Thursday, November 10, 2011

Arbitrable Claims Must Be Arbitrated, Even If Brought With Nonarbitrable Ones: Supreme Court

This posting was written by John W. Arden.

The Federal Arbitration Act (FAA) requires the arbitration of pendent arbitrable claims brought in a court action that includes nonarbitrable claims, even when the result would be the inefficient maintenance of separate proceedings in different forums, the U.S. Supreme Court held on November 7.

Thus, a Florida state court erred in refusing to compel arbitration of claims because two of the four claims brought in an action were nonarbitrable, including a claim brought under the Florida Deceptive and Unfair Trade Practices Act (FDUTPA).

Courts must examine a complaint with care to assess whether any individual claim must be arbitrated, the Supreme Court advised in a per curiam opinion.

Investment Losses

In this instance, 19 individuals and entities that purchased interests in one of three limited partnerships brought an action against the partnerships, an investment company, and an auditing firm after the partnerships lost millions of dollars investing with notorious financier Bernie Madoff.

Only the claims against the auditing firm (KPMG) were at issue in this case. The individuals alleged four causes of action: negligent misrepresentation, violation of the Florida Deceptive and Unfair Trade Practices Act, professional malpractice, and aiding and abetting a breach of fiduciary duty.

The individuals and entities alleged that KPMG failed to use proper auditing standards with respect to the financial statements of the partnerships, leading to “substantial misrepresentations” about the funds and resulting in investment losses.

Motion to Compel Arbitration

KPMG moved to compel arbitration based on a clause in its auditing service agreement with the partnerships and investment company. That clause stated that any dispute or claim involving any person or entity for whose benefit auditing services were provided was to be resolved by mediation or arbitration.

The Florida circuit court denied the motion to compel arbitration and the court of appeals affirmed the ruling, noting that none of the individuals or entities bringing suit expressly assented to the auditing agreement or the arbitration provision. The arbitration clause could be enforced only if the claims were derivative—that is, arising from the auditing performed under the auditing services agreement.

The appellate court held that the negligent misrepresentation claims and the FDUTPA claims were “direct” rather than derivative, and therefore were not abitrable. However, the court failed to address the abitrability of the remaining two claims—professional malpractice and aiding and abetting a breach of fiduciary duty.

Policy in Favor of Arbitration

According to the Supreme Court, the Federal Arbitration Act reflected an “emphatic federal policy in favor of arbitral dispute resolution.” Mitsubishi Motors Corp. v. Soler-Chrysler Plymouth, Inc., 473 U.S. 614 (1985), CCH Business Franchise Guide ¶8387. This policy requires courts to enforce the bargain of the parties to arbitrate.

“What is at issue is the Court of Appeal’s apparent refusal to compel arbitration on any of the four claims based solely on a finding that two of them, the claim of negligent misrepresentation and the alleged violation of the FDUTPA, were nonarbitrable,” the court stated.

The Supreme Court has held that the FAA “leaves no place for the exercise of discretion by a district court, but instead mandates that district courts shall direct the parties to proceed to arbitration on issues as to which an arbitration agreement has been signed.” Dean Witter Reynolds Inc. v. Byrd, 470 U.S. 213 (1985).

When a complaint contains both arbtirable and nonarbitrable claims, the FAA requires a court to compel arbitration of the arbitrable claims, even when such a ruling would cause the inefficient maintenance of separate proceedings in different forums.

“To implement this holding, courts must examine a complaint with care to assess whether any individual claim must be arbitrable. The failure to do so is subject to immediate review.”

The judgment of the Florida appellate court was vacated and the case was remanded for examination of whether either of the remaining two claims required arbitration.

The decision is KPMG LLP v. Cocchi, No. 10-1521, November 7, 2011. Text of the opinion will appear in CCH Business Franchise Guide and CCH State Unfair Trade Practices Law.

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