On The Case

In diamond moguls’ fight over $200 million arbitration award, jurisdiction was key

(Reuters) - The well-chronicled Israeli billionaire Lev Leviev, sometimes called the “King of Diamonds,” won confirmation this week of an arbitration award against another international diamond dealer, Julius Klein, in federal court in Manhattan. All told, Leviev’s judgment against the Klein entities, which had been his partners in three joint ventures, totals about $209 million.

That number, as well as Leviev’s outsized persona, made U.S. District Judge Jesse Furman’s just-unsealed opinion fodder for the New York tabloids – especially because one of the arbitrators who originally awarded Leviev all of that money was convicted of tax fraud in Belgium in the middle of the Klein arbitration. Litigation over the validity of arbitration awards is usually pretty dry stuff. The facts of the Leviev case are about as sexy as these things get.

But there’s also a pretty interesting legal question at the heart of Judge Furman’s opinion. This case mostly hinged on the appropriate jurisdiction for the Kleins’ challenge to the arbitration award, since New York State Supreme Court and federal district courts are guided by different precedent on the significance of an arbitrator’s criminal record. The Kleins, as you’ll see, tried to use Leviev’s own previous resort to state court against him. Leviev, meanwhile, had to convince Judge Furman that he was a defendant, even though he was the one who initiated the arbitration. In the end, Judge Furman said, the Kleins lost their “far from frivolous” attack on the arbitration award because federal law requires deep deference to the arbitrators’ decisions. Had the challenge been heard in state court, the outcome – and the tabloid headlines – might have been quite different.

Leviev brought the arbitration in February 2013, after he and the Kleins couldn’t reach an agreement on a fair buyout price from their 10-year joint venture. (This account is drawn from Judge Furman’s opinion.) Leviev and the Kleins each chose one arbitrator; the arbitrators selected the third member of their panel, Jacob Bronner. Bronner, like the other two arbitrators (and, for that matter, Leviev and the Kleins) is in the diamond business. He disclosed that he had professional relationships with the other arbitrators and a social acquaintance with Leviev but said those engagements should not create justifiable doubt about his impartiality.

At around the same time as Bronner’s appointment, Leviev filed a petition in New York State Supreme Court, seeking a preliminary injunction against the Kleins for the duration of the arbitration. The state court judge denied the petition, holding that Leviev should address his request for an injunction to the arbitrators. In December 2013, the arbitration panel awarded Leviev an interim judgment of $102 million. In 2014, after the Kleins paid him about $67 million, Leviev went back to state court to have the $102 million interim award confirmed.

The Kleins opposed confirmation, arguing both that it was premature because the award was not final and that Bronner had engaged in misconduct by failing to disclose the extent of his relationship with Leviev. The state court judge agreed Leviev had jumped the gun by seeking confirmation of an interim award but also ruled that the Kleins had waived the right to object to Bronner’s participation on the panel because they allowed the arbitration to proceed after they learned of his connections to Leviev.

In early 2016, after more unpleasantries involving alleged conflicts amongst the arbitrators, the panel held a seven-day hearing in Israel. Before the arbitrators ruled, however, the panel’s own counsel disclosed to Leviev and the Kleins that Bronner had been convicted in Belgium, along with about 100 other defendants, “of tax fraud and other offenses relating to a scheme involving the use of sham transactions to nominally export diamonds from Belgium while, in fact, reselling them on the black market,” as Judge Furman described the offense.

The Kleins asked Bronner to resign from the panel. He and the panel decided he would remain an arbitrator on the case. The panel issued its award in June 2016, granting Leviev $112 million in addition to the $67 million the Kleins already paid him, plus interest.

The Kleins filed a challenge to the award in New York State Supreme Court – the same jurisdiction, you will recall, where Leviev had sued to confirm the interim award. But this time around, Leviev had a different strategy. He sued in Manhattan federal court to confirm the final award. He also removed the Kleins’ state-court challenge to federal court.

Why did the two sides want to proceed in different jurisdictions? I should first point out that both the Kleins and Leviev brought in new lawyers after the arbitration to fight over confirmation – Steptoe & Johnson for Leviev and Cooley for the Kleins. Cooley was banking on a 2001 New York State Supreme Court decision called Velez v. J.C. Contracting, in which the court vacated an arbitration award because one of the arbitrators had been convicted of bribery and hadn’t disclosed that conviction to the parties. The state court, deciding the case under New York law, said the arbitrator’s conduct “tainted the integrity of the arbitration process and created an appearance of impropriety” – obviously very helpful language for the Kleins.

But federal case law backed Leviev. In 2002, the 7th U.S. Circuit Court of Appeals held in United Transportation Union v. Gateway Western Railway that an arbitrator’s undisclosed felony conviction did not require vacating an award to the union. The arbitrator’s conviction was not related to the issues in the arbitration, Judge Richard Posner wrote in the 7th Circuit’s opinion. And to allow the railroad to overturn the award based on the arbitrator’s unrelated misconduct, Judge Posner said, “would encourage losing parties to an arbitration to conduct a background check on the arbitrators, looking for dirt - a particularly questionable undertaking because arbitrators, unlike judges, are not subjected to background checks when appointed.”

I’m not saying jurisdiction was the only factor in this complicated case, but it was an awfully big one. Cooley argued for the Kleins that Judge Furman should allow a New York court to hear its challenge because Leviev himself had gone to state court earlier in the case. Only defendants can remove state-court suits to federal court, the Kleins contended, and Leviev wasn’t a defendant because he initiated state court litigation. The Kleins also said Judge Furman didn’t have subject matter jurisdiction under the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards because the entities in the arbitration were New York citizens engaged in domestic business.

That was an easy argument to refute, according to Judge Furman, because the Leviev and Klein entities were indisputably involved in the international diamond trade. Removal of the state court case was a tougher question, but Judge Furman ended up siding with Leviev on that point as well.

“To be sure, LGC initiated the state-court proceedings in the first instance by filing its petition for injunctive relief in aid of arbitration and, later, seeking confirmation of the interim award. But once the arbitration commenced, there was nothing pending in state court until the Kleins filed their petition to vacate the award.” As of the moment the Kleins filed, Furman said, the Kleins controlled the suit and Leviev was defending it, regardless of how New York captioned the suit. (Furman’s opinion delves deeply into precedent on the issue but I will spare you.)

The Kleins’ last hope was persuading Judge Furman to apply New York law, rather the Federal Arbitration Act, but the judge said federal law applies because Leviev and the Kleins had not specified otherwise in their arbitration agreement. And under the FAA’s extremely high bar for vacating an award, Judge Furman said, the Kleins could not show the arbitration was tainted.

Charles Michael led Leviev’s team from Steptoe. Alan Levine of Cooley was the Kleins’ lead lawyer. He didn’t respond to my phone message but told the New York Post that the Kaplans plan to appeal.