Goldman v. KPMG, LLP

Opinion

SUMMARY

The plaintiffs in two lawsuits, consolidated on appeal, seek millions of dollars in damages in connection with allegedly fraudulent tax shelter schemes developed, marketed and implemented by their former accountants, lawyers and investment advisers. In one of the tax shelter schemes, a step in the process included the formation of limited liability companies in which plaintiffs and their investment advisers became members. The limited liability companies had standard operating agreements containing broad arbitration clauses. When plaintiffs sued the accountants, lawyers and investment advisers, the accountants and lawyers, who were not parties to the operating agreements, sought an order compelling arbitration. Relying on the doctrine of equitable estoppel, they argued that plaintiffs, as signatories to an arbitration agreement with the investment advisors, should be equitably estopped from asserting the right they otherwise would have had to pursue their claims against the accountants and lawyers in court.

The trial court in each case denied the motions to compel arbitration (in one case, in part only), and the accountants and lawyers appealed. We conclude the doctrine of equitable estoppel has no application in these cases. The sine qua non for allowing a nonsignatory to enforce an arbitration clause based on equitable estoppel is that the claims the plaintiff asserts against the

Relying on the representations from KPMG and Sidley, Goldman decided to invest in the Plan in 2000. KPMG introduced Goldman to Haber of DGI; Haber then formed AD Managed Equity Fund LLC (AD Managed Fund) as the limited liability company through which Goldman would make the investment, with DGI and Alpha as the founding and comanaging members. Goldman purchased four options involving the NASDAQ 100 Index at a cost of $1.2 million, and contributed the four options to AD Managed Fund as his capital investment in AD Managed Fund. DGI charged Goldman $2.1 million in fees for arranging the transaction, including a $600,000 advisory fee remitted to KPMG. A month or so later, Goldman withdrew from AD Managed Fund, pursuant to prior directions of KPMG and DGI, understanding that as a result, he would incur a tax loss of about $61 million. Sidley provided Goldman with a lengthy opinion letter, as promised, and “pursuant to a prior conspiracy” between KPMG, DGI and Sidley, KPMG paid or caused DGI to pay Sidley a fee in excess of $300,000 for providing the opinion letter. Sidley did not independently research or analyze whether the Plan would withstand a legal challenge, but merely attached its signature to a form opinion letter drafted by KPMG. Goldman claimed a tax deduction for the losses generated by AD Managed Fund on his 2000 federal and state tax returns. In November 2004, Goldman agreed to pay the State of California and the federal government tens of millions of dollars in taxes and interest as a result of the deductions claimed for losses generated by the investment in AD Managed Fund.

Goldman’s complaint asserted claims of breach of fiduciary duty, fraud, fraudulent nondisclosure, negligent misrepresentation, and negligent nondisclosure against KPMG and Sidley (as well as professional negligence against

Respondents Jeffrey R. Haines and his wife (collectively, Haines) filed a lawsuit, also in September 2005, against KPMG, Sidley and DGI, alleging substantially the same facts and causes of action as the Goldman complaint. Haines was induced to invest in another variation of the Son of Boss tax shelter, and was told by KPMG that in exchange for payments of approximately $1.0 million, Haines would generate a tax loss of approximately $16 million in about 60 days. The players and the scenario were the same as in the Goldman transaction, except that the limited liability company through which Haines would make his investment was called the AD FX Investment Fund LLC (AD FX Fund).

Both Goldman and Haines sought damages of not less than $10 million, plus punitive damages.

B. The motions to compel arbitration.

In both the Goldman and Haines cases, KPMG and Sidley filed motions to compel arbitration. Neither had arbitration agreements with any of the plaintiffs. However, the limited liability companies through which the Goldman/Haines tax losses were generated—AD Managed Fund and AD FX Fund, respectively—each had standard operating agreements containing broad arbitration clauses, and Goldman and Haines signed those operating agreements to become members of the funds. Consequently, Goldman and Haines agreed to arbitrate any disputes with DGI and Alpha “arising out of or relating to” the operating agreements. KPMG and Sidley were not parties to those agreements, but argued Goldman and Haines were equitably estopped from avoiding arbitration of their claims against KPMG and Sidley. The doctrine of equitable estoppel applied, they claimed, in either of two circumstances, both of which were asserted to exist in their cases: (1) when plaintiffs’ claims rely upon or are intimately founded in and intertwined with an agreement to arbitrate, or (2) where the signatories raise allegations of

We first summarize KPMG and Sidley’s contentions with respect to the proper application of equitable estoppel, and why their formulation is incorrect. We then describe the general legal principles in play, the rationale underlying the application of equitable estoppel, the precedents informing our conclusion as to the proper standards for application of the doctrine, and the specific application of those standards to the circumstances of these cases.

A. The KPMG/Sidley contentions and the proper standard.

KPMG and Sidley argue, as they did to the trial courts, that the law of equitable estoppel requires arbitration under either of two circumstances: (1) when a signatory’s (Goldman/Haines) claim against a nonsignatory (KPMG/Sidley) “makes reference to or presumes the existence of’ an agreement containing an arbitration clause, or (2) when a signatory alleges interdependent and concerted misconduct by signatories and nonsignatories. While this formulation uses terms that appear in cases discussing equitable estoppel, those cases show that the KPMG/Sidley formulation is incomplete as to both circumstances:

— As to the first circumstance, merely “mak[ing] reference to” an agreement with an arbitration clause is not enough. Equitable estoppel applies “when the signatory to a written agreement containing an arbitration clause ‘must rely on the terms of the written agreement in asserting [its] claims’ against the nonsignatory.” (MS Dealer Service Corp. v. Franklin (11th Cir. 1999) 177 F.3d 942 , 947 (MS Dealer).) The difference between “reference,” the word chosen by KPMG/Sidley, and “reliance,” as employed by MS Dealer and others, is significant.

— As to the second circumstance, while the cases recite the language which KPMG and Sidley proffer (interdependent and concerted misconduct by signatories and nonsignatories), the cases also show that this language

— Second, the court observed, it was clear that Franklin’s claims against the seller and MS Dealer were based on the same facts and were inherently inseparable; she alleged MS Dealer conspired with the seller and its assignee (also not a signatory) to defraud her by charging excessive amounts for the service contract. Significantly: “It is important to note that Franklin’s obligation to pay the $990.00 charge arose under the Buyers Order and that she specifically alleges that MS Dealer worked hand-in-hand with [the seller] and [its assignee] in this alleged fraudulent scheme. Her ‘allegations of such pre-arranged, collusive behavior establish[] that [her] claims against [MS Dealer are] intimately founded in and intertwined with the obligations imposed by the [Buyers Order].’ [Citations.]” (MS Dealer, supra, 177 F.3d at p. 948, italics added.)

In short, MS Dealer itself—both in its facts and in the court’s analysis— establishes, contrary to the contentions of KPMG and Sidley, that mere allegations of collusive behavior between signatories and nonsignatories to a contract are not enough to compel arbitration between parties who have not agreed to arbitrate: those allegations of collusive behavior must also establish that the plaintiff’s claims against the nonsignatory are “ ‘intimately founded in and intertwined with the obligations imposed by the [contract containing the arbitration clause].’ ” (MS Dealer, supra, 177 ,F.3d at p. 948.) It is the relationship of the claims, not merely the collusive behavior of the signatory and nonsignatory parties, that is key.

The cases upon which MS Dealer relied make the same point. MS Dealer cites two cases relevant to applying equitable estoppel based on the second circumstance (substantially interdependent and concerted misconduct): Boyd v. Homes of Legend, Inc. (M.D.Ala. 1997) 981 F.Supp. 1423 (Boyd) and Roberson, supra, 954 F.Supp. 1519 . These cases (decided by the same court) confirm that equitable estoppel applies when collusive behavior between signatories and nonsignatories is alleged, but only where the plaintiff’s claims are intertwined with the obligations imposed by the contract with the arbitration clause. Thus:

— In Boyd, the district court explained there are two factual scenarios under which a court can find that the claims against a nonsignatory are “intimately founded in and intertwined with the underlying contractual obligations . . . .” (Boyd, supra, 981 F.Supp. at p. 1432.) The first occurs when “adjudication of the disputes between the signatory and nonsignatory parties would require interpretation, and probably enforcement, of the specific

— In Roberson, the district court applied equitable estoppel to compel arbitration, at the instance of an insurer who was not a party to a loan agreement which contained an arbitration clause. Plaintiffs alleged that the signatory lender and nonsignatory insurer conspired to defraud them, by suppressing information and misrepresenting to plaintiffs that they could not qualify for loans unless they purchased expensive insurance. (Roberson, supra, 954 F.Supp. at p. 1522.) The court concluded that “at least some of the claims against defendants were closely intertwined and arose in connection with the loan agreement itself’; the allegations that a scheme to load unnecessary insurance policies onto high-interest consumer loan agreements “[gave] rise to a set of complaints about their contract obligations that implicate all defendants inseparably.” (Id. at p. 1529.) Notably, the court expressly stated: “Admittedly, to warrant equitable estoppel, it is not enough that the plaintiff be in a position to raise similar and parallel claims against both the other party to the contract and the third party. Therefore, it is irrelevant whether or not claims are indeed raised against both parties. What is necessary is that the claim against the nonsignatory be inextricably bound up with the terms and duties of the contract the plaintiff has signed with the other defendant.” (Ibid., italics added.) As we shall see (pt. E., post), it is this necessary element that is entirely missing from the Goldman/Haines claims against KPMG and Sidley.

fraudulent contract cannot help but be “ ‘intimately founded in and intertwined with’ that contract.” (Ibid.) In short, Metalclad, like MS Dealer and Grigson, in no way suggests that allegations of collusive behavior by signatories and nonsignatories, with no relationship to the terms of the underlying contract, can justify application of equitable estoppel to compel arbitration.

c. Brown.

In its reply brief, Sidley cites Brown, supra, 462 F.3d 384 , where the court found the district court did not abuse its discretion (although the point was “close”) in determining that signatories to an arbitration agreement were estopped, “under Grigson’s second prong,” from asserting that the lack of an arbitration agreement precluded arbitration. (462 F.3d at p. 398.) But in Brown, the plaintiffs sued all the defendants in connection with investment decisions of a broker handling the plaintiffs’ account under a client agreement with an arbitration clause. (Id. at p. 389.) The district court found “there was no way to bring actions against [two nonsignatories] without considering the actions of [the signatory to the contract and its representative],” and the court found that conclusion was not “patently incorrect.” (Id. at p. 398.) This was because “[w]hether and how [the nonsignatories] defrauded or breached duties owed to the [plaintiffs]” depended in some part on the nature of tortious acts allegedly committed by the signatory and its representative, and the plaintiffs failed to allege any tortious acts by the nonsignatories that were “separate and apart” from those of the signatory’s representative, whose acts were covered by the arbitration clause of the brokerage agreement. (Brown, supra, 462 F.3d at pp. 398-399.) Here, by contrast, Goldman and Haines could certainly bring actions against KPMG and Sidley without depending on the nature of the tortious acts of DGI; KPMG’s alleged fraud, breach of fiduciary duty and professional negligence in no way “depend[ed]” on its tortious conduct. Moreover, Brown expressly cited Grigson’s reasoning for applying equitable estoppel: “We reasoned that equity does not allow a party to ‘seek to hold the non-signatory liable pursuant to duties imposed by the agreement, which contains an arbitration provision, but, on the other hand, deny arbitration’s applicability because the defendant is a non-signatory.’ ” (Brown, supra, 462 F.3d at p. 398, quoting Grigson, supra, 210 F.3d at p. 528.) This, as we shall see post, is not such a case.

3. In re Humana.

As we have previously noted, some cases have expressly articulated the view we take in this case. Indeed, the Eleventh Circuit, which decided MS Dealer, did so in In re Humana Inc. Managed Care Litigation (11th Cir. 2002)

KPMG and Sidley argue that they satisfy MS Dealer’s first set of circumstances in which equitable estoppel may be applied, namely, “when the signatory to a written agreement containing an arbitration clause ‘must rely on the terms of the written agreement in asserting [its] claims’ against the nonsignatory.” (MS Dealer, supra, 177 F.3d at p. 947.) By now, of course, it will be clear that Goldman and Haines do not rely on, or even mention, the terms of the operating agreements. KPMG and Sidley slough over this requirement by cherry-picking words from the formulations articulated by various courts, and ultimately by disregarding the core of the principle. Thus they claim, for example, that the Haines allegations “logically presuppose the existence of the AD FX Fund and, therefore, of the Fund’s Operating Agreement,” because the operating agreements were a necessary step in effectuating the tax shelter transactions. But they ignore the fact that “presuming] the existence of’ an agreement is not a stand-alone principle, but merely an elaboration on the underlying principle, stated in all the cases: actual reliance on the terms of the agreement to impose liability on the nonsignatory. Ultimately, KPMG and Sidley simply omit the necessary central core of the standard: the plaintiffs allegations must rely on or depend on “ ‘the terms of the written agreement’ ” (MS Dealer, supra, 177 F.3d at p. 947), not simply on the fact that an agreement exists. As the court observed in Palmer: “While [the document at issue] may play a role in the ultimate outcome of this suit, it is not a part of Plaintiffs’ causes of action. ... In this case, Plaintiffs are not trying to ‘have it both ways’ [by seeking to hold the nonsignatory liable pursuant to duties imposed by the agreement, but at the same time denying applicability of the agreement’s arbitration clause] because Plaintiffs are not relying on the [document] to hold [the nonsignatory defendant] liable. As a result, equitable estoppel does not permit [the nonsignatory] to enforce the arbitration agreement.” (Palmer, supra, 254 Fed.Appx. at p. 432; see also Boucher, supra, 127 Cal.App.4th at p. 272 [“[t]he fundamental point is that a party may not make use of a contract containing an arbitration clause and then attempt to avoid the duty to arbitrate”]; Boyd, supra, 981 F.Supp. at p. 1433 [“here the court need not even read, let alone interpret or possibly enforce, the specific terms and conditions of the purchase contracts [containing the arbitration clause] to fully adjudicate the plaintiffs’ claims against [the nonsignatory manufacturer]”].)

KPMG also cites throughout its briefs to Turtle Ridge, supra, 140 Cal.App.4th 828 , a case from this division. But Turtle Ridge does not supply what is missing in this case: any reliance by Goldman or Haines on the terms

2. The Goldman/Haines allegations of concerted misconduct are not founded in or bound up with the terms or obligations of the operating agreements.

KPMG insists the “concerted misconduct” alleged in the complaints is “integrally tied up with” the operating agreements, because but for their execution of the operating agreements, Goldman and Haines could not have invested in the funds and generated their tax losses. But this does not satisfy the requirement that the allegations of concerted misconduct, be founded in or

We end this aspect of our discussion with one further point. KPMG insists there are “strong policy reasons” to conclude that a plaintiff’s allegations of concerted misconduct by signatories and nonsignatories, standing alone, is a proper basis for applying equitable estoppel. This is, it says, because “the non-defendant signatories, who bargained for resolution in a private forum, become, in essence, parties to a public proceeding—with the resulting loss of time and money—because of their required participation in the litigation,” citing Grigson and MS Dealer. But “policy reasons” alone cannot replace the necessary predicate for the application of equitable estoppel, and nothing in Grigson or MS Dealer suggests otherwise. The proposition that a court should compel arbitration to avoid denying the signatory defendant the benefit of his arbitration clause, and merely to avoid duplicative litigation, is, to the extent it purports to be based on principles of equitable estoppel, simply wrong. Parties who have not agreed to arbitrate may not be compelled to do so simply because two defendants, one with an arbitration agreement and one without, have colluded to defraud the plaintiff.