Garten v. Kurth, PLAINTIFFS-APPELLEES

• Decision Date: 01 August 2000
• Docket Number: DEFENDANTS-APPELLANTS,PLAINTIFFS-APPELLEES,Docket No. 01-7379
• Citation: 265 F.3d 136
• Parties: (2nd Cir. 2001) JAMES GARTEN, KARI GARTEN, HARRIS SCHWARTZBERG, MICHAEL JOANNOU AND THERESA JOANNOU, v. PETER C. KURTH, PAULA RUDOFSKY, JULIA KURTH, THE PETER C. KURTH OFFICE OF ARCHITECTURE AND PLANNING, P.C., MKC CONSTRUCTION MANAGEMENT CORP., INC., PGM CONSTRUCTION MANAGEMENT, INC., KRK CONSTRUCTION MANAGEMENT, INC., AND PETER C. KURTH, AIA, D/B/A DESIGN WORKS CONSTRUCTION, INC., CYNTHIA DARDEN, ABC CORPORATIONS NOS. 1 THROUGH 10, JOHN DOE NOS. 1 THROUGH 10 (A FICTITIOUS NAME) AND JOHN SERGEANT, DEFENDANTS
• Court: U.S. Court of Appeals — Second Circuit

Page 136

265 F.3d 136 (2nd Cir. 2001)

JAMES GARTEN, KARI GARTEN, HARRIS SCHWARTZBERG, MICHAEL JOANNOU AND THERESA JOANNOUPLAINTIFFS-APPELLEES, v.PETER C. KURTH, PAULA RUDOFSKY, JULIA KURTH, THE PETER C. KURTH OFFICE OF ARCHITECTURE AND PLANNING, P.C., MKC CONSTRUCTION MANAGEMENT CORP., INC.,PGM CONSTRUCTION MANAGEMENT, INC., KRK CONSTRUCTION MANAGEMENT, INC., AND PETER C. KURTH, AIA, D/B/A DESIGN WORKS CONSTRUCTION, INC., DEFENDANTS-APPELLANTS.

CYNTHIA DARDEN, ABC CORPORATIONS NOS. 1 THROUGH 10, JOHN DOE NOS. 1 THROUGH 10 (A FICTITIOUS NAME) AND JOHN SERGEANT, DEFENDANTS.

Docket No. 01-7379

August Term, 2000

UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT

Argued: August 6, 2001

Decided September 7, 2001

Appeal from a judgment of the United States District Court for the Southern District of New York(Charles L. Brieant, J.),denying Defendants' motion to compel arbitration.

Reversed.

David S. Pegno, Dewey Pegno & Kramarsky, New York, Ny, for Appellees.

Matthew G. Roseman, Forchelli Curto Schwartz Mineo Carlino & Cohn, Mineola, Ny, for Appellants.

Before: Miner, Calabresi, and Cabranes, Circuit Judges.

Calabresi, Circuit Judge

Defendants appeal from the decision of the United States District Court for the Southern District of New York(Charles L. Brieant, J.) to deny Defendants' motion to compel arbitration for a variety of claims brought by Plaintiffs with respect to a construction project on Plaintiffs' property.The district court held that threats made by DefendantPeter Kurth concerning both his ample knowledge of arbitration and the costs of arbitration for Plaintiffs were part of an effort to force Plaintiffs to over-pay for the construction project; these threats, accordingly, established a "substantial relationship" between the arbitration clause and the fraudulent scheme and warranted the court's decision not to enforce the arbitration provision.We reverse.

BACKGROUND

In early 1998, Plaintiffs James and Kari Garten decided to have a playhouse built for their daughter behind their house.The Gartens contacted DefendantPeter Kurth, a licensed architect who had designed the Garten's home for its prior owner.At the first meeting, Mr. Kurth said that he was an experienced architect with the professional capacity to complete the project.The Gartens decided to retain Defendant The Peter C. Kurth Office of Architecture and Planning("Architecture and Planning") as the architect for the project.On May 14, 1998, the Gartens signed an Agreement (the "Garten Agreement") with Architecture and Planning for the construction of the playhouse.This agreement contained an arbitration clause that stated:

Claims, disputes or other matters in question between the parties to this Agreement arising out of or relating to this Agreement or breach thereof shall be subject to and decided by arbitration in accordance with the Construction Industry Arbitration Rules of the American Arbitration Association currently in effect unless the parties mutually agree otherwise.No arbitration arising out of or relating to this Agreement shall include, by consolidation, joinder or in any other manner, an additional person or entity not a party to this Agreement, except by written consent containing a specific reference to this Agreement signed by the Owner, Architect, and any other person or entity sought to be joined.Consent to arbitration involving an additional person or entity shall not constitute consent to arbitration of any claim, dispute or other matter in question not described in the written consent.The foregoing agreement to arbitrate and other agreements to arbitrate with an additional person or entity duly consented to by the parties to this Agreement shall be specifically enforceable in accordance with applicable law in any court having jurisdiction thereof.

....

The award rendered by the arbitrator or arbitrators shall be final and judgment may be entered upon it in accordance with applicable law in any court having jurisdiction thereof.

Following the signing of the Garten Agreement, Mr. Kurth prepared the plans for the project and provided the Gartens with an estimate of $165-$185 per square foot, for a total cost of approximately $180,000.He also told the Gartens that he would collect and submit to them proposals for the construction of the playhouse.The summary of the bids that Mr. Kurth gave the Gartens included those from DefendantsMKC Construction Company("MKC"), PGM Construction Management, Inc.("PGM"), and Peter C. Kurth, AIA d/b/a Design Works Construction, Inc.("Design Works"), plus bids from five other companies.MKC, PGM, and Design Works, the three lowest bidders, were all controlled by Mr. Kurth at the time of the bidding.Mr. Kurth did not inform the Gartens about his connections to these companies.Design Works' bid (and budget) of $179,572 was the lowest and was accepted by the Gartens.As a result, the Gartens entered into a Construction Management Agreement with Design Works; this agreement also contained an arbitration clause.Design Works' role was to be general contractor for the project.

Due to rising costs in the ongoing construction project, the Gartens -after paying the bills - requested an accounting around April 1999.Though they were entitled to such an accounting pursuant to the Garten Agreement, they never received it.When the Gartens had paid over $400,000, they met with Mr. Kurth to discuss the growing costs and were told that the project could be completed "in the $400,000 range."On May 15, 1999, the Gartens gave Mr. Kurth checks for two further invoices.But, the next day, upon determining that they had paid him almost $700,000, they stopped payment on the checks and contacted Mr. Kurth to review the situation.¹

Within a few days, the Gartens met with DefendantsPeter Kurth and Paula Rudofsky(Mr. Kurth's assistant) and offered $50,000 to complete the project.Mr. Kurth accepted this offer and the Gartens provided a check for $50,000 marked "full and final payment," which he cashed.Soon after, Mr. Kurth and Mr. Garten spoke again.At that time, Kurth warned Garten that more money would be needed to complete the job and that Garten would be required to pay any additional costs.He pointed out that the Gartens could not litigate the issue, but would have to go into arbitration - something he was very familiar with, but a process for which the Gartens would need to hire an attorney.Defendants did not provide further payments to subcontractors or perform any work after this point.On June 7, 1999, the Gartens terminated their relationship both with Architecture and Planning and with Design Works.Architecture and Planning then filed and served a mechanic's lien for over $50,000 against the Gartens' property; Design Works did the same for an amount in excess of $100,000.The Gartens requested an itemized statement for the liens but were given only the same invoices that they had already received.

In October 1999, Plaintiffs began this action against, inter alia, DefendantsPeter Kurth, Rudofsky, Architecture and Planning, MKC, PGM, and Design Works alleging RICO violations as well as various statutory and common law claims sounding in fraud, malpractice, breach of fiduciary duty, and unjust enrichment.After Plaintiffs amended their complaint, Defendants² moved to compel arbitration under the Federal Arbitration ActandN.Y. C.P.L.R. 7503 and to dismiss the suit on the grounds of failure to state a cause of action and/or lack of jurisdiction.

In a Memorandum and Order dated October 23, 2000, the district court declined to dismiss the Amended Complaint.It denied the motion to compel arbitration with respect to Plaintiffs' claims against Peter Kurth, Darden, PGM, and Julia Kurth(the "Non-Signatory Defendants") because no agreement to arbitrate existed between the Non-Signatory Defendants and Plaintiffs.And, it reserved decision on Defendants' motion to compel arbitration for the claims against Architecture and Planning and Design Works pending an evidentiary hearing.

The court took cognizance of the existence of an arbitration agreement with these latter parties and it noted that the validity of a contract that provides for arbitration is usually an issue for the arbitrators.It further pointed out that "[t]he Federal Arbitration Act`does not permit the federal court to consider claims of fraud in the inducement of contract generally,'" and that the "court may address allegations of fraud only if they are directed to the arbitration clause itself."Here, however, Plaintiffs had alleged that the arbitration clauses were used to facilitate Defendants' fraud.As a result, the court stated, the question whether the fraud alleged went to the arbitration clause must be decided before arbitration can be compelled or Plaintiffs can be allowed to proceed with their claim in district court.The court's order permitted discovery solely on the issue "of fraud in the inducement of the arbitration provisions" in the contracts.And, the court stayed the action with respect to all the Non-Signatory Defendants until it could adjudicate the validity of the arbitration agreement between the Gartens and the two Defendants - Architecture and Planning and Design Works - who had signed contracts with them.³

The district court conducted a two-day hearing on the question.On March 14, 2001, it issued findings of fact and conclusions of law.In its decision, the court reviewed the evidence surrounding Plaintiffs' allegations.It found that the focus of the fraud alleged was the systematic overcharging of Plaintiffs for services performed by subcontractors.Thus, for invoices dated September 1998 to December 1999, Mr. Kurth had paid subcontractors $354,000 while the Gartens had paid out more than $700,000.This, the district court concluded, sufficed to "show a continuing pattern of fraud and deceit."⁴As to the relevance of the arbitration clause to this fraud, the...