DUTSCHKE (KENNETH), ET AL. VS. JIM RUSSELL REALTORS, INC. , ET AL.
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RENDERED: AUGUST 1, 2008; 2:00 P.M.
TO BE PUBLISHED
Commonwealth of Kentucky
Court of Appeals
NO. 2007-CA-001146-MR
SHARON DUTSCHKE;
KENNETH DUTSCHKE
v.
APPELLANTS
APPEAL FROM JEFFERSON CIRCUIT COURT
HONORABLE MARTIN MCDONALD, JUDGE
ACTION NO. 03-CI-07011
JIM RUSSELL REALTORS, INC.;
JIM RUSSELL; JOSEPH HINES;
MICHAEL FAUST, PERSONAL
REPRESENTATIVE OF THE ESTATE
OF FRED FAUST AND TRUSTEE
OF THE FAUST FAMILY TRUST
APPELLEES
OPINION
AFFIRMING
** ** ** ** **
BEFORE: COMBS, CHIEF JUDGE; KELLER, JUDGE; HENRY,1 SENIOR
JUDGE.
Senior Judge Michael L. Henry, sitting as Special Judge by assignment of the Chief Justice
pursuant to Section 110(5)(b) of the Kentucky Constitution and KRS 21.580.
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HENRY, SENIOR JUDGE: Sharon Dutschke and Kenneth Dutschke appeal from
the dismissal of their claims against the above captioned appellees in a dispute
concerning the Dutschkes’ purchase of a residence from Fred Faust, deceased.
The real estate purchase contract contained an arbitration clause, which the circuit
court determined was enforceable. The Dutschkes allege that the underlying
contract was a product of fraud, and that to the extent that the Kentucky Uniform
Arbitration Act contained in KRS Chapter 417 (KUAA) compels arbitration under
such circumstances, the Act is unconstitutional under the jural rights doctrine, the
right to a jury trial contained in Section 7 of the Kentucky Constitution, the
separation of powers doctrine, and the prohibition against arbitrary power
contained in Section 2 of the Kentucky Constitution, Louisville Peterbilt, Inc. v.
Cox, 132 S.W.3d 850 (Ky. 2004), notwithstanding. For the reasons stated below,
we affirm.
FACTUAL AND PROCEDURAL BACKGROUND
Jim Russell is the owner of a real estate agency, Jim Russell Realtors,
Inc., d/b/a Remax Elite Realty Office. Joseph Hines is one of the real estate agents
employed at the agency.
In early 2002 Kenneth and Sharon decided to sell their farm in
Breckinridge County, Kentucky, and relocate to the Shively area of Jefferson
County, where Sharon had grown up.
In the course of searching for a residence in the area the Dutschkes
were referred to Joseph Hines. They eventually retained Hines as their buyer’s
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agent to help them search for a home. While looking through a listing magazine at
the Remax office one day, Sharon noticed a promising listing for a residence
located at 1828 Farnsley Road. The residence was owned by Fred Faust, who had
had the dwelling built in 1950. Faust had earlier signed a contract engaging
Remax Elite to handle the sale of the residence. As part of the process involved in
selling the home, Faust completed a seller’s disclosure statement. The parties
dispute whether this statement was ever provided to the Dutschkes.2
The Dutschkes visited the home, inspected it, and noticed several
needed repairs. As part of their negotiations, the Dutschkes prepared a list of
needed repairs totaling $13,152.65 to be presented to Faust in an attempt to get him
to lower the price. On June 15, 2002, Faust accepted the Dutschkes’ offer to
purchase the residence for $103,000.00. The Dutschkes did a final walk through
on July 14, 2002, and the closing on the property occurred on July 18, 2002.
The Dutschkes’ purchase of the property was consummated through
the use of a standardized sales and purchase contract prepared by the Greater
Louisville Association of Realtors, Inc. Paragraph 17 of the contract provides as
follows:
17. BINDING ARBITRATION: All claims or disputes,
for a sum greater than the limits of small claims court
jurisdiction, of Sellers, Buyers, brokers, or agents or any
of them arising out of this contract or the breach thereof
or arising out of or relating to the physical condition of
the property covered by this purchase agreement
(including without limitation, claims of fraud,
misrepresentation, warranty and negligence) shall be
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The Arbitrator concluded that it was not.
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decided by binding arbitration in accordance with the
rules of the real estate industry, then in effect, adopted by
the American Arbitration Association unless the parties
mutually agree otherwise. Notice of the demand for
arbitration shall be filed in writing by registered or
certified mail with the other parties to the contract and
with a registered arbitrator (a list of which is available at
the Greater Louisville Association of Realtors main
office) or other arbitrators which the parties may agree
upon and shall be made within one (1) year after the
dispute has arisen. An actual oral hearing shall be held
unless the parties mutually agree otherwise. The
Kentucky Real Estate Commission still retains
jurisdiction to determine violations of KRS 324.160.
Any proceeding pursuant to KRS 324.420(1) to
determine damages shall be conducted by an arbitrator
pursuant to this clause and not in court. By signing
below the agents, on behalf of themselves and their
brokers, agree to be bound by this arbitration clause, but
are not parties to this contract for any other purpose. The
terms of this Paragraph 17 shall survive the closing.
Following the closing, among other problems, the Dutschkes
experienced leaks in their basement following heavy rainfall; discovered that the
plumbing in the upstairs bathroom was defective resulting in leaking behind the
walls; determined that the basement plumbing was not hooked up to the municipal
sewer system but, rather, was connected to a septic system; learned for the first
time that the home was located in a flood plain; and discovered rotting around the
windows.
Faust paid the Dutschkes for the expenses required to repair the
basement leaking; however, based upon the perceived extensive lack of disclosure
concerning the condition of the dwelling, on August 12, 2003, the Dutschkes filed
a “Petition for Declaratory Relief and Civil Complaint” in Jefferson Circuit Court.
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As relevant here, the Complaint alleged that Remax Elite, Russell, Hines, and
Faust had fraudulently induced the Dutschkes to purchase the Farnsley Road
residence. The complaint did not, however, allege that the Dutschkes were
fraudulently induced to enter into the arbitration agreement. At this time Marks v.
Bean, 57 S.W.3d 303 (Ky.App. 2001), was the controlling case in situations
involving fraud and the enforceability of an arbitration clause. It held that an
allegation of fraud in the inducement relating to the underlying contract alone was
sufficient to avoid the enforcement of an arbitration clause.
On October 3, 2003, Remax, Russell, and Hines filed a motion to
dismiss or, in the alternative, for enforcement of the arbitration clause contained in
the purchase and sales agreement.3 It appears, however, that the motion was never
ruled upon. Discovery then proceeded, and a trial date was set for May 17, 2005.
In the meantime, the Supreme Court issued its decision in Louisville
Peterbilt, Inc. v. Cox, 132 S.W.3d 850 (Ky. 2004). The decision, overruling Marks
v. Bean, supra, held that a party to a contract containing an arbitration clause could
not avoid arbitration where the alleged fraud was limited to fraudulent acts
inducing the party to enter into the underlying contract alone; rather, avoidance
could only be had when the allegations of fraud went to the making of the
arbitration clause itself.
On the eve of the scheduled trial, based upon the holding in Louisville
Peterbilt, the defendants renewed their motion to dismiss or, in the alternative,
Because the Complaint alleged fraud in the inducement regarding the underlying contract,
pursuant to Marks v. Bean, supra., the clause would not have been enforced.
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arbitrate. On May 18, 2005, the trial court entered an order granting the motion in
the alternative. The matter accordingly proceeded to arbitration.
Following a hearing, the Arbitrator issued his Arbitrator’s Opinion
and Award, which was filed into the circuit court record on October 21, 2005. The
Arbitrator substantially agreed with the Dutschkes upon their claims relating to
undisclosed defects, but awarded them only $12,691.00 out of the total of
$41,600.00 they sought.
On February 21, 2006, the Dutschkes filed a motion to vacate the
arbitration award on the basis that the award was grossly inadequate. They also
argued that the Arbitrator erred by failing to rescind the contract altogether. The
defendants responded, and in the Dutschkes’ reply memorandum they raised the
constitutional arguments at issue herein. Notice was provided to the Attorney
General concerning their constitutional challenges to the KUAA, who on May 22,
2006, filed a notice that he would not intervene in the Dutschkes’ challenge to the
constitutionality of aspects of the KUAA.
On October 23, 2006, Fred Faust passed away and his estate was
substituted as a party to the case.
On May 8, 2007, the trial court entered an order denying the
Dutschkes’ motion to vacate the arbitration award and, instead, confirming the
award. This appeal followed.
DISCUSSION
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In Louisville Peterbilt, in overruling Marks v. Bean, the Supreme
Court interpreted the “savings clause” contained in KRS 417.050 4 consistent with
the U.S. Supreme Court’s interpretation of analogous language contained in the
Federal Arbitration Act (FAA) as enunciated in Prima Paint Corporation v. Flood
& Conklin Manufacturing Company, 388 U.S. 395, 87 S.Ct. 1801, 18 L.Ed.2d
1270 (1967). This interpretation is referred to as the “separability doctrine,” and,
in summary, requires courts to separate an otherwise valid arbitration clause from
the contract within which it is contained to allow arbitration of all claims not going
to the validity of the arbitration clause itself.
In other words, under the holding in Louisville Peterbilt, fraudulent
acts inducing someone to enter into the underlying contract is not a basis for
avoiding the arbitration clause; rather, to avoid the clause upon the basis of fraud,
the fraudulent inducement must relate specifically to the arbitration clause. The
underlying notion is that the Arbitrator himself is capable of evaluating and issuing
a ruling upon allegations relating to fraud in the inducement vis-à-vis the
underlying contract.
Upon examination, it is the above holding in Louisville Peterbilt
which underlies the Dutschkes’ constitutional challenge. Pursuant to their
constitutional theories, they contend that their claim that they were fraudulently
KRS 417.050 provides that “[a] written agreement to submit any existing controversy to
arbitration or a provision in written contract to submit to arbitration any controversy thereafter
arising between the parties is valid, enforceable and irrevocable, save upon such grounds as exist
at law for the revocation of any contract.” (Emphasis added).
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induced to enter into the underlying contract itself should suffice to challenge the
arbitration clause, which mirrors the holding in Marks v. Bean. Thus, they argue
that we should, in effect, abrogate the Supreme Court’s holding in Louisville
Peterbilt pursuant to their constitutional theories.
Though the Supreme Court did not address the constitutional issues as
raised by the Dutschkes in its Louisville Peterbilt decision, we have grave doubts
that we may rule in accordance with the Dutschkes’ constitutional arguments.
“The Court of Appeals is bound by and shall follow applicable precedents
established in the opinions of the Supreme Court and its predecessor court.” Rules
of the Kentucky Supreme Court (SCR) 1.030(8)(a). “[A]s an intermediate appellate
court, this Court is bound by established precedents of the Kentucky Supreme
Court.” Smith v. Vilvarajah, 57 S.W.3d 839, 841 (Ky.App. 2000) (citations
omitted).
Nevertheless, we will briefly address the Dutschkes’ constitutional
arguments.
JURAL RIGHTS DOCTRINE
In their brief the Dutschkes purport to challenge the constitutionality
of Chapter 417 under the jural rights doctrine. They have headings in their brief
reflecting this, and they state “Post [Louisville Peterbilt], KRS 417.050 eliminates
the rights of trial by jury in a common law fraud claim, a facial violation of the
Dutschkes’ jural rights.” Appellant’s Brief, pg. 16. However, an examination of
their arguments under what they identify as their jural rights doctrine headings
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discloses that it appears they are interchanging the term “jural rights” with the right
to a jury trial contained in Section 7 of the Kentucky Constitution. Indeed, they
state that the “[a]pplication of jural rights principles begins with Section 7.”
Appellant’s Brief, pg. 15.
We believe the Dutschkes’ use of the term “jural rights” in their
arguments to be a misnomer. Section 7 is not an aspect of the jural rights doctrine
in Kentucky as used in its normal sense. Nevertheless, we will briefly address the
constitutionality of Chapter 417 under the jural rights doctrine. We examine the
constitutionality of the Act under Section 7 – which appears to be the actual thrust
of the Dutschkes’ argument - in the next section of this opinion.
The jural rights doctrine is not expressly set out in the Kentucky
Constitution. Rather, the doctrine is derived from a reading of Sections 14,5 54,6
and 2417 of the Kentucky Constitution. In essence, the doctrine states that the
General Assembly has no authority to abolish or restrict a common law right of
recovery for personal injury or wrongful death. Bishop v. Manpower, Inc. of Cent.
Section 14 provides “All courts shall be open, and every person for an injury done him in his
lands, goods, person or reputation, shall have remedy by due course of law, and right and justice
administered without sale, denial or delay.”
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Section 54 provides “The General Assembly shall have no power to limit the amount to be
recovered for injuries resulting in death, or for injuries to person or property.”
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Section 241 provides “Whenever the death of a person shall result from an injury inflicted by
negligence or wrongful act, then, in every such case, damages may be recovered for such death,
from the corporations and persons so causing the same. Until otherwise provided by law, the
action to recover such damages shall in all cases be prosecuted by the personal representative of
the deceased person. The General Assembly may provide how the recovery shall go and to
whom belong; and until such provision is made, the same shall form part of the personal estate of
the deceased person.”
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Kentucky, 211 S.W.3d 71 (Ky.App. 2006); Williams v. Wilson, 972 S.W.2d 260,
265 (Ky. 1998); Ludwig v. Johnson, 243 Ky. 533, 49 S.W.2d 347 (1932). The
doctrine has also been articulated as “preclud[ing] any legislation that impairs a
right of action in negligence that was recognized at common law prior to the
adoption of the 1891 Constitution.” McDowell v. Jackson Energy RECC, 84
S.W.3d 71, 73 (Ky. 2002); see also Thomas P. Lewis, Jural Rights Under
Kentucky's Constitution: Realities Grounded in Myth, 80 Ky.Law J. 953 (1992).
In summary, the jural rights doctrine is limited to application in the
areas of negligence, personal injury, or wrongful death. As fraud in the
inducement does not fall within any of those categories, we believe the jural rights
doctrine to have no application to the issues under consideration.
RIGHT TO JURY TRIAL
The Dutschkes contend that Chapter 417 violates Section 7 of the
Kentucky Constitution by denying them their right to a trial by jury upon their
claim that they were fraudulently induced into entering the subject real estate
contract.
Section 7 of the Kentucky Constitution provides, “The ancient mode
of trial by jury shall be held sacred, and the right thereof remain inviolate, subject
to such modifications as may be authorized by this Constitution.” (Emphasis
added). Thus, the Section contemplates that there may be other provisions in the
Constitution which may make exceptions to the general rule that a citizen is
entitled to a trial by jury. One of these exceptions is contained in Section 250 of
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the Constitution, which provides that “[i]t shall be the duty of the General
Assembly to enact such laws as shall be necessary and proper to decide differences
by arbitrators, the arbitrators to be appointed by the parties who may choose that
summary mode of adjustment.”8
We believe Section 250 to be dispositive of the issue. The Section
specifically provides for a system of arbitration to be enacted by the legislature
and, by definition, arbitration does not include a trial by jury. Moreover,
Louisville Peterbilt holds that arbitration is a proper forum in which to invoke a
claim that the underlying contract is a product of fraud. Accordingly, we disagree
with the Dutschkes’ contention that the KUAA violates Section 7 of the Kentucky
Constitution.
SEPARATION OF POWERS
The Dutschkes contend that Chapter 417 violates the separation of
powers doctrine contained in Section 28 of the Kentucky Constitution. Their
argument is somewhat difficult to follow, but it appears that they allege that the
legislature usurped powers vested in the judicial branch of government by drafting
the KUAA in a manner which does not provide for judicial review of whether a
party who enters into a contract containing an arbitration clause freely, knowingly,
and voluntarily waived his Section 7 right to a jury trial.
The separation of powers doctrine is reflected in the Kentucky
Constitution in Sections 27 and 28. The Kentucky Constitution Section 27 states:
Similar provisions were contained in Article VI, Section 10, of Kentucky’s Second Constitution
adopted in 1799, and in Article 8, Section 10, of Kentucky’s Third Constitution adopted in 1850.
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The powers of the government of the Commonwealth of
Kentucky shall be divided into three distinct departments,
and each of them be confined to a separate body of
magistracy, to wit: Those which are legislative, to one;
those which are executive, to another; and those which
are judicial, to another.
Kentucky Constitution Section 28 states:
No person or collection of persons, being of one of those
departments, shall exercise any power properly belonging
to either of the others, except in the instances hereinafter
expressly directed or permitted.
We first note that, as previously discussed, Section 250 of the
Kentucky Constitution specifically vests the legislature with the power to enact
necessary and proper laws to establish an arbitration system in Kentucky. It
follows that it was not a violation of the separation of powers doctrine for the
legislature to enact the KUAA.
However, analogizing to a standard often used in the waiver of
constitutional rights in criminal cases, the Dutschkes contend that the standard
which should be applied in evaluating the validity of an arbitration clause is “an
affirmative demonstration that the contract was freely, knowingly, and voluntarily
entered into[.]”
The relevant standard concerning the validity of an arbitration clause
has previously been established as follows: “[t]he burden of establishing the
existence of an arbitration agreement that conforms to statutory requirements rests
with the party seeking to enforce it, but once prima facie evidence thereof has been
presented, the statutory presumption of its validity (KRS 417.050) accrues, and the
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burden of going forward with evidence to rebut the presumption then shifts to the
party seeking to avoid the agreement, Marciniak v. Amid, 162 Mich.App. 71, 412
N.W.2d 248 (1987), and this is a heavy burden.” Valley Const. Co., Inc. v. Perry
Host Management Co., Inc., 796 S.W.2d 365, 368 (Ky.App. 1990) (citing Rancho
Pescado, Inc. v. Northwestern Mutual Life Ins. Co., 140 Ariz. 174, 680 P.2d 1235
(1984) and Board of Education, Taos Municipal Schools. v. The Architects, Taos,
103 N.M. 462, 709 P.2d 184 (1985)). This standard was reaffirmed in Louisville
Peterbilt. Id. at 857.
We are unpersuaded that in order for a party to be bound by an
arbitration clause that his acquiescence to the agreement must be proven under the
same standards applicable to a defendant’s waiver of a constitutional right in a
criminal case. In any event, the Supreme Court reaffirmed the above standard in
Louisville Peterbilt, and we are bound by its holding upon the issue.
SECTION 2
Finally, the Dutschkes contend that the KUAA violates Section 2 of
the Kentucky Constitution in that it fails to provide for meaningful judicial review
of an arbitration decision. They cite to the holding in American Beauty Homes
Corporation v. Louisville and Jefferson County Planning and Zoning Commission,
379 S.W.2d 450, 456 (Ky. 1964), to the effect that there is an inherent right of
appeal from orders of administrative agencies where constitutional rights are
involved. Analogizing to this holding, they maintain that “[i]n granting favored
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status to an alternate system for dispute resolution the legislature must provide for
judicial review unless the right is waived.”
Section 2 of the Kentucky Constitution provides “Absolute and
arbitrary power over the lives, liberty and property of freemen exists nowhere in a
republic, not even in the largest majority.”
Contrary to the appellant’s assertion, KRS Chapter 417 does provide
for judicial review. KRS 417.160 provides as follows:
(1) Upon application of a party, the court shall vacate an
award where:
(a) The award was procured by corruption, fraud or other
undue means;
(b) There was evident partiality by an arbitrator
appointed as a neutral or corruption in any of the
arbitrators or misconduct prejudicing the rights of any
party;
(c) The arbitrators exceeded their powers;
(d) The arbitrators refused to postpone the hearing upon
sufficient cause being shown therefor or refused to hear
evidence material to the controversy or otherwise so
conducted the hearing, contrary to the provisions of KRS
417.090, as to prejudice substantially the rights of a
party; or
(e) There was no arbitration agreement and the issue was
not adversely determined in proceedings under KRS
417.060 and the party did not participate in the
arbitration hearing without raising the objection; but the
fact that the relief was such that it could not or would not
be granted by a court is not ground for vacating or
refusing to confirm the award.
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(2) An application under this section shall be made
within ninety (90) days after delivery of a copy of the
award to the applicant; except that, if predicated upon
corruption, fraud or other undue means, it shall be made
within ninety (90) days after such grounds are known or
should have been known.
(3) In vacating the award on grounds other than stated in
paragraph (a) of subsection
(1) of this section, the court may order a rehearing before
new arbitrators chosen as provided in the agreement, or
in the absence thereof, by the court in accordance with
KRS 417.070, or, if the award is vacated on grounds set
forth in paragraphs (c) and (d) of subsection (1) of this
section, the court may order a rehearing before the
arbitrators who made the award or their successors
appointed in accordance with KRS 417.070. The time
within which the agreement requires the award to be
made is applicable to the rehearing and commences on
the date of the order.
(4) If the application to vacate is denied and no motion
to modify or correct the award is pending, the court shall
confirm the award.
Further, KRS 417.170 provides as follows:
(1) Upon application made within ninety (90) days after
delivery of a copy of the award to the applicant, the court
shall modify or correct the award where:
(a) There was an evident miscalculation of figures or an
evident mistake in the description of any person, thing or
property referred to in the award;
(b) The arbitrators have awarded upon a matter not
submitted to them and the award may be corrected
without affecting the merits of the decision upon the
issues submitted; or
(c) The award is imperfect in a matter of form, not
affecting the merits of the controversy.
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(2) If the application is granted, the court shall modify
and correct the award so as to effect its intent and shall
confirm the award as so modified and corrected.
Otherwise, the court shall confirm the award as made.
(3) An application to modify or correct an award may be
joined in the alternative with an application to vacate the
award.
Thus, we disagree with the appellants that the KUAA does not
provide for judicial review. We believe the level of judicial review provided is
consistent with the underlying purposes of arbitration generally, one of which is to
avoid the time and expense involved with courtroom litigation; is authorized by
Section 250 of the Constitution; and, moreover, is sufficient to comply with the
requirements of Section 2 of the Constitution.
CONCLUSION
For the foregoing reasons, the judgment of the Jefferson Circuit Court
is affirmed.
KELLER, JUDGE, CONCURS.
COMBS, CHIEF JUDGE, CONCURS AND FILES SEPARATE
OPINION.
COMBS, CHIEF JUDGE, CONCURRING: It is my profound wish
that the General Assembly would re-visit the issue of arbitration in Kentucky. I
hope that it would defer to the common law, common sense notion that fraud in the
inducement to enter into a contract should not be tolerated – much less rewarded –
in allowing the fraudulent actor to escape the scrutiny of the courts by recourse to
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arbitration. Until the General Assembly decrees otherwise, arbitration has
effectively usurped and supplanted the constitutional guarantee of access to the
courts under grossly unfair circumstances.
In light of Peterbilt, I must concur with the correctly reasoned
majority opinion. I do so, however, with deep regret tempered with the hope that
this lamentable state of affairs may attract the attention of our legislature.
BRIEF AND ORAL ARGUMENT
FOR APPELLANT:
BRIEF AND ORAL ARGUMENT
FOR APPELLEE:
Kirk Hoskins
Louisville, Kentucky
Michael F. Lawrence
Louisville, Kentucky
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