Hoeft v. Mvl Group, Inc.

• Citation: 343 F.3d 57
• Decision Date: 03 September 2003
• Docket Number: Docket No. 02-9155.
• Parties: Richard HOEFT, III, individually and as trustee under the Hoeft Charitable Remainder Unitrust, Carol J. Hoeft, as trustee under the Hoeft Charitable Remainder Unitrust, Petitioners-Appellants, v. MVL GROUP, INC., Discovery Research Group of Utah, Inc., formerly known as Discovery Acquisition Corp., Respondents-Appellees.
• Court: United States Courts of Appeals. United States Court of Appeals (2nd Circuit)

343 F.3d 57

Richard HOEFT, III, individually and as trustee under the Hoeft Charitable Remainder Unitrust, Carol J. Hoeft, as trustee under the Hoeft Charitable Remainder Unitrust, Petitioners-Appellants, v. MVL GROUP, INC., Discovery Research Group of Utah, Inc., formerly known as Discovery Acquisition Corp., Respondents-Appellees.

Docket No. 02-9155.

United States Court of Appeals, Second Circuit.

Argued: March 27, 2003.

Decided: September 3, 2003.

COPYRIGHT MATERIAL OMITTED

Louis B. Kimmelman (Marissa Molé, on the brief), O'Melveny & Myers LLP, New York, NY, for Petitioners-Appellants.

James T. Shearin, Pullman & Comley, LLC, Bridgeport, CT, for Respondents-Appellees.

Before: B.D. PARKER, Jr. and RAGGI, Circuit Judges, and GOLDBERG, Judge.^*

B.D. PARKER, JR., Circuit Judge.

This is one of those rare cases in which a district court vacated an arbitration award because of the arbitrator's manifest disregard of the law. The arbitrator, Steven Sherrill, issued a $1,402,565 award in favor of petitioners Richard Hoeft, III and Carol J. Hoeft. The Hoefts filed a petition to confirm the award in the United States District Court for the Southern District of New York, and respondents MVL Group, Inc. and Discovery Research Group of Utah, Inc. (collectively, "MVL") moved to vacate the award. After limited discovery including a court-supervised deposition of the arbitrator, the District Court (Kimba M. Wood, Judge) denied the Hoefts' petition to confirm the award and granted MVL's motion to vacate it, concluding that Sherrill had manifestly disregarded the law. Because we conclude that the District Court should not have permitted MVL to depose the arbitrator regarding his reasoning and decision-making processes, and because we believe that the arbitrator neither manifestly disregarded the law nor exceeded his powers, we reverse the judgment of the District Court.

BACKGROUND

In the 1980s Richard Hoeft, III founded two companies that specialize in the field service area of the market research industry, Discovery Research Group, Inc. and Discovery Research Group of Utah, Inc. By February 2000, Hoeft individually and the Hoeft Charitable Remainder Unitrust, of which Hoeft and his wife Carol J. Hoeft were co-trustees, were the sole shareholders of both companies. In a February 2000 Stock Purchase Agreement and Amendment to Stock Purchase Agreement, the Hoefts sold their shares for $6.5 million to MVL Group, Inc. and Discovery Acquisition Corporation.¹

The sale closed on February 29, 2000, but the parties agreed that MVL could defer paying a portion of the purchase price until the following year and that the Hoefts would receive a purchase price adjustment if the value of the companies increased. The adjustment would be based on a calculation of EBITDA, which was defined in the Amendment as follows:

For purposes of this Amendment, the term EBITDA shall mean income from operations before interest expense, provisions for income taxes, interest and other investment income, other income, depreciation and amortization, which shall be determined in accordance with generally accepted accounting principles consistently applied....

(Amendment to Stock Purchase Agreement § 1(b).) The Hoefts would receive the adjustment if, and only if, EBITDA for the year following the closing (the "Secondary Year") was equal to or greater than EBITDA for the year preceding the closing (the "Primary Year"). If Secondary Year EBITDA was equal to or greater than Primary Year EBITDA, the purchase price would be increased by the difference between 5.5 times Primary Year EBITDA, on the one hand, and $6,500,000, on the other.

The Amendment provided that, in the event of a dispute as to the calculation of either Primary or Secondary Year EBITDA, the parties were to

use their reasonable best efforts to resolve such dispute, and in the event that they are unable to do so such dispute shall be resolved by Steven Sherrill, whose decision in such matters shall be binding and conclusive upon each of the parties hereto and shall not be subject to any type of review or appeal whatsoever.

(Amendment to Stock Purchase Agreement § 1(d).) Sherrill is a certified public accountant who represented the Hoefts in this transaction and had also worked as a consultant to MVL. The parties ultimately disagreed over the calculation of Primary Year EBITDA. The disagreement involved the proper treatment of certain one-time payments to employees — sale-related bonuses and stock option extinguishment costs — made in connection with the February stock sale. MVL believed that these one-time payments should reduce "income from operations," a component of EBITDA under § 1(b) of the Amendment, while the Hoefts believed that they should not. The parties were unable to resolve the dispute themselves, and the Hoefts' attorney wrote to Sherrill requesting that he resolve it.

A general arbitration clause in the Stock Purchase Agreement (from which the more specific § 1(d) of the Amendment represented a carve-out) referred most disputes arising under the Agreement to the American Arbitration Association (the "AAA"). Invoking this clause, MVL initiated a proceeding with the AAA seeking to disqualify Sherrill and to have the AAA appoint a new arbitrator. MVL argued, on the basis of a draft calculation of Primary Year EBITDA that Sherrill had circulated in November 2000, that he had prejudged the matter and could not act impartially.² The AAA denied MVL's motions as premature, noting that, if MVL felt that Sherrill conducted the arbitration proceeding with "evident partiality," it could seek to have the award vacated on that ground after the proceeding was concluded and Sherrill rendered his award. See 9 U.S.C. § 10(a)(2).

Sherrill proceeded to arbitrate the dispute over Primary Year EBITDA. The parties submitted documentary evidence and expert reports supporting their conflicting calculations. In July 2001, Sherrill issued a draft award and circulated it to the parties. After receiving comments and additional evidence from the parties, Sherrill issued his final award in August 2001. Relying on his perception of the parties' intent, Sherrill adopted the Hoefts' contention that the one-time payments did not reduce Primary Year income from operations (nor, therefore, Primary Year EBITDA). Sherrill rejected MVL's argument that income from operations could be determined solely according to Generally Accepted Accounting Principles ("GAAP"), as GAAP defined neither "income from operations" nor "EBITDA." Pursuant to the formula prescribed in § 1(e) of the Amendment, Sherrill determined that, if Secondary Year EBITDA was equal to or greater than his calculation of Primary Year EBITDA, MVL owed the Hoefts $1,402,565. MVL conceded that Secondary Year EBITDA was equal to or greater than Primary Year EBITDA.

In September 2001, the Hoefts filed a petition in the District Court to confirm the award pursuant to the Federal Arbitration Act, 9 U.S.C. §§ 1-16 (1999) (the "FAA"). MVL, in turn, filed a demand with the AAA to vacate the award, as well as a slew of motions in the District Court. These motions sought to: vacate the arbitration award; stay the District Court action pending the outcome of the AAA proceeding; stay the District Court's consideration of the Hoefts' petition pending discovery; and compel arbitration. The Hoefts cross-moved to stay the AAA proceeding. In a November 2001 order the District Court denied MVL's motion for a stay pending the outcome of the AAA proceeding, denied MVL's motion to compel arbitration, granted the Hoefts' motion to stay the AAA proceeding, and denied MVL's motion to stay consideration of the Hoefts' petition pending discovery.

Following the District Court's resolution of these motions, MVL sought a broad range of discovery: interrogatories, document production, and depositions, including the deposition of the arbitrator. At the time, MVL had asserted four grounds for vacating the arbitration award: (1) that Sherrill had exceeded his powers, (2) that the arbitrator had manifestly disregarded the law by failing to apply GAAP, (3) that the dispute resolution mechanism of § 1(d) of the Amendment had not been properly triggered, and (4) that the arbitrator had prejudged the dispute. The Hoefts argued that the District Court should not permit any discovery but that, to the extent any discovery would be permitted, the only useful testimony would be the arbitrator's. The District Court ordered that MVL could depose the arbitrator for one-half hour, under the court's supervision.

On the day of the arbitrator's deposition, the parties disputed its proper scope. MVL's counsel indicated that he intended to question the arbitrator regarding whether he had manifestly disregarded the law, while the Hoefts' counsel argued that the deposition should be limited to whether the arbitrator had prejudged the dispute (i.e., to events that occurred before the Amendment's dispute resolution mechanism had been triggered). The court declined to limit the scope of the deposition, expressly permitting MVL's counsel to examine the arbitrator regarding his alleged manifest disregard of the law.

The in-court deposition of the arbitrator proceeded, with the court supervising. MVL's counsel did not question the arbitrator regarding the allegations of bias or prejudgment. Instead, MVL's counsel questioned the arbitrator regarding his understanding of the calculation of EBITDA under the Amendment and the substance of his decision-making process in calculating Primary Year EBITDA, including the role of GAAP in his calculation. Sherrill testified that he had "disregard[ed] the phrase `generally accepted accounting principles'" in calculating Primary Year EBITDA and that "the preponderance of evidence suggested that had GAAP been applied, in my determination those two expense items [i.e., the sale-related bonuses and stock option extinguishment costs] would have reduced EBITDA under...