Petition for Writ of Certiorari — Leon C. Baker P. C. v. Lynch

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oy,

011150 FEB - 4 2002

In the Supreme Court of the United States

October Term 2001

Leon C. Baker P.C. and Leon C. Baker, individually,

Petitioners

V.

Merrill Lynch, Pierce, Fenner & Smith Inc.,

Respondent

PETITION FOR A WRIT OF CERTIORARI

TO THE SUPREME COURT OF THE

STATE OF ALABAMA

Arthur R. Miller

Attorney for Petitioner

1545 Massachussetts Avenue

Cambridge, Massachussetts 02138

Telephone: (617) 495-4111

Date: February 4, 2002

QUESTION PRESENTED

If a contract governed by the Federal

Arbitration Act, 9 U.S.C. §2 ("FAA"), provides that all

disputes arising hereunder’ shall be submitted to

arbitration," should disputes about preclusion (res

judicata and collateral estoppel) nevertheless be ruled on

by judges, rather than by arbitrators?

TABLE OF CONTENTS

QUESTION PRESENTED PI¹PDPDDZi: n.. i

TABLE OF AUTHORITIES ..........----e sere eee ii

Opinions Below ....... ele OE AS ET EPP ETT EEL ee 1

„„ „„ „„ „„ „„ 2

Constitutional and Statutory Provisions Involved 2

Corporate Disclosure Statement .........----seeeeseeee 3

STATEMENT OF THE CASEERERʒiʒigſiůͥiůin eee e ee eeeee 3

A. Nature of the Cassnsse . 3

B. The Rush to Judgment 5

EIn p e 6

D. The Questions Presented for Review by This

Court Were Raised in the Alabama. Court᷑s 14

E. Reasons for Granting the Wrilt. 15

POINTI: BOTH FEDERAL AND STATE COURTS

ARE SHARPLY DIVIDED AS TO

WHETHER REQUIRING A JUDGE TO

DECIDE PRECLUSION ISSUES IN A

DISPUTE GOVERNED BY AN

il

POINT II:

ARBITRATION AGREEMENT

VIOLATES SECTION TWO OF THE

FEDERAL ARBITRATION ACPI. 16

WHETHER COURTS MAY CREATE

EXCEPTIONS UNDER THE FEDERAL

ARBITRATION ACT FOR PRECLUSION

ISSUES WHEN THE PARTIES HAVE

CONTRACTED TOSUBMIT “ALL”

DISPUTES TO ARBITRATION CALLS

INTO QUESTION IMPORTANT FEDERAL

POLICIES WORTHY OF THIS COURTS’

Fe cere her dee Aka ds eeeues 27

— ͤ]l]ll]sns.. ß

BLE OF AUTHORITIES

CASES

Allied Bruce Terminix Cos. v. Dobson, 513 U.S.

„„ „„ „„ „% % „ „ „ „„ „ „ „ „„ „ 27, 28

Board of Education v. Patchogue-Medford Congress

of Teachers, 48 N.Y.2d 812, 424 N.Y.S.2d 122, 399,

N.E.2d 1143 (1979) 2.0... cee cee cece cere „„%„õ 26

Chiron Corp. v. Ortho Diagnostic Systems, Inc.,

207 F.3d1126 (0 Cir. 20000 / ů ce eee eee renee 24

Clements v. Central Railroad Co. of New Jersey,

399 F.2d 825 (3d Cir. 1968) ) ꝰqu! Un... 17

John Hancock Mutual Life Ins. Co. v. Olick,

151 F.3d 132 (3d Cir. 1998)... :...... 17

Kelly v. Merrill Lynch, Pierce, Fenner & Smith, Inc.,

985 F.2d 1067 (11 Cir. 1993). )))7)».. 19

Mastrobuono v. Shearson Lehman Hutton, Inc.,

SIA UG. M % K 29

Miller v. Runyon, 77 F.3d 189, 194 MW 22

Miller Brewing Co. v. Fort Worth Distributing, 781

F.2d 494 (5™ Cir. 1986) ·ͥ ́ : n eee eee eres 18, 19

National Fire Ins. Co. v. National Gypsum Co.,

101 F.3d 813 (2d Cir. 19960 .Uu U ... 24

iv

National Union Fire Ins. Co. of Pittsburgh, Pa. v.

Belco Petroleum Corp., 88 F.3d 129 (2™ Cir. 1996) 22, 23, 24

Prima Paint Corp. v. Flood & Conklin, Mfg. Co.,

, eee Ter re rs 28

Rembrandt Indus. Inc, v. Hodges International, Inc,

38 N.Y. 2d 502, 381 N.Y.S.451, 344 N. E. 2d

„ 25

Southland Corp. v Keating, 465 U.S. 1 (1984) 14, 16

State Farm Fire & Cas. Co. v. Owen, 729 So.2d 834

CAD, TOPO v6 6.0005 0000996502000646404000 ee 10

Telephone Workers of New Jersey v. New J.ersey Bell Tel.,

ee ccecvvuvicuaetenesseus 17

Waterfront Construction, Inc. v. North End 49ers,

51 Va. 417, 468 S.E. 2d 894 (1996) (en banc) .......... 26

& A Securities Litigation, 38 F.3d 380 (8" Cir. 1994) .. 20

Constitutional Provisions

United States Constitution, Fourteenth Amendment 2

United States Constitution, Article II, Section3 .......... 2

United States Constitution, Article IV, Section] ......... 2

Federal Arbitration Act, Section 22 3

v

In the Supreme Court of the United States

October Term 2001

Leon C. Baker P. C. and Leon C. Baker, individually,

Petitioners

v.

Merrill Lynch Pierce Fenner & Smith Inc.,

Respondent

PETITION FOR A WRIT OF CERTIORARI

TO THE SUPREME COURT OF THE

STATE OF ALABAMA

Petitioners, Leon C. Baker, P. C. (“P. C.“) and

Leon C. Baker ("Baker") pray that a Writ of Certiorari

be issued to review the opinion and judgment of the

Supreme Court of Alabama entered on August 31, 2001.

Opinions Below

The opinion of the Circuit Court of Jefferson

County, Alabama, is not reported. A copy is set forth at

page A-lof the Appendix.

The opinion of the Alabama Supreme Court is set

forth at page C-1 of the Appendix. It is not yet reported in

South 2d.

Jurisdiction

The opinion of the Alabama Supreme Court was

entered on August 31, 2001. An application for rehearing

was filed on September 13, 2001 and was denied on

November 16, 2001. This Petition for a Writ of Certiorari

was filed within ninety days of the denial. The Court’s

jurisdiction is invoked under 28 U.S.C. § 1257(a).

Constitutional and Statutory Provisions

Involved

Article II, Section 3 of the United States

Constitution provides in pertinent part:

The Congress shall have the Power * * *

To regulate Commerce with foreign Nations,

and among the several States, and with the

Indian Tribes * * *.

Article IV, Section I of the United States

Constitution provides in pertinent part:

Full faith and credit shall be given in each

state to the public acts, records, and judicial

proceedings of every other state.

The Fourteenth Amendment to the United States

Constitution provides in pertinent part:

[NJor shall any state deprive any person of life,

liberty, or property, without due process of law

* 4 *

*

The Federal Arbitration Act, Section 2, provides

in pertinent part:

A written provision in any maritime

transaction or a contact evidencing a

transaction involving commerce to settle by

arbitration a controversy thereafter arising out

of such contract or transaction, shall be valid,

irrevocable, and enforceable * * *.

Corporate Disclosure Statement

Petitioner, Leon C. Baker P.C., is a New York

professional corporation authorized to practice law in that

state. The P. C.’s sole shareholder is Leon C. Baker. It

has no subsidiaries.

STATEMENT OF THE CASE

A. Nature of the Case

The P.C. has a securities brokerage account with

Respondent, Merrill Lynch, Pierce, Fenner & Smith Inc.

(Merrill Lynch") and signed the form of agreement

Merrill Lynch requires its customers to execute. The

3

agreement provides that the parties will submit all“

disputes to arbitration. A dispute did arise, the details of

which are set forth later in this Petition. The parties were

unable to resolve the dispute by negotiation, and the P.C.

sued Merrill Lynch in Florida, the state in which Baker,

its sole shareholder, has been a resident and citizen since

1989. |

Merrill Lynch moved to require arbitration.

When reminded of the arbitration provision, the P.C. did

not oppose Merrill Lynch’s motion. The Florida court

entered an agreed order directing arbitration and retained

jurisdiction to enforce any award which might be entered.

The P.C. commenced an arbitration proceeding

before the National Association of Securities Dealers, Inc.

("NASD"), the tribunal selected by Merrill Lynch

pursuant to its arbitration agreement. Merrill Lynch filed

an answer alleging res judicata as its principal defense.

As is set forth more fully below, the P.C. maintains that res

judicata is not applicable based both on the facts and on

the law.

The NASD then submitted a list of prospective

Florida arbitrators, from which a panel of three were to

be appointed. The P.C. selected three lawyers from the

NASD list. Merrill Lynch did not object to any of the P.

C.’s nominees; nor did Merrill Lynch submit any

alternative nominees. Accordingly, the arbitration panel

would have consisted of three lawyers.

On the very eve of the hearing, without any notice

to the P.C. or to the Florida court that had ordered

arbitration, Merrill Lynch obtained from an Alabama trial

court an ex parte restraining order prohibiting the P. C.

and Baker from proceeding with the arbitration. '

B. The Kush to Judgment

The irreparable injury that Merrill Lynch alleged

as the ground for equitable relief against the arbitration

was that it asserted a defense of res judicata which,

Merrill Lynch argued, non lawyer arbitrators would not

understand (ignoring the fact that all the chosen

arbitrators were lawyers). Baker and the P. C. objected

that an Alabama court could not interfere with an

arbitration ordered by a Florida court, and that Merrill

Lynch had waived any right it might have had to object to

arbitration, first, by seeking arbitration, and, second, by

participating in it. Moreover, the P.C. showed that res

judicata was not applicable because, as is more fully set

forth below, the P.C. was not a party to the earlier

proceedings and could not have appealed. Both the

Alabama trial court and the Alabama Supreme Court

1. Merrill Lynch may have elected to sue in Alabama, rather

than in Florida, among other reasons, because Alabama is notoriously

hostile to arbitration. See Ala. Code 8-1-41, which invalidates agreements

to arbitrate entered into before a claim has arisen.

rejected these objections and entered final judgment in

favor of Merrill Lynch.

Although these were serious errors, the P.C. and

Baker are not seeking certiorari with respect to them,

paradoxically, because there is no conflict among the

circuits (or state courts) a) that demanding and

participating in arbitration waive any objections to

arbitration, and b) that a non-appealable order can

have no preclusion effect. Of course, if this Court grants

certiorari on the grounds set forth in this Petition, the

Court could reverse for those errors as well.

The Alabama trial court held that the P.C.’s claim

was barred by res judicata and granted a permanent

injunction. On appeal Merrill Lynch dropped its

misrepresentation that the Florida arbitrators would be

non-lawyers. Instead it argued that 1) despite the

arbitration provision in Merrill Lynch’s customers

agreement requiring that al disputes be arbitrated, and

2) despite the FAA, actions in which the defendant avers

a defense of preclusion (res judicata or collateral

estoppel) must be submitted to courts rather than

arbitrators. The Alabama Supreme Court affirmed a) the

ruling of the trial court that the P.C. was barred by res

judicata and b) the issuance of the permanent injunction.

C. The Facts

Neither the P.C. nor Merrill Lynch were parties to

the original dispute and the lawsuits that ultimately gave

rise to the arbitration and the present lawsuit. The prior

litigation on which Merrill Lynch bases its preclusion

defense was between Baker and J. R. Bennett and Laura

Bennett, all residents of Florida. There were a total of

four lawsuits in Alabama between Baker and the

Bennetts, denominated in the Alabama Supreme Court ‘s

opinion (Appendix C-2) as "Alabama-Baker I" through

" Alabama-Baker IV.“

Those four lawsuits arose out of a computer leasing

transaction more than twenty years ago between persons

completely unrelated either to the present litigation or to

the lawsuits by the Bennetts against Baker in Alabama.

Those persons were Gibbs and West, the owners of a coal

mine in Alabama, and Atlantic Computer Leasing Ltd.,

an English computer lessor ("Atlantic"). Baker, then

practicing law in New York, represented Atlantic.

In 1980 oil prices were very high as a result of the

production restrictions of OPEC. This created a strong

demand for coal, and Gibbs and West’s Alabama mine

became very profitable. They invested their profits and all

the money they could borrow in digging shafts and

tunnels and purchasing mining equipment. Near year

end, they realized they did not have, and could not

borrow, enough funds to pay their income taxes.

Their Alabama accountants, who had worked with

Baker on tax matters for other clients, telephoned him in

New York and asked him to find a computer leasing tax

shelter" for Gibbs and West. Such tax shelters" do not

produce tax saving. They only defer taxes. Taxes saved“

during an initial five year accelerated depreciation period

have to be paid during later years, when there are no

depreciation deductions. What the investor receives from

such a tax shelter" is, in effect, an interest free loan“

from the United States Treasury. For Gibbs and West,

though, this was exactly what they needed. They asked

Baker to find them a computer leasing transaction. He

did so with his client, Atlantic. Gibbs and West survived

their cash crisis.

Six months later the accountants for Gibbs and

West telephoned Baker to inform him that they had sold

their mine and no longer needed tax deferral. The

accountants added that they had another client, J. R.

Bennett, who had a similar problem. Bennett’s mobile

home business was very profitable, but it was also

expanding very rapidly, and he was short of cash. He

wished to solve his problem by acquiring from Gibbs and

West a half interest in their contracts with Atlantic. The

accountants requested that Baker ask his client to

consent, which Atlantic did. Baker received no fee for his

services.

Nine years later the Internal Revenue Service

challenged the deductions J. R. Bennett and his wife had

taken, and they paid approximately $850,000 of deferred

taxes and interest. The taxes, of course, would have been

payable later in any event. Moreover, the Bennetts

received a tax deduction for the interest they paid. Thus

their actual loss was small--particularly when compared

with the value of saving Bennett’s business. Nevertheless,

the Bennetts sued Baker for $850, 000 plus punitive

damages. The Alabama Supreme Court refers to that

case as Alabama-Baker I."

The Bennetts asserted two theories: First that

Baker had acted as Bennett’s attorney and had advised

Bennett erroneously of the tax consequences of the

transfer from Gibbs and West. The Huntsville, Alabama

trial court directed a verdict dismissing this count.

Second, the Bennetts alleged that Baker had committed

intentional fraud in representing that a computer leasing

transaction would provide a good tax shelter. Since the

correctness of Baker’s legal opinion was a matter of law

for the court, Baker urged, based on Federal tax

authorities, that the fraud count also should be dismissed.

The court, however, simply left the tax issue for the jury

to decide without any instructions on Federal tax law.

The jury returned a verdict, for compensatory

damages of $440,000 but no punitive damages. The

Alabama Supreme Court affirmed. It held that, although

there was no evidence of intentional misrepresentation or

failure to disclose facts, the jury could have found liability

for innocent misrepresentation or innocent non-disclosure.

This was an unprecedented ruling since, both under

prior Alabama law and general common law, there can be

no damages for innocent misrepresentation or non-

disclosure. The remedies are rescission or reformation, but

neither of those remedies could have been obtained against

Baker, because he was not a party to the original

transaction between Gibbs and West and Atlantic

Computer Leasing Ltd. or the subsequent assignment by

Gibbs and West of a half interest to Bennett. Six years

later, in State Farm Fire & Cas. Co. v. Owen, 729 So. 2d 834

(Ala. 1998), the Alabama Supreme Court overruled its

decision against Baker in Alabama-Baker I. By then it

was too late for Baker to reopen the case.

The action which the Alabama Supreme Court refers

to as Alabama-Baker II arose out of the Bennetts’ efforts to

collect their judgment in Alabama even though Baker is

not a resident of Alabama and has no assets there. The

Bennetts served garnishments on the Alabama offices of a

number of national securities firms. Baker never had an

account with any of those Alabama offices, but the Bennetts

contended that service on the Alabama offices required the

10

offices required the firms to deliver Baker’s assets they

held in offices outside Alabama.

The Huntsville court held that garnishment may

not be used to reach a non-resident’s assets by serving a

resident bailee who holds the assets outside the state. The

firms could be regarded as residents of Alabama, because

of their local offices, but the assets of out-of-state

customers held in other states could not be garnished in

Alabama. With regard to the use of equity power, the

court held that the Alabama Constitution, which prohibits

imprisonment for debt, bars enforcement of money

judgments by contempt proceedings.

In the lawsuit the Alabama Supreme Court refers

to as Alabama-Baker III," the Bennetts’ lawyers

successfully evaded the decision in Alabama-Baker II.

They did so through the initial negligence of Merrill

Lynch and its subsequent complicity.

The Bennetts’ lawyers brought a new action in a

different Alabama venue, in Birmingham. They served

discovery notices on the major national securities

brokerage firms, including Merrill Lynch, demanding

copies of statements of any accounts Baker might have

with them. Baker moved to dismiss on the ground of res

judicata, but the court never ruled on his motion.

It was at this point, through the gross neglect of

Merrill Lynch, that the P.C. was dragged into the

litigation. The P.C. had, and still has, a brokerage account

with Merrill Lynch. When Merrill Lynch sent out

monthly account statements, it abbreviated the name on

the P.C.’s statements to "Leon C. Baker," omitting the

corporate designation P. C.“

Over the years the P. C. had objected that its

account name should be stated correctly, including P. C.“

Merrill Lynch responded that the P.C. need not be

concerned because the name was shown correctly on its

internal account records. Nevertheless, the P. C. insisted

that the statements be issued with the correct name.

Merrill Lynch finally complied—but, unfortunately, not

until after the disastrous events of Alabama-Baker III.

Merrill Lynch responded to the Bennetts’

discovery request in the Birmingham action with a

monthly statement of the P. C. but with P. C.“ omitted!

Based on this statement, the court directed Merrill

Lynch to liquidate a Treasury bill in the P.C.’s account

and to pay $723,353 to the Bennetts’ attorneys.

Merri'l Lynch responded by submitting an affidavit

of its executive responsible for the P.C.’s account, who

stated that the actual name on Merrill Lynch’s records was

Leon C. Baker P.C." and that Merrill Lynch had made

an error. Even so, the Birmingham court refused to

12

withdraw its order.”

At this point, only Merrill Lynch could appeal from

the payment order. Baker could not, because his property

had not been seized. The P.C. could not, because, under

Alabama law, only parties can appeal. Merrill Lynch was

a bailee that had made a mistake with respect to its bailor’s

property, which it was obligated to take legal action to

protect. It could have intervened, appealed, and posted a

bond rather than pay over the funds. Merrill Lynch chose

not to do so.

Instead, Merrill Lynch sought to protect itself at

the expense of its customer. It proposed that it would waive

its objection and pay the $723,353 to the Bennetts if the

court entered an order releasing Merrill Lynch from

any liability to the P.C. for doing so. Counsel for the

Bennetts prepared that order. Baker’s assent was not

required, because he claimed no interest in the account.

The P.C. was not a party, and its consent was not

sought. Nevertheless, Merrill Lynch contends that the

order provides it with a preclusion defense on two

points: 1 ) that Merrrill Lynch has no liability to the P.

C. and 2) that the account belongs to Baker, not the

|

2. The Alabama Supreme Court, at page 3 of its opinion in the present

case, noted that the account had been opened in the name of Leon C.

Baker P.C., ostensibly a corporate account of the P.C., rather than as an

individual account of Baker" (emphasis by the court].

13

As an alternative basis for preclusion barring the

Florida arbitration Merrill Lynch relies on the fact“ that

Alabama-Baker III was affirmed in Alabama-Baker IV.

True there was an affirmance, but the appeal was solely by

Baker on an unrelated issue. Since the P.C. was not a

party to the action, under Alabama law it could not appeal

even though its property had been seized. Consequently the

order could not be, and was not, appealed or affirmed in

Alabama-Baker IV and could not give rise to preclusion.

D. The Question Presented for Review By This

Court Was Raised In The Alabama Courts

When Merrill Lynch sought an injunction in the

Alabama trial court against the arbitration which was about

to be tried in Florida, the P. C. and Baker filed a

memorandum of law in opposition. The caption of a major

point of the memorandum was the following:

THE INJUNCTION MERRILL IS SEEKING IN THIS ACTION

IS BARRED BY THE FEDERAL ARBITRATION STATUTE.

In support, the P.C. and Baker cited, among

other authorities, this Court’s holding in Southland

Corp. v. Keating, 465 U.S. 1 (1984). They argued that

Congress has declared a national policy favoring

arbitration and has withdrawn the power of the states

to require a judicial forum for the resolution of claims

14

which the contracting parties agreed to resolve by

arbitration. The trial court, nevertheless, permanently

enjoined the Florida arbitration.

In the Alabama Supreme Court, Baker and the

P. C. argued: The Federal Arbitration Act applies to

arbitration agreements involving interstate commerce

and preempts state law with respect to such agreements."

That court, however, affirmed and denied reargument.

E. Reasons For Granting The Writ

There is a growing division of authority among

the United States Courts of Appeals and among various

state courts of last resort as to whether there should be

a judicially created exception to Section 2 of the FAA

for cases in which one party to an arbitration agreement

asserts preclusion. The usual rationale advanced for

creating such an exception is that preclusion law is

recondite and beyond the ken of lay arbitrators.

Another, much narrower, rationale for reading in

an exception to the federal statute for preclusion defenses

was articulated by the Alabama Supreme Court (and by

some United States Courts of Appeals). It is that the

rendering court is better able to determine what was

decided than arbitrators. However, the rendering court

and the enforcing court are often entirely different

tribunals. This defect in the theory is illustrated by this

15

very case. The judge who decided Alabama-Baker III

was no longer on the court. The Alabama judge in the

present case was just as uninformed about the earlier

case as the Florida arbitrators would have been.

POINT I

BOTH FEDERAL AND STATE COURTS ARE

SHARPLY DIVIDED AS TO WHETHER REQUIRING

A JUDGE TO DECIDE PRECLUSION ISSUES IN A

DISPUTE GOVERNED BY AN ARBITRATION

AGREEMENT VIOLATES SECTION TWO OF THE

FEDERAL ARBITRATION ACT.

The contract between the P.C. and Merrill Lynch,

relates to interstate commerce because it covers sales and

purchases on stock exchanges, through NASDAQ and in

over-the-counter securities markets. In disputes under

contracts which arise out of interstate commerce, the FAA

requires federal and state courts to enforce arbitration

provisions. In Southland Corp. v. Keating, 465 U.S. 1

(1984), this Court said :

In enacting § 2 of the federal Act,

Congress declared a national policy favoring

arbitration and withdrew the power of states to

require a judicial forum for the resolution of

claims the contracting parties agreed to resolve

by arbitration.

Id. at 9.

The United States Courts of Appeals disagree as

to whether, when parties have agreed to arbitrate all

their disputes under a contract governed by the FAA, u

defense of preclusion nevertheless should be decided

by a judge. As shown below, early cases did not take

the FAA into account in holding that judges, rather

than arbitrators, should rule on a preclusion defense.

More recent cases, but by no means all, hold that if the

parties agreed to arbitrate a// their disputes under the

contract, the FAA requires that the arbitrators, not a

judge, should rule on a preclusion defense. It is

primarily because of this disagreement among the

circuits that this Petition should be granted.

An early reported federal case was Clements v.

Central Railroad Co. of New Jersey, 399 F.2d 825 (3d

Cir.1968). Both the trial court and the Third Circuit

assumed that the court was required to consider the

preclusive effect of a prior judgment before compelling

the parties to arbitrate. Another Third Circuit decision

sometimes cited for the same proposition is Telephone

Workers of New Jersey v. New Jersey Bell Tel. Co., 584

F.2d 31 (3d Cir. 1978). However, that was not the issue

on which the court decided that case. In fact, it did not

even consider that issue. In John Hancock Mutual Life

Ins. Co. v. Olick, 151 F.3d 132 (3d Cir. 1998), the Third

Circuit had it both ways. It held that judges should rule

on claims of preclusion based on prior judgments but

that arbitrators should rule on claims of preclusion

based upon prior awards.

17

In Miller Brewing Co. v. Fort Worth Distributing,

781 F.2d 494 (5" Cir. 1986), Miller and Fort Worth

Distributing (referred to as FWD C“ in the court’s

opinion) entered into an agreement under which

FWDC distributed Miller beer. The agreement

provided that if Miller terminated the agreement

without cause, an arbitration panel could order Miller

to pay compensatory damages.

Miller did terminate and FWDC sued in a Texas

state court. Miller removed to a federal district court

but the Fifth Circuit remanded. FWDC took no steps to

schedule arbitration until almost four years later, when

its state court action was about to be dismissed for

want of prosecution. Miller’s attempt in a federal

district court to enjoin the arbitration was denied. The

Fifth Circuit reversed, holding that FWDC waived its

right to arbitrate by taking depositions and by other

activities before the state lawsuit was dismissed. In

dictum, the Fifth Circuit added that the action also

could have been dismissed on the ground of res

judicata. Although FWDC had not sought damages in

its state lawsuit (only an injunction), it could have. The

court noted:

The doctrine of res judicata * * * and its

cousin collateral estoppel have probably done

more to prevent useless and wasteful litigation

than arbitration ever could.

Id. at 497 n.3.

18

That dictum and supposition are not much of a

precedent for the proposition that only judges, and not

arbitrators, should rule on res judicata and collateral

estoppel. Nevertheless, they were followed by some

Courts of Appeals. The first was Kelly v. Merrill Lynch,

Pierce, Fenner & Smith Inc., 985 F.2d 1067 (11 Cir.

1993). Kelly sued Merrill Lynch in a federal district

court alleging violations of SEC Rule 10b-5. After the

district court dismissed the complaint, Kelly began an

arbitration on related state law claims.

The Eleventh Circuit affirmed an injunction

against arbitration of the state law claims primarily on

the authority of the Miller Brewing case but there was

one important difference between the cases. In Miller

Brewing the ground for enjoining the arbitration was

that the defendant, FWDC, had waived arbitration by

pursuing its failed lawsuit. The Eleventh Circuit

ignored this holding and focused on the dictum that

Miller Brewing might have been dismissed on the

ground of res judicata. It declared:

Courts should not have to stand by while

parties re-assert claims that have already been

resolved.

Id. at 1069. It cited as authority the Fifth Circuit’s

speculation that res judicata has "probably done

more to prevent useless and wasteful litigation than

’ arbitration ever could." Id. at 269.

19

In Y & A Securities Litigation, 38 F.3d 380 (8"

Cir. 1994), the court considered the preclusion effect of

a settled elass action. In particular, the court explored

whether claim preclusion applies either for or against

class defendants who were not actual parties. The class

action was brought in a United States district court in

Missouri alleging fraud on the market,“ which

inflated the price of Y & A stock. The settlement was

incorporated into a district court consent judgment.

Dean Witter Reynolds Inc., a securities

brokerage firm, was not a defendant in the class action.

Volk, a customer, and a member of the plaintiff class,

commenced an arbitration against Dean Witter under

its customers agreement. Volk alleged that he had

incurred losses on Y & A stock because a Dean Witter

broker forged his signature on a margin account

agreement "well before the period covered by the class

settlement.“ Dean Witter then obtained, on the ground

of res judicata, a preliminary injunction from the

federal district judge who had entered the consent

judgment barring the arbitrators from proceeding. The

Eighth Circuit affirmed.

The court’s decision is cited as authority that a

court, rather than arbitrators, should decide a res

judicata issue. It is an authority, but it is not a strong

one. Only a preliminary injunction was appealed. The

Eighth Circuit did not have to, and did not, reach the

merits. It only had to determine that the district court’s

20

legal analysis was plausible and might be sustained on

an appeal from a final order. The opinion declared:

Here the district court * * * has

concluded that Dean Witter is likely to be able

to prove that the class plaintiffs intended to

release for free third party brokers like Dean

Witter for bad acts which 1) Y & A had no

responsibility for and could not possibly be

indemnified for; and 2) affected individuals

rather than the class. While at first blush this

may appear to be a surprising outcome, we are

not convinced the district clearly erred in so

holding."

Id. at 384. Chief Judge Arnold, concurring in the

judgment, declared:

In general, when parties agree to submit

a matter to arbitration, they contract for the

arbitrator’s decision on legal questions as well as

on issues of fact. Such legal questions would

include defenses, such as res judicata, and I do

not read this Court’s opinion today to hold

generally that courts may by injunction, control

the decision of arbitrators on questions of issue

or claim preclusion.

Id. at 384.

The Seventh Circuit, in a dictum, has speculated

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"if the party opposing arbitration on grounds of

collateral estoppel asks the court to enjoin arbitration

before there is any award, * * * the court will have to

decide whether to refuse or order arbitration * * *."

Miller v. Runyon, 77 F.3d 189, 194 (0 Cir. 1996).

There is no ambiguity in the contrary holding of

the Second Circuit in National Union Fire Ins. Co. of

Pittsburgh Pa. v. Belco Petroleum Corp., 88 F.3d 129

(2™Cir. 1996), that Section 2 means exactly what it

provides. In brief the statute does not permit issues to

be decided by courts which the parties have agreed to

submit to arbitration.

The case arose out of the seizure of Belco’s oil

fields and equipment by the Peruvian government. The

dispute was between Belco and a group of insurance

companies which had issued policies insuring Belco

against expropriation. The insurers sought to rescind

the policies alleging that Belco had made

misrepresentations. The policies provided that all

disputes arising under them should be arbitrated, and

the arbitrators awarded Belco approximately $145

million plus interest.

Belco later recovered $3 million from a different

insurer for vessels taken by the Peruvian government.

The insurers who had paid the earlier award demanded

a portion under a provision in their policies that

proceeds collected from other insurance should be

shared between them and Belco. When Belco disputed

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this claim, the insurers initiated a second arbitration.

Belco sought a declaratory judgment that the claim was

barred by res judicata, and the insurers countered with

a petition to compel arbitration. The district court ruled

that under federal law the arbitrators had to decide the

preclusion issue. The Second Circuit affirmed,

reasoning:

Belco’s claim of preclusion is a legal

defense to National Union’s claim. As such it is

itself a component of the dispute on the merits.

Belco’s attempt to characterize the preclusion

issue as not related to the merits is unavailing. It

as much related to the merits as a time limit in

the arbitration agreement or laches. * * *

The [arbitration] provision covers all

disputes which may arise under or in connection

with this policy" {emphasis added by the court},

and is not limited, as Belco contends, to disputes

that require interpretation of the AIG policy. We

do not believe the arbitration provision is

ambiguous, but even if it were, the FAA would

require resolving any ambiguity in favor of

arbitration.

Id. at 135.

The Alabama Supreme Court (at Appendix

C-10) sought to limit Belco by declaring that it held

only “that the preclusive effect of a prior arbitration

23

proceeding on claims asserted in a subsequent arbitration

proceeding is arbitrable.“ Four months after Belco,

however, the Second Circuit elaborated its position on

the preclusive effect of a prior judgment in National Fire

Ins. Co. v. National Gypsum Co., 101 F. 3d 813 (2d Cir.

1996). The district judge granted an injunction against

arbitration of a claim he held was precluded by his

affirmed decision in a prior case. In reversing, the Second

Circuit said:

Our decision is consistent with our recent

holding that the issue-preclusion effect of a prior

arbitration is arbitrable and must be arbitrated.

Belco, 88 F.3d at 135-36. In Belco we rejected

the argument that issue preclusion is not related

to the merits of an agreement and nonarbitrable,

noting that "Belco’s claim of preclusion is a legal

defense to National Union’s claim. As such it is a

component of the dispute on the merits." Belco,

88 F.3d at 135. Although the present dispute

involves the preclusive effect of a prior

judgment, Wellington’s arbitration agreement

covers any disputed issues within [its] scope.

Thus a defense based on the issue preclusive

effect of a prior judgment is part of the dispute

on the merits

Id. at 817. The Alabama Supreme Court’s narrow

interpretation of Belco is obviously erroneous.

In Chiron Corp. v. Ortho Diagnostic Systems,

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Inc., 207 F.3d 1126 (9 Cir. 2000), the district court

confirmed an arbitration award. The Ninth Circuit

aligned itself with the Second Circuit, declaring:

Like the agreement in Belco, Chiron and Ortho’s

arbitration agreement is undeniably broad.

Ortho’s res judicata defense to a subsequent

arbitration proceeding necessarily involves an

inquiry into Chiron’s underlying claims. As with

respect to other affirmative defenses, such as

laches and the statute of limitations, we agree

with the Second Circuit that a res judicata

defense is a "component" of the merits of the

dispute and is thus an arbitrable issue.

Id. at 1134.

The manifest split in the United States Courts of

Appeals demonstrated above exists as well among state

courts. The division is not only in cases in which the

state courts are applying their domestic laws, but also

when the FAA requires them to apply federal law.

The Alabama Supreme Court in this case, for

example, cited Rembrandt Indus. Inc. v. Hodges

international, Inc., 38 N.Y. 2d 502, 381 N. V. S. 2d 451, 344

N. E. 2d 383 (1976). (App. C.13 ) The arbitration

defendant brought suit on a counterclaim, alleging that

the arbitrators had refused to consider it. The plaintiff

responded that the arbitrators had rejected the

counterclaim and that it was barred by res judicata. A

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divided New York Court of Appeals held that the lower

court had not abused its discretion in permitting res

judicata to be pleaded as a defense. Neither party

demanded arbitration so the issue was one for the court.

By contrast, when the parties have agreed to arbitrate all

their disputes, as in this case, the same court held that

arbitrators are to determine preclusion issues. Board of

Education v. Patchogue- Medford Congress of Teachers,

48 N.Y. 2d 812, 424 N.Y.S.2d 122, 399 N.E.2d 1143

(1979).

A Virginia case cited by the Alabama Supreme

Court, Waterfront Construction, Inc. v. North End 49ers,

51 Va. 417, 468 S.E.2d 894 (1996)(en banc), discusses the

role of courts and arbitrators with respect to preclusion

issues. It held that a court rather than arbitrators

should rule on the res judicata effect of an arbitration

when the parties had not agreed to arbitrate that issue.

Given the major conflict of authority amorg

the United States Courts of Appeals and the highest

courts of some states as to whether preclusion defenses

are to be ruled on by arbitrators or solely by courts, this

Petition for Certiorari should be granted. Only this

Court can provide a much needed uniform construction

of the FAA on this important and recurrent issue.

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POINT II

WHETHER COURTS MAY CREATE EXCEPTIONS

UNDER THE FEDERAL ARBITRATION ACT FOR

PRECLUSION ISSUES WHEN THE PARTIES HAVE

CONTRACTED TO SUBMIT "ALL" DISPUTES TO

ARBITRATION CALLS INTO QUESTION

IMPORTANT FEDERAL POLICIES AND THE

DIVISION AMONG THE FEDERAL AND STATE

COURTS ON THIS POINT IS WORTHY OF THIS

COURT’S ATTENTION.

The present case is a perfect vehicle for this Court

to resolve the manifest conflict among the federal Courts

of Appeals and state courts, because the question is

squarely presented without diversionary side issues. The

Merrill Lynch customers agreement provides that all“

disputes under it shall be submitted to arbitration. It

indisputably relates to interstate commerce. Nor are

there any factual disputes which detract from the clarity

of the legal issues.

The issue in this case is important and "ripe" for

determination. As this Court has noted, courts have not

suffered arbitration gladly. Bernhardt v. Polygraphic Co.

of America, 350 U.S. 198, 211 (1958). The history of

arbitration in this Court is the abrogation, step by step, of

the reluctance of lower courts to accept arbitration as a

substitute for litigation. In Allied-Bruce Terminix Cos. v.

Dobson, 513 U.S. 265 (1995), this Court summarized the

history as follows:

27

First, the basic purpose of the Federal

Arbitration Act is to overcome courts’ refusals

to enforce agreements to arbitrate.* * * The

origins of those refusals apparently lie in

“ancient times," when the English courts fought

for "extension of jurisdiction----all of them

being opposed to anything which would deprive

every one of them of jurisdiction * * *."

American courts initially followed the English

practice, perhaps just "stand[ing]... upon the

antiquity of the rule" prohibiting arbitration

clause enforcement rather than "upon its

excellence or reason"* * *, Regardless, when

Congress passed the Arbitration Act in 1925, it

was "motivated, first and foremost, bya* * *

desire" to change this antiarbitration rule* * *.

It intended courts to "enforce [arbitration]

agreements into which parties entered * * *

upon the same footing as other contracts * * *

"

*

Id. at 270.

This Court has rejected contentions 1) that the FAA

applies only in federal question cases, Prima Paint Corp. v.

Flood & Conklin, Mfg. Co., 388 U.S. 395 (1967), 2) that the

FAA does not preempt conflicting state (Alabama) anti-

arbitration law, Allied Bruce Terminix Co., supra, and 3)

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that the FAA does not supersede state law prohibiting

arbitrators from awarding punitive damages. Mastrobuono

v. Shearson Lehman Hutton, Inc., 514 U.S. 52 (1995).

Although the P.C. argued in the Alabama courts that

the FAA requires them to give effect to the agreement of the

parties that "all "their disputes should be resolved through

arbitration, there is no mention of the FAA in either the

ruling of the Alabama trial court or the decision of the

Alabama Supreme Court.

Judges who have taken it upon themselves to rule on

preclusion issues, despite agreements of the parties that all

disputes be resolved by arbitration, in effect have viewed

themselves as quasi parties to the controversy. The judges

feel free to override the agreement of the parties on the

theory that a) the judges have an independent interest in

their prior rulings and b) they have not agreed to submit

their contentions to arbitration. That is a fundamental error

which this Court should correct.

Section 2 of the FAA and the decisions of this Court

establish the importance of arbitration, and seek to

overcome the reluctance of courts to enforce arbitration

contracts. Only this Court can determine the propriety, or

impropriety, of courts extracting issues--such as preclusion

but potentially other matters as well—from arbitration,

either because they are deemed too complex or for some

other reason.

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The issue presented by this Petition is critical to the

arbitration process and currently is the subject of highly

divergent judicial decisions both on the federal and state

levels. A uniform principle needs to be be established,

because the scope of arbitration under the FAA should not

depend on the fortuity of the Circuit or state court in which

the dispute arises or be subject to forum shopping of counsel

seeking to halt arbitration. Moreover, the declaration of a

uniform principle would eliminate the unseemly business of

a court in one state (Alabama) enjoining an arbitration

ordered by a court of another state (Florida) as occurred in

this case.

CONCLUSION

This petition for a writ of certiorari should be granted.

Respectfully submitted,

Arthur R. Miller

Attorney for the Petitioner

1545 Massachussetts Ave.

Cambridge, Massachussetts 02138

Telephone: (617) 495-4111

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