Wild KPMG Fees Decision
posted by Dave Hoffman
Barely one day old, and Gonzalez-Lopez is already making waves in corporate law. To see the connection, however, you’ll have to bear with me for a bit of brush-clearing.
Judge Lewis A. Kaplan (S.D.N.Y.) today ruled on certain individual defendants’ motions to dismiss an indictment arising from the KPMG tax shelter investigation. (Large pdf here.) According to the defendants, their due process rights were violated when the U.S. Attorney pressured their former employer (KPMG) not to advance and reimburse legal fees incurred as individuals defendants. Judge Kaplan found a due process violation, scolded the government, and suggested a new lawsuit against KPMG to recover those legal fees, in which today’s decision would have collateral effect and make the proceedings summary. In short: the decision seems to constitutionalize the right to receive indemnification from your employer.
KPMG had a “longstanding voluntary practice” of paying legal fees where employees required separate counsel in matters arising from the employment relationship, regardless of whether the employee had been charged criminally or civilly with wrongdoing. These arrangements were not memorialized in the partnership agreement governing most of the defendants, nor were there contractual provisions about it. No mention is made in the opinion of the relevant insurance negotiations or provisions.
The background law governing most of the partner-defendants (Delaware) requires neither indemnification nor pre-payment. However, two of the defendants, mere employees residing in California, had a right to indemnification arising out of California statutory law.
Judge Kaplan construed this arrangement as a legal entitlement. At the least, according to Judge Kaplan, the defendants had “every reason to expect that KPMG would pay their legal expenses in connection with the government’s investigation.” (But this was the sort of expectation, as Judge Kaplan later argued (p.57) that might give rise to a tortuous interference claim). In the alternative, and in a footnote, Judge Kaplan wrote that “arguably” the defendants had a contract “implied in fact from KPMG’s uniform past practice and the circumstances of the business.” (Fn. 119).
Wow. But how does this contract problem get turned into a Gonzalez-Lopez due process problem? Ah, it turns out that the government has a set of prosecution guidelines to help it determine when to indict a corporation. As a part of those guidelines, the government treated payment of an employee’s legal fees as a blemish on the corporation’s record. And, thus, the U.S. Attorney negotiating with KPMG (itself desperate to avoid indictment) told the Firm that “under the fedaral guidelines misconduct can not be rewarded [by the payment of fees of wrongdoers."]
KPMG got the message. Shortly thereafter, KPMG notified the defendants that their legal fees would be compensated only as long as they cooperated — they could not take the Fifth, for example. Further, KPMG apparently capitulated to the government’s demand by backing away on a recommendation that the defendants obtain counsel.
Judge Kaplan found that this conduct by the government violated the defendants’ right to a fair trial and (I think) to counsel of their choice. In a passage of the opinion I don’t really grasp, the court (p. 49) found that the pressure to cooperate exerted by the Thompson memorandum (the relevant prosecutorial guidelines) on KPMG should be subject to “strict scrutiny” because (1) this will be a big trial, requiring “substantial resources”; and (2) the government interfered with the ability of the KPMG defendants “to obtain resources they otherwise would have had.” While the government claimed that it only used its guidelines to infer lack of cooperation when the payment of fees was used to impede investigations, the court found that the public perception of such pressure is what matters: “[f]ew if any competent defense attorneys would advise a corporate client at risk of indictment that it should feel free to advance legal fees to individuals in the face of the language of [the guidelines." (p.51) And, under Gonzalez-Lopez, this prejudice creates a per se violation. Judge Kaplan appears to hold that the prosecution guidelines are unconstitutional to the extent that they pressure corporations not to provide indemnification to their employees.
The weirdest part of this interesting decision is the remedy. The court refused to dismiss the indictment (for one, I assume, this would result in an immediate appeal). The government suggested that KPMG be allowed to consider again if it wanted to pay fees, without any threat of retaliation. No go, said the court. Instead, the court said that the defendants must be compensated for all of the expenses they had or would incur. Unfortunately, sovereign immunity bars relief against the government, even though it was the wrong-doer. Instead, the court held that KPMG, a non-party to the proceeding, was obligated to pay. However, the court lacked personal jurisdiction over KPMG. Therefore, the court recommended that the individual defendants sue KPMG. The court would then conduct a “expeditious[]” hearing and provide relief. [There is apparently an arbitration agreement in the partnership agreement which could delay matters, but the court suggested what it thinks of that provision by saying “Assuming that the KPMG Defendants pursue relief against KPMG and that KPMG remains insistent upon its alleged arbitration remedy, the questions whether the arbitration clause properly is so construed and, if so, whether it is void as against public policy [as frustrating the court’s decision] will be addressed . . . .” (fn. 239). Hee.]
To sum up. KPMG, which had no clear contractual obligation to pay these fees, now must do so compelled by a judicial order. The government can not discourage indemnification to criminal defendants as a part of making a decision about the firm’s cooprative attitude (or, at least, it can’t do so in writing). One possible result of the case: potentially vulnerable firms will draft by-laws or contracts that exclude indemnification absent cooperation, to make clear that the government has the right to demand cooperation from employees.
The prosecutors, scolded by the court as “economical with the truth” (p. 80-81), must be feeling angry. The defendants, 83 pages later, are still going to trial. But the 28 private firms listed in the caption will get paid.
[UPDATE: More at the White Collar Crime Blog.]
June 27, 2006 at 11:49 am
Posted in: Constitutional Law, Corporate Law, Criminal Law, Criminal Procedure, Current Events, Economic Analysis of Law, Employment Law, Securities
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Responses (8)
Nate Oman - June 27, 2006 at 3:29 pm
Dave: This is facinating to me. I am still unclear about the nature of the legal entitlement that the government interfered with. If I understand you correctly, there is a statutory right in California, but not in Delaware. Did Judge Kaplan actually do the analysis of the contract issue under Delaware law, ie was there actually an implied in fact or implied in law contract to indemnify?
If there really was a legal obligation to indemnify that the government interfered with, why do we need the constitutional pyrotechnics to protect that legal entitlement? It seems to my that we say that KPMG has a contractual obligation to indemnify. Under pressure from the government, it does not. The former-employees then sue KPMG for breach of contract. KPMG must pay, since I can’t see how the government’s threats could constitute some sort of a defense on the contract claim.
I haven’t read the case, so I may be missing something really obvious here, but I don’t see how the government has deprived the indemnitees of anything more than the cost of enforcing their contract (no minor thing that, but hardly a loss of legal representation).
PK - June 27, 2006 at 5:16 pm
To follow up Nate’s comment, even if the judge did find such an implied contract under DE law, how does he justify attempting to bind KPMG (through some from of res judicata) when they were not a party to the proceeding?
One Who Read It - June 28, 2006 at 12:27 am
Did you bother reading the opinion? It is well labeled and very specific on each and every point.
John K - June 28, 2006 at 12:34 am
The government controls KPMG through the Deferred Prosecution Agreement. The government, which has effective control over KPMG (the proverbial gun to its head), can just advance the fees.
The prosecution violated the Constitution. The prosecution cannot be sued because of sovereign immunity. The absence of a direct remedy does not mean no right exists or no violation occurred. It might have precluded jurisdiction, had the court not already had ancillary jurisdiction, which is discussed in the opinion.
Laura - June 28, 2006 at 12:37 am
I can’t see how the government’s threats could constitute some sort of a defense on the contract claim.
Toertious interference with contract that also abrogrates your right to choice of counsel is both a contract and a constitutional claim.
Dave Hoffman - June 30, 2006 at 12:27 am
To respond to a few of these comments. Nate: The Judge did not do any analysis of the contract issue, the holding is that the expectation creates an entitlement even without (I take it) an real contractual right. That is, he doesn’t hold that the employees get to sue for breach, but instead get to sue as (I think) a holder of a constitutional damages right that KPMG, as an enabler of the violation, must pay.
The opinion is well-labeled and well-written, but I do not see (cf. Ribstein and others) why this makes sense as a constitutional claim. Assume that there was no employment relationship, simply an ordinary contract between me and Nate, whereby I agreed to pay Nate’s legal bills. Before the indictment issues, the prosecutors or police (does it matter?) pressure me and I breach the contract. Does Nate really have a constitutional claim against me? I doubt it (being no expert on the 6th Amendment, I can’t be more sure than that.)
John K, and the judge, make an “effective control” argument. I find it really hard to see how the DPA makes KPMG a state actor, or its equivalent. Is the government on the hook should these fees prove extraordinarily large, driving KPMG into bankruptcy (unlikely, to be sure, but consider the possibility).
Laura argues that TIWC is a contract and a constitutional claim when it “abrogates your right to choice of counsel”. But here, it hasn’t abrogated that right, but simply made the employees seek other sources of funding. Moreover, the judge didn’t find that there was a contract, just a reasonable expectation of payment, which I would have thought made a pretty significant impact. I teach my class that to tort a contract, there usually has to be a contract that you know about. But cf. Texaco.
Not Dave Hoffman - June 30, 2006 at 2:11 pm
Does Nate really have a constitutional claim against me? I doubt it (being no expert on the 6th Amendment, I can’t be more sure than that.)
But the pre-indictment stuff was a 5th Amendment claim. If you look at cases like Moran v. Burbine (1986) 475 U.S. 412, the Court has made clear that the test is the Due Process Clause’s “shock the conscience” test.
The standard for being an agent of the government is rather low; see Hammad.
Also, how could the prosecutors have said, “cut the fees” if they didn’t know there were fees being paid?
Laura - June 30, 2006 at 2:18 pm
But here, it hasn’t abrogated that right, but simply made the employees seek other sources of funding.
Isn’t this an intent question focused on the federal actor? Why isn’t the intent to abrograte and the denial of funding enough?
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