Truserv Corp. v. Ernst & Young, Llp

• Decision Date: 28 August 2007
• Docket Number: No. 1-06-2749.,No. 1-06-3484.,1-06-2749.,1-06-3484.
• Citation: 876 N.E.2d 77
• Parties: TRUSERV CORPORATION, Petitioner-Appellant, v. ERNST & YOUNG LLP, Respondent-Appellee. Ernst & Young LLP, Petitioner-Appellee, v. TruServ Corporation, Respondent-Appellant.
• Court: United States Appellate Court of Illinois

876 N.E.2d 77

TRUSERV CORPORATION, Petitioner-Appellant, v. ERNST & YOUNG LLP, Respondent-Appellee.

Ernst & Young LLP, Petitioner-Appellee, v. TruServ Corporation, Respondent-Appellant.

No. 1-06-2749.

No. 1-06-3484.

Appellate Court of Illinois, First District, Second Division.

August 28, 2007.

Rehearing Denied September 20, 2007.

Grippo & Elden LLC, Chicago (Gary M. Elden, Philip C. Stahl, Claudia M. Laurens & Patrick R. Malone, of counsel), for Appellant.

Kirkland & Ellis LLP, Chicago (Emily Nicklin and Jonathan C. Bunge, of counsel), for Appellee.

Justice HOFFMAN delivered the opinion of the court:

TruServ Corporation (TruServ), appeals from an order of the circuit court confirming an arbitration award issued in a contract dispute with Ernst & Young LLP (Ernst & Young). The circuit court confirmed the arbitration award in its entirety and denied TruServ's petition to vacate that portion of the award requiring it to pay attorney fees and costs incurred by Ernst & Young. On appeal, TruServ contends that (1) the arbitration panel exceeded its authority in awarding Ernst & Young attorney fees and costs under section 10a(c) of the Illinois Consumer Fraud and Deceptive Business Practices Act (Consumer Fraud Act) (815 ILCS 505/10a(c) (West 2004)), (2) the arbitration panel exceeded its authority in awarding attorney fees and costs that were not recoverable under the Consumer Fraud Act and were not supported by evidence establishing that they were incurred in defending the consumer fraud claim, and (3) the circuit court erred in denying TruServ's request for post-arbitration discovery. For the reasons that follow, we reverse and remand.

The record demonstrates that TruServ engaged Ernst & Young to perform financial auditing services for the fiscal years 1997, 1998, and 1999. The relationship between the parties was defined by a letter of engagement which provided for binding arbitration of all contract disputes that could not be resolved through voluntary mediation. The arbitration procedures contained in the contract provided, in relevant part, as follows:

"The arbitrators may not award non-monetary or equitable relief of any sort. They shall have no power to award punitive damages or any other damages not measured by the prevailing party's actual damages, and the parties expressly waive their right to obtain such damages in arbitration or in any other forum. In no event, even if any other portion of these provisions is held to be invalid or unenforceable, shall the arbitrators have power to make an award or impose a remedy that could not be made or imposed by a court deciding the matter in the same jurisdiction. * * * The result of the arbitration will be binding on the parties, and judgment on the arbitrators' award may be entered in any court having jurisdiction."

The arbitration agreement also stated that it was to be governed by the Federal Arbitration Act. 9 U.S.C. § 1 et seq. (2000).

For the years 1997 and 1998, TruServ's reported financial results were disappointing but still profitable, and no material weaknesses were found in TruServ's financial reports. For 1999, Ernst & Young discovered and reported material weaknesses in TruServ's financial statements that required the reporting of an unexpected loss of $131,000,000. Specifically, Ernst & Young found that, because TruServ had not performed account reconciliations on a timely basis, it was necessary to record a material adjustment in the fourth quarter of 1999, resulting in the $131,000,000 loss.

In July 2002, TruServ filed a demand for arbitration with the American Arbitration Association (AAA), asserting claims against Ernst & Young for breach of contract, professional malpractice, common-law fraud, and consumer fraud under the Consumer Fraud Act (815 ILCS 505/1 et seq. (West 2004)). All of TruServ's claims were predicated on allegations that Ernst & Young (1) failed to perform its financial audits in accordance with generally accepted auditing standards (GAAS), (2) failed to promptly discover and report that TruServ's financial statements contained material weaknesses, and (3) improperly certified that TruServ's financial statements for 1997 and 1998 had been prepared in accordance with generally accepted accounting principles (GAAP). As relief, TruServ sought to recover more than $500,000,000 in damages, including compensatory and punitive damages, and any other relief deemed appropriate. TruServ's claims were submitted to a panel of three arbitrators in accordance with the contract, and both parties requested an award for their attorney fees and costs. Specifically, TruServ sought to recover more than $10,000,000 in attorney fees and costs.

Following three years of arbitration proceedings, including extensive discovery and a 24-day evidentiary hearing, the arbitration panel dismissed all of TruServ's claims. The panel's decision was based on the determination that TruServ had failed to prove that Ernst & Young breached any of its auditing obligations. In particular, the panel found that (1) TruServ had failed to establish that its financial statements for 1997 and 1998 contained material weaknesses, (2) Ernst & Young properly certified the 1997 and 1998 financial statements as having been prepared in accordance with GAAP, and (3) Ernst & Young complied with GAAS in performing its financial audits. In addition, the panel decided that Ernst & Young, as the prevailing party, was entitled to recover its reasonable attorney fees and costs incurred in defending the arbitration.

Thereafter, Ernst & Young submitted a petition for fees and costs of $18,232,518.19. In response, TruServ filed a motion to modify and/or clarify the fee award, asserting that the arbitration panel lacked authority to award attorney fees and costs. In deciding this motion, the panel recognized that its authority was limited by the parties' arbitration agreement and that their agreement did not expressly address the issue of attorney fees or expenses. The panel determined that the award of attorney fees and costs was authorized under section 10a(c) of the Consumer Fraud Act (815 ILCS 505/10a(c)) (West 2004) and was properly based upon its finding that TruServ had shown bad faith in pursuing its claims. The panel further determined that, although TruServ had not demonstrated sufficient bad faith to satisfy the "categorical standard" applied by some Illinois courts, TruServ had failed to consider the extent of the audit work done by Ernst & Young prior to commencing the litigation and had pressed its case on several issues where it had no chance of success. The arbitration panel concluded that these circumstances established bad faith on TruServ's part.

The panel also found that the fees and costs incurred in defending the consumer fraud claim could not be differentiated from those incurred in defending the other claims because all of TruServ's claims were premised on the same central factual issues. Specifically noting instances of overstaffing, duplication of effort, and inflated increases in hourly rates, the panel reduced the fee request by more than $6,000,000 and awarded Ernst & Young $12,191,000 as the reasonable attorney fees and costs incurred in the arbitration.

TruServ subsequently filed a petition in the circuit court seeking vacatur of the arbitration panel's award of attorney fees and costs. Ernst & Young cross-petitioned for confirmation of the award and entry of judgment thereon. Following arguments, the circuit court confirmed the arbitration panel's decision in its entirety, denied TruServ's petition to vacate, and entered judgment on the arbitration award. This appeal followed.

On appeal, TruServ asserts that the award of attorney fees and costs must be vacated because the arbitration panel exceeded the scope of its authority under the arbitration agreement. The issue of whether an arbitration panel has exceeded its authority is one of law, which we review de novo. Water Pipe Extension, Bureau of Engineering Laborers' Local 1092 v. City of Chicago, 318 Ill.App.3d 628, 634, 251 Ill.Dec. 915, 741 N.E.2d 1093 (2000).

TruServ first argues that the arbitration panel exceeded its authority by awarding Ernst & Young attorney fees and costs under section 10a(c) of the Consumer Fraud Act in the absence of a finding of bad faith under the standard imposed by Supreme Court Rule 137. We disagree.

Both parties agree that resolution of this issue is governed by the supreme court's decision in Krautsack v. Anderson, 223 Ill.2d 541, 308 Ill.Dec. 302, 861 N.E.2d 633 (2006), which clarified conflicting Illinois law with regard to the award of attorney fees and costs under section 10a(c) of the Consumer Fraud Act. In Krautsack, the supreme court resolved a split in authority among appellate decisions and held that the circuit court must make a threshold finding of bad faith by the plaintiff in order to award attorney fees and costs to a prevailing defendant under the Consumer Fraud Act. Krautsack, 223 Ill.2d at 559-60, 308 Ill.Dec. 302, 861 N.E.2d 633. In addition, the court held that in seeking fees under section 10a(c) of the Consumer Fraud Act, a prevailing defendant is not limited by Supreme Court Rule 137, which provides sanctions for false or frivolous filings. Krautsack, 223 Ill.2d at 561-62, 308 Ill.Dec. 302, 861 N.E.2d 633. In reaching this result, the supreme court concluded that, because Rule 137 addresses only the pleadings, motions and other papers filed in the action, it does not provide a sanction against all asserted instances of bad-faith conduct by a litigant or counsel during the course of the proceedings. Krautsack, 223 Ill.2d at 562, 308 Ill.Dec. 302, 861 N.E.2d 633. The court recognized that, although a party's pleadings may conform to Rule 137, that party may be guilty of conduct, such as other rule violations, that amount to bad faith. Krautsack, 223 Ill.2d at 562, 308 Ill.Dec. 302, 861 N.E.2d 633. The court held, therefore, that the...