Creative Solutions Group v. Pentzer Corp.

• Decision Date: 08 May 2001
• Docket Number: No. 01-1146,01-1146
• Parties: (1st Cir. 2001) CREATIVE SOLUTIONS GROUP, INC.; FORM HOUSE HOLDINGS, INC., Plaintiffs-Appellees, v. PENTZER CORPORATION, Defendant-Appellant. Heard
• Court: U.S. Court of Appeals — First Circuit

Page 28

252 F.3d 28 (1st Cir. 2001)

CREATIVE SOLUTIONS GROUP, INC.; FORM HOUSE HOLDINGS, INC., Plaintiffs-Appellees, v. PENTZER CORPORATION, Defendant-Appellant.

No. 01-1146

UNITED STATES COURT OF APPEALS FOR THE FIRST CIRCUIT

Heard May 8, 2001

Decided June 5, 2001

Lawrence A. Wojcik with whom Sonya D. Naar, Raj N. Shaw, Piper Marbury Rudnick & Wolfe, Edward P. Leibensperger, Marc A. Polk, Nutter, McClennen & Fish, LLP, were on brief for defendant-appellant Pentzer Corporation.

Mark D. Cahill with whom Robert A. Kole and Choate, Hall & Stewart were on brief for plaintiffs-appellees Creative Solutions Group, Inc. and Form House Holdings, Inc.

Before Boudin, Circuit Judge, Bownes, Senior Circuit Judge, and Schwarzer,^* Senior District Judge.

SCHWARZER, Senior District Judge.

This case presents the question of whether the disputes between the parties are subject to arbitration under their agreement and, to the extent they are, if arbitration has been waived.

The case arises out of an agreement ("the Agreement") by which plaintiffs Creative Solutions Group (through its predecessor, Heritage Fund II Investment Corporation--"Heritage") purchased the capital stock of five companies known as Creative Solutions Group, Inc. from defendant Pentzer Corporation ("Pentzer"). Pentzer and Heritage entered into the Agreement on March 31, 1999, the closing date for the transaction. The stipulated purchase price, based on December 31, 1998, financial statements, was subject to post-closing adjustments made pursuant to procedures delineated in the Agreement. To that end, the Agreement required Pentzer to deliver to Heritage certain financial information called the Purchase Price Financials, which reflected the position of the companies as of March 31, 1999. Heritage had the right under the Agreement to review related work papers of Deloitte & Touche, Pentzer's auditors. The Agreement provided that "in the event that [Heritage or its accountants] dispute any portion of [Pentzer's] calculation of any of the Purchase Price Financials," notice shall be given to Pentzer and, if the dispute is not resolved, it shall be submitted to arbitration. The Agreement further provided for adjustment of the purchase price to the extent the March 31, 1999, book value or net worth of the five companies being purchased differed from the book value or net worth as of December 31, 1998.

Following the closing, Pentzer delivered the Purchase Price Financials to Heritage on August 5, 1999, and advised that as a result of the Deloitte & Touche audit, Heritage was entitled to an adjustment of the purchase price in addition to the adjustment agreed on at the closing. Heritage then requested access to the Deloitte & Touche work papers pursuant to the terms of the Agreement, but the parties were unable to arrive at mutually satisfactory terms for access and Heritage never received the papers.

Plaintiffs filed this action on April 7, 2000, stating causes of action for breach of certain representations and warranties in the Agreement, breach of the implied covenant of good faith and fair dealing, fraud, negligent misrepresentation, and violation of Massachusetts General Laws Chapter 93A (1997) ("Regulation of Business Practices for Consumers Protection"). In support of these causes of action, plaintiffs alleged three breaches of the Agreement by Pentzer: (1) overstatement of the companies' 1998 earnings before interest, taxes, depreciation and amortization (the EBITDA claim); (2) overstatement of the companies' net worth as of March 31, 1999 (the NWO claim); and (3) failure of two companies to comply with OSHA (29 U.S.C. 651-678) standards. The last claim is not an issue in this appeal.

Pentzer waived formal service of the complaint and at the end of the sixty-day period obtained an extension to plead to July 6, 2000, when it moved to dismiss four of the six counts of the complaint. Plaintiffs served partial initial disclosures on July 25, 2000. Because damage computations were not included, Pentzer made a request for them. On August 11, 2000, plaintiffs served document requests on Pentzer. On September 7, 2000, Pentzer invoked the dispute resolution procedure under the Agreement, including a demand for arbitration. Plaintiffs did not respond and Pentzer, on September 11, 2000, moved to compel arbitration.

On November 13, 2000, the district court ruled on the motion. It held that plaintiffs' claims were not based on mistakes of accounting in the Purchase Price Financials, but on the overall course of the negotiations leading up to the Agreement. Accordingly, the dispute was not one over the calculation of any of the Purchase Price Financials subject to the arbitration clause, but over Pentzer's representations and warranties concerning the financial strength of the companies. Because the court concluded "that the majority of the plaintiffs' claims relate not to the Purchase Price Financials," it denied the motion.

Pentzer moved for reconsideration. On January 5, 2001, the court reaffirmed its prior order. The court specifically addressed the NWO claim, which expressly concerns calculation of the final purchase price derived from the Purchase Price Financials. While the court found this claim to be governed by the arbitration agreement, it held that Pentzer had waived its right to arbitrate. It found that plaintiffs had been prejudiced by Pentzer and Deloitte & Touche's failure to turn over accounting records and work papers, forcing plaintiffs to seek to compel production, investigate the suspected fraud, and commence the litigation, incurring legal expenses along the way. Pentzer had also caused plaintiffs to incur legal expense by making discovery requests and refusing to return settlement documents to plaintiffs. Given the narrow scope of this arbitration agreement, the court found that it would be inefficient to require plaintiffs to arbitrate the NWO claim while simultaneously or subsequently litigating the far more substantial EBITDA and OSHA claims. The court denied the motion and denied a stay pending appeal.

The district court had jurisdiction of the action under 28 U.S.C. 1332. We have appellate jurisdiction under 28 U.S.C. 1292 and under the Federal Arbitration Act, 9 U.S.C. G16.

I. WHICH CLAIMS ARE SUBJECT TO ARBITRATION?

Arbitration is "simply a matter of contract between the parties; it is a way to resolve the disputes--but only those disputes--that the parties have agreed to submit to arbitration." Coady v. Ashcraft & Gerel, 223 F.3d 1, 10 (1st Cir. 2000) (quoting First Options of Chicago, Inc. v. Kaplan, 514 U.S. 938, 943, 131 L. Ed. 2d 985, 115 S. Ct. 1920 (1995)). "[A] party cannot be required to submit to arbitration any dispute which he has not agreed so to submit." AT&T Tech. v. Communications Workers, 475 U.S. 643, 648, 89 L. Ed. 2d 648, 106 S. Ct. 1415 (1986) (quoting United Steelworkers of Am. v. Warrior & Gulf Navigation Co., 363 U.S. 574, 582, 4 L. Ed. 2d 1409, 80 S. Ct. 1347 (1960)).

We agree with the district court that the EBITDA claim of misrepresentation in the companies' December 31, 1998, financial statement is not a claim the parties agreed to submit to arbitration. Article 2.6 of the Agreement represents that those statements "fairly present[] the financial condition and results of operation of the [companies]." Article 10.1 provides that Pentzer shall indemnify, defend, and hold plaintiffs harmless from any loss arising from a breach by Pentzer of any representation or warranty. And Article 10.7 states that "the provisions of this Article 10 shall be the sole and exclusive remedy . . . for all claims of breach . . . pursuant to this Agreement. . . ." Thus, not only does the exclusive remedy provision govern the EBITDA claim relating to the December 31, 1998, statements, but the arbitration agreement, by its terms, also excludes them. Article 1.6, the arbitration provision, deals with "Calculation of Final Closing Date Purchase Price." It concerns only "disputes [over] any portion of [Pentzer's] calculation of any of the Purchase Price Financials." The Purchase Price Financials, in turn, consist of the financial statements of the companies as of the closing date (March 31, 1999, also the valuation date) with supporting calculations.

Pentzer argues that the EBITDA claim is a dispute over the Purchase Price Financials, because the factual allegations underlying plaintiffs' complaint could be resolved by an independent arbitrator reviewing the Purchase Price Financials. It is true, as Pentzer argues, that the closing date financial statements would reflect the historical financial record of the companies. However, it does not follow that if the closing date statements correctly reflect the results of operations as of March 31, 1999, those financial statements for the preceding periods were also correct. In other words, it would be fallacious to say that if there were no inventory overstatements as of March 31, 1999, none resided in the December 31, 1998, or earlier statements.

Plaintiffs' claim of net worth overstatement in the March 31, 1999, financial statements, on the other hand, falls squarely within the arbitration provision's scope. While a portion of the NWO claim may reflect the EBITDA shortfall during the prior periods,...