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Hebbronville Lone Star Rentals, LLC v. Sunbelt Rentals Industrial Services, LLC

United States District Court, W.D. Texas, Austin Division

March 15, 2017

HEBBRONVILLE LONE STAR RENTALS, LLC, et al.
v.
SUNBELT RENTALS INDUSTRIAL SERVICES, LLC

          REPORT AND RECOMMENDATION OF THE UNITED STATES MAGISTRATE JUDGE

          ANDREW W. AUSTIN, UNITED STATES MAGISTRATE JUDGE

         TO: THE HONORABLE ROBERT PITMAN UNITED STATES DISTRICT JUDGE

         Before the Court are Plaintiffs' Motion for Vacatur (Dkt. No. 8); Defendant Sunbelt Rentals Industrial Services, LLC's Response in Opposition to Plaintiffs' Motion (Dkt. No. 12); and Plaintiffs' Reply (Dkt. No. 13). The District Court referred the above motion to the undersigned Magistrate Judge for report and recommendation pursuant to 28 U.S.C. §636(b)(1)(A), Fed. R. Civ.

         P. 72, and Rule 1(c) of Appendix C of the Local Rules.

         I. GENERAL BACKGROUND

         Hebbronville Lone Star Rentals, LLC and its owners Samuel and Leslie Lovett (collectively “Lone Star”) bring this suit against Sunbelt Rentals Industrial Services, LLC. Lone Star moves to partially vacate an arbitrator's award. It challenges the award on the basis of 9 U.S.C. § 10(a)(4), arguing that the arbitrator exceeded his powers.

         A. Asset Purchase Agreement Terms

         This suit is based on an asset purchase agreement (Agreement) executed on August 1, 2014, by which Sunbelt acquired the assets of Lone Star. As part of the Agreement, Sunbelt agreed to pay Lone Star, post-closing, three contingent payments, the details of which are set forth in Section 3.5 of the Agreement. Only the first contingent payment is at issue here. Whether a payment is due depends on whether receipts from certain pre-closing customers of Lone Star reach a specified level. The Agreement refers to these as “Business Customers” and lists them in Schedule 3.5(a)(iii) of the Agreement. It refers to the target amount as the “Threshold” or “Contingent Payment Threshold.” The Agreement provides that if Sunbelt's revenues from these customers for certain defined time periods meet or exceed the Threshold, then Lone Star is entitled to an additional payment from Sunbelt. For the initial time period, the additional base payment is $7, 000, 000. The Agreement further provides that if the revenues are less than 100%, but at least 90%, of the Threshold, then Lone Star is entitled to the $7, 000, 000 contingent payment, less two times the percentage difference below 100% that the revenues represent, times $7, 000, 000. See Agreement § 3.5(d)(ii) (Dkt No. 9-1 at 16). If, however, the revenues for the period are less than 90% of the Threshold, then no payment is due. The Threshold is a sum certain set out in § 3.5(a)(ii) of the Agreement; for the first period it is $36, 265, 141.50. Dkt. No. 9-1 at 14.[1] Thus, for Lone Star to receive any additional payment for the initial period, Sunbelt's revenues from Business Customers would have to have been at least 90% of the Threshold, or $32, 638, 627.35.

         Section 3.5 also addresses the resolution of disputes regarding Sunbelt's revenue calculations for each of the three contingent payments. The process called for Sunbelt to provide Lone Star with its calculation of the revenue from Business Customers from the relevant period within 30 days of the end of that period. Lone Star then had 30 days to decide whether it accepted the calculation. If Lone Star “believe[d] such Revenue Calculation was not determined in accordance with this Agreement, ” it was to provide Sunbelt notice of its dispute in “reasonable detail, ” along with its proposed adjustments. Dkt. No. 9-1 at 15 (§ 3.5(b)). The parties were then to negotiate in good faith to resolve the dispute, but if those negotiations did not resolve all disputes within 20 days, Lone Star and Sunbelt were to “jointly select the Accounting Firm to resolve any remaining dispute over [Lone Star's] proposed adjustments.” Id. The Agreement in a separate section provides that “[e]xcept for disputes resolved as set forth in Sections 3.3, 3.4, 3.5, and 3.6, the Parties hereby irrevocably submit to the exclusive jurisdiction of the federal or state courts of the State of Texas any Proceeding arising out of or relating to this Agreement or any of the Transactions. . . .” Dkt. No. 9-2 at 12.[2]

         B. The First Contingent Payment

         Shortly after the end of the first period, Sunbelt provided to Lone Star the revenue calculations for the first period. According to Sunbelt's calculations, Lone Star was $1.3 million short of 90% of the Threshold. Lone Star responded, stating it disagreed with Sunbelt's revenue calculations for two customers. With the first, COG Operating LLC (COG), Sunbelt had excluded a significant portion of the revenues because COG was listed under a different name on Sunbelt's accounts-COG Operating, LLC (the difference being the existence of a comma prior to “LLC”). Sunbelt argued that COG (with a comma) was not a Business Customer that should have been included in the revenue calculations. Alternatively, Sunbelt contended that because the pre-acquisition revenues from COG (with a comma) had not been included in the calculations leading to the parties' agreement on the Threshold, the post-acquisition revenues should similarly not be included in the first period revenue calculations, regardless of whether it was the same customer. Lone Star disagreed, arguing that COG was a Business Customer, and under the plain language of the Agreement all of its revenues must be included in the first period revenue calculation. For the second implicated customer, BHP Billiton, Sunbelt had completely excluded its revenues from the calculation. Lone Star objected to this, as BHP had recently acquired Petrohawk Energy LLC, and Petrohawk was an identified Business Customer. Lone Star believed all of BHP's revenues should be included in the revenue calculation as Sunbelt had improperly attributed much of Petrohawk's revenues as belonging to BHP. Sunbelt disagreed, and in fact, during negotiations further reduced the revenues it attributed to Petrohawk.

         Sunbelt and Lone Star were unable to agree on the calculation of the revenue derived from these two customers, and subsequently submitted the dispute to Dennis Neier of Anchin, Block & Anchin LLP, an accounting firm. The parties signed an engagement letter, which stated that the arbitrator was to resolve “their disagreement as to whether the threshold amount for the First Contingent Payment Period has been met, and if the threshold amount has been met, the amount of the First Contingent Payment.” Dkt. No. 9-10 at 3. The letter further provided that no discovery would be permitted, “except for the production by [Sunbelt] to [Lone Star] of certain invoices in connection with whether the threshold amount . . . has been met, ” but that the parties were to provide all documents “reasonably requested” by the arbitrator. Id. at 8. The letter also stated that at any hearing only the arbitrator-and not the parties-would be permitted to ask questions. Id. at 9. The engagement letter noted that the arbitrator retained the “sole discretion” to engage independent legal counsel, but if he wished to be reimbursed for those costs, he was required to seek approval from the parties in advance of incurring such costs. Id. at 10.

         C. The Arbitrator's Decision

         In a 98 page “Reasoned Decision and Award, ” the arbitrator found that Lone Star was not entitled to any sums for the First Contingent Payment. The first part of the decision is unchallenged. Here, the arbitrator found that all the revenues from COG (both with and without a comma) and a percentage of the revenues from BHP/Petrohawk should have been included in the revenue calculation. Both COG entities were found to be the same company and therefore a Business Customer and the revenues attributed to both were to be included in the revenue calculation. With regard to BHP, the arbitrator found that it and Petrohawk were not the same company. However, he agreed with Lone Star that Sunbelt had improperly attributed some of Petrohawk's (a Business Customer) revenues to BHP (not a Business Customer). As it was difficult to determine the specific amount that should have been attributed to Petrohawk, the arbitrator decided that a percentage of BHP's revenues would be added to the revenue calculation. With these two changes, the arbitrator determined that the total revenue from Business Customers for the first period was $34, 820, 837.22. Because this figure equates to 96% of the first period Threshold figure stated in the Agreement, had the decision ended here, Lone Star would have been entitled to a reduced Contingent Payment of $6, 440, 000 under Section 3.5(d)(ii).

         However, the arbitrator did not end his decision here. Sunbelt contended that the parties had made a mutual mistake when they calculated the Threshold amount. Specifically, Sunbelt argued that the Threshold was intended to represent the pre-closing trailing twelve month revenues of the “Business Customers” listed in Schedule 3.5(a)(iii) of the Agreement, businesses that were customers of Lone Star before the acquisition. Sunbelt contended that the Threshold was supposed to be the sum of Lone Star's revenues for all Business Customers, plus Sunbelt's pre-acquisition revenues for the same customers, for the twelve months leading up to the closing. Sunbelt argued that it and Lone Star mutually erred in calculating what the twelve month revenues for these customers had been, when they left out of the Threshold amount the parties' pre-closing revenues from COG (with a comma). Had they included those revenues in the calculation, Sunbelt argued, the Threshold figure stated in the Agreement would have been significantly higher. Relying on these facts, Sunbelt contended that the arbitrator should reform the Agreement to correct the error based on the mutual mistake doctrine under Texas law.

         Lone Star objected to this, and objected to the arbitrator's power to even address the issue. Disagreeing, the arbitrator found that whether the Agreement should be reformed was within the scope of the dispute the parties agreed to arbitrate before him. His reasoning was that “one of the ‘remaining dispute[s]' under Section 3.5 of the Agreement is whether the Contingent Payment Threshold has been met. That question necessarily turns on whether Section 3.5(a) . . . can be reformed due to mutual mistake of the Parties.” Dkt. No. 9-7 at 4. After determining he had the power to decide Sunbelt's mutual mistake argument, the arbitrator moved to the merits and decided that the Agreement should be reformed. He found that the parties made a mutual mistake in calculating the figure listed in the Agreement as the Contingent Payment Threshold. Because he found the parties intended the Threshold to be the twelve-month trailing revenues of all the Business Customers, the revenues from COG (with a comma) should have been included in the calculation. He further found that the omission of those revenues was a mistake of both parties. He thus reformed the Agreement reflecting this change, which increased the Threshold for the first period from the $36, 265, 141.50 stated in the Agreement to $39, 606, 349. Using the figure he had earlier found to be the correct amount of Business Customer revenue for the first period-$34, 820, 837.22-he concluded that the first period revenue represented only 88% of the reformed Threshold amount, and, therefore, Lone Star was not entitled to the any first Contingent Payment Amount.

         Lone Star moves to vacate the award on two bases. Lone Star argues that reformation of the agreement is outside the scope of the arbitration agreement, and thus this part of the decision should be vacated. Second, Lone Star argues that even if the arbitrator had the power to reach the issue, he manifestly disregarded Texas contract law in finding that the parties had made a mutual mistake.

         II. LEGAL STANDARD

         The Federal Arbitration Act (FAA) was enacted to codify “the national policy favoring arbitration and place[] arbitration agreements on equal footing with all other contracts.” Buckeye Check Cashing, Inc. v. Cardegna, 546 U.S. 440, 443 (2006). Thus, a court's review of an arbitration award is limited. First Options of Chi., Inc. v. Kaplan, 514 U.S. 938, 943 (1995). The FAA provides that a court may vacate an award:

(1) where the award was procured by corruption, fraud, or undue means;
(2) where there was evident partiality or corruption in the arbitrators, or either of them;
(3) where the arbitrators were guilty of misconduct in refusing to postpone the hearing, upon sufficient cause shown, or in refusing to hear evidence pertinent and material to the controversy; or of any other misbehavior by which the rights of any party have been prejudiced; or
(4) where the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the ...

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