Supreme Court also agreed with BDO's assertions, including that, under New York law, an arbitration clause must provide that New York law governs its enforcement. Since that language was absent from the 2001 Consulting Agreement, the terms of the Federal Arbitration Act (FAA) applied. The FAA requires arbitration of the fraudulent-inducement claim. And since the claim of unconscionability concerned the contract as a whole, and was not limited to the arbitration provision, arbitration and not the court had to decide the issue.

According to the FAA, "If any suit or proceeding is brought in any of the courts of the United States upon any issue referable to arbitration under an agreement in writing for such arbitration, the court in which such suit is pending, upon being satisfied that the issue involved in such suit or proceeding is referable to arbitration under such agreement, shall on application of one of the parties stay the trial of the action until such arbitration has been had in accordance with the terms of the agreement, providing the applicant for the stay is not in default in proceeding with such arbitration."

SSW listed sixty instances of actions and inactions that it believes constitute fraud on the part of BDO. The company concluded that it hired BDO because of its reliance on what it later found were intentional, material misrepresentations. SSW also asserted substantive unconscionability existed because the consulting agreement did not allow pre-hearing discovery unless authorized by the arbitration panel, and that punitive damages are disallowed - certainly SSW's primary motivation, since it could likely get the arbitration panel to authorize discovery.

Lastly, the Arkansas Supreme Court reiterated that if a claim of fraudulent inducement relates to a contract generally, and the contract contains an arbitration clause, the language of the FAA provides that the dispute must be adjudicated in arbitration, not the courts.

MR Perspective: Unique Characteristics of Professional Services Disputes

Many boilerplate firm contracts call for arbitration as the dispute resolution mechanism. It is common for disputes in cases where the contract calls for arbitration, and that later need to be adjudicated, to start with legal maneuvering to invalidate arbitration clauses. Marin County's dispute with Deloitte also followed this track, with similar results. The main difference in that case is the parties did not have to fund the expense of an appeal.

As we noted in our coverage in that case, professional services lawsuits in the US, and in all developed countries, encounter a somewhat unique set of circumstances that are rarely experienced by lawsuits involving litigants in other industries. That circumstance is a nearly perfect understanding by the courts and litigants' counsel of the professional services industry.

We believe this condition may expose clients to a legal system bias that favors firms. Details on our perspective can be found in the last section of our Deloitte-Marin County case coverage from February 2011 (link below).

Arkansas Supreme Court Ruling (2012 Ark. 1, 11-165; CV 2009-1332)

$115 Million Marin County Case Moves to U.S. Federal Court; Deloitte Positions Advance in State and Federal Cases