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Arbitration Nuts & Bolts: Vacating Arbitration Awards — Part IV: Federal Arbitration Act Section 10(a)(3) – Procedural Misconduct

April 26th, 2010 Arbitration Practice and Procedure, Grounds for Vacatur, Procedural Misconduct, Reinsurance Arbitration Comments Off on Arbitration Nuts & Bolts: Vacating Arbitration Awards — Part IV: Federal Arbitration Act Section 10(a)(3) – Procedural Misconduct By Philip J. Loree Jr.

I. Introduction

In this part IV of our Nuts & Bolts vacatur feature, we focus on Section 10(a)(3) of the Federal Arbitration Act, which provides in pertinent part (with bracketed numbering and text added for convenience): 

[An arbitration award may be vacated:]

where the arbitrators were guilty [(1)] of misconduct [(a)] in refusing to postpone the hearing, upon sufficient cause shown, or [(b)] in refusing to hear evidence pertinent and material to the controversy; or [(2)] of any other misbehavior by which the rights of any party have been prejudiced[.]

Section 10(a)(3) might be referred to as a procedural due process provision, and courts sometimes suggests it defines the level of due process that must be present in an arbitration for a court to confirm the award without violating constitutional due process requirements.   We do not find that line of reasoning to be particularly helpful, and its validity is debatable.  But Section 10(a)(3) certainly prescribes a baseline level of procedural protection to parties who agree to arbitrate without expressly specifying procedural protections.  And it imposes a no-harm-no-foul rule:  procedural misconduct or misbehavior — including not following agreed procedural rules — does not undermine an award unless the misconduct or misbehavior prejudiced the challenging party.   

II.  Grounds for Vacatur under Section 10(a)(3)

Section 10(a)(3) says a court for may vacate an arbitration award for “misconduct” or “misbehavior.”  It specifies only two types of misconduct:  “refusing to postpone the hearing, upon sufficient cause shown” and “refusing to hear evidence pertinent and material to the controversy.”  But it contains a catch-all provision that authorizes vacatur when the arbitrators are “guilty.  .  .  of any other misbehavior by which the rights of any party have been prejudiced.”    We have discussed in a prior posts the Ninth Circuit’s recent decision rejecting certain Section 10(a)(3) challenges to a reinsurance arbitration award.  (Post here.)

The key to Section 10(a)(3) is whether the challenging party has been denied a “fundamentally fair hearing” or has otherwise been prejudiced.  And in evaluating whether that standard has been met, courts assume that when parties agree to arbitrate they trade-off some of the procedural “niceties” that apply in court.  So what might be considered the denial of a fundamentally fair hearing in court might be considered fair in arbitration.  For example, parties in arbitration are not entitled to the same discovery rights they might have in court, arbitrators are generally not bound to follow procedural and evidentiary rules strictly, and arbitrators generally have a great deal of leeway to formulate their own procedural rules, provided they do not conflict with the parties’ agreed rules (if any).       

A. Misconduct:  “Refusing to Postpone the Hearing Upon Sufficient Cause Shown”

An arbitrator’s refusal to grant a continuance can be a ground for vacatur, provided the party requesting it showed the arbitrator “sufficient cause” for it to be granted.  But this ground for vacatur is no panacea for those seeking to delay the day of reckoning, and arbitrators should not consider it as such.    

When courts evaluate claims premised on this ground, they usually accord the arbitrators a great deal of deference in determining what is “sufficient cause shown.”  Courts are not likely to deem “sufficient cause” was shown when the need for a continuance was the fault of the party that unsuccessfully sought it.  

But when the denial of a continuance prejudiced the challenging party, and the need for it was not of the challenger’s own making, then courts may grant relief.  For example, if a party who otherwise acted prudently could not produce an important witness at the hearing because the arbitrators denied a continuance, then this branch of Section 10(a)(3) may authorize a court to vacate the award.  The key questions are whether the arbitrator acted arbitrarily and whether the challenging party was prejudiced as a result.          

B.  Misconduct:  “Refusing to Hear Evidence Pertinent and Material to the Controversy” 

When parties agree to arbitrate, the law presumes they intended that the arbitrators would allow them to present material and pertinent evidence supporting their position.  That does not mean that a party is entitled to present cumulative testimony or seek the broad discovery permitted by the Federal Rules of Civil Procedure. 

If arbitrators exclude evidence which, if admitted and credited, would have justified a different outcome, then a court may grant relief.  Again, the touchstone is prejudice:  would the outcome have been different had the arbitrator admitted and credited the evidence?  Even if the outcome would not necessarily have been different, was the challenging party afforded a fundamentally fair hearing even though the arbitrators would not hear the proferred evidence?  

Burlage v. Superior Court of Ventura Cty., 178 Cal. App. 4th 524 (2d Dist. Oct. 20, 2009), rev. denied, No.  S178328 (Cal. Sup. Ct. Jan. 21, 2010), is an excellent example of the type of case where relief for excluding material evidence was warranted and granted.  As explained in prior posts (here and here), a seller and buyer entered into a contract to purchase land.  Seller knew that the land — including a swimming pool and a fence — encroached on an enjoining property but did not tell buyer.  A dispute arose between the parties concerning the encroachment, and buyer claimed that seller had defrauded it.  The dispute was submitted to arbitration as required by the arbitration agreement in the contract of sale. 

After the escrow closed, but before the arbitration hearing, the title insurer paid the adjoining landowner $10,950 for a lot-line adjustment that gave buyer title to the encroaching land.  But despite this buyer sought damages for alleged diminution in value of the property, and for the cost of moving the pool and fence that were situated on previously encroaching land that buyer now owned because of the lot-line adjustment. 

Seller sought to introduce evidence of the lot-line adjustment, and buyer moved to exclude it.  Buyer said that damages must be ascertained from the date of the escrow closing, a contention the seller disputed.  The arbitrator granted the motion, ruling that damages were to be fixed as of the date of the escrow closing, and excluded evidence of the effect of the lot-line adjustment had on buyer’s damages claim. 

At the hearing buyer’s experts testified that, as of the date of the closing, it would have cost approximately $100,000 to fix the problem.  The arbitrator’s prior ruling precluded the seller from rebutting that expert testimony by showing either:  (a) that there were no damages; or (b) that damages were limited to the amount of money the title company paid to fix the encroachment problem.  After the hearing the arbitrator ruled that:  (a) seller knew that the pool and fence encroached on adjoining land; (b) seller did not disclose this fact to buyer; and (c) the encroachment materially affected the property’s value.  The arbitrator awarded buyer $552,750 in compensatory damages, $250,000 in punitive damages, and $732,570 in costs and attorney fees. 

The trial court vacated the award and the Court of Appeal, Second District, affirmed 2-1.  The court held that the evidence the seller sought to introduce was material, its exclusion was prejudicial and vacatur was therefore warranted under California’s version of Section 10(a)(3), Cal. Civ. Code § 1286.2(a)(5):  

What could be more material than evidence that the problem was “fixed” and there are no damages?  Yet, the Burlages presented expert testimony about the effect of what had become a nonexistent encroachment.  Their experts testified about the cost to move a pool and fence, neither of which had to be moved.  Spencer was not even permitted to refute the Burlages’ expert who opined that the encroachment reduced the value of the property $100,000.  Spencer could not show that the title company solved the encroachment issue through a payment of approximately one-tenth that amount.

Without this crucial evidence, the arbitration assumed the nature of a default hearing in which the Burlages were awarded $1.5 million in compensatory and punitive damages they may not have suffered. An arbitrator must consider this evidence to make an informed decision.

178 Cal. App. 4th. at 530. 

But Section 10(a)(3) is not supposed to be a license for courts to second guess evidentiary and merits rulings by arbitrators.  For example, sometimes the question whether evidence is “pertinent and material” depends on the resolution of a legal question pertaining to the merits.  Suppose the parties disputed whether the law of State X permitted consequential damages for breach of contract in light of the circumstances presented.  And suppose the arbitrator rules that, under the facts at hand, the law of State X does not permit consequential damages, and subsequently refuses to hear evidence of consequential damages.  Assuming the basis for the arbitrator’s ruling on the legal question was at least barely colorable, then the plaintiff should not have any basis for vacating the award under Section 10(a)(3). 

Some might say that the Burlage case was wrongly decided for this very reason:  The arbitrator ruled that damages were to be “fixed” as of the date of the escrow closing in the sense that mitigation-of-damages evidence could not be introduced, and the arbitrator’s exclusion of the subsequently occurring lot-line-adjustment evidence was simply a logical consequence of that ruling.  But evidence of what subsequently transpired was material to the controversy over the amount of damages.   The amount the title company actually paid the adjoining landowner for the lot-line adjustment after the closing is highly probative of the amount it would have cost as of  the closing.  If the title company was able to resolve the encroachment problem for approximately $11,000 shortly after the closing, then it is more probable than not that buyer could have done the same thing at the time of the closing, even if it did not have title insurance.  And $11,000 is a whole lot less than the more than $1.5 million in damages and fees that the arbitrator awarded.

C.  Other Misbehavior that Prejudiced one of the Parties’ Rights

Section 10(a)(3)’s catchall provision allows vacatur where the arbitrators engaged in “misbehavior” that “prejudiced” one of the parties.  Misbehavior does not necessarily connote intentional wrongdoing by the arbitrators.  It encompasses procedural misconduct as well as procedural error, other than the two types discussed in Section A., above.  It also includes ex parte contacts.  But, as with “misconduct,” the no harm no foul rule applies:  The challenger must show prejudice.

One example of a case that may warrant relief under the catchall provision can arise when arbitrators change the rules midstream without affording the parties sufficient notice to adjust their case-presentation strategy accordingly.  Suppose an arbitrator rules that a party does not have to present evidence in a particular form to support his or her position, or that the elements of a party’s claim or defense are X, Y and Z.  Suppose the party relies on these rulings, but that the arbitrator, after the close of the hearing, rules that the party had to present evidence in a different form, or that the elements of one of the claim or defense were A, B and C, rather than X, Y and Z.   If the arbitrator issues an adverse award based on such a ruling, then the aggrieved party should be able to vacate it under the catchall provision of Section 10(a)(3).  

D.  A Word to Arbitrators

Lawyers appearing in arbitration proceedings will sometimes attempt to bolster their procedural arguments by suggesting that a ruling other than in their client’s favor will lead to vacatur under Section 10(a)(3).  For the most part, such claims should be taken with a grain of salt, since, as explained above, Section 10(a)(3) reaches only serious procedural errors that prejudice a party. 

In response to such claims, however, certain arbitrators attempt to insulate themselves against putative Section 10(a)(3) claims by simply granting virtually every request for procedural relief made by the parties.  That knee-jerk approach simply multiplies time and money costs, depriving the parties of one of the key benefits of arbitration. 

The better approach is to make the tough calls, actively manage the proceedings and move things along.  To do this effectively, while minimizing the chances that they may commit the type of procedural error that might spoil an award, arbitrators should familiarize themselves with the law interpreting Section 10(a)(3).

In part V of our Nuts & Bolts vacatur series we shall discuss Section 10(a)(4), which authorizes vacatur “where the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made.”

         

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