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Kaplan v. First Options of Chicago

filed: March 31, 1994.


Appeal from the United States District Court for the Eastern District of Pennsylvania. (D.C. Civil Action No. 92-00210).

Present: Stapleton, Mansmann and Hutchinson, Circuit Judges.

Author: Hutchinson


HUTCHINSON, Circuit Judge.

Appellants Manuel Kaplan, Carol Kaplan ("Kaplans"), and M.K. Investments, Inc. ("MKI") appeal an order of the United States District Court for the Eastern District of Pennsylvania. It confirmed an arbitration award arbitrators appointed under the rules of the Philadelphia Stock Exchange ("the Exchange") had entered in favor of appellee First Options of Chicago, Inc. ("First Options").

The Kaplans argue that the arbitration panel lacked jurisdiction over them. First Options says that the Kaplans have waived any jurisdictional objections. Because they raised their objection to arbitral jurisdiction several times during the arbitration proceedings, we hold that the Kaplans have not waived it. We also reject First Options' alternate argument that an agreement MKI signed as part of a "workout" meant to settle a dispute arising out of Mr. Kaplan's activities as a principal of MKI and a former member of the Exchange evidences the Kaplans' consent to arbitrate and the Kaplans' individual liability for performance of the workout. There was no arbitration clause in the workout document the Kaplans signed.

First Options' argument that Mr. Kaplan's position as an officer of MKI compelled him to arbitrate his obligations under the workout as an "associated person" of a member, MKI, is also rejected. The record does not contain any U-4 Form or other document evidencing Mr. Kaplan's agreement to arbitrate, and the terms of the workout plainly show that he did not agree to submit his personal responsibility for MKI's obligations to arbitration.

In addition, we reject First Options' argument that Mr. Kaplan's former membership in the Exchange subjected him to arbitration under its rules relating to members. The only dispute that arose while Mr. Kaplan was a member was the dispute that led to the workout, not the dispute over the workout's performance that the arbitrators heard.

Finally, we reject First Options' argument that Mr. Kaplan is the alter ego of MKI. The evidence of failure to observe corporate formalities in some distributions MKI made to him is insufficient to show that MKI was a sham that Mr. Kaplan manipulated in fraud of creditors.

We will therefore reverse the district court's order confirming the arbitration award against the Kaplans and remand the case to it with instructions to enter an order granting the Kaplans' request to vacate the arbitrators' award against them as individuals.*fn1 We will, however, affirm the district court's order confirming the arbitration award as to MKI.*fn2

I. Factual & Procedural History

First Options is a "clearing firm" or "clearinghouse" and member of the Exchange. MKI, a Pennsylvania corporation, was an "options market maker"*fn3 on the Exchange from 1984 through 1989. First Options acted as MKI's clearing firm on the Exchange pursuant to a Market Maker's Agreement between MKI and First Options dated November 15, 1984. The Market Maker's Agreement, executed by Mr. Kaplan on behalf of MKI, provided in part that "any controversy between [First Options and MKI] arising out of [MKI's] business or this agreement . . . shall be submitted to and determined by arbitration . . . ." Appendix ("App.") at 73. Mr. Kaplan has been the president, a director and the sole shareholder of MKI since 1986. MKI has been a member of the Exchange since 1984. From November 8, 1981, to December 8, 1987, Mr. Kaplan was also a member of the Exchange individually.

On October 19, 1987, corporate equities suffered an unprecedented drop in value. Stocks traded on the New York Stock Exchange, and those traded on regional exchanges, crashed. The Philadelphia Stock Exchange was no exception. Five days before the crash, MKI's trading account had a balance or net equity of approximately $10.5 million. On October 19, 1987, MKI lost over $12 million and its account had a deficit of $2.1 million by the end of the trading day.

As the clearing firm for MKI, First Options guaranteed to the Exchange and the persons with whom MKI traded that all positions in MKI's accounts would be covered. After trading closed on October 19, 1987, First Options was at risk on the $2.1 million deficit in MKI's accounts.

First Options' agreement with MKI gave it the right to liquidate MKI's positions "whenever in [First Options'] discretion [First Options] deemed it necessary." App. at 72. Therefore, First Options took control of MKI's trading accounts and proceeded to liquidate any remaining positions which, in its opinion, posed significant unacceptable risks. First Options' liquidation of MKI's positions increased MKI's deficit to $5.1 million.

MKI and First Options had, in the meantime, entered into settlement negotiations about MKI's continued operation. First Options pressed Mr. Kaplan to assume personal liability for MKI's obligations. Mr. Kaplan refused. Instead, he and MKI disputed the size of MKI's deficit and claimed that First Options' mishandling of the liquidation was only increasing the deficit. During these negotiations, Mr. Kaplan and his counsel told First Options that neither MKI nor Mr. Kaplan had any liquid assets to contribute to any settlement or workout beyond MKI's interest in a joint trading account, certain exchange memberships and the 1987 federal income tax refund the Kaplans were anticipating.*fn4

Negotiations continued during November and December and there is evidence that the parties reached a "hand-shake" deal in December. On December 8, 1987, Mr. Kaplan relinquished his membership on the Exchange and negotiations continued. On March 24, 1988, the Kaplans, MKI, and First Options separately executed four documents evidencing an overall method of settling the dispute that had resulted from MKI's October 19, 1987, deficit. They were: (1) a Letter Agreement executed by First Options, MKI, Mr. Kaplan, Mrs. Kaplan, and certain other entities and individuals; (2) a Guaranty executed only by MKI; (3) a Subordinated Loan Agreement executed by First Options, MKI, and a separate entity; and (4) a Subordinated Promissory Note executed by MKI. Only one of these four documents, the Subordinated Loan Agreement, contained an arbitration clause, and only First Options, MKI and the other entity, whose agreement to arbitrate is not material to this case, signed that document.*fn5 Individually, Mr. and Mrs. Kaplan signed only the Letter Agreement. It did not have an arbitration clause.

Under the terms of the Workout:

- MKI agreed to repay a total of $6,227,188, the full amount of its trading deficits, including the added $3 million incurred while First Options' was liquidating its risky accounts;

- MKI immediately transferred four Exchange memberships to First Options;

- MKI and Mr. Kaplan immediately contributed $900,000 to a new Trading Account and MKI resumed trading on the new account in April 1988;

- Mr. Kaplan paid First Options $80,000;

- Mr. and Mrs. Kaplan agreed to remit to First Options their 1987 tax refund, estimated to be at least $300,000, upon its receipt;*fn6 and

- MKI agreed to split its trading profits with First Options.

First Options agreed to release MKI from any claims First Options might have against it for the disputed debt upon MKI's performance of all its obligations under the workout. First Options also agreed to release Mr. Kaplan, individually, from any claims First Options might have against him beyond those he had undertaken in the workout.

MKI resumed trading in April of 1988. On January 16, 1989, before the parties had carried out all the terms of the March 1988 workout, MKI's account suffered another loss of over $1.5 million as a result of a takeover bid for one of the companies in whose stock MKI had a position.*fn7 In response, First Options ordered Mr. Kaplan to reduce MKI's risk by adjusting some of the positions in MKI's account. Mr. Kaplan did not reduce the risk in MKI's account to First Options' satisfaction.

On January 17, 1989, First Options again took over MKI's accounts and began to liquidate all its positions. First Options also barred MKI and Mr. Kaplan from conducting business on the Exchange and ordered all MKI traders off the trading floor. This second liquidation took about four months. It added $65,000 to the deficit that had been outstanding when the workout began.

After taking control of MKI, First Options demanded an opportunity to inspect MKI's corporate books and the Kaplans' tax returns. It also demanded payment of the $300,000 tax refund the Kaplans had agreed to turn over and contended Mr. Kaplan, along with MKI, was liable for all sums still due from MKI because they were alter egos of each other. The Kaplans refused First Options' demands, asserting that it was again compounding the problem by its ongoing liquidation of MKI's accounts. First Options then declared all sums still due under the workout accelerated and demanded immediate payment of the accelerated debt.

Ultimately, First Options submitted the dispute over the workout to the Exchange. It sought: (1) $6,292,421.60 from MKI for breach of contract; (2) $300,000, the amount of the Kaplans' 1987 tax refund, from the Kaplans individually; (3) $6,292,421.60 from Mr. Kaplan on the theory he was individually liable as MKI's controlling person; (4) $6,292,421.60 from Mr. Kaplan as MKI's alter-ego; plus (5) interest, costs, and attorneys' fees against MKI and the Kaplans.*fn8 MKI and First Options signed a submission agreement, separate and apart from the arbitration provision contained in the Subordinated Loan Agreement, submitting the case to the Exchange for arbitration. Mr. and Mrs. Kaplan have never signed any such agreement.

On July 24, 1989, the Kaplans and MKI filed responses denying liability, and Mr. Kaplan and MKI filed counterclaims against First Options, each seeking $10,000,000 from First Options for breach of contract, interference with prospective business opportunities and libel and slander. The Kaplans also submitted written objections to the arbitrators' jurisdiction under the Exchange's arbitration rules. In them, the Kaplans stated, "The Philadelphia Stock Exchange . . . and the Arbitration Committee . . . lack jurisdiction over this matter and the purported claim should be dismissed." App. at 311-12.

On February 26, 1990, not quite two years later, there was a pre-hearing discovery conference. The Kaplans' former counsel participated in it without renewing the objections to the arbitrators' jurisdiction. The Kaplans contend his limited participation in the discovery conference did not waive their objections to jurisdiction. Neither the Kaplans nor First Options submitted any documents to the Exchange that confirmed the Kaplans' withdrawal of their objections to the arbitrators' jurisdiction at the discovery conference or thereafter, and the arbitration panel's February 26, 1990, discovery order did not mention jurisdiction.

For the next twenty-two months, no discovery took place and no motions were filed; nor did the arbitration panel conduct any proceedings or issue any rulings before January 10, 1992. In December 1991, the Kaplans retained new counsel. On January 6, 1992, they filed a motion to dismiss for lack of jurisdiction. They also complained about the arbitrators' failure to rule on the objections they had filed two years earlier and said they were "reiterating and renewing their objections to the Committee's jurisdiction." App. at 194.

In response to the Kaplans' motion to dismiss for lack of jurisdiction, First Options argued in the alternative that Mr. Kaplan was bound to arbitrate under Exchange rules because he was a member of the Exchange at the time of the October 19, 1987 crash, because he is an associated person of a member, or because he was MKI's alter ego. The Exchange denied the Kaplans' motion to dismiss for lack of jurisdiction without comment.

Sometime in May 1992, the matter finally proceeded to arbitration and, after eight days of hearings, the seven-member arbitration panel voted five to two to pierce the corporate veil and, on June 5, 1992, entered an award for $5,662,188.00 plus interest in favor of First Options and against Mr. Kaplan and MKI jointly and severally. The panel also ordered the Kaplans, jointly and severally, to remit their 1987 tax refund, $346,342.00, plus interest. Finally, it found for First Options on Mr. Kaplan's and MKI's counterclaims.

The Kaplans and MKI filed a petition to vacate the award in the district court and First Options filed a cross-petition for its confirmation. In an order accompanied by a memorandum opinion dated September 25, 1992, the district court confirmed the award. It held that Mr. and Mrs. Kaplan had consented to Exchange arbitration under the arbitration clause in the Subordinated Loan Agreement even though neither had ever signed that particular document. Alternately, the court held that the Kaplans' former counsel's participation in the 1990 discovery conference had waived their jurisdictional objections.

The district court then went on to affirm the arbitrators' decision to pierce the corporate veil on the merits. It also held, without explanation, Mr. Kaplan's release from individual liability was conditioned upon performance of the workout and that the release was ineffective because the workout had not been fully performed,*fn9 but explained that the corporate veil would have been properly pierced even if the workout's provision released the Kaplans as individuals. The Kaplans and MKI filed a timely notice of appeal.*fn10

II. Jurisdiction & Standard of Review

The district court had subject matter jurisdiction over this action to confirm or vacate the arbitration award under 28 U.S.C.A. § 1332 (West 1993) and 9 U.S.C.A. §§ 9, 10 (West 1970 & Supp. 1993). We have appellate jurisdiction over MKI's and the Kaplans' appeal from the final judgment of the district court confirming the award under 28 U.S.C.A. § 1291 (West 1993).

We review a district court's denial of a motion to vacate a commercial arbitration award de novo. Colonial Penn Ins. Co. v. Omaha Indem. Co., 943 F.2d 327, 331 (3d Cir. 1991); Mutual Fire, Marine & Inland Ins. Co. v. Norad Reinsurance Co., 868 F.2d 52, 56 (3d Cir. 1989) ("In reviewing the district court's denial of appellants [sic] motion to vacate the arbitration award, this Court will stand in the shoes of the district court and determine whether appellants were entitled to vacate the arbitration award pursuant to 9 U.S.C. § 10(d)."); see also RM Perez & Assocs. v. Welch, 960 F.2d 534, 540 (5th Cir. 1992); Moseley, Hallgarten, Estabrook & Weeden v. Ellis, 849 F.2d 264, 267 (7th Cir. 1988).

First Options asks us to reconsider these holdings and adopt instead the standard the United States Court of Appeals for the Eleventh Circuit uses. That court reviews decisions denying petitions to vacate arbitration awards for abuse of discretion. See Robbins v. Day, 954 F.2d 679, 681-82 (11th Cir.), cert. denied, 113 S. Ct. 201 (1992). We reject First Options' invitation. Even if this panel were to look favorably on the new standard it suggests, we could not adopt it. See Third Circuit Internal Operating Procedure 9.1 (1993) ("No subsequent panel overrules the holding in a published opinion of a ...

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