SUMMER 2009 FINDING THE BALANCE ALONG THE ANTITRUST WATERFRONT A Conversation with Randall L. Allen and Debra D. Bernstein ELEVENTH CIRCUIT VACATES CLASS CERTIFICATION ORDER By Kristine McAlister Brown and Kimberly L. Fogarty MARK-TO-MARKET ACCOUNTING IN THE CROSSHAIRS AGAIN By Darren L. McCarty CALIFORNIA COURTS RESIST FINALITY OF ARBITRATION AWARDS By Stephanie A. Jones VALUATION OF PUBLICLY TRADED COMPANIES IN AVOIDANCE ACTIONS By Matthew W. Levin IN LITIGATION TRENDS TM •••
Transcript
Summer 2009
Finding the Balance along the antitrust WaterFront
A Conversation with Randall L. Allen and Debra D. Bernstein
eleventh circuit vacates class certiFication order
By Kristine McAlister Brown and Kimberly L. Fogarty
Mark-to-Market accounting in the crosshairs again
By Darren L. McCarty
caliFornia courts resist Finality oF arBitration aWards
By Stephanie A. Jones
valuation oF PuBlicly traded coMPanies in avoidance actions
By Matthew W. Levin
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• • •
Few attorneys are ever granted the privilege of arguing before the United States Supreme Court. Alston & Bird’s own Randall Allen will have that opportunity this fall. We are all proud of Randall’s achievement. You will find Randall’s comments about his upcoming Supreme Court argument and other antitrust issues of interest in his interview by Debra Bernstein in this edition of Trends.
Our other featured articles are also well worth reading. Kristy Brown and Kim Fogarty first highlight a recent important decision by the United States Court of Appeals for the Eleventh Circuit denying class certification in a matter where Alston & Bird represented the defendant. This opinion will have wide-sweeping implications for all class actions litigated in this Circuit. We next feature an article by Darren McCarty that analyzes the re-emergence of mark-to-market accounting issues in litigation. Stephanie Jones then looks at the California Supreme Court’s view on the finality of arbitration awards. Finally, Matthew Levin examines recent decisions concerning the valuation of publicly traded companies in bankruptcy avoidance actions.
We hope you enjoy Trends and, as always, we value your comments.
Finding the Balance along the antitrust WaterFront
A Conversation with Randall L. Allen and Debra D. Bernstein
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Randall Allen was first drawn to antitrust issues in law school when he argued a problem that centered on the NFL’s draft rules as a member of the Moot Court Board. Since joining A&B’s antitrust practice in 1986, his attraction to antitrust law has continued to grow. Why? He says it’s because it is intellectually challenging, critically important to clients and affords him the opportunity to contribute to his clients’ business-planning issues. In practice, this boils down to a fine balance between the adversarial, competitive elements of litigation and the cooperative, consensus-focused elements of helping clients accomplish their business goals. Both are interesting and exciting. Antitrust litigator Debra Bernstein recently sat down with Randall to discuss how he leads the firm’s antitrust lawyers in finding the right balance.
Debra Bernstein:
You chair the firm’s Antitrust Group. Can you give some examples of the work the group is doing?
Randall Allen:
It’s a full-service antitrust practice. We provide advice to clients on an array of legal and business issues to help them achieve their business goals and comply with antitrust laws. We also help clients with transactional matters — evaluating whether a merger is a smart business tactic or whether it may run into scrutiny by state, federal or international antitrust enforcement authorities. And, we litigate civil and criminal antitrust cases from monopolization to price-fixing. We literally cover the whole waterfront.
Debra:Tell me about some of the group’s recent civil litigation cases.
Randall:
We have 37 lawyers across the country, from Los Angeles to New York, engaged in civil antitrust litigation, and we currently have appeals pending in multiple federal Circuit Courts of Appeal.
Recently, we represented a chemical manufacturer in an interesting case in Georgia that highlights the intersection of intellectual property and antitrust law. The plaintiff was essentially seeking to enjoin our client from enforcing its patent rights, alleging that lawful monopolies in the context of the patent were obtaining unlawful business objectives. Happily, we won that case with a very favorable order from the District Court. We’ve litigated similar cases in other industries.
For many of our clients, the Robinson-Patman Act and price discrimination rules present unique challenges. In one case in Boise, Idaho, a distributor claimed that our client had discriminated in price. We defeated that claim, and recently had that victory affirmed on appeal by the Ninth Circuit. We even received a significant award of attorney’s fees on behalf of our client. The case raised some unique issues and we developed equally unique defenses. Robinson-Patman or price discrimination issues are frequently recurring areas of concern for our clients and we work with a large number of companies developing pricing strategies. It’s a thorny legal area.
We also recently defeated a Sherman Act claim alleging monopolization in the credit reporting arena. After winning a dismissal of the action, our antitrust team successfully defended the victory in the Sixth Circuit.
Debra:
You mentioned a number of victories in the federal Courts of Appeal within the last year. Can you tell me about some of the recent appellate litigation the Antitrust Group has handled?
Randall:
Actually, the Antitrust Group handled three matters in the Ninth Circuit, and one each in the Sixth and Eleventh Circuits within the last year, and we were successful in all of those appeals. We are also lead counsel in a case on appeal before the United States Supreme Court on an important civil procedure issue. The Supreme Court granted certiorari on a question regarding the scope of appellate jurisdiction and the matter will be argued to the Court in October.
•••We have 30 lawyers
across the country, from Los Angeles to New York, engaged in civil antitrust
litigation, and we currently have appeals pending in multiple federal Circuit
Courts of Appeal.
•••
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Debra:
I understand you’ve wrestled with the U.S. Department of Justice on some merger investigations.
Randall:
Despite the conventional wisdom in the business press, the previous administration had been active in investigating mergers in recent years in a variety of industries, and we worked on a number of those. In one interesting example, we represented the second largest North American home entertainment specialty retailer in its acquisition of Hollywood Entertainment. When Blockbuster, the largest video rental retail operation at the time, initiated a hostile takeover of Hollywood Entertainment, we negotiated with the Department of Justice to assist our client in consummating its transaction by navigating the antitrust regulatory authorities while defeating Blockbuster’s effort. That was a great success.
More recently, we worked on a merger for Graphic Packaging, which makes boxboard paper used in packaging in a variety of applications like cereal boxes, food packaging and carriers for canned and bottled drinks. Last year, they acquired a competitor following a six-month investigation by the Department of Justice. An informal investigation was followed by an onerous second request process. We responded to the second request in about 60 days, an extraordinary team effort of both in-house counsel and A&B lawyers. We’ve also recently worked on mergers with clients in the mining, construction aggregates, clothing, retail and banking industries.
Debra:
Antitrust litigation and government investigations can be expensive. How do you keep costs down for clients?
Randall:
The first way to keep costs down is to create an open line of communication with the client. I think lawyers go wrong when they disassociate themselves from the client and begin to run things without proper coordination and consultation. The client is tuned in to the cost, has great and well-informed ideas about how to get things done, and frequently has staff that will do a great job.
•••The first way to keep costs down is to create an open line of communication
with the client.
•••
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A lot of costs go to document discovery, and there are many mechanisms to keep these costs down. We design management mechanisms to share the workload with the client where that is an option, using the clients’ in-house expertise when possible to help accomplish the goal and solve problems. In cases where the client does not have existing resources to manage a document production, we have an appropriate team of lawyers and non-lawyers to run the production in a cost-effective manner.
Debra:
How do you help clients avoid litigation and prevent problems?
Randall:
We work with clients at the planning stages of a new business strategy, whether starting a new marketing campaign, terminating a distributor, contemplating the acquisition of a competitor or establishing a new relationship with a competitor. We provide event-specific counseling on how to accomplish their business objectives in a way that not only reduces liability, but also avoids the appearance of impropriety that, frankly, attracts the plaintiff ’s bar. There’s nothing more frustrating to clients than to be involved in expensive lawsuits when there is nothing inappropriate about the transaction, activity or marketing campaign.
Compliance training is another approach. We help clients design and implement antitrust compliance programs to raise awareness of antitrust pitfalls, and identify areas where employees ought to be especially careful, whether it’s pricing or territorial distribution issues. It’s the prophylactic approach to avoiding litigation and potential criminal penalties.
Debra:
What hot antitrust issues should companies be paying attention to?
Randall:
I’d highlight three things: First is the intersection of intellectual property law and antitrust law, as we discussed earlier. Clients must be able to go to market with their intellectual property without raising the antitrust specter.
•••Clients must be able to go to market with their intellectual property without raising the antitrust specter.
•••
6
Second is the globalization of antitrust enforcement, which is now very much on the horizon. The EU is pursuing enforcement in a gangbuster fashion. And in China, South America and Latin America, antitrust and competition enforcement is on the rise.
The last thing is simple. There are basic antitrust rules that every company needs to remember: never take your eye off of the basic compliance issues, make sure your employees understand those issues and be sure they understand what’s expected of them.
Debra:
What’s the most interesting antitrust case you’ve worked on?
Randall:
The recent IP-antitrust litigation in Georgia that I mentioned earlier was a fascinating case. We represented a chemical manufacturer patent holder accused of improperly utilizing its patent in the sale of its product. The client had an interesting business model that was important to the litigation. We tried the case in a preliminary injunction proceeding that lasted about seven days and had a little bit of everything you could imagine — including a successful Daubert motion filed by our team. And, maybe not a big surprise, but lawyers usually do consider the most interesting cases to be the ones we win, so that was nice!
Debra:
What take-away lessons at the intersection of IP and antitrust would you pass on?
Randall:
There are two, one from each side. From the IP side, it’s important for companies that accumulate intellectual property in a particular arena to realize that, even though they do everything right and dot all the Is and cross all the Ts, other parties are going to want the things they’ve purchased, so they’ll become a target for litigation. Fortunately, there are steps companies can take to protect against possible litigation or to ensure success if litigation is unavoidable. This problem won’t go away, so be prepared if it comes.
•••The globalization
of antitrust enforcement... is now very much on the horizon.
•••
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On the antitrust side, there’s a tendency for plaintiffs to employ a simplistic view of the intersection of patent technology and the antitrust markets. But it’s wise to consider the basic antitrust market principles beforehand. If a company assumes a narrow market definition to help its litigation, but it doesn’t make sense in the real world or from an antitrust market definition principle, it doesn’t get you anywhere.
Debra:
What changes in antitrust policies and enforcement do you foresee under the Obama administration?
Randall:
There is little doubt that the Obama administration will bring its theme of “change” to antitrust enforcement. President Obama has been critical of the Bush administration for being lax in antitrust enforcement and promised greater enforcement energy, particularly with regard to mergers and healthcare. The President’s antitrust agency appointments seem to be serious about that change. The new head of the Department of Justice Antitrust Division recently announced her new and more aggressive enforcement agenda. She seems to be particularly, but not exclusively, focused on the activities of large companies. We have been assisting a number of our clients in understanding how the new enforcement approach may impact their respective industries.
Debra:
What advice would you give a young lawyer who is interested in getting into antitrust law?
Randall:
Have a sound understanding of the business community — spreadsheets, the ebb and flow of business economics. Most cases boil down to economic motivation and economic impacts, so a solid business understanding is helpful in antitrust law.
Debra:
I know you have a long, strong commitment to community service. Tell us about some of those activities.
•••The Obama
administration will bring its theme of “change” to antitrust enforcement.
•••
8
Randall:
I have been very involved with the Atlanta Ronald McDonald House Charities. My wife was a pediatric hematology oncology nurse and introduced me to them years ago. I’ve been involved for over 15 years and just finished a two-year term as Chairman of the Board of Directors. We just completed the construction of a $15 million 50-room facility near Egleston Hospital in Atlanta. Now we’re in the early planning stages of an expansion of our facility near Children’s Healthcare at Scottish Rite. Our mission is to provide a home away from home for children and their families when they’re undergoing medical treatment at Atlanta area hospitals. It’s very rewarding.
I’m also honored to be on the Georgia State University College of Law Board of Visitors. As an alumnus, I’ve very much enjoyed watching the institution grow and succeed.
eleventh circuit vacates class certiFication order
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On April 7, 2009, the United States Court of Appeals for the Eleventh Circuit issued a significant class certification decision in the case of Vega v. T-Mobile, vacating the District Court’s grant of class certification and ordering that the plaintiff ’s claims proceed on an individual basis. See Vega v. T-Mobile USA, Inc.1 The Court’s opinion emphasizes the rigorous analysis that District Courts must apply when deciding class certification, as well as the named plaintiff ’s burden of establishing that class certification is appropriate under Rule 23. The Vega decision is required reading for any defendant opposing class certification. Alston & Bird represented T-Mobile in the appeal.
Background
In 2005, Plaintiff Henry Vega brought a putative class action against T-Mobile, asserting claims for “unpaid wages” and unjust enrichment. Vega alleged that T-Mobile improperly “charged back” commissions it advanced retail sales representatives for the sale of prepaid wireless service plans when the plans deactivated within a certain charge-back period. Vega sought to represent a nationwide class consisting of all former T-Mobile employees whose commissions for prepaid service were charged back or, in the alternative, a Florida-only class.
Despite Rule 23’s admonishment that class certification should be decided “at an early practicable time,”2 Vega did not file his motion for class certification until after the close of all discovery, more than one year after filing the complaint. Vega’s motion for class certification remained pending for more than five months and, during that time period, T-Mobile filed a motion for summary judgment. Just six days before the case was scheduled to go to trial, the District Court issued a single order that certified Vega’s proposed Florida class and denied T-Mobile’s motion for summary judgment. The District Court engaged in only a cursory analysis of Rule 23’s requirements, skipping some requirements entirely and misapplying others.
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T-Mobile filed a petition for interlocutory review of the class certification decision under Federal Rule of Civil Procedure 23(f), and the Eleventh Circuit granted that petition on August 22, 2007.
Significant Aspects of the Eleventh Circuit’s Decision
• Every Rule 23 Requirement Must Be Established And Supported by Evidence. In its decision, the Eleventh Circuit took the opportunity to remind named plaintiffs and District Courts alike of their responsibilities under Rule 23. The named plaintiff bears the burden of establishing every element of Rule 23, and the District Court’s factual findings “must find support in the evidence before it.”3 Even numerosity — described by the Eleventh Circuit as a “generally low hurdle” to class certification — cannot be assumed.4 In Vega, the District Court found that the named plaintiff had established numerosity even though he did not come forward with any evidence as to the number of T-Mobile retail sales representatives employed in Florida during the class period. The Eleventh Circuit noted that “T-Mobile is a large company, with may retail outlets, and, as such, it might be tempting to assume” that numerosity is satisfied.5 Nevertheless, the Eleventh Circuit held that the District Court abused its discretion by finding that Vega had established numerosity, explaining that “the [D]istrict [C]ourt’s inference of numerosity for a Florida-only class without the aid of a shred of Florida-only evidence was an exercise in sheer speculation.”6
• Consideration of the Merits is Appropriate To Determine Whether Rule 23’s Requirements are Satisfied. It is well-established that a District Court should not determine the merits of a named plaintiff ’s claims at the class certification stage. The Vega decision makes it clear, however, that courts can and should conduct an in-depth analysis of the merits to the extent necessary to determine class certification.7 For example, in considering whether Vega had established commonality and predominance with respect to his “unpaid wages” claim, the Eleventh Circuit analyzed (i) whether Florida law recognizes an independent cause of action for “unpaid wages;” (ii) the elements of a breach of contract claim under Florida law; and (iii) whether T-Mobile’s compensation program gave rise to enforceable contractual rights under
•••The Vega decision makes it clear... that courts can and should conduct an in-depth
analysis of the merits to the extent necessary to
determine class certification.
•••
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Florida law. The Court did not end its substantive analysis there — it went on to consider the “substantial individualized evidence” required to prove the claims of absent class members, as well as the “individualized and varying evidence” relevant to T-Mobile’s defense. After analyzing all of these issues, the Eleventh Circuit concluded that individualized issues would inevitably subsume any common ones, and Vega had not established predominance.8
• To Establish Superiority, Plaintiffs May Be Required to Submit Trial Plans. The Eleventh Circuit held that a District Court must give “meaningful consideration” to how a case would be tried when determining whether Rule 23(b)(3)’s superiority requirement is satisfied. It is not enough to con-clude in conclusory fashion that the class action mechanism is superior.9 In analyzing superiority, the Eleventh Circuit criticized Vega for failing to propose a trial plan that feasibly set forth how his claims could be tried on a class-wide basis. The Eleventh Circuit noted that submission of a trial plan is not a prerequisite to a finding of superiority in every case.10 Nevertheless, the Eleventh Circuit “recommend[ed] that [D]istrict [C]ourts make it a usual practice to direct plaintiffs to present feasible trial plans, which should include proposed jury instructions, as early as practicable when seeking class certifica-tion.”11 This language paves the way for defendants to request trial plans from plaintiffs in connection with class certification briefing — or even as a part of the Rule 26(f) conference.
• Class Certification Should be Decided Early. The Eleventh Circuit emphasized that Rule 23 “demands an early consideration of class certification, including its practical implications for case manageability.”12 The Vega decision provides defendants with a basis for arguing that class certification briefing should take place before the close of merits discovery.
The Vega decision is more than just a helpful case for defendants to cite in their oppositions to class certification. It is a case that stands to affect case management issues in all class actions, providing defendants with support for arguing that (i) discovery should be staged, focusing first on class certification issues; (ii) named plaintiffs should be required to move for class certification early, rather than after the close of discovery; and (iii) named plaintiffs should be required to provide a feasible trial plan, rather than
•••The Vega decision is more
than just a helpful case for defendants to cite in their oppositions to class
certification.
•••
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simply assuring the District Court that a class action would be manageable.
Kristy McAlister Brown is a partner in the firm’s Litigation and Trial Practice Group. She focuses her practice on complex commercial litigation, with a particular emphasis on defending class actions. Ms. Brown has defended class actions in 17 states and has obtained dismissal of more than 13 putative class actions at the motion to dismiss stage. She has also defeated class certification in plaintiff-friendly jurisdictions like Alabama and Florida and has successfully handled several class action appeals. Ms. Brown represented T-Mobile in the Vega appeal discussed in this article.
Kim Fogarty is a member of the firm’s Labor and Employment Group. She represents management in all aspects of employment law and concentrates her practice on employment litigation and counseling. She received her J.D. in 2004 from the University of Virginia School of Law and her B.S. in political science and economics from Vanderbilt University in 2001.
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Mark-to-Market accounting in the crosshairs again
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With the fall of Enron, “mark-to-market accounting” became an unlikely household phrase. Along with other suspect practices, Enron investigators quickly focused on the internal models used by Enron’s management to mark-to-market the current value of Enron’s long-term energy contracts. Because these contracts had no active market, Enron used “management’s best estimate considering various factors.”1 Unfortunately, the world soon discovered that “[t]he assumptions underlying these models were, in the best case, necessarily subjective and, in the worst, subject to deliberate manipulation.”2 Enron’s mark-to-market failures cost investors and others enormous sums.
Despite the costs associated with Enron’s use or misuse of mark-to-market accounting, in 2007 the setters of accounting standards affirmed the application of fair value accounting with FAS 157. The Financial Accounting Standards Board (FASB) intended FAS 157 to bring additional consistency and comparability across the various accounting standards requiring the application of fair-value measurements, of which mark-to-market accounting is a form. Whether FASB got it right is subject to significant debate. Yet there is no question about the significance of fair-value accounting in the current market. According to a recent study by the Securities and Exchange Commission, 45% of all assets at financial institutions were recorded under fair-value accounting measures as of first quarter-end 2008.3
Because of its significance, many blame mark-to-market accounting for figuring prominently in the stress and failure of financial institutions in 2008 and 2009. When the markets for mortgage-backed securities and similarly situated instruments froze in 2008, the once vibrant market that provided easily observable transactions for valuations quickly became opaque. Transactions that did occur were sometimes at fire-sale prices to provide liquidity at weaker institutions, affecting values across the board. Safeguards in FAS 157 meant to ensure that valuations reflected orderly market transactions were likely less effective as fire-sale transactions multiplied. After all, who was to say what a normal transaction
Trend
Darren L. McCarty, PartnerLitigation & Trial Practice
•••[Some contend that] while mark-to-market accounting might be doing what was
intended—reporting current values for assets
and liabilities— it might not fully account for long-term prospects.
•••
was—or, as FAS 157 puts it, “an orderly transaction between market participants”—in the face of continuing distress in the market for those instruments? Not surprisingly, FASB began looking at ways to improve fair-value accounting again in 2008 with the release of additional proposals.
Congress noticed the importance of mark-to-market rules and put additional pressure on FASB. The House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises held a hearing in March 2009 to discuss proposed changes. At least partly in response to government pressure, FASB announced additional changes to fair-value accounting on April 2, 2009. These changes were applied in some cases even to first quarter 2009 reporting. The new guidance heavily emphasized that values should be based upon orderly transactions, even if there was an absence of an active market. The modifications will no doubt relieve some ailing balance sheets, particularly in the financial sector. Nevertheless, many expect that it will force even more difficult judgments upon management.
Despite these herculean efforts from both public and private oversight boards, shareholder litigation was a constant companion of troubled financial institutions in 2008, and continues to be in 2009. Accountants took a harder look at valuation models and advocated reductions in value for instruments in illiquid markets.4 Corporate management, attempting to explain sharp reductions in fair value, offered opinions that, over the long term, mark-to-market devaluations would reverse on instruments intended to be held to maturity.5 In other words, they emphasized their belief that, while mark-to-market accounting might be doing what was intended—reporting current values for assets and liabilities—it might not fully account for long-term prospects. Nevertheless, as the market continued to decline and more institutions saw steep drops in stock value or faced insolvency, shareholder class-action complaints grew. Plaintiffs’ lawyers made it clear last year that substantially more litigation should be expected.
Mark-to-market accounting’s role in these complaints was illustrated in a December 2008 complaint against Ambac Financial Group. Plaintiffs alleged that Ambac failed “to mark its . . . exposure in a manner reflecting the actual performance and declining market value of those securities. Ambac’s ‘proprietary model’ produced values divorced from the prevailing market indices . . . .”6
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Complaints filed in the wake of financial sector troubles also turned management’s own words against them. In a case filed against Lehman Brothers, plaintiffs claimed that even management’s own concerns about mark-to-market valuations misled investors. Plaintiffs alleged that Lehman Brothers’ Chief Financial Officer made materially false and misleading statements merely by saying: “[A]lthough many of these assets don’t appear to be trading at their fundamental values, we have marked our book to the actual prices being transacted in the market. Fair value means marking to levels at which the assets will trade, not where we think they should trade.”7 Whether recorded or found in off-the-cuff remarks, mark-to-market measurements have themselves become toxic issues for the financial sector.
Mark-to-market accounting is fertile ground for a spate of new lawsuits. Much like accounting for contingencies, which has been a frequent topic of litigation, mark-to-market accounting, absent a highly active, liquid market, will always demand professional judgment in developing models, determining appropriate market proxies and the like. Hindsight is 20/20 and experts will be called upon to determine after the fact whether judgments made under fire were appropriate.
When unusual markets—like today’s—fundamentally alter the landscape, avoiding litigation over mark-to-market accounting will be nearly impossible for many market participants. The jolting reverberations of Enron’s mark-to-market accounting failures may only have foreshadowed a protracted struggle over the contours of mark-to-market valuations that will be played out in courts across the country for years to come.
Endnotes1 Staff of S. Comm. on Governmental Affairs, 107th Cong., Financial Oversight
of Enron: The SEC and Private Sector Watchdogs 35 (Comm. Print 2002), available at http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=107_cong_senate_committee_prints&docid=f:82147.pdf.
2 Id. at 43.
3 Office of the Chief Accountant, Div. of Corp. Fin., SEC, Report and Recom-mendations Pursuant to Section 133 of the Emergency Economic Stabilization Act of 2008: Study on Mark-to-Market Accounting 46 (2008), available at http://sec.gov/news/studies/2008/marktomarket123008.pdf.
4 “The Credit Crunch: Mark It and Weep,” Economist, Mar. 8, 2008, at 58.
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AbouT The AuThor
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Darren McCarty is a partner practicing in both the firm’s Litigation and Trial Practice Group and Securities Litigation Group. He is located in the Dallas office. Darren focuses on complex financial and securities disputes. He is a graduate of the University of Texas and the William and Mary School of Law. He served as a judicial clerk to the Honorable Karen J. Williams, United States Court of Appeals for the Fourth Circuit, after graduating from law school. Prior to beginning his legal career, Darren practiced as a CPA in Texas.
5 See, e.g., Complaint at ¶ 184, Tolin v. Ambac Fin. Group, Inc., No. 08 CIV 11241 (S.D.N.Y. Dec. 24, 2008).
6 Id. at ¶ 202.
7 Amended Class Action Complaint at ¶ 373, Operative Plasterers & Cement Masons Int’l Ass’n Local 262 Annuity Fund v. Lehman Brothers Holdings, Inc. (In re Lehman Bros. Equity/Debt Sec. Litig.), No. 1:09-md-02017-LAK (S.D.N.Y. Oct. 27, 2008).
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caliFornia courts resist Finality oF arBitration aWards
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Parties to construction contracts frequently include provisions in their contracts that require all disputes that arise under the contract to be submitted to binding arbitration. This enables the parties to bypass time-consuming and costly judicial adjudication of disputes, and participate in the selection of the person who will resolve the dispute—usually an expert in the relevant subject area. Traditionally, arbitration awards have only been subject to review by the courts based on the limited standards set forth in the Federal Arbitration Act or applicable state arbitration acts, and have not been subject to review for legal error.
Under both the Federal Arbitration Act and California’s state law counterpart, the California Arbitration Act, courts are only permitted to vacate an arbitration award in the following circumstances: the award (1) was procured by corruption, fraud or undue means; (2) was issued by corrupt arbitrators; (3) was affected by prejudicial misconduct on the part of the arbitrators; or (4) was in excess of the arbitrator’s powers. Losing parties frequently file motions to challenge the arbitrator’s decision in the trial court, arguing that the arbitrator exceeded the scope of his or her authority by incorrectly applying the law to the dispute. Although the courts permit the losing party to brief the issues and seek a hearing, these challenges invariably fail and the courts routinely enter orders confirming arbitrators’ decisions in the face of these challenges.
While parties have sometimes sought to preserve their right to judicial review by including provisions in their contracts that purport to provide for this right, these provisions have time after time been held unenforceable. This approach has effectively precluded any real review on the merits, and resulted in rubber stamping the arbitration award by the court, even if clear errors of law have been made in the award.
However, in Cable Connection, Inc. v. DIRECTV, Inc., 190 P.3d 586 (Cal. 2008)*, the California Supreme Court changed the landscape
* Alston & Bird continues to represent DIRECTV, Inc. in connection with this matter.
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regarding the finality of arbitration awards where California law applies to the dispute, holding that arbitration awards are judicially reviewable for errors of law made by the arbitrator in rendering the award. Under the holding of Cable Connection, judicial review is now available as long as the parties include in their contracts arbitration provisions that evidence a “clear agreement” that “legal errors are in excess of arbitral authority.”
In Cable Connection, the arbitration provision at issue provided that, “[t]he arbitrators shall not have the power to commit errors of law or legal reasoning, and the award may be vacated or corrected on appeal to a court of competent jurisdiction for any such error.” In determining that the provision was enforceable, the Court held that (1) the California Arbitration Act does not preclude such provisions and (2) the Federal Arbitration Act does not preempt the California Arbitration Act. As a result, the provision was held sufficiently clear as evidence of an agreement to subject the award to judicial review for legal error.
In reaching its decision, the Court acknowledged that criticism exists of increasingly “judicialized” arbitrations that have many of the attributes of court proceedings. Mindful of this criticism, the Cable Connection Court noted that the judicial system is not served by disregarding the parties’ clear agreement and forcing them to choose between the risk of a legally incorrect arbitration award and the burden of litigating their dispute entirely in the judicial system. As a result, the Court reasoned that “[i]ncorporating traditional judicial review by express agreement preserves the utility of arbitration as a way to obtain expert factual determinations without delay, while allowing the parties to protect themselves from perhaps the weakest aspect of the arbitral process—its handling of disputed rules of law.”
As a result of Cable Connection, if parties provide for legal review in their contract, they will now have an opportunity to obtain substantive review by the courts to determine whether the arbitrator correctly applied the law. Moreover, the availability of judicial review of legal issues should prompt arbitrators to be more careful and circumspect in their awards, since parties are not likely to continue to engage arbitrators who have awards frequently overturned for errors of law.
On the other hand, parties to smaller contracts with limited damages exposure should be wary of including provisions for judicial review
•••Under the holding of Cable Connection, judicial review is now available as long as the parties include in their contracts arbitration
provisions that evidence a “clear agreement” that “legal errors are in excess
of arbitral authority.”
•••
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of errors of law in their contracts. Judicial review, while valuable in high stakes cases, will still significantly increase the costs, expense and delay in final resolution of the dispute. Finally, it should be noted that, for cases that are governed by the Federal Arbitration Act, contractual provisions that provide for judicial review of errors of law are unenforceable. Absent a change in federal law, courts will continue to rubber stamp these arbitration awards just as they have in the past.
AbouT The AuThor
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Stephanie Jones is a partner in the Construction & Government Contracts Group in the firm’s Los Angeles office. She also maintains a substantial Products Liability practice. She is a graduate of the University of California and the University of San Diego Law School.
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Trend
valuation oF PuBlicly traded coMPanies in avoidance actions
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In the wake of the current economic crisis, many highly leveraged companies have stumbled into Bankruptcy Court, and there are undoubtedly more shoes to drop. As a consequence of these filings, there will surely be an increase in avoidance action claims brought by debtors, such as preferences and fraudulent transfer actions. In that context, it is useful to consider recent developments in the valuation arena.
A preference occurs when a debtor makes a payment to a creditor on a preexisting debt during the 90-day period preceding the bankruptcy filing, at a time when the debtor was insolvent. Insolvency is presumed to exist during that 90-day period, but it is a rebuttable presumption. A fraudulent transfer occurs when a debtor transfers property to another party without receiving reasonably equivalent value in exchange for such transfer, at a time that the debtor was either insolvent or rendered insolvent by the transfer.
Accordingly, in any preference or fraudulent transfer action, the solvency of, and hence, the proper method to value, the debtor both before and after the transaction is a key issue. In a fraudulent transfer case against Motorola, Inc. arising out of the Iridium Chapter 11 case, the Bankruptcy Court for the Southern District of New York adopted a market-based approach to determining solvency with regard to publicly traded debtors, finding “insufficient cause to set aside the verdict of solvency and capital adequacy already given to Iridium by the public markets.”1 In its opinion, the Bankruptcy Court adopted the Third Circuit’s approach in VFB LLC v. Campbell Soup Co.,2 which “validates the use of market data for purposes of valuing a public company for fraudulent transfer purposes and makes clear that the public markets constitute a better guide to fair value than the opinion of hired litigation experts whose valuation work is performed after the fact and from an advocate’s point of view.”3
The background of the Iridium case is illuminating. The genesis of the dispute occurred years prior to the bankruptcy case, when Motorola spun Iridium off in a series of private placements taking place over a couple of years. Iridium took on a large amount of
debt to fund the spinoff. Motorola then contracted with Iridium to develop a global telecommunications network, using satellites and other technology to provide a system that was capable, in theory, of operating worldwide. Suffice to say, the system did not work as designed (the Bankruptcy Court referred to it as a “spectacular” failure), and Iridium was forced to file for bankruptcy relief shortly after the system launched. Ultimately, Iridium’s assets were sold for a small fraction of their cost. The Official Creditors’ Committee filed a lawsuit against Motorola and one of the causes of action was that $3.7 billion of payments made to Motorola under pre-petition spinoff agreements and other agreements were received at a time when Iridium was insolvent or had unreasonably small capital and, thus, were recoverable as fraudulent transfers.
In addressing the solvency issue in the case, the Bankruptcy Court noted that the spinoff-related offering documents contained detailed and accurate descriptions of Iridium’s projected performance and risks. Turning to the two-year period prior to the bankruptcy filing, the Bankruptcy Court noted that Iridium conducted two successful public equity offerings and three successful public debt offerings. During that time period, Iridium’s stock price ranged from $17 to more than $70 per share, implying a market capitalization of between $2.3 and $10 billion, and its bonds generally traded at or near par. In light of these facts, the Bankruptcy Court found that Iridium was solvent during the relevant time periods. The Bankruptcy Court essentially held that, in the absence of a compelling reason to ignore the public market valuation of Iridium, it would accept that valuation as reasonably accurate. In making its ruling, the Bankruptcy Court adopted the Third Circuit’s approach to valuing public companies in a fraudulent transfer case, holding that the public markets are the best indicator of value.4 The Bankruptcy Court held that
[a]ny reader of The Wall Street Journal knows that the markets are risky and unpredictable and that share prices frequently are influenced by a variety of factors unrelated to the fundamentals and potential of a particular company. Nonetheless, the public trading market constitutes an impartial gauge of investor confidence and remains the best and most unbiased measure of fair market value and, when available to the Court, is the preferred standard of valuation.5
•••The Bankruptcy Court
adopted the Third Circuit’s approach to valuing public companies in a fraudulent transfer case, holding that the public markets are the best indicator of value.
•••
22
Another interesting aspect of the Bankruptcy Court’s opinion is its dismissal of expert valuation testimony presented by the Creditors’ Committee to show that Iridium was insolvent during the relevant time period. The Committee advocated disregarding market data entirely, and asked the Bankruptcy Court instead to rely on expert valuations based on discounted cash flows and restated cash flow projections. The Bankruptcy Court did not agree. The Bankruptcy Court was especially concerned with the Committee’s experts’ failure to even address the market valuations, and to show why they were unreliable. The Bankruptcy Court concluded, essentially, that the Committee’s experts were hired guns, who had prepared their expert opinions tailored to the litigation result they were trying to achieve. For example, instead of relying upon the projections prepared by Iridium and various other parties at the time of the various transactions, the Committee’s experts constructed “bottom up” projections, and then utilized those projections in the discounted cash flow valuation. The Bankruptcy Court held that such “substitution of judgment” must be viewed with a fair amount of skepticism. The Bankruptcy Court also held that, in preparing projections to be used in the determination of value, courts will not accept hindsight. Experts must look at what was known at the time when the original projections and market analyses were prepared, not what was later learned. At the very least, expert opinions on value will be given less weight if they do not address and explain why contemporaneous market valuations should be disregarded.
In light of Iridium and VFB v. Campbell Soup, courts in the two most common venues for large Chapter 11 cases — the Southern District of New York and Delaware (which is in the Third Circuit) — have adopted a rule favoring market evidence over expert testimony in evaluating whether a publicly traded debtor was insolvent for purposes of avoidance actions. It seems that one of the few ways such market evidence can be rebutted is if a plaintiff can demonstrate that the market failed to take into account relevant information because of, for example, financial fraud. Theoretically, it may also be possible to discount the public market valuation if the stock in question was too thinly traded to be a reliable indicator of value. Of course, these decisions may have little impact in cases involving privately held companies, where neither the stock nor the debt was publicly traded.
•••[In Iridium,
the Bankruptcy Court] held that in preparing
projections to be used in the determination of value, courts will not
accept hindsight.
•••
23
Endnotes1 Statutory Committee of Unsecured Creditors v. Motorola, Inc. (In re Iridium
4 “Absent some reason to distrust it, the market price is ‘a more reliable measure of the stock’s value than the subjective estimates of one or two expert wit-nesses.’” VFB v. Campbell Soup, 482 F.3d at 633.
5 Iridium, 373 B.R. at 293.
AbouT The AuThor
l l l
Matthew Levin, a partner in the firm’s Atlanta office, focuses his practice on corporate restructurings, bankruptcy litigation and nonsubstantive consolidation opinions and true sale opinions for securitizations. Mr. Levin’s expertise has been most notable in the area of debtor representations, assisting entities in a number of different industries in navigating their way through the Chapter 11 process. Mr. Levin is featured as one of the leading Georgia lawyers for bankruptcy practice in Chambers USA: America’s Leading Lawyers for Business. He is a member of the American Bankruptcy Institute, and the Bankruptcy Sections of both the Atlanta Bar Association and the State Bar of Georgia. Mr. Levin has also spoken and written on a variety of bankruptcy issues both in Georgia and nationally.
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