Meuse, et al. v. Henry, et al., Virginia Supreme Court, No. 170604 (4 October 2018)
Arbitration; judicial review of arbitration; confirmation of arbitration award
Charles Dickens had a talent for naming characters with names suggesting the character’s personality. Recall, for example, in A Tale of Two Cities, the character Jerry Cruncher, an odd-job man, messenger, porter, occasional grave robber, and a brawny fellow who, for sufficient compensation, would crunch people. If Dickens had written the story of this case, he might have named a central character Mr. Bogle. Indeed, in the real case there was a Mr. Bogle, who had two daughters, Nancy Bogle Fife and Jacqueline Bogle Meuse. As sometimes happens in families, even those not created by Dickens, the Bogle sisters intensely disliked each other, and eventually their animosity found its way to court.
The relevant facts are not simple. In 1980, Mr. Bogle founded Bogle Industries, Inc. (“BII”). BII controlled two limited liability companies, King Street Metro Venture, LLC (“King Street”) and 4601 Eisenhower, LLC (“4601 Eisenhower”). Each company owned commercial property in Alexandria, Virginia.
By 1991, Mr. Bogle’s finances were in a parlous state, and he filed for personal bankruptcy. Pursuant to his bankruptcy plan, Mr. Bogle created the Bogle Trust (the “Trust”) and transferred BII’s preferred voting stock to the Trust. The Trust’s beneficiaries were Mr. Bogle’s creditors, who had a 65% interest in the Trust, and a designee whom Mr. Bogle would appoint to distribute the remaining 35% interest. A lawyer named Bruce Henry represented both BII and the trustee of the Trust.
In 2003, a large loan secured by the 4601 Eisenhower property came due. Faced with a potential foreclosure, Henry and the trustee pursued refinancing. As a condition of refinancing, the lender demanded a personal guaranty from someone outside the Bogle family and the removal anyone in the Bogle family from control of the borrower. A commercial mortgage broker who helped obtain refinancing proposed that Henry be the guarantor. Initially, Henry refused, but later agreed to guarantee the loan after the lender refused to drop the guarantor requirement. Henry’s law firm represented 4601 Eisenhower in the refinancing transaction.
To satisfy the condition that members of the Bogle family be removed from control of the borrower, Bogle resigned as president of BII. Henry became the manager of both 4601 Eisenhower and King Street. Bogle also created a new entity called Alexandria Investments, LLC (“AI”). Bogle created AI as a vehicle to make a gift to his daughters. He exercised his power of appointment under the Trust and designated AI as the beneficiary of the Trust’s remaining 35% interest in BII’s preferred voting stock. He then executed a deed of gift granting Meuse and Fife each 50% of his membership in AI. However, Bogle did not want his daughters to control AI, and for that reason he appointed Henry to manage AI.
There were two important provisions in AI’s operating agreement. One provision stated that Henry, as the manager of AI, could not be removed except for willful misconduct or knowing violation of the criminal law. The other provision provided for the expulsion from AI of any member who challenged the exercise of the manager’s (Henry’s) powers or the validity of any provision of the operating agreement, unless the member prevailed on the merits of an action seeking solely to remove the manager for cause. These were poison pills that Mr. Bogle included in the operating agreement to deter his two quarreling daughters from trying to gain control of AI and from attacking each other by challenging Henry’s decisions as manager of AI.
Mr. Bogle died in 2012. In 2015, Meuse, individually and derivatively on behalf of the Bogle entities, sued Fife, Henry, Henry’s wife, Henry’s law firm and the trustee of the Bogle Trust, alleging various causes of action including conspiracy, conversion, legal malpractice, and breach of fiduciary duty.
AI’s operating agreement had an arbitration clause, and the dispute was arbitrated before a panel of three arbitrators. The arbitrators held an eight-day hearing and found for the defendants on all counts and awarded attorneys’ fees and costs to the defendants. The circuit court confirmed the arbitration award, and this appeal followed.
Virginia has an arbitration statute, Code of Virginia, Chapter 21, §§ 8.01-577 through 581.016. A circuit court’s review of an arbitration award is limited to the specific statutory criteria in the statute. Signal Corp. v. Keane Federal Systems, Inc., 265 Va. 38, 45 (2003). A circuit court’s denial of an application to vacate an arbitration award presents a question of statutory interpretation, which the Supreme Court reviews de novo. Chamberlain v. Marshall Auto & Truck Ctr., Inc., 293 Va. 238, 242 (2017). The party attacking an arbitration award bears the burden of proving the invalidity of the award. Bates v. McQueen, 270 Va. 95, 100 (2005).
The Arbitration Act, §8.01-581.010, provides that an arbitration award shall be vacated if the arbitrators exceed their powers. Meuse argued that the appointment and forfeiture provisions of AI’s operating agreement violated public policy because Henry failed to comply with Rule 1.8(a) of the Code of Professional Responsibility. Meuse asserted that Henry had a conflict of interest because he had previously represented Bogle in transactions involving BII, was the guarantor of the refinanced loan for 4601 Eisenhower, and was the manager of AI. Meuse argued that this conflict of interest violated public policy and for that reason the arbitrators exceeded their power by enforcing the contested provisions of AI’s operating agreement. Specifically, Meuse attacked the clause making it hard to remove Henry or to overrule his management decisions, and the forfeiture clause imposing the severe penalty forfeiture for an unsuccessful challenge to Henry’s position as manager.
The Court said that in determining whether the arbitrators exceeded their authority the issue is not whether the award is legally correct. A court decides only whether the arbitrators had the power to decide the parties’ claims. BBF, Inc. v. Alstom Power, Inc., 274 Va. 330 (2007). That is because Virginia Code §8.01-581.010 states that “[t]he fact that relief was such that it could not or would not be granted by a court of law or equity is not grounds for vacating or refusing to confirm the award.” Arbitrators derive their authority solely from the parties’ contractual agreement to arbitrate disputes arising under the contract. Trustees of Asbury United Methodist Church v. Taylor & Parrish, Inc., 249 Va. 144, 153 (1995). Furthermore, an allegation that the arbitrators have exceeded their powers must be carefully evaluated in order to assure that the claim is not used as a ruse to induce the court to review the merits of the arbitrators’ decision. Signal Corp. v. Keane Federal Systems, Inc., 265 Va. at 46. Noting that the words “manifest disregard of the law” were “[c]onspicuously missing” from Code §8.01-581.010, the Court refused to examine “whether the arbitrators’ conclusions were legally correct.” Id. at 45-46.
The Court said that the statute and related legal precedents does not displace the common law rule that “[i]f a contract violates public policy, it is void and of no legal effect.” Shuttlesworth Ruloff & Giordano, P.C. v. Nutter, 254 Va. 494, 497 (1997). “It is an undoubted principle of the common law that it will not lend its aid to enforce a contract to do an act that is illegal; or which is inconsistent with sound morals or public policy. Steele v. Drummond, 275 U.S. 199, 204 (1927). Therefore, an arbitration agreement that is voidable or void-ab-initio can be challenged under Code §8.01-581.01, just as any agreement without an arbitration clause could be judicially challenged on the same grounds.
Meuse contended that Henry violated Rule 1.8(a), which provides that a lawyer shall not enter into a business transaction with a client unless (i) the terms of the transaction are fair and reasonable to the client and are fully disclosed, (ii) the client is given a reasonable opportunity to seek the advice of independent counsel, and (iii) the client consents in writing thereto. The Court rejected Meuse’s argument.
The evidence showed that Bogle and AI had their own independent counsel, Zaccardelli, to advise them on the refinancing, the creation of AI, and the terms of AI’s operating agreement. Henry sent a letter to the trustee of the Bogle Trust explaining the terms under which he would participate in the transaction, including the designation of himself as manager of AI and the forfeiture provision discussed above. Zaccardelli testified that he carefully reviewed the letter with Bogle and that Bogle fully understood the refinancing transaction and agreed to execute the refinancing documents, including the operating agreement. Although there was no evidence that Bogle consented in writing, the Court held that the evidence was sufficient to prove compliance with Ethics Rule 1.8 and that the circuit court did not err in refusing to vacate the arbitration award.
The Court also upheld an award of attorneys’ fees to Fife. The award was not based on Fife’s status as a prevailing party. It was based on the arbitrators’ finding that Meuse commenced her action against Fife without reasonable cause. Virginia Code §13.1-1045 provides that a court may require the plaintiff to pay the defendant’s attorney’s fees if it finds that a derivative action was commenced without reasonable cause. Under Code §8.01-271.1, an attorney’s or party’s signature on a pleading certifies that “to the best of his knowledge and information and belief, formed after reasonable inquiry,” the pleading “is well grounded in fact” and “is not interposed for any improper purpose.” The temporal focus of both these statures is on the time an action is filed. A plaintiff cannot satisfy these statutes by filing an action with the expectation that discovery will uncover support for his claims. Thus, the Court refused to vacate the arbitrators’ award of attorneys’ fees.