Outsourcing Law & Business Journal™ – November 2011
November 14, 2011 by Bierce & Kenerson, P.C.
OUTSOURCING LAW & BUSINESS JOURNAL™ : Strategies and rules for adding value and improving legal and regulation compliance through business process management techniques in strategic alliances, joint ventures, shared services and cost-effective, durable and flexible sourcing of services. www.outsourcing-law.com. Visit our blog at http://blog.outsourcing-law.com.
Insights by Bierce & Kenerson, P.C. Editor. www.biercekenerson.com.
Vol. 11, No. 9, November 2011
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1. To Arbitrate or Not, That is the Question.
2. Humor.
3. Conferences.
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1. To Arbitrate or Not, That is the Question. In KMPG LLP v. Cocchi, the U.S. Supreme Court ruled on November 7, 2011, that agreements to arbitrate must be enforced in federal and state courts under the Federal Arbitration Act, 9 U.S.C. §1 et seq. 565 U.S. ___ (2011). Judicial interpretation of arbitration clauses has resulted in the bifurcation of remedies before courts and arbitrators on the same facts. Such bifurcation adds costs and leads to uncertainty for the parties.
This case serves as a reminder to both parties to consider possible risk management and relationship governance frameworks. This article analyzes some ways to identify and minimize the risk of such bifurcation and piecemeal dispute resolution that neither party wanted. The parties may wish to evaluate and, at least internally, quantify the impact for pricing purposes in contract negotiation.
This decision relates to alleged professional malpractice by a regulated professional service provider. For unregulated BPO “professional” service providers, it raises red flags. It shows the risk profile for claims from persons other than the enterprise customer. The parties therefore may wish to consider the interests of persons who might be adversely affected by the BPO services, such as the BPO service recipient’s own customers, suppliers, users and licensees. Such interests can be addressed in the frameworks of relationship governance, risk management and compliance. For more, click here.
2. Humor.
Arbitration, n. (1) clandestine back-alley street fight, conducted in total confidence to avoid embarrassment, oppressive disclosure and discovery rules and judicial delays; (2) private justice for private failures.
Arbitrary, adj. (1) the outcome of an arbitrable claim; (2) the result of a preponderance of the credible evidence.
Enforce, v. (1) to apply power where shame, remorse, regret, denial, fear and hostility fail to get results.
3. Conferences.
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FEEDBACK: This newsletter addresses legal issues in sourcing IT, HR, finance and accounting, procurement, logistics, manufacturing, customer relationship management including outsourcing, shared services, BOT and strategic acquisitions for sourcing. Send us your suggestions for article topics, or report a broken link at wbierce@biercekenerson.com. The information provided herein does not necessarily constitute the opinion of Bierce & Kenerson, P.C. or any author or its clients. This newsletter is not legal advice and does not create an attorney-client relationship. Reproductions must include our copyright notice. For reprint permission, please contact: wbierce@biercekenerson.com. Edited by Bierce & Kenerson, P.C. Copyright (c) 2011, Outsourcing Law Global, LLC. All rights reserved. Editor-in-Chief: William Bierce of Bierce & Kenerson, P.C., located at 420 Lexington Avenue, Suite 2920, New York, NY 10170, 212-840-0080
To Arbitrate or Not, That is the Question
November 14, 2011 by Bierce & Kenerson, P.C.
In KMPG LLP v. Cocchi, the U.S. Supreme Court ruled on November 7, 2011, that agreements to arbitrate must be enforced in federal and state courts under the Federal Arbitration Act, 9 U.S.C. §1 et seq. 565 U.S. ___ (2011). Judicial interpretation of arbitration clauses has resulted in the bifurcation of remedies before courts and arbitrators on the same facts. Such bifurcation adds costs and leads to uncertainty for the parties.
This case serves as a reminder to both parties to consider possible risk management and relationship governance frameworks. This article analyzes some ways to identify and minimize the risk of such bifurcation and piecemeal dispute resolution that neither party wanted. The parties may wish to evaluate and, at least internally, quantify the impact for pricing purposes in contract negotiation.
This decision relates to alleged professional malpractice by a regulated professional service provider. For unregulated BPO “professional” service providers, it raises red flags. It shows the risk profile for claims from persons other than the enterprise customer. The parties therefore may wish to consider the interests of persons who might be adversely affected by the BPO services, such as the BPO service recipient’s own customers, suppliers, users and licensees. Such interests can be addressed in the frameworks of relationship governance, risk management and compliance.
The Parties. This case involved parties claiming that KPMG LLP was liable to them as investors in limited partnership investments that were allegedly defrauded by convicted securities fraud Bernie Madoff. KPMG had audited the financial statements of the investment partnerships. KPMG had included an arbitration clause in the engagement letter that covered all claims from their services, or so it thought.
The Claims. The defrauded investors asserted four different claims against KPMG. Two were common law claims: negligent misrepresentation and professional malpractices. Two arose from statutes intended to protect claimants, but none of those claimants were signatories to the engagement letter: violation of the Florida Deceptive and Unfair Trade Practices Act (FDUPTA) and aiding and abetting a breach of fiduciary duty. All the claims are based on the same alleged facts, that KPMG allegedly failed to use proper auditing standards that proximately led to substantial misrepresentations about the financial condition of the investment funds, resulting in investors’ losses.
“Derivative or Direct?” Whose Claims Are Covered by the Agreement to Arbitrate? The Court reviewed the question whether the arbitration clause could only be enforced if the plaintiffs’ claims were “derivative” (subordinate, arising out of the services that KPMG performed for the investment partnerships that were KPMG’s clients and therefore subject to arbitration). Applying Delaware law, the Court of Appeal for the Fourth Circuit concluded that the claims of negligent misrepresentation and violations of FDUPTA were direct, not derivative, and therefore could be asserted directly by the investors. Unless the claimants have agreed to arbitrate, “direct” claims are not arbitrable. That Court of Appeal affirmed the trial court’s denial of KPMG’s motion to arbitrate.
The Supreme Court concluded that the characterization of claims as derivative or direct is a matter of state law. That was not in dispute.
Limitation on Trial Court Discretion in Deciding Which Claims are Direct (and thus Outside the Arbitration Clause) and Which Are “Derivative.” The Supreme Court revered and remanded that lower court’s decision because the lower courts had rejected KPMG’s motion to compel arbitration of those claims that were covered by the arbitration clause. In short, the lower courts had wrongly decided that, if two of the four claims were NOT arbitrable, then none of the claims were arbitrable. The Supreme Court held that the lower courts failed to follow the plain meaning of the Federal Arbitration Act and a 1985 precedent, Dean Witter Reynolds, Inc. v. Byrd, 470 U.S. 213, 217 (1985), by their failure to “examine a complaint with care to assess whether any individual claims must be arbitrated,” when a complaint contains both arbitrable and non-arbitrable claims. Slip Op., at p. 4.
Lessons for Outsourcing. Outsourcing contracts are very similar to the KPMG audit services agreements. The parties agree to arbitrate all disputes arising out of the agreement. Any “direct” claims by customers or users of the services are independent of the arbitration clause and thus subject to direct litigation in courts.
Value of Arbitration. A well-drafted arbitration clause offers many benefits:
- shield the parties from the publicity of their dispute;
- obtain a neutral decision under well-administered scheduling process;
- escape from the whims and attitudes of a jury that is not sophisticated and generally may consider non-business, maybe non-legal, sentiments rather than what is “commercially reasonable”;
- confidentiality enables some more avenues for negotiated resolution, without judicial supervision of the settlement;
- become enforceable not only in the United States, but in other countries that are parties to arbitral enforcement conventions.
In global sourcing, reputational damage can arise from publicity of a dispute, so the confidentiality has some benefits for each party.
Shared Risk Management. Early “master services agreements” shifted to the service provider the responsibilities for risk management and compliance. Some commentators (such as Kate Vitasek, a professor in University of Tennessee) suggest that a partnership approach can mutually reduce individual and collective costs and liabilities in risk management and compliance. The KPMG v. Ciocchi decision invites providers and recipients of global services to implement effective communications and joint decisions, and to reduce potential liability to third parties. In the KPMG situation, however, the service recipient (managers of limited partnerships as investment funds) had no knowledge of the “professional standards” for auditing, and thus did not really care, or had no incentive, to share, in the risk management issues facing the “professional services provider” (auditors).
Professional Services: GRC Challenges for “Professional Services.” The KPMG decision also reminds licensed professionals such as architects, attorneys, accountants, engineers, auditors and other licensed professionals that “the buck stops here.” As is well settled under the Dean Witter Reynolds decision in 1985, such licensed professionals cannot escape statutory liability (and court litigation) from affected individuals even if their corporate client signs an arbitration agreement. So they need to consider the pricing impact of such potential liability, as well as the costs of defense where they could eventually win against the affected individuals (such as customers, users, licensees, employees of the client enterprise) who allege statutory rights, including potential punitive damages and “racketeering” triple damages.
Enterprise customers have an interest in the viability of their service providers. Clients of Arthur Anderson experienced significant lost time and lost value when Enron collapsed and the accounting firm “disappeared.” For the same reasons, outsourcing customers should respect the rights of service providers to limit liability and to participate in joint risk management and compliance activities. In short, transparency and effective relationship governance offer real value to both sides.
Service Providers. For BPO service providers, the KPMG v. Ciocchi decision is a wake-up call to identify, in due diligence, the risks of litigation with an enterprise customer’s downstream clients, users and customers under the “direct vs. derivative” dichotomy. If such risks exist, then BPO service provider may wish to discuss indemnification issues.
The BPO service provider can therefore raise the question whether it should be indemnified for claims arising from indirect users of those services, such as a bank’s customers, an insurance company’s insured policy holders, or a mortgage origination company’s loan applicants. Such an indemnification would not convert the “direct” claims into “derivative” claims, but would leave the service provider in the position of asserting an indemnification claim against its BPO customer. Assuming its customer is solvent, then the customer has assumed the liability of such “direct” claims, and the courts could then be asked to compel arbitration for all such claims if such BPO customer had obtained arbitration agreements from its own end-users or downstream customers.
Enterprise Customers. For enterprises purchasing BPO services, the KPMG v. Ciocchi decision highlights the need for adopting and implementing their own arbitration dispute methods in contracts with their own clients, users and customers. If the BPO service provider comes to you asking for an indemnification or a higher price, you will get the message. Maybe you can sidestep the issue by simply refusing to indemnify, since the enterprise is not responsible to its clients, users and customers for the wrongdoing of its BPO service provider for “direct” claims that escape arbitration under the Dean Witter decision. Or maybe you would be happy to pay a higher price to escape the indemnification. Or you might reject the BPO service provider as an eligible vendor. These issues can be explored in the “assessment” and “selection” processes.
Impact of KMPG Decision on BPO Governance Models for Dispute Resolution and Relationship Governance. Whatever its negotiating position, the enterprise customer needs to adopt risk management strategies that address its potential vicarious liability that might arise from an insufficient legal structure for relationship governance or a failure to actually track and implement a robust governance process. In short, the enterprise customer has potential vicarious liability to its own customers, clients and users under principles of respondeat superior and negligent supervision. The enterprise customer may mitigate its potential liability by obtaining insurance coverage and indemnification for willful misconduct and gross negligence of the BPO service provider. But respondeat superior and negligent supervision apply to cases where the enterprise customer failed to “manage” and “oversee” the BPO service provider’s ordinary negligence. All this invites further discussion at the planning stage.
Risk Management Practices. Each party needs to identify and address issues that relate to the use of arbitration (or, alternatively, litigation in court) by contract.
Courts of India as an Inconvenient Forum: Impact of Long Delays in Access to Court Procedure
October 9, 2009 by Bierce & Kenerson, P.C.
“Justice delayed is justice denied.” Enforcement of contract rights depends on a viable system that not only applies the rule of law, but does not delay the application of law to the aggrieved party’s petition for judicial redress. In one recent judicial decision in New York, the court addressed the question whether a possible ten year delay in adjudication in the courts of a foreign country was a sufficient balancing factor to justify retention of the case in New York rather than in the foreign forum. The foreign forum was India.
Forum Non Conveniens.
Under the basic principle of judicial jurisdiction, a court may exercise its competency to adjudicate disputes. Competency derives from the applicable constitutional delegation of authority to adjudicate, as well as the existence of a sufficient connection between the parties, the subject matter or the location of the events in dispute.
Under the common law system, courts have adopted the principle that they will not exercise their jurisdiction in all situations. They have adopted the principle of “forum non conveniens”, or “inconvenient forum,” to send the adjudication of the dispute to another forum that has a greater connection, a greater public interest or tighter connection with the subject matter and/or the parties.
Under New York law, the factors to be considered in a defendant’s motion to dismiss include:
- the burden on the New York courts.
- the potential hardship to the defendant.
- the unavailability of an alternative forum in which the plaintiff may bring suit.
- the fact that both parties are nonresidents of New York.
- the fact that the transactions out of which the cause of action arose occurred primarily in foreign jurisdiction.
No one factor is decisive. Islamic Republic of Iran v. Pahlavi, 62 NY2d 474, 479 (cert. denied 469 U.S. 1108).
Delays in India as Basis for Denial of Motion to Dismiss.
In a dispute concerning the interpretation of a letter of credit, the New York Supreme Court, Appellate Division, ruled that a trial court must consider factors in addition to the fact that the courts of India are clogged for many years. The case involved a letter of credit issued in India to the Japanese seller of commercial goods.
The plaintiff, a Japanese corporation with principal offices in Japan, submitted an opinion of Bhupinder Nath Kirpal, a former Chief Justice of India, who expressed his conclusion that because of the huge backlog of existing cases, the fact that no preference is given to commercial cases or newly submitted cases and the shortage of judges in India, it would take the New Delhi High court at least ten years to decide this type of case.
In contrast, the defendant bank tendered an affidavit of Aziz Mushabber Ahmadi, another former Chief Justice of India, explaining that India provides an adequate alternative forum, and that the Indian Code of Civil Procedure had been amended in 1999 and 2002 in order to expedite the resolution of commercial matters. Former Justice Ahmadi expressed the view Indian courts could dispose of a commercial case within a year. Another reference suggests that the case could be disposed of within one to three years.
The trial court in New York relied on the delays in India and the fact that the Indian defendant has an office in New York. Consequently, the trial court retained jurisdiction, denying the Indian defendant’s motion to dismiss for inconvenient forum.
Other Factors.
On appeal, the Appellate Division overruled the lower court for not considering any other factors.
- Interpretation of Foreign Law; Need for Expert Testimony.
The New York appellate court considered that the need to interpret foreign law outweighed the risk of a lengthy delay in the foreign court system.
…[The motion court failed to consider the burden of having to interpret Indian banking law. The applicability of foreign law is an important consideration in determining a forum non conveniens motion [citation] and weighs in favor of dismissal [citation], given that expert testimony is essential. NYLJ, May 24, 2004, p. 31, at cols. 3-4 (1st Dept. May 18, 2004).
- Comity and Interest of Foreign Courts.
The New York appellate court also underscored the importance of the principle of judicial restraint in respect of the public interest of foreign courts and foreign legal systems. This principle of restraint, adopted early in U.S. judicial history with Marbury v. Madison, serves to enhance the respect of foreign courts for judicial decisions of New York courts reciprocally under the principle of comity. Thus, in considering a motion to dismiss for forum non conveniens, New York courts should:
defer to India’s interest in resolving its own affairs. New York courts have recognized that where a foreign forum has a substantial interest in adjudicating an action, such interest is a factor weighing in favor of dismissal. [Citation.] As the affidavit of former Chief Justice Ahmadi noted, Indian courts are keenly interested in governing the affairs of its financial institutions to insure uniformity and consistency in the processing of financial transactions and in the interpretation of Indian banking statutes and laws.
In conclusion, the appellate court ruled that the lower court erred in concluding that India was not an adequate forum because of the delays in its court system. The lower court had relied on an earlier decision finding that delays in Indian courts were from 15 to 20 years. That earlier decision had been decided before the Indian judicial procedure reforms in 1999 and 2002.
Lessons in Outsourcing.
This decision highlights the critical importance of properly drafting dispute resolution clauses in outsourcing contracts.
- Foreign Governmental Interest.
While the dispute related to letters of credit, the appellate court noted the critical interest of Indian courts in adjudicating matters relating to “processing of financial transactions.” The same interest could be said to exist for virtually any IT-enabled transaction processing in India. This covers all business process outsourcing. - Choice of Law.
This decision relates to interpretation of foreign law. Parties to international commercial contracts in outsourcing should understand the applicable law and its role in the decision-making process under the principle of forum non conveniens. - Choice of Forum.
This case underscores the need for the parties to choose the relevant forum. The New York decision did not have any discussion of the terms of the Indian bank’s letter of credit. This litigation might have been avoided if the letter of credit had not only identified the mutually chosen applicable law, but also a mutually agreed exclusive forum for resolution of the disputes. Perhaps the issuing bank chose not to include that choice of forum in its letter of credit terms, possibly due to the pre-reform decisions that had adjudicated that Indian courts were not a viable solution to dispute resolution. - Guarantees.
A guarantee is a contractual obligation to pay money or perform certain acts under pre-defined conditions. In this situation, the dispute related to a bank guarantee in the form of a letter of credit. In outsourcing, enterprise customers should consider the availability and suitability of possible guarantees of performance. In view of the recent infamous bankruptcies of Enron and WorldCom, service providers may also take note of the possible value of guarantees of payment by the customer, or alternative contractual provisions assuring the service provider of its own rights of enforcement or alternatives to judicial enforcement. - Role of Arbitration.
An arbitration clause may overcome issues of forum non conveniens. But arbitration still retains the risk (albeit small) of non-enforcement under the rules governing recognition and enforcement of foreign arbitral awards. - Role of Offshore Judicial Reform in Offshore Outsourcing.
This case is a beacon and warning for foreign governments that have byzantine, poorly administered, politically influence or backlogged judicial systems. If your government wishes to promote exports of services, you should offer a judicial system that is accessible and viable as an alternative forum under the principle of forum non conveniens. In the absence of a credible judicial system, your service providers will be forced into courts such as those of New York, and the customary international financial and practical guarantee structures in offshore outsourcing transactions might serve as barriers to entry for new service providers. Development of a credible judicial system does not occur overnight, but failure to make steps in that direction may retard economic development.
Decision:
Shin-Etsu Chemical Co., Ltd. v. ICICI Bank Limited, __ N.Y.S.2d __, NYLJ May 24, 2004, p. 18, cols. 1-6, p. 31, cols. 1-6 (1st Dept. May 18, 2004), by Sullivan, J. (Docket No. 3033).
Published: May 26, 2004