A South Carolina school district has hit a setback in its quest to recoup millions of dollars that were allegedly siphoned off as part of a massive kickback scheme orchestrated by its CFO. The school district wants to take the case before a jury, but the 4th U.S. Court of Appeals has instructed a federal judge to reconsider the defendants’ argument that the case should be resolved through arbitration instead.
Knauff Insurance and its employee, Stanley Pokorney, provided insurance brokerage and consulting services to the Berkeley County School District from 2001 to 2012. Hub International acquired Knauff in 2012 and both Stanley and Scott Pokorney continued to provide services to the district with their new employer.
Beginning in 2005 and lasting until 2017, the chief financial officer of the district, Brantley Thomas, steered the district into “a series of excessive and unnecessary insurance policies” with Hub and Knauff, according to the school district’s complaint. In return, the insurance companies and Pokorneys paid Thomas kickbacks in the form of cash, expensive trips, hotel rooms, dinners, and spa services.
The district claimed that the “massive” fraud and conspiracy scheme resulted in losses of almost $10 million. In support of its allegations, the district pointed to federal and state charges filed against Thomas for wire fraud and embezzlement. Thomas pleaded guilty to the charges, admitting in state court to deliberately causing Berkeley schools to overpay a vendor.
The defendants sought to compel arbitration, relying on arbitration provisions found in six purported brokerage services agreements spanning the period from 2002 to 2011. Each of the agreements was addressed to Thomas, although four of them were unsigned, one was signed by Thomas, and the sixth was signed on behalf of the school district by Thomas’s assistant.
But the school district contended that it had never agreed to arbitrate any disputes, attesting that none of the agreements were in its records and that neither Thomas nor his assistant had the authority to bind the district. U.S. District Judge David Norton sided with the school district and denied the motion, and the defendants appealed to the 4th Circuit.
On Dec. 4, the 4th Circuit unanimously vacated the ruling and remanded the case for trial on the issue of whether the parties had come to an agreement to arbitrate any disputes.
In an opinion authored by Judge Robert B. King, the panel held that the lower court was obliged to conduct a trial when faced with disputed material factual issues about the purported agreement to arbitrate.
“Questions of material fact abound with respect to Thomas’s actual or apparent authority to assent—on Berkeley Schools’ behalf—to the fugitive documents that constitute the unsigned Brokerage Service Agreements and the Arbitration Clauses therein,” King wrote. “Those factual questions concern the formation of the Agreements and the Arbitration Clauses, and can only be resolved by proceedings conducted pursuant to the Trial Provision.”
Court ‘obliged’ to conduct trial
Under the Federal Arbitration Act, a party that believes that an opposing party is refusing to abide by an arbitration agreement can petition a U.S. district court for an order compelling arbitration. The law provides that if the “making of the arbitration agreement” remains “in issue,” then “the court shall proceed summarily to the trial thereof,” King noted.
“[The FAA] thus requires that the district court—rather than an arbitrator—decide whether the parties have formed an agreement to arbitrate,” King wrote. “In making such a decision, the court is obliged to conduct a trial under the Trial Provision when a party unequivocally denies ‘that an arbitration agreement exists,’ and ‘show[s] sufficient facts in support’ thereof.”
It doesn’t matter that neither the school district nor the defendants requested a trial on the arbitration motion, King said, as the panel was “satisfied that the court was obliged to conduct one, in that genuine disputes of material fact exist regarding whether Berkeley Schools agreed to arbitrate the claims alleged in the operative complaint.”
The panel identified several genuine disputes of material fact that required resolution, including the school district’s knowledge of the brokerage service agreements purportedly formed during the period encompassed by the operative complaint.
“On the one hand, [four of the] agreements are in the nature of fugitive documents and are not signed by Berkeley Schools or anyone else,” King wrote, with a witness for the school district swearing that the documents were not in the district’s files.
On the other hand, the school district paid large sums of money for the purported brokerage services over a seven-year period.
“A reasonable factfinder could thus infer Berkeley Schools’ knowledge of, and acquiescence to, the agreements, which contained provisions relating to brokerage services,” the court said. “A factual dispute therefore exists with respect to Berkeley Schools’ knowledge of the unsigned Agreements. And that dispute is material in these proceedings because it concerns Berkeley Schools’ acceptance of the Agreements and the Arbitration clauses.”
Authority remains up in the air
Another major factual dispute was Thomas’s actual or apparent authority to assent, on behalf of the school district, to the brokerage service agreements and their arbitration clauses, King said.
The district stated that Thomas lacked the actual authority to contract for the procurement of insurance consulting services, but as part of his guilty plea in federal court, he agreed that he was “responsible for procuring and paying for [the school district’s] insurance policies.”
Further, a factual dispute remained concerning Thomas’s apparent authority.
The school district held him out as its CFO, a fact that “might lead a reasonable person to believe that Berkeley Schools had granted Thomas ample authority to contract on its behalf,” King wrote. Alternatively, “[a] reasonable factfinder could also conclude that those agreements resulted from actions to carry out the steering and kickback fraud scheme and conspiracy, and that the other unsigned agreements also resulted therefrom.”
“At bottom, there are multiple disputes of material fact as to ‘the making of [any] arbitration agreement’ between Berkeley Schools and the [defendants],” the court concluded. “The Trial Provision obliged the district court to conduct trial proceedings and thereby resolve those disputes before resolving the Arbitration Motion.”
Josh Whitley of Smyth Whitley in Charleston represented the school district.
“Although we feel strongly the district court got the decision correct, the Court of Appeals result was not unexpected,” he said in a statement. “We feel encouraged that the court did not send the case to arbitration and welcome the opportunity to prove that Thomas lacked the authority to enter into the brokerage service agreements in question.”
Michael G. Pattillo, Jr. of Washington, D.C., represented the defendants. He did not respond to a request for comment.
The 34-page decision is Berkeley County School District v. Hub International Limited (Lawyers Weekly No. 011-197-19).