Ernst & Young v. Baker O'Neal Holding ( 2002 )

In the
United States Court of Appeals
For the Seventh Circuit
____________
No. 01-3862
ERNST & YOUNG LLP and CHARLES J. ROACH,
Defendants-Appellants,
v.
BAKER O’NEAL HOLDINGS, INC., and AMERICAN
PUBLIC AUTOMOTIVE GROUP, INC.,
Plaintiffs-Appellees.
____________
Appeal from the United States District Court
for the Southern District of Indiana, Indianapolis Division.
No. 00 C 1538—David F. Hamilton, Judge.
____________
ARGUED FEBRUARY 26, 2002—DECIDED SEPTEMBER 23, 2002
____________
Before FAIRCHILD, COFFEY, and KANNE, Circuit Judges.
KANNE, Circuit Judge. Plaintiffs Baker O’Neal Holdings,
Inc. and American Public Automotive Group, Inc. filed for
relief under Chapter 11 of the Bankruptcy Code. Shortly
thereafter, the plaintiffs initiated an adversary proceed-
ing against Ernst & Young LLP and Charles J. Roach
(“Ernst & Young”), asserting various claims. Ernst & Young
then objected to provisions of the plaintiffs’ Chapter 11 plan
of reorganization, arguing that provisions within the pro-
posed plan would infringe upon Ernst & Young’s ability
to bring an action or assert a defense against third par-
ties in the adversary proceeding. The plaintiffs then mod-
2 No. 01-3862
ified their proposed plan to Ernst & Young’s apparent
satisfaction, and the bankruptcy court confirmed the
plan as modified. As described in both the plan and the
plan’s confirmation order, the bankruptcy court express-
ly retained jurisdiction for the purpose of “[a]djudication
of any pending adversary proceeding, or other controversy
or dispute.” After the plan’s confirmation, Ernst & Young
filed a motion to dismiss the adversary proceeding or to
stay the proceeding pending arbitration based on prior
contractual language between the parties. The plaintiffs
objected, asserting that in light of their confirmed plan,
the bankruptcy court retained jurisdiction to adjudicate
the merits of the adversary proceeding. The bankruptcy
court agreed, denying Ernst & Young’s motion, and the
district court affirmed. For the reasons stated herein, we
affirm.
I. History
American Public Automotive Group is a wholly owned
subsidiary of Baker O’Neal Holdings. Together, they em-
ployed the services of Ernst & Young from 1994 to 1998,
working closely with Charles J. Roach, a partner at Ernst
& Young. In October 1996 and again in August 1997, Ernst
& Young entered into “Engagement Letters” with the
plaintiffs. The terms of the Engagement Letters included
a provision that required the parties to resolve any “con-
troversy or claim arising out of or relating to the services
covered by this letter or hereafter provided by [Ernst &
Young]” through arbitration.
The plaintiffs filed for civil bankruptcy relief on October
30, 1998. On December 7, 1999, they initiated adversary
proceedings against Ernst & Young and Charles J. Roach,
seeking to avoid and recover fraudulent transfers of prop-
erty, and to recover damages. In addition to professional
misconduct, the plaintiffs alleged that Charles J. Roach
No. 01-3862 3
assisted James O’Neal, Baker O’Neal Holdings’s former
president and chief executive officer, in obtaining a $3.7
million loan from Baker O’Neal Holdings.
On December 13, 1999, the plaintiffs filed a proposed
plan of reorganization and Ernst & Young filed an objec-
tion to that plan on January 19, 2000. The objection stated
that a settlement agreement and release in the plan
would limit Ernst & Young’s ability to bring an action or
assert a defense against Patrick J. Baker, the sole share-
holder of Baker O’Neal Holdings and the Chairman of the
Board of Directors, or his wife Penny. On February 11,
2000, the plaintiffs modified the settlement agreement
and release in the plan, excluding Ernst & Young from
any limitation in pursuing an action or asserting a de-
fense against the Bakers. The modification apparently
satisfied Ernst & Young, as they withdrew their objec-
tion to the plan. The plan was then confirmed on Febru-
ary 23, 2000 by the bankruptcy court.
Under the terms of both the plan and the confirma-
tion order, the bankruptcy court retained jurisdiction for
the purpose of “[a]djudication of any pending adversary
proceeding, or other controversy or dispute.” On March 10,
2000, Ernst & Young filed a motion to dismiss or stay
the adversary proceeding pending arbitration, citing the
terms of the Engagement Letters. The plaintiffs ob-
jected. The bankruptcy court denied Ernst & Young’s
motion, and the district court affirmed, finding that ar-
bitration was precluded by the terms of the confirmed
plan and that Ernst & Young, in any event, had waived
its right to arbitrate.
On appeal, Ernst & Young argues, inter alia, that the
district court erred in ruling that confirmation of the
plan altered the parties’ prior arbitration agreement. Cit-
ing language in the plan and the confirmation order,
Ernst & Young claims that the documents merely con-
4 No. 01-3862
firm the bankruptcy court’s ability to “retain control over
the case” and do not supersede the arbitration provisions
of the Engagement Letters. Ernst & Young also disputes
the lower court’s conclusion that its actions in the bank-
ruptcy proceeding were sufficient to waive its right to
arbitrate. Ernst & Young contends that its actions were
“defensive” in nature and therefore should not constitute
waiver of the right to proceed in another forum.
II. Analysis
A. Terms of the Plan
Denial of a motion to stay proceedings pending arbitra-
tion is reviewed de novo, see Adamovic v. METME Corp.,
961 F.2d 652, 653 (7th Cir. 1992). In their Engagement
Letters, the parties provided for “arbitration of any ‘con-
troversy or claim arising out of or relating to the services
covered by this letter or hereafter provided by [Ernst &
Young].’ ” However, the plaintiffs’ subsequent confirmed
plan of reorganization provides that the bankruptcy court
retains jurisdiction “to adjudicate” any “pending adver-
sary proceeding, other controversy or dispute.”
A confirmed plan of reorganization is in effect a con-
tract between the parties and the terms of the plan de-
scribe their rights and obligations. See In re Chicago,
Milwaukee, St. Paul and Pacific R.R., Co., 891 F.2d 159,
161 (7th Cir. 1989). Ernst & Young argues that the focus
of our analysis should be on the words “retains jurisdic-
tion” and that the bankruptcy court can satisfy its obliga-
tion to retain jurisdiction over the pending adversary
proceeding by simply hearing arguments on the motion
to compel arbitration or to stay the proceedings. We
disagree. The plaintiffs’ plan expressly provides for the
bankruptcy court to retain jurisdiction to adjudicate pend-
ing adversary proceedings, controversies, and disputes.
While, as the district court explained, the terms of the
No. 01-3862 5
plan could have called for the bankruptcy court to retain
jurisdiction over a dispute while its merits are arbitrated,
the terms of this plan specifically called for the bankruptcy
court to retain jurisdiction to adjudicate such disputes.
See BARRON’S LAW DICTIONARY 11 (Ed. 1996) (defining “ad-
judication” as “the determination of a controversy and
a pronouncement of a judgment based on evidence pre-
sented, implies a final judgment . . . as opposed to a pro-
ceeding in which the merits of the cause of action were
not reached”). Consequently, we believe that the bank-
ruptcy court’s retention of jurisdiction to adjudicate pend-
ing adversary proceedings, controversies and disputes
should not be read to limit the bankruptcy court’s juris-
diction to a ruling on Ernst & Young’s motion to compel
arbitration. See Merit Ins. Co. v. Leatherby Ins. Co., 581
F.2d 137, 143 (7th Cir. 1978) (“A motion to stay proceed-
ings and to compel arbitration focuses judicial scrutiny
upon the arbitrability of the controversy, not upon the
controversy itself. . . . It has no effect on the merits them-
selves.”).
Had Ernst & Young wished to protect its right to arbi-
trate, it certainly could have done so in the same manner
in which it sought to protect its rights against the Bakers.
See, e.g., In re GWI, Inc., 269 B.R. 114, 118 (Bankr. D. Del.
2001) (finding that because the parties expressly adopted
arbitration provisions of pre-petition agreements into a
plan of reorganization, the prior arbitration provisions
were enforceable and not superceded by generalized lan-
guage in the confirmed plan conferring jurisdiction on
the bankruptcy court). We believe that in this instance,
Ernst & Young’s right to arbitrate is superseded by the
terms of the confirmed plan.
B. Waiver of Rights of Arbitration
Regardless of how we interpret the term “adjudication” in
the plan, Ernst & Young waived any right to arbitrate. The
6 No. 01-3862
factual determinations that a district court predicates a
finding of waiver upon are reviewed for clear error, while
the legal question of whether the conduct amounts to
waiver is reviewed de novo. See Iowa Grain Co. v. Brown,
171 F.3d 504, 509 (7th Cir. 1999 ). Reviewing for “clear
error” means that the Court of Appeals will reverse only
if it reaches a firm and definite conviction that the dis-
trict court made a mistake. See St. Mary’s Medical Center of
Evansville, Inc. v. Disco Aluminum Prods. Co., 969 F.2d
585, 589 (7th Cir. 1992).
A contractual right to arbitrate may be waived expressly
or implicitly, and a party that chooses a judicial forum
for the resolution of a dispute is presumed to have waived
its right to arbitrate. See Cabinetree, Inc. v. Kraftmaid
Cabinetry, Inc., 50 F.3d 388, 390 (7th Cir. 1995). Courts
must examine the totality of the circumstances and “deter-
mine whether based on all the circumstances, the [party
against whom the waiver is to be enforced] has acted
inconsistently with the right to arbitrate.” Grumhaus v.
Comerica Securities, Inc., 223 F.3d 648, 650-51 (7th Cir.
2000) (quotation omitted); see also Iowa Grain Co., 171 F.3d
at 510. Although several factors may be considered in
determining waiver, diligence or the lack thereof should
weigh heavily in the decision—“did that party do all it
could reasonably have been expected to do to make the
earliest feasible determination of whether to proceed judi-
cially or by arbitration?” Cabinetree, 50 F.3d at 391 (empha-
sis added).
In Cabinetree, the plaintiffs filed a breach of contract
suit, which was removed to federal court by the defendant
due to diversity of citizenship. See id. at 389. Six months
later, the defendant moved to stay the action pending
arbitration. See id. On appeal, we noted that the defendant
had participated in pretrial activities without challeng-
ing the forum or moving for arbitration. See id. at 390-91.
Under these circumstances, we held that the defendant’s
No. 01-3862 7
actions were sufficient to demonstrate the party’s selection
of a forum and established a presumption of waiver of the
right to arbitrate. See id.
Similarly, the plaintiffs filed a complaint against Ernst
& Young on December 7, 1999. In the months following,
Ernst & Young’s actions indicated an intention to pro-
ceed with the adversary proceeding in litigation, not in
arbitration. As the district court highlighted below, Ernst
& Young did not pursue arbitration until after its objec-
tion to the plaintiffs’ plan was resolved. At this point, the
bankruptcy court had already evaluated all claims with
respect to the confirmation of the reorganization plan.
Further, Ernst & Young’s objection to the plaintiffs’ plan
emphasized its concern about its rights as against the
Bakers in the adversary proceeding. Because the Bakers
were not bound by the arbitration provisions in the En-
gagement Letters, Ernst & Young’s concern with respect
to the Bakers implied that Ernst & Young was intend-
ing to proceed judicially. Moreover, as we have already
discussed, the plan included terms that called for the
bankruptcy court “to adjudicate” any pending adversary
proceedings, and Ernst & Young did not raise any con-
cerns about either the adjudication provision in the plan
or the plan’s effect, if any, on their right to arbitrate.
Ernst & Young argues that we should follow the Dela-
ware Bankruptcy Court in In re Charter Behavioral Health
Sys., LLC, 277 B.R. 54 (Bankr. D. Del. 2002). In this case,
the debtor filed for Chapter 11 relief in February 2000 and
commenced an adversary proceeding against a creditor
in June 2001. See id. at 56. The creditor-defendant filed
its Answer in August but did not mention its contrac-
tual right to compel arbitration. See id. The creditor-
defendant then participated in limited scheduling and
discovery actions until December 2001, when it filed its
motion to dismiss the adversary proceeding in favor of
arbitration. See id. The bankruptcy court dismissed the
8 No. 01-3862
adversary proceeding in favor of arbitration, finding that
the creditor-defendant’s actions were not sufficient to
waive its right to arbitrate. See id. at 58-59.
We find the case at bar to be distinguishable from
Charter. Specifically, in Charter the creditor-defendant
seeking to proceed in arbitration did not actively partici-
pate in the process of confirming the debtor’s plan of re-
organization. In contrast to the passive creditor-defendant
in Charter, Ernst & Young had actively participated in the
plan confirmation process prior to seeking arbitration. We
believe that Ernst & Young’s particular acts of participa-
tion were sufficient to waive its right to arbitrate.
Neither the bankruptcy court nor the district court
found any reason why Ernst & Young might not have
asserted its desire to arbitrate at an earlier date. We agree,
and because we find no error in the lower court’s assess-
ment of the situation, we are similarly unable to excuse
Ernst & Young’s delay. Ernst & Young’s failure to assert
its desire to preserve its rights to arbitrate claims—while
having already filed an objection, which revealed an in-
tent to pursue litigation—cannot amount to “all it could
reasonably have been expected to do to make the earli-
est feasible determination of whether to proceed judicial-
ly or by arbitration.” Cabinetree, 50 F.3d at 391. Because
Ernst & Young’s actions were inconsistent with its claimed
right to arbitrate and because Ernst & Young’s actions
were not exercised in a diligent manner, we find any right
to compel such a proceeding waived.
III. Conclusion
For the foregoing reasons, we AFFIRM the district court’s
denial of Ernst & Young’s motion to compel arbitration.
No. 01-3862 9
FAIRCHILD, Circuit Judge, dissenting. My colleagues
interpret the Plan so that it “superceded” Ernst & Young’s
right to arbitrate. In substance, they hold that Article 8.1
of the Plan limits the jurisdiction of the bankruptcy court
so as to exclude its otherwise unquestioned jurisdiction
to recognize and implement the parties’ promise to arbi-
trate. Article 8.1 begins, “Notwithstanding confirmation
of the Plan or occurrence of the Effective Date, the Bank-
ruptcy Court shall retain jurisdiction for the following
purposes: . . . .” There follows a list of seventeen types
of actions that the bankruptcy court might be expected
to perform. This long and comprehensive list suggests
that an inclusive rather than an exclusive description of
retained jurisdiction was intended.
Paragraph (o), one of the seventeen, lists “[a]djudication
of any pending adversary proceeding, or other contro-
versy or dispute, in the Debtors’ Chapter 11 Cases, which
arose pre-confirmation and over which the Bankruptcy
Court had jurisdiction prior to confirmation of the Plan.”
My colleagues limit the meaning of “adjudication” to a
process of final determination of the adversary proceed-
ing on its merits, and exclude a determination of a motion
to dismiss or stay the adversary proceeding so as to en-
force the promise to arbitrate.
In this context, this reading of adjudication seems too
narrow. Again, the language of (o) seems inclusive (“adver-
sary proceeding, or other controversy or dispute”), and
the grant of a motion to compel arbitration would be a
decision on the merits of the controversy raised by that
motion.
Indeed, courts have often referred to the determination
of the right to arbitrate as an “adjudication.” The Su-
preme Court has recognized that, when presented with a
motion under § 3 of the Federal Arbitration Act (to stay
the underlying district court proceedings while the par-
10 No. 01-3862
ties arbitrate), a court may “adjudicate” the issue whether
the parties executed an enforceable arbitration agreement.
Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S.
395, 403-04 (1967). Other federal courts have reiterated
that resolution of motions brought under §§ 3 and 4 of
the FAA is “adjudication.” See, e.g., Walton v. Rose Mobile
Homes LLC, 298 F.3d 470, 473 (5th Cir. 2002) (elaborat-
ing how a two-step inquiry governs the “adjudication of
motions to compel arbitration under the FAA”); National
Iranian Oil Co. v. Mapco Int’l, Inc., 983 F.2d 485, 491 (3d
Cir. 1992) (“The Arbitration Act authorizes a district court
to adjudicate the substantive issues of the making and
performance of an arbitration agreement.”); Reed &
Martin, Inc. v. Westinghouse Elec. Corp., 439 F.2d 1268,
1276 (2d Cir. 1971) (the right to arbitrate is an issue “to
be adjudicated by the federal courts whenever such
courts have subject matter jurisdiction”) (internal quota-
tion marks and citation omitted); Bothell v. Hitachi Zosen
Corp., 97 F. Supp. 2d 1048, 1050-51 (W.D. Wash. 2000)
(court had “jurisdiction to adjudicate” dispute over exis-
tence of valid arbitration agreement).
My colleagues support their narrow interpretation of
“adjudication” with a dictionary definition. They offer
BARRON’S LAW DICTIONARY, which defines “adjudication”
as “impl[ying] a final judgment . . . as opposed to a proceed-
ing in which the merits of the cause of action were not
reached.” But though a dictionary collects common usages,
it hardly exhausts the “full range of nuances that context
lends to meaning.” Unelko Corp. v. Prestone Prods. Corp.,
116 F.3d 237, 241 (7th Cir. 1997); see also TE-TA-MA
Truth Foundation–Family of URI, Inc. v. World Church of
the Creator, 297 F.3d 662, 666 (7th Cir. 2002) (“[D]ictio-
naries reveal a range of historical meanings rather than
how people use a particular phrase in contemporary cul-
ture.”). A single word can take multiple meanings. Calderon
v. Witvoet, 999 F.2d 1101, 1104 (7th Cir. 1993). In BLACK’S
No. 01-3862 11
LAW DICTIONARY (7th ed. 1999), for instance, “adjudication”
has three definitions, the first of which emphasizes proc-
ess: “[t]he legal process of resolving a dispute; the process
of judicially deciding a case.” A DICTIONARY OF MODERN
LEGAL USAGE (2d ed. 1995) introduces three more defini-
tions, beginning with “the process of judging.”
In my view Article 8.1(o) effected no change in the
bankruptcy court’s pre-confirmation authority to enforce
the parties’ arbitration agreements. “Confirmation does
not alter the basic jurisdictional analysis applicable to
bankruptcy courts.” 8 COLLIER ON BANKRUPTCY ¶ 1142.04[1]
(15th ed. rev. 2002). This interpretation also conforms to
the strong federal policy favoring arbitration. See Green
Tree Fin. Corp.-Alabama v. Randolph, 531 U.S. 79, 91
(2000).
My colleagues go on to conclude that, regardless of how
the term “adjudication” in the Plan is interpreted, Ernst
& Young waived any right to arbitrate. In support, they
state that Ernst & Young’s actions indicated an intention
to proceed with the adversary proceeding in litigation
rather than arbitration; that Ernst & Young’s active par-
ticipation in the confirmation process was sufficient to
waive its right to arbitrate; and that Ernst & Young
did not seek arbitration in a diligent manner. With all
respect, I conclude that the record does not support any
of these propositions and therefore does not support a
conclusion of waiver.
The question of Ernst & Young’s diligence requires a
chronology of the adversary proceeding. The complaint
was filed on December 7, 1999. Summons was issued on
December 19, requiring an answer to be filed by January
19, 2000. Ernst & Young received consecutive extensions
to respond, first by February 18 and then by March 10,
2000. On March 10—only 16 days after confirmation of the
Plan—Ernst & Young filed in the district court its motion
12 No. 01-3862
for arbitration (the appellees, furthermore, do not dis-
pute Ernst & Young’s representation on appeal that it
had raised its right to arbitrate informally with the plain-
tiffs “[w]ell before filing its Arbitration Motion”). Also on
March 10, Ernst & Young filed in the bankruptcy court
a motion to dismiss, or in the alternative, a motion to
stay proceedings pending arbitration. That very same
day, Ernst & Young sought (and later received) a third
extension to answer the complaint pending the court’s
ruling on its motion to dismiss or alternatively its motion
to stay.
The majority believes that this case is controlled by
Cabinetree, Inc. v. Kraftmaid Cabinetry of Wisconsin, Inc.,
50 F.3d 388, 391 (7th Cir. 1995), in which we explained
that “diligence or lack thereof” should, among other fac-
tors, “weigh heavily in the decision whether to send the
case to arbitration.” In that case, we found waiver be-
cause the party seeking an eleventh-hour arbitration
already had removed the case to federal court, actively
engaged in discovery, and compelled the opponent to pro-
duce almost 2,000 documents. See also St. Mary’s Med. Ctr.
of Evansville, Inc. v. Disco Aluminum Prods. Co., 969 F.2d
585, 591 (7th Cir. 1992) (party waived right to arbitrate
by spending ten months filing discovery requests and
participating in depositions); Creative Solutions Group, Inc.
v. Pentzer Corp., 252 F.3d 28, 33 (1st Cir. 2001) (party did
not waive right to arbitrate by moving to dismiss com-
plaint and engaging in limited discovery because it did
not “substantially invoke[ ]” the “litigation machinery”)
(internal quotation marks and citation omitted). No such
substantial resort to litigation occurred here. In any event,
Ernst & Young did not delay: it asserted its right to ar-
bitrate as soon as it was legally required to do so; beyond
that, it owed no explanation for the timing of its request.
The majority also believes that this case falls within
Cabinetree’s holding that an election to proceed before
No. 01-3862 13
a nonarbitral forum to resolve a dispute presumptively
waives the right to arbitrate, even if the opposing party
would not be prejudiced by an order compelling arbitra-
tion. 50 F.3d at 390. According to my colleagues, Ernst &
Young manifested an intent to proceed in a judicial forum
when it actively participated in the Plan confirmation
process before seeking arbitration. As they explain, be-
cause Ernst & Young did not assert its desire to arbitrate
“at an earlier date,” it acted “inconsistent[ly]” with—and
therefore waived—its claimed right to arbitrate.
In Cabinetree, we held that a presumptive waiver may
arise from recourse to the judicial process, but we also
recognized that this is just a presumption and not an
invariable rule. We noted that there may be situations in
which such recourse “does not signify an intention to
proceed in a court to the exclusion of arbitration.”
Cabinetree, 50 F.3d at 390. For instance, the “shape of
the case might so alter as a result of unexpected develop-
ments during discovery or otherwise that it might become
obvious that the party should be relieved from its waiver
and arbitration allowed to proceed.” Id. at 391. More
recently we interpreted Cabinetree as establishing the
proposition that a party waives its right to arbitrate
only when it “elect[s] a judicial forum rather than the
arbitral tribunal.” Iowa Grain Co. v. Brown, 171 F.3d 504,
509 (7th Cir. 1999).
Ernst & Young never elected a judicial forum over an
arbitral forum. Its only substantive act in the bankruptcy
proceeding was to file an objection (on January 19, 2000)
to the Plan. Article IX of the Plan incorporated a Baker
Settlement Agreement releasing Patrick J. Baker (sole
shareholder of debtor Baker O’Neal) and his wife from
all claims that any creditor of the debtors may have
against them. Ernst & Young, a creditor, objected to the
“nonconsensual release of claims of all creditors” against
the Bakers. The objection stated that the release would
14 No. 01-3862
“disadvantage creditors such as Ernst & Young in the
adversary proceeding and any other litigation.” It noted
Ernst & Young’s right to initiate a third-party complaint
against the Bakers in the adversary proceeding, which
right would be nullified by the release, as well as other
claims and non-party defenses “whether in the adversary
proceeding or outside of it.” The most that can be said
concerning this language is that Ernst & Young had not
yet decided to participate in merit litigation of the adver-
sary proceeding. The obvious purpose of the objection
was to protect Ernst & Young from release of its claims
against the Bakers. The Bakers were not parties to the
arbitration agreement, and the language of the objection
showed that Ernst & Young was still considering the
adversary proceeding as one forum in which to pursue
those claims, although the objection made clear that there
were other fora. The language cannot be read as a state-
ment that Ernst & Young intended to participate in the
adversary proceeding rather than to exercise its right
to arbitrate. See Iowa Grain Co., 171 F.3d at 510 (filing
a class action lawsuit rather than an arbitration claim
was insufficient to waive right to arbitrate individual
claims).
I respectfully dissent.
A true Copy:
Teste:
________________________________
Clerk of the United States Court of
Appeals for the Seventh Circuit
USCA-97-C-006—9-23-02