LGC Holdings, Inc. v. Julius Klein Diamonds, LLC, No. 16-CV-05352 (S.D.N.Y. Feb. 28, 2017) [click for opinion]
Petitioner LGC sought to confirm the results of an arbitration with its former business partners in the international diamond business, the Kleins (together with various entities controlled by the Kleins, the "Respondents"). Respondents sought to vacate the award.
In 2002, LGC and the Kleins became joint venture partners in three diamond businesses. The parties agreed to a valuation process in the event that the parties needed to unwind their joint ventures. The parties also agreed to arbitrate any controversy or claim arising out of or relating to their agreements. In 2012, LGC demanded that the Kleins buy out its interests in all three joint ventures; however, the parties could not agree how to disentangle their interests. Accordingly, the parties initiated arbitration proceedings in 2013 before a panel of three arbitrators—one appointed by each of the parties and the third appointed by the arbitrators. At the time, the neutral arbitrator declared that he had professional or social relationships with LGC and the other arbitrators; Respondents acknowledged and ratified his appointment.
LGC filed a petition in New York state court seeking preliminary injunctive relief in aid of arbitration; the state court denied the petition holding that any request for relief should be decided by the arbitrators. LGC then sought preliminary relief from the arbitrators, including an interim award. The panel issued an order requiring that Respondents pay LGC approximately $102 million; however, the panel stayed its order a day later so the parties could pursue a global settlement. The stay was in effect until November 2014, during which time Respondents paid LGC approximately $67 million as partial redemption of LGC's interests. In December 2014, LGC sought to confirm the interim award in the same New York state court. The state court denied confirmation of the interim order. On June 30, 2016, the panel awarded LGC approximately $112 million, in addition to the $67 million the Kleins had already paid.
Respondents filed a motion in the existing New York state court case seeking to vacate the award. LGC then filed a petition to confirm the award in the District Court for the Southern District of New York. LGC also removed the state court case to the Southern District of New York.
As a preliminary matter, the district court confirmed that it had subject matter jurisdiction under the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards, codified as Chapter 2 of the Federal Arbitration Act ("FAA"). The court concluded that jurisdiction was proper because the legal relationship between the parties was not entirely domestic in scope because the dispute involved property located abroad and envisaged performance abroad. The court also held that LGC's removal of the state court case was proper. Respondents argued that LGC could not remove the case from state court because only a defendant can remove an action relating to an arbitration agreement. The court explained that federal law determines who is a plaintiff and who is a defendant for removal cases and that the relevant inquiry is a functional one. The court concluded that LGC was the true defendant in this case using the functional test. LGC had initiated the state court proceedings by filing its petition for injunctive relief in aid of arbitration and then seeking confirmation of the award. However, once the arbitration commenced, nothing was pending in state court until the Kleins filed their petition to vacate the award. Thus, at the moment of removal, the continuation of the proceedings depended on the actions of the Kleins, who were in control of the litigation. The court also concluded that timing of the removal was proper because Section 205 of the FAA allows removal any time before trial. The court then upheld the arbitration award.
The court explained that, because the parties' agreements were silent as to the choice of arbitral law, the court would follow other courts in the district and apply the FAA. A party moving to vacate an award has the burden of proof, and the showing required to avoid confirmation is very high.
Applying this standard, the court considered three arguments for vacatur. First, Respondents argued that there was evident partiality and corruption of the neutral arbitrator. The court explained that evident partiality should be found where a reasonable person would have to conclude that an arbitrator was partial to one party. In determining the partiality of the arbitrator, the court noted that the arbitrator had disclosed his relationships with the other arbitrators and Petitioner. Thus, the court concluded that the arbitrator had shared enough information to put Respondents on notice, yet they did not object until after the panel issued the interim award. Accordingly, the court held that Petitioner had not met the high burden of demonstrating objective facts inconsistent with impartiality.
Respondents also sought vacatur based on the arbitrator's failure to disclose an indictment and conviction. However, the court explained that federal courts have been unreceptive to the argument that undisclosed legal trouble of an arbitrator requires vacatur under the FAA unless it affected the outcome of the arbitration. The court concluded that vacatur was not warranted here because neither the legal troubles nor the failure to disclose the legal troubles affected the outcome of the arbitration.
Third, Respondents argued that the panel exceeded its powers and acted in manifest disregard of the law when it rendered the award and imposed personal liability on the Kleins. The court explained that the "manifest disregard" standard is very hard to meet. It requires that arbitrators knew of a governing legal principle, which was well defined, explicit, and clearly applicable to the case, yet refused to apply it. Here, the scope of the panel's authority was broad—reaching any controversy or claim arising out of or relating to the agreements. In addition, the Kleins explicitly invoked their ability to buy out LGC's interest in the companies. Moreover, the Kleins participated actively in the arbitration process and in doing so waived any right to object to the imposition of personal liability. In fact, it was not until the arbitration was over that the Kleins objected to the imposition of personal liability. The court held that the panel's decision to impose personal liability could not be second guessed.
The claims for vacatur failed. The award was confirmed.