ANTHONY METZ, Bankruptcy Judge
Plaintiff, Gregory S. Fehribach, Chapter 7 Trustee of Taurus Foods Inc. (the "Plaintiff") filed a complaint against Defendant Ernst Young LLP ("E Y") on June 8, 2001. That complaint is in four (4) counts, alleging negligence and breach of contract, in connection with E Y's audits of the fiscal year 1995 and 1996 financial statements of Taurus Foods, Inc. ("Taurus"). In response to E Y's motion to compel arbitration, the Plaintiff filed an Amended Complaint, dropping the two counts based on the 1996 financial statements. Thus the only counts remaining are the counts alleging negligence and breach of contract in connection with E Y's audit of Taurus's financial statements for the fiscal year 1995 (the "Claims").
Counts I and III of the original complaint alleged negligence and breach of contract with respect to the 1995 audit; Counts II and IV alleged negligence and breach of contract with respect to the 1996 audit. Although E Y issued an audit report for the 1995 financial statements, E Y did not issue an audit report for the 1996 financial statements.
E Y has moved this Court to compel the Plaintiff to submit the Claims to arbitration pursuant to the terms of a written arbitration agreement which was executed in March, 1996, after E Y issued an audit report for the 1995 financial statements. The main issue is whether that arbitration agreement applies to the Claims, and who should decide that issue. E Y has also moved to stay all proceedings pending arbitration.
Hearing on E Y's Motion to Stay Pending Arbitration and all responses, replies, surreplies and other pertinent materials, was held on April 23, 2002. Present at that hearing were Christopher A. Byrne and John C. Hoard for the Plaintiff, and Brian W. Welch and Stanley J. Parzen for E Y. The Court, having reviewed all the briefs described above and having heard oral argument on such matters, took the matter under advisement and directed counsel to submit their proposed findings of fact and conclusions of law. Counsel have complied with that directive. Accordingly, the Court now enters the following Findings of Fact, Conclusion of Law and Order, in accordance with F.R.Bankr.P. 7052.
FINDINGS OF FACT
1. Taurus is an Indiana corporation with its principal place of business in Indianapolis, Indiana.
2. E Y is a limited liability partnership doing business in, among other places, Indiana.
3. E Y issued an audit report with respect to Taurus' 1994 financial statements, concluding that the Taurus financial statements presented fairly, in all material respects, the financial position of Taurus and the results of its operations as of January 29, 1994, in accordance with Generally Accepted Accounting Principles ("GAAP"). E Y submitted a copy of that audit opinion as Exhibit 2 to its Reply.
4. In or around November, 1994, E Y and Taurus entered into an agreement whereby E Y would audit and report on the Taurus financial statements for the year ending January 28, 1995 (the "1995 audit") in accordance with Generally Accepted Auditing Standards ("GAAS"), and would prepare two tax returns, and render miscellaneous consultation.
5. There is no written reference before the Court to any contract that exists between the parties or an engagement letter describing the nature of the services to be provided by E Y with respect to the 1995 audit.
6. E Y commenced work on the 1995 audit in 1994 and completed the work in 1995. On August 4, 1995, E Y issued an audit report with respect to the 1995 financial statements, concluding that the Taurus financial statements presented fairly, in all material respects, the financial position of Taurus and the results of its operations as of January 28, 1995, in accordance with GAAP. E Y submitted a copy of that audit opinion as Exhibit 1 to its Reply.
7. Approximately seven (7) months after the 1995 audit report was issued, E Y and Taurus in March, 1996 entered into an agreement whereby E Y would audit and report on the Taurus financial statements for the year ending January 27, 1996 (the "1996 audit") in accordance with GAAS, along with the preparation of two tax returns. Ultimately, however, E Y did not issue an audit opinion on the 1996 financial statements.
8. The services that E Y was to perform with respect to the 1996 audit was set forth in an engagement letter dated March 13, 1996 (the "1996 Engagement Letter"). The 1996 Engagement Letter confirmed E Y's "engagement to audit and report on the financial statements of Taurus Foods, Inc. for the year ended January 27, 1996" and proposed a fee for its "1996 audit services".
9. The 1996 Engagement Letter also contained an arbitration provision. That provision states as follows:
Any controversy or claim arising out of or relating to the services covered by this letter or hereafter provided by us to the Company [Taurus] (including any such matter involving any parent, subsidiary, affiliate, successor in interest, or agent of the Company or of Ernst Young LLP) shall be submitted first to voluntary mediation, and if mediation is not successful, then to binding arbitration, in accordance with the dispute resolution procedures set forth in the attachment to this letter. Judgment of any arbitration award may be entered in any court having proper jurisdiction.
10. The two-page dispute resolution procedures attached to the 1996 Engagement Letter provided "the following procedures shall be used to resolve any controversy or claim ("disputes") as provided in our engagement letter of March 13, 1996." Under that language were six (6) paragraphs under the subtitle "Arbitration", of which the second paragraph provided:
Any issue concerning the extent to which any dispute is subject to arbitration, or concerning the applicability, interpretation, or enforceability of these procedures, including any contention that all or part of these procedures are invalid or unenforceable, shall be governed by the Federal Arbitration Act and resolved by the arbitrators."
11. The Controller of Taurus executed the 1996 Engagement Letter in November, 1997.
12. On January 5, 1998, three petitioning creditors filed an involuntary petition requesting that an order for relief under Chapter 11 of Title 11 of the United States Code (the "Bankruptcy Code") be entered against Taurus.
13. On February 19, 1998, the United States Bankruptcy Court for the Southern District of Indiana entered an order for relief pursuant to Rule 1013(b) of the Federal Rules of Bankruptcy Procedure (" F.R.Bankr.P.") against Taurus.
14. After the Plaintiff commenced this adversary proceeding and filed his complaint, E Y responded by filing its Motion to Stay Proceedings Pending Arbitration, to which replies and responses were filed. The Plaintiff filed his Amended Complaint on March 22, 2002, limiting the negligence and breach of contract claims to the 1995 audit.
15. In response to the Amended Complaint, E Y has renewed its motion to stay the proceedings pending arbitration.
CONCLUSIONS OF LAW
1. E Y's Renewed Motion is based on the provisions of the Federal Arbitration Act ("FAA") which provides in pertinent part that an arbitration clause in a "contract evidencing a transaction involving commerce . . . shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract." 9 U.S.C. § 2.
2. The question of whether parties to a contract agreed to arbitrate a particular dispute is a matter of contract law. The FAA does not change this; merely, its enactment "was intended to reverse centuries of judicial hostility to arbitration agreements by placing arbitration agreements upon the same footing as other contracts". Zink v. Merrill Lynch Pierce Fenner Smith, 13 F.3d 330, 333 (10th Cir. 1993) quoting Shearson/American Express, Inc. v. McMahon, 482 U.S. 220, 225-26, 107 S.Ct. 2332, 2336-37, 96 L.Ed.2d 185 (1987). Placing such agreements upon the same footing "simply requires courts to enforce privately negotiated agreements to arbitrate, like other contracts, in accordance with their terms". Collins Aikman Products Co. v. Building Systems, Inc., 58 F.3d 16, 19-20 (2nd Cir. 1995), quoting Volt Info. Sciences, Inc. v. Board of Trustees of Leiand Stanford Junior Univ., 489 U.S. 468, 478, 109 S.Ct. 1248, 1255, 103 L.Ed.2d 488 (1989). Since rules of contract construction provide the framework for enforcing arbitration agreements, it follows that not even the FAA requires the parties to arbitrate when they have not agreed to do so because "a party cannot be required to submit to arbitration any dispute which he has not agreed so to submit," United Steelworkers v. Warrior Gulf Navigation Co., 363 U.S. 574, 582 (1960),
3 The disputes between the parties here are multi-leveled: the first level is whether E Y was negligent and breached its contract entered into with Taurus with respect to the 1995 audit, i.e. the merits of the case. The second level is whether the parties agreed to arbitrate the merits of the case. The third level is "who should have the primary power to decide" the second level dispute — do the arbitrators or does the court decide whether the parties agreed to arbitrate the merits of the case? First Options of Chicago v. Kaplan, 514 U.S. 938, 942 (1995). The third, or threshold level dispute, must first be considered.
4. Unless the arbitration agreement commits the decision of who decides to the arbitrator, the court decides arbitrability. First Options, 514 U.S. at 944. In First Options, the Supreme Court set forth the test for determining the threshold choice of forum question of who — court or arbitrator — has the primary authority to determine whether a party has agreed to arbitrate:
Just as the arbitrability of the merits of a dispute depends upon whether the parties agreed to arbitrate that dispute . . . so the question "who has the primary power to decide arbitrability" turns upon what the parties agreed about that matter . . .514 U.S. at 943. (citations omitted).
5. In deciding what the parties agreed to about "that matter" — arbitrability — "ordinary state-law principals that govern the formation of contracts" should control. First Options, 514 U.S. at 944. Unlike the "presumption of arbitrability" that exists with respect to disputes over whether the parties agreed to arbitrate the merits of the claim, when it comes to whether the parties agreed to arbitrate arbitrability, the "[c]ourts should not assume that the parties agreed to arbitrate arbitrability unless there is `clea[r] and unmistakable' evidence that they did so." First Options at 944-45. The reason for this difference lies in the fact that when parties have a contract that provides for arbitration of some issues, "the parties likely gave at least some thought to the scope of the arbitration", but with respect to who decides whether the parties agreed to arbitrate the merits, "a party often might not focus upon the question or upon the significance of having arbitrators decide the scope of their own powers". First Options at 945.
6. Using the methodology described in First Options, the court looks to the language of the contract and applies state-law contract principles. The "who decides arbitrability" clause set forth in the dispute resolution procedures attachment provided that the procedures were to be used to resolve " any controversy or claim ("disputes") as provided in our engagement letter of March 13, 1996." (emphasis added), and provided:
. . . Any issue concerning the extent to which any dispute is subject to arbitration, or concerning the applicability, interpretation, or enforceability of these procedures, including any contention that all or part of these procedures are invalid or unenforceable, shall be governed by the Federal Arbitration Act and resolved by the arbitrators." (emphasis added).
7. A fair reading of this provision clearly provides that the arbitrator is the proper person to decide which disputes are arbitrable pursuant to the 1996 Engagement Letter, i.e., those disputes which arose out of or related to the services performed with respect to the 1996 audit. However, the 1996 Engagement Letter was executed seven months after the 1995 audit and covered exclusively the 1996 audit. There is no express provision that the "dispute resolution procedures" set forth in the attachment to the 1996 Engagement Letter were to be applied retroactively; the coverage was limited to disputes as provided for in the 1996 Engagement Letter. The method by which the pre-1996 audit claims were to be resolved was not expressly stated in the 1996 Engagement Letter, and therefore, from a contract construction perspective, the 1995 audit claims do not "reasonably fit within the specific language the parties used in the agreement". Mislenkov v. Accurate Metal Detinning, Inc., 743 N.E.2d 286, 291 (Ind.App. 2001). With no "clear and unmistakable evidence" that the parties intended for the arbitrators to decide whether the 1995 audit claims should be arbitrated, the court will decide the issue.
In Mislenkov, the plaintiff, Mislenkov had worked for the defendant, Accurate Metal, for nearly eighteen months, until June 1, 1997, when the employment relationship was terminated. Twelve days later, on June 12, 1987, the parties signed an employment agreement and release which invalidated all prior agreements and which also contained a provision which provided for arbitration of disputes "arising out of or relating to this Agreement". Later, Accurate Metal sued Mislenkov and alleged that, prior to June 1, 1997, Mislenkov purloined Accurate Metal's technology and customers. The Court of Appeals determined that the pre-agreement claims did not "fit" into the language of the arbitration provision, and that the arbitration provision covered disputes arising out of the agreement, not the parties employment relationship.
8. It is true that this Court found a similar clause contained in a similarly worded E Y engagement letter to mean that the arbitrator decides this issue. See, Order dated September 21, 2000, Baker O'Neal Holdings, Inc. et al. v. Ernst Young LLP et al., Adversary Proceeding No. 99-518, at 12 (emphasis in original). However, Baker O'Neal is distinguishable.
Ultimately, this court denied arbitration for reasons related to the terms of an order confirming Baker O'Neal's chapter 11 plan and unrelated to the scope or interpretation of the arbitration clauses contained in the agreement between the parties.
In Baker O'Neal, the debtor in possession sued E Y and an E Y partner under both bankruptcy and state law theories. Among the state law theories alleged were fraud, breach of fiduciary duty, negligence, breach of contract and aiding and abetting a breach of fiduciary duty. In a previous but unrelated adversary proceeding in the Baker O'Neal bankruptcy, Baker O'Neal, the corporate chapter 11 debtor, had sued and had obtained a judgment against the president/ CEO of Baker O'Neal and related corporation American Public Automotive Group ("APAG") under Bankruptcy Code Section § 548 (fraudulent transfer) as well as the Indiana Fraudulent Transfer Act as a result of the principal's misappropriation of corporate funds. The factual allegations in the complaint against E Y alleged that E Y had knowledge of and participated in the principal's misappropriation of corporate funds because it was aware of the principal's deteriorating financial condition and that, though its analysis and modification of the corporate balance sheets and income statements for 1994 through 1997, knew that the amounts taken out by the principal and disguised as "loans" could never be repaid and should not have been listed as an asset of the corporation.
Although E Y and Baker O'Neal didn't enter into engagement letters until October, 1996 and August, 1997, the funds misappropriated by the principal appeared as a loan" on the corporate balance sheets for 1995, 1996 and 1997. The factual allegations alleged, in part, that during the period of 1994 through 1997, E Y knew of the principal's precarious financial condition, and yet classified the amounts misappropriated by the principal as "loans" and reported them as "assets" of the corporation when in fact E Y knew them to be, or should have known they were valueless. These factual allegations — at least with respect to E Y's alleged acts in 1996 and 1997 — arguably arose out of or were related to the services E Y agreed to provide in its 1996 and 1997 engagement letters.
Because the primary dispute between the parties was covered at least in part by the arbitration provision, the court held that it was the arbitrator who decided the scope of the arbitration clause, to the extent it was enforceable, and cited Trott v. Paciolla, 748 F. Supp. 305, 308-09 (E.D. Pa. 1990). In Trott, the broad arbitration clause provided for arbitration of any controversy between the parties "arising out of your business or this agreement". The plaintiff sued their broker and his two employers under state common law theories for breach of contract, breach of fiduciary duty, conversion, fraud and negligence as well as for violations of the Securities Exchange Act and state securities laws. The plaintiffs began their business relationship with the broker in 1979 but did not sign agreements (which contained arbitration clauses) until 1982 and 1984 when they signed a "customer agreement" and a "standard option agreement". The plaintiffs argued that claims arising from the defendants' actions from 1979 to 1982 should not be subject to arbitration because no agreement was in place until 1982. The Trott court rejected this argument and considered it a question of the scope of the arbitration agreement, which it held should be left to the arbitrators. Trott, 748 F. Supp at 308-09. The arbitration clauses spoke in terms of relationships, and not timing, and were broad enough to encompass pre-agreement claims that nevertheless arose out of the business relationship; determination as to what extent the claims were covered was left to the arbitrators.
9. Having concluded that the court decides whether the merits of the dispute are to be arbitrated, the court next turns to the "second level" issue — whether the merits of the dispute here are to be arbitrated. The first step in this process is whether the parties agreed to arbitrate the particular dispute between them. Mehler v. Terminix International Company, L.P., 205 F.3d 44, 47 (2nd Cir. 2000); see also, P.M. Perez Associates, Inc. v. Welch, 960 F.2d 534, 538 (5th Cir. 1992). Again, the starting point for such determination is the contract itself. Assuming the contract contains an arbitration clause, the scope of the arbitration clause, for the purpose of determining whether the dispute is covered by it, is a question of federal contract law. Kittay v. Landegger, et al (In re Hagerstown Fiber Limited Partnership), 277 B.R. 181 (Bankr. S.D.N.Y. 2002); Mehler, 205 F.3d at 47.
10. In determining whether the parties agreed to arbitration, the court must consider whether the arbitration clause is narrow or broad. Although a "narrow" or a "broad" arbitration clause is not capable of an exact definition, each has certain attributes. Clauses that are "time based" and not "relationship based" would be less broad and more susceptible to being defined as "narrow". If an arbitration clause is classified as "narrow", then the court considers whether the dispute "is on its face within the purview of the clause" or whether the dispute involves a collateral issue "that is somehow connected to the main agreement that contains the arbitration clause". Hagerstown, 277 B.R. at 198. To make this inquiry, the court must look to the "factual allegations underlying the dispute to determine whether they implicate issues of contract construction of the parties' rights and obligations thereunder. If they do, the collateral dispute is subject to arbitration; otherwise, it is beyond the scope of the parties' agreement to arbitrate". Hagerstown, 277 B.R. at 198; Collins, 58 F.3d at 23.
11. However, clauses that provide for arbitration of disputes "arising under or related to, or in connection with" certain business relationships and impose no time restriction have consistently been held to be "broad" arbitration clauses. See, for example, Trott v. Paciolla, 748 F. Supp. 305, 308 (E.D. Pa. 1990) (where one of the two agreements at issue provided for arbitration of "any controversy between us arising out of your business or this agreement"); Zink v. Merrill Lynch Pierce Fenner Smith, 13 F.3d 330, 331-32 (same provision, "any controversy between us arising out of your business or this agreement"); Rand Bond of North America, Inc., v. Saul Stone Co., 726 F. Supp. 684, 687 (N.D. III., 1989) ("any controversy or claim arising out of or relating to your accounts); Kiefer Specialty Flooring, Inc. v. Tarkett, Inc., 174 F.3d 907, 909 ("any controversy or claims arising out of or relating to [certain agreements between the parties]"); Perez, 960 F.2d at 539 ("any controversy between us arising out of or relating to the contract or the breach thereof and "any controversy arising out of the handling of any of the transactions referred to in this agreement"); Hagerstown Fiber Limited, 277 B.R. at 190 (any "dispute or matter in controversy [that] arises between the [o]wner and the [c]ontractor under this agreement").
12. As in the case of narrow arbitration clauses, the underlying factual allegations of the dispute must be examined to determine whether the dispute comes within the coverage of even broad arbitration agreements. However, in this context, the presumption is "reversed"; there is a presumption that the dispute is arbitrable and the court must compel arbitration "unless it may be said with positive assurance that the arbitration clause is not susceptible of an interpretation that covers the asserted dispute". Collins, 58 F.3d at 19; See also, First Options, 514 U.S. at 945. Stated another way, "if the allegations underlying the claims "touch matters" covered by the parties' . . . agreements, then those claims must be arbitrated". Collins, 58 F.3d at 21 quoting Genesco, Inc. vT. Kakiuchi Co. Ltd., 815 F.2d 840, 846 (2nd Cir. 1987); Mehler, 205 F.3d at 50.
13. The arbitration clause here can best be described as narrow; it refers to an agreement that is limited in scope and reach. Specifically, the arbitration clause provides that "any controversy or claim arising out of or relating to the services covered by this letter or hereafter provided by us". The "services covered by this letter" were services "to audit and report on the financial statements of Taurus Foods, Inc. for the year ended January 27, 1996"."
14. Using the 1996 Engagement Letter as a backdrop, are the factual allegations underlying the dispute on their face "within the purview" of the arbitration clause? If they are, the dispute is subject to arbitration; otherwise, it is beyond the scope of the parties' agreement to arbitrate.
15. Generally, the factual allegations refer to E Y's alleged failure to spot "red flags" that occurred in January 1994 through January 1995, and that, despite having knowledge by August 1995 of irregularities that occurred within that period, E Y nevertheless issued a "clean" audit opinion for 1995. Specifically, the Plaintiff states that the Defendant was aware of certain information, including a four year downward trend in net sales and that Taurus' operating income barely covered high fixed costs; that, by August 1995, the Defendant was aware of additional information, including the "unusually high" inventory levels, continued decrease in sales, and that operations were depleting instead of generating cash; that the Defendant did not compare the financial information it had available by August 1995 with similar financial information dating from 1994 to determine if the changes were the result of ongoing financial problems, as required by GAAS; and that the Defendant did not make a "going concern" inquiry of Taurus' management as required by GAAS.
16. The 1996 Engagement Letter, to which the only arbitration clause in this case refers, covers services rendered only with respect to the 1996 audit. To perform the 1996 audit (which was never issued here), E Y would have to look back to the financial statements for 1995 (which had already been completed), but to perform the 1995 audit, which is the subject of the dispute here and for which there is no express arbitration agreement, E Y would have to look back to the financial statements for 1994 (for which there is no engagement letter). In other words, in performing the 1995 audit, E Y would not be considering trends which occurred during the time period covered by the 1996 Engagement Letter inasmuch as this time period was in the future. Any trends that occurred after January 1995 would be included in the 1996 audit, and allegations that E Y was negligent in failing to spot ominous trends that occurred in 1995 would be covered by the 1996 Engagement Letter, since the "lookback" period in performing the 1996 audit would have included 1995. However, no such allegations currently exist, and the only allegations still before this court allege negligence in performing the 1995 audit, either by failing to pick up on ominous trends that occurred in 1994, or, failing to revise the 1995 audit opinion after certain financial information from 1994 to 1995 came to light later in 1995. But the services used to do that would have still been limited to looking at the financial statements from January 1994 to January 1995, and would not have been any of the services described under the 1996 Engagement Letter. The arbitration clause in the 1996 Engagement Letter is prospective in nature as it covers only services to be rendered with respect to the "1996 audit" or services rendered thereafter. As the 1995 audit was completed prior to the execution of the 1996 Engagement Letter, it is clear that the dispute on its face is not within the purview of the 1996 Engagement Letter. However, even if the arbitration provision is classified as a broad one, it cannot be said that the allegations underlying the claims "touch matters" covered by the 1996 Engagement Letter, and therefore, the court concludes that there was no agreement between the parties to arbitrate the Claims.
If the arbitration clause had provided for arbitration of "any controversy or claim arising out of or relating to the services covered by this letter or heretofore or hereafter provided", this clause would not have been so time specific, but the word "heretofore" is not found in the 1996 Engagement Letter which makes it prospective rather than retroactive in nature.
17. The court is well aware of the cases that hold that arbitration clauses can extend to disputes that arose prior to the execution of the arbitration agreement, but those cases that have so held either contained arbitration clauses that cover open-ended ongoing business or professional relationships not limited to specific time periods, or the disputes arose during the time period specified. See e.g. Rand Bond of North America, Inc. v. Saul Stone Co., 726 F. Supp. 684, 687-88 (N.D. III. 1989) (arbitration agreement covering "[a]ny controversy or claim arising out of or relating to your accounts"); Zink v. Merrill Lynch Pierce Fenner Smith, 13 F.3d 330, 331-32 ("any controversy between us arising out of your business or this agreement", with no time limitation contained in the agreement); Mehler, 205 F.3d at 47 ("any controversy or claim between [the parties] arising out of or relating to this agreement", where the agreement itself did not put a time restriction on the extermination services to be rendered); Collins, 58 F.3d at 20 ("any claim or controversy arising out of or relating to the agreement", again, where the agreement did not limit the business relationship between the parties to a specific time frame); Becker Autoradio, U.S.A., Inc. v. Becker Autoradiowerk, et. al, 585 F.2d 39, 41 (the arbitration court shall have sole jurisdiction over "all disputes arising out of and about this agreement", where the purported promise to extend an exclusive distributorship agreement occurred within the time period covered by the 1974 agreement); Zink v. Merrill Lynch Pierce Fenner Smith, Inc., 13 F.3d 330, 332 (10th Cir. 1993) (where arbitration clause applied to "any controversy between us arising out of your business or this agreement,"); see also, R.M. Perez Assoc., Inc. v. Paine Webber Jackson Curtis, 960 F.2d 534, 539 (5th Cir. 1992) (broadly worded arbitration agreement applied to disputes even where party did not sign the agreement until after the complained of transactions took place).
18. The arbitration clause here, albeit broad, refers to an agreement that covers services to be rendered for a defined and specific time, and the Claims alleged do not cover those services. Accordingly, the parties did not agree to arbitrate the Claims, and will therefore be tried before this court. The Defendant's Renewed Motion to Stay Proceedings Pending Arbitration is DENIED.
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