Thursday, March 2, 2017
C.A. Overturns $30 Million Arbitration Award
Panel Says Defendant Entitled to Reasonable Notice of Potential Punitive Damages
By a MetNews Staff Writer
A businessman, who was hit with a $30 million-plus award following an arbitration hearing he did not attend, was deprived of fundamental fairness because he was not given notice of the potential for an award of punitive damages, the Fourth District Court of Appeal ruled yesterday.
Div. One said San Diego Superior Court Judge Jacqueline Stern erred in confirming the award in favor of several investors against Stephen Kaplan and Houston LLC. The plaintiffs had invested in a self-storage facility in Texas, and claimed that the defendants had breached fiduciary duties in connection with the investment.
According to news accounts, Kaplan; his father Howard Kaplan; and his brother Eric Kaplan were the principals of Equity Based Services, which sold investment units in self-storage facilities around the country.
The Kaplans were accused of imposing excessive fees, commingling funds between different storage projects, and raising more money than necessary for acquisitions. At its height, EBS acquired 77 self-storage businesses, marketing them as separate syndication deals to investors, one report said.
The report said EBS regularly paid returns between 2002 and 2010, but Howard Kaplan began shifting funds from some self-storage syndications in 2006 to pay preferred returns promised to investors who had bought into underperforming ventures.
The Kaplans pled guilty to wire fraud charges in 2015. U.S. District Judge Cathy Ann Bencivengo sentenced Howard Kaplan to six month in custody and six months in home detention, Stephen Kaplan to a year in home detention, and Eric Kaplan to five years’ probation.
A suit by the Texas investors was filed in San Diego Superior Court, where the defendants moved to compel arbitration. The motion was granted without opposition, but arbitration was stayed due to the pendency of the criminal case.
Between Stephen Kaplan’s plea and sentencing, a telephonic arbitration hearing was scheduled, with about two-and-a-half weeks’ notice. The day before the hearing, the plaintiffs’ counsel emailed a brief increasing the original damages claim and asking for punitive damages for the first time.
The arbitrator awarded more than $30.835 million, without specifying the grounds or nature of the award. Kaplan’s request to vacate or modify the award was never heard, because the arbitrator recused himself from all further arbitration proceedings and the arbitration administrator declined to reassign the case.
Kaplan then moved to vacate the award, while the plaintiffs moved to confirm it. Stern ruled for the plaintiffs, and judgment was entered for the amount of the award.
Justice Judith Haller, however, writing for the Court of Appeal, said the award of punitive damages violated the rules of the American Arbitration Association, which were incorporated by reference into the arbitration agreement.
Under those rules, the arbitrator may only award remedies of which the parties had reasonable notice, and at least 14 days’ notice must be given of “[a]ny new or different claim or counterclaim,” Haller noted. In addition, if the new or different claim is offered after an arbitrator has been appointed, the arbitrator must consent to its submission.
The plaintiffs argued that their belated request for punitive damages was not a new or different claim. But even if it wasn’t, Haller said, the notice given—less than 24 hours—was inadequate under the AAA rules and under principles of fundamental fairness, particularly since the plaintiffs knew that Kaplan was unrepresented in the civil case and was awaiting sentencing.
The justice also rejected the argument that Kaplan wasn’t prejudiced because he had already decided not to appear. Haller reasoned that Kaplan might have retained counsel or appeared, at least to oppose the punitive damages request, given that the award substantially exceeded the $1 million prayed for in the initial arbitration claim and the $10 million prayed for in the Superior Court complaint.
Haller went on to say that there were further procedural irregularities requiring that the award be vacated, including the lack of a showing that Kaplan had notice of prior hearings and orders, an ambiguity as to how much the plaintiffs were claiming in compensatory damages, and the administrator’s refusal to reassign the case. The concern about those irregularities is heightened, the justice said, in light of the size of the award.
Because the arbitrator did not specify how much of the award was punitive damages, the entire award must be vacated, the justice concluded.
The case is Emerald Aero, LLC v. Kaplan, 17 S.O.S. 1051.
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