I.       Introduction

Parts I and II of this three-part post discussed Chief Judge Frank H. Easterbrook’s decision in Trustmark Ins. Co. v. John Hancock Life Ins. Co. (U.S.A.), No. 09-3682, 2011 WL 285156 (7^th Cir. Jan. 31, 2011), and said that Trustmark, in conjunction with  Sphere Drake Ins. Co. v. All American Life Ins. Co., 307 F.3d 617, 622 (7th Cir. 2002) (Easterbrook, J.),  demonstrates that the district court should not have vacated on evident partiality grounds the arbitration award in Scandinavian Reinsurance Co. v. Saint Paul Fire & Marine Ins. Co, No. 09 Civ. 9531(SAS), 2010 WL 653481 (S.D.N.Y. Feb. 23, 2010).     This Part III.A explains some of the reasons why that is so.    

II.        Background:  Scandinavian Re

In Scandinavian Re the district court vacated the award on alleged Federal Arbitration Act Section 10(a)(2) “evident partiality” grounds on the theory that  two arbitrators (one neutral, one party-appointed) did not disclose their temporally-overlapping service on another arbitration panel hearing a dispute that the district court characterized as involving:  (a) a common witness; (b) one or two “similar” issues; (c) “similar” contract terms; (d) “the same type of reinsurance business”; and (e) a party that had succeeded to reinsurance business assumed by the party in whose favor the award was made.  The parties dispute whether the two arbitrations involved “similar” issues and contract terms, or even the “same type of reinsurance business,” but irrespective of how the United States Court of Appeals for the Second Circuit ultimately resolves those disputes, it will not change the outcome warranted by Trustmark and Sphere Drake.  This post therefore assumes – and for the sake of argument only — that the district court accurately portrayed the facts.      

According to the district court, the arbitrators’ overlapping service in the other arbitration created “a material conflict of interest”:

[T]he Scandinavian Re Arbitration and the [other] arbitration were presided over by two common arbitrators, overlapped in time, shared similar issues, involved related parties, included.  .  .  a common witness that supported interpreting [the agreement in the other arbitration] as written but interpreting the Scandinavian Re Agreement in light of Scandinavian Re’s intent at the time it entered into the agreement.  Additionally, [another witness] was employed by [the party in the other arbitration that had succeeded to business assumed by the prevailing party in the Scandinavian Re Arbitration] at the time she appeared as a witness in the Scandinavian Re Arbitration.  By participating in both the Scandinavian Re Arbitration and [the other arbitration], [the two arbitrators] placed themselves in a position where they could receive ex parte information about the kind of reinsurance business at issue in the Scandinavian Re Arbitration, be influenced by recent credibility determinations they made as a result of [the common witness’] testimony in [the other arbitration], and influence each other’s thinking on issues relevant to the Scandinavian Re Arbitration.  By failing to disclose their participation in the [other arbitration], [the two arbitrators] deprived Scandinavian Re of an opportunity to object to their service on both arbitration panels and/or adjust their arbitration strategy.  .  .  .  

2010 WL 653481 at *8. 

II.      Applying Trustmark/Sphere Drake to the Scandinavian Re Facts

Scandinavian Re turns on whether the arbitrators displayed “evident partiality” within the meaning of Federal Arbitration Act Section 10(a)(2).  9 U.S.C. § 10(a)(2).  Section 10(a)(2) does not define “evident partiality,” but both the Second and Seventh Circuits have declared that “arbitrators are not subject to the same standards of impartiality as [federal] judges.”   Applied Indus. Materials Corp. v. Ovalar, 492 F. 3d 132, 137 (2d Cir. 2007); see also Morelite Constr. Corp. v. New York City Dist. Council Carpenters Benefit Fund, 748 F.2d 79, 83-84 (2d Cir. 1984)); Sphere Drake, 307 F.3d at 621. 

A.    The Trustmark/Sphere Drake Analytical Framework

 Trustmark and Sphere Drake demonstrate that evident-partiality cases like Scandinavian Re can frequently be disposed of by assessing whether the asserted basis for evident partiality would, under the strict standards of impartiality applicable to federal judges (the “Judicial Impartiality Standards”), disqualify a judge from hearing the matter were it pending in federal court.  If the answer is “no,” then the evident partiality challenge must fail.     

Trustmark’s analytical framework is based on Sphere Drake.  There the Court rejected an evident partiality challenge based on a non-neutral, party-appointed arbitrator’s alleged failure to disclose (or fully disclose) his prior legal representation of one of the parties in a four-year-old, unrelated matter.  The Court said that the non-neutral arbitrator satisfied Judicial Impartiality Standards, and, even assuming he were a neutral, his award could not be vacated for evident partiality.  See 307 F.3d at 621-22.  The arbitrator’s failure to disclose was irrelevant, because not even a federal judge would have been required to disclose anything under Judicial Impartiality Standards.  See 307 F.3d at 622. 

B.      Did the Scandinavian Re Arbitrators Meet Judicial Impartiality Standards?

 1.      What Are those Standards?   

28 U.S.C. Section 455 sets forth the Judicial Impartiality Standards, which federal judges must meet in each case over which they preside.   Section 455(a) describes a “catchall” impartiality standard:  “(a) Any justice, judge, or magistrate judge of the United States shall disqualify himself in any proceeding in which his impartiality might reasonably be questioned.”  Section 455(b) sets out specific circumstances under which a judge is disqualified from hearing a case because of actual bias or prejudice or certain interests or relationships:    

 (1) Where he has a personal bias or prejudice concerning a party, or personal knowledge of disputed evidentiary facts concerning the proceeding;

(2) Where in private practice he served as lawyer in the matter in controversy, or a lawyer with whom he previously practiced law served during such association as a lawyer concerning the matter, or the judge or such lawyer has been a material witness concerning it;

(3) Where he has served in governmental employment and in such capacity participated as counsel, adviser or material witness concerning the proceeding or expressed an opinion concerning the merits of the particular case in controversy;

(4) He knows that he, individually or as a fiduciary, or his spouse or minor child residing in his household, has a financial interest in the subject matter in controversy or in a party to the proceeding, or any other interest that could be substantially affected by the outcome of the proceeding;

(5) He or his spouse, or a person within the third degree of relationship to either of them, or the spouse of such a person:

(i) Is a party to the proceeding, or an officer, director, or trustee of a party;

(ii) Is acting as a lawyer in the proceeding;

(iii) Is known by the judge to have an interest that could be substantially affected by the outcome of the proceeding;

(iv) Is to the judge’s knowledge likely to be a material witness in the proceeding.

Judges who do not meet these demanding Judicial Impartiality Standards in any given case are obligated to recuse themselves, that is, step aside and let another judge hear the case. If they do not do so, and it turns out an appellate court thinks they should have, then their orders and/or judgments may be vacated, and the parties may need to relitigate the case before a properly-qualified judge.   

2.      Did the Scandinavian Re Arbitrators Meet the Requirements of 28 U.S.C. § 455(b)? 

The most efficient way to analyze impartiality questions under Section 455 is to start with the specific (Section 455(b)) and move to the general (Section 455(a)).  There is nothing in Section 455(b) that even arguably suggests that the arbitrators in Scandinavian Re would be subject to disqualification if that rule applied to them.   

Subsection 455(b)(1) is the only one that might provide even a barely plausible basis for challenging an arbitrator in a case like Scandinavian Re.  But even assuming the accuracy of the district court’s factual findings, the Scandinavian Re arbitrators did not violate subsection 455(b)(1).        

First, there is no evidence of any “bias” or “prejudice,” both of which terms have a “pejorative connotation.” See Liteky v. United States, 510 U.S.540, 550 (1994) (Scalia, J.).  Under the “extrajudicial source doctrine,” “bias” or “prejudice” generally cannot be based on knowledge obtained from participation in judicial proceedings, or on predispositions legitimately reached as a result, because there is nothing wrongful or inappropriate about judges having that kind of knowledge or developing those predispositions.  As the United States Supreme Court pointed out in Liteky:    

Not all unfavorable disposition towards an individual (or his case) is properly described by th[e] [terms ‘bias or prejudice’].  One would not say, for example, that world opinion is biased or prejudiced against Adolf Hitler.  The words connote a favorable or unfavorable disposition or opinion that is somehow wrongful or inappropriate, either because it is undeserved or because it rests upon knowledge that the subject ought not to possess (for example, a criminal juror who has been biased or prejudiced by receipt of inadmissible evidence concerning the defendant’s prior criminal activities), or because it is excessive in degree (for example, a criminal juror who is so inflamed by properly admitted evidence of a defendant’s prior criminal activities that he will vote guilty regardless of the facts).  The ‘extrajudicial source’ doctrine is one application of this pejorativeness requirement to the terms ‘bias’ and ‘prejudice’ as they are used in [§].  .  .  455(b)(1) with specific reference to the work of judges. 

510 U.S. at 550 (emphasis in original).

Knowledge obtained from other proceedings; judicial opinions reached during those proceedings concerning applicable law and its application to facts; and judicial views formed during those proceedings concerning a party’s or witness’ credibility or character, may cause a judge to be favorably or unfavorably disposed to a particular position, party or witness.  But in the vast majority of cases those predispositions are in no way “wrongful” or “inappropriate”: 

The judge who presides at a trial may, upon completion of the evidence, be exceedingly ill disposed towards the defendant, who has been shown to be a thoroughly reprehensible person.  But the judge is not thereby recusable for bias or prejudice, since his knowledge and the opinion it produced were properly and necessarily acquired in the course of the proceedings, and are indeed sometimes (as in a bench trial) necessary to completion of the judge’s task.  .  .  .  Also not subject to deprecatory characterization as ‘bias’ or ‘prejudice’ are opinions held by judges as a result of what they learned in earlier proceedings.  It has long been regarded as normal and proper for a judge to sit in the same case upon its remand, and to sit in successive trials involving the same defendant.

.  .  .  . 

[J]udicial rulings alone almost never constitute a valid basis for a bias or partiality motion.  In and of themselves (i.e., apart from surrounding comments or accompanying opinion), they cannot possibly show reliance upon an extradjudicial source; and can only in the rarest circumstances evidence the degree of favoritism or antagonism required.  .  . when no extrajudicial source is involved.  .  .  .  [In addition,] opinions formed by the judge on the basis of facts introduced or events occurring in the course of the current proceedings, or of prior proceedings, do not constitute a basis for a bias or partiality motion unless they display a deep-seated favoritism or antagonism that would make fair judgment impossible. .  .  . 

510 U.S. 550-51 & 555-56 (citations omitted; emphasis in original). 

Even assuming the correctness of the district court’s factual findings, at most the Scandinavian Re arbitrators served in two proceedings featuring a common witness, some similar issues and contract terms, the same type of reinsurance business, and a related party.  The source of any alleged “bias” or “prejudice” was not “extradjudical,” and therefore it was presumptively proper and appropriate for the arbitrators to have whatever knowledge they obtained from their participation in the other proceeding, and any predispositions resulting from it.  See 510 U.S. at 550.  And that presumption was not rebutted, because there was no evidence of “deep-seated favoritism or antagonism that would make fair judgment impossible.”  Id.  Judges serve in related proceedings all the time – even simultaneously.  They likewise hear cases involving identical issues, even ones involving one or more common parties.  But nobody legitimately considers such service wrongful or inappropriate, let alone a basis for disqualification.    

Second, the Scandinavian Re arbitrators had no “personal knowledge of disputed evidentiary facts concerning the proceeding,” Section 455(b)(1)’s other ground for disqualification.  Perhaps the arbitrators had already heard in one proceeding testimony on factual issues allegedly common to both, including testimony from a common witness.  Perhaps they were already quite familiar with the relevant contract wording, which allegedly was similar. 

But that doesn’t mean they obtained personal knowledge of the facts established in the other proceeding and thus could testify as fact witnesses.  No one claims they were involved in the underlying transactions that gave rise to either dispute; their involvement was solely in an adjudicative capacity.  As Chief Judge Easterbrook put it in Trustmark:

[J]udges regularly hear multiple suits arising from the same controversy.  The district judge who resolved this very dispute also entered the order enforcing the 2004 award. If knowing about what happened in 2004 is an impermissible “interest,” or makes the person a “fact witness” about what had occurred in 2004, then the district judge should have stepped aside from the current suit. Yet that was not required.  .  .  .

2011 WL 285156, at *3.

3.      Were the Scandinavian Re Arbitrators Subject to Disqualification Under § 455(a)?  

Having determined the arbitrators were not subject to disqualification under Section 455(b) (assuming it applied to them), the only remaining question is whether they were subject to disqualification under Section 455(a)’s catchall standard, which requires disqualification where a judge’s “impartiality might reasonably be questioned.”  28 U.S.C. § 455(a).  Liteky provides a refreshingly straightforward answer:  a judge’s “impartiality” cannot “reasonably be questioned” where, as in Scandinavian Re, the alleged impartiality is based on knowledge obtained, or opinions or views formed, by the judge in the ordinary course of legitimately discharging his or her adjudicative responsibilities in another proceeding:    

[T]he pejorative connotation of the terms ‘bias’ and ‘prejudice’ demands that they be applied only to judicial predispositions that go beyond what is normal and acceptable.  We think there is an equivalent pejorative connotation, with equivalent consequences, to the term ‘partiality.’  See American Heritage Dictionary 1319 (3d ed. 1992) (‘partiality’ defined as ‘[f]avorable prejudice or bias’).  A prospective juror in an insurance claim case may be stricken as partial if he always votes for insurance companies; but not if he always votes for the party whom the terms of the contract support.  ‘Partiality’ does not refer to all favoritism, but only to such as is, for some reason, wrongful or inappropriate.  Impartiality is not gullibility.  Moreover, even if the pejorative connotation of ‘partiality’ were not enough to import the ‘extrajudicial source’ doctrine into § 455(a), the ‘reasonableness’ limitation (recusal is required only if the judge’s impartiality ‘might reasonably be questioned’) would have the same effect.  To demand the sort of ‘child-like innocence’ that elimination of the ‘extrajudicial source’ limitation would require is not reasonable. 

510 U.S. at 552. 

IV.  Was There any Legitimate Basis for the District Court’s Decision to Vacate the Scandinavian Re Arbitration Award?

The answer is “no.”  Even if the strict Judicial Impartiality Standards applied to Scandinavian Re arbitrators, they satisfied them, and that means they necessarily satisfied the more lenient ones imposed by Section 10(a)(2). 

A.  There Was No “Conflict of Interest”

The district court’s conclusion that the arbitrators had a “conflict of interest” was misplaced.  The district court said the arbitrators “placed themselves in a position where they could receive ex parte information about the kind of reinsurance business at issue in the Scandinavian Re Arbitration, be influenced by recent credibility determinations they made as a result of [the common witness’] testimony in [the other arbitration], and influence each other’s thinking on issues relevant to the Scandinavian Re Arbitration.”  2010 WL 653481 at *8.  But a judge or arbitrator cannot have a “conflict of interest” unless he or she has an interest in a matter — whether imposed by law, or created by economic, social or professional circumstances or relationships — which is at odds with his or her legal or contractual obligations with respect to that matter.  Trustmark and Liteky foreclose any argument that an arbitrator’s discharge of legitimate adjudicative functions in matter A can create an “interest” in the outcome of related matter B, let alone a conflicting one.        

Likewise, the risk that that the arbitrators might “influence each other’s thinking on” allegedly similar common issues does not create a conflict of interest or otherwise establish evident partiality.  That risk is usually present to some degree on three-judge appellate panels, and is particularly high in the United States Supreme Court, where the same nine Justices generally hear each case.  But nobody thinks that Circuit Judges or Supreme Court Justices should recuse themselves in matter B because they served together in related matter A, and thus might, in matter B, influence the thinking of judges or justices who had not heard matter A.  

B.    But What About the Arbitrators’ Failure to Disclose their Contemporaneous Involvement in the Two Arbitrations? 

Some practitioners and business people may think that the Second Circuit should affirm the district court in Scandinavian Re because the arbitrators did not disclose their involvement in the other proceeding.  They may think that even though the arbitrators could have served as judges, their failure to disclose their overlapping service in the other proceeding evidenced some sinister motive that somehow spoiled the award.  Alternatively, some may concur with the district court’s conclusion that the arbitrators’ nondisclosure somehow “deprived Scandinavian Re of an opportunity to object to their service on both arbitration panels and/or adjust their arbitration strategy.”  See 2010 WL 653481, at *8. 

These arguments are misplaced for several reasons, but it is enough to say that accepting them would impose on arbitrators ethical standards far more onerous than those imposed on federal judges.  Where, as in Scandinavian Re, there is no basis on which the judge’s “impartiality might reasonably be questioned,” the judge is not required to disclose anything, and there is no basis for challenging impartiality.  See Sphere Drake, 307 F.3d at 622; see also Section III.A, above.  Obviously the Scandinavian Re arbitrators did not have to disclose anything that a similarly-situated federal judge would not have to disclose.      

Part III.B will explain why the United States Court of Appeals for the Fifth Circuit should reverse in Dealer Computer Svcs., Inc. v. Michael Motor Co., No. H-10-2132, 2010 WL 5464266 (S.D. Tex. December 29, 2010).

[Editor's Note:  Karl Bayer's and Beth Graham's  Disputing blog has published as a guest post materially identical versions of Parts I-III.A of this post, which you can read here, here and here.]

In it I argue that the Stolt-Nielsen decision is both inexplicably broad and inexplicably narrow in scope, and may provide fodder for those who assert that Congress should enact the Fairness in Arbitration Act of 2009.  I also deconstruct the reasoning of the decision and explore some of its other practical and legal implications.   

Alternatives to the High Cost of Litigation is a subscription-only publication. Subscription information is available at this page, as well as at the publisher’s, John Wiley & Sons’s,  website here.

I would like once again to take this opportunity to thank CPR, and Russ Bleemer, Editor of Alternatives, for their kind assistance and support in featuring my article.   As I have said before, Russ is a keen,  intelligent and professional editor with whom it is a pleasure to work.

A.   Introduction

In Part I (here) we explained why the standard for challenging an award based on its outcome is important in reinsurance arbitration practice.  And, after briefly reviewing pre-Stolt-Nielsen law on outcome-based standards of review, we explained how Stolt-Nielsen has established a fairly searching, standard of review.  This Part II explores the legal and practical implications of that standard of review.    

B.   Legal Implications of the Stolt-Nielsen Decision’s Manifest Disregard of the Agreement Standard of Review

1.  Courts May Interpret Stolt-Nielsen’s Outcome-Based Standard of Review Liberally

Reinsurance-  and other commercial-arbitration awards are now subject to the same standard of review as labor-law awards – and in Stolt-Nielsen, the Court applied that standard of review pretty liberally.  The Court has put to rest the notion that Federal Arbitration Act Section 10(a)(4) vacatur is limited to questions concerning whether the arbitrators decided a matter falling within the scope of the parties’ arbitration agreement or submission.   The outcome of the arbitration is now subject to at least some, limited scrutiny. 

The focus will now be on whether the arbitrators interpreted, applied and enforced the contract, and applied applicable law or norms.  Express or implied reliance on extra-contractual considerations, such as public policy, may spoil an award, unless those extra-contractual considerations are grounded in applicable law.  Not heeding clear and unambiguous contract language, effectively deleting or disregarding contractual provisions or otherwise rewriting the contract may also subject the award to vacatur. 

Interpreting a contract according to reinsurance custom and practice will remain permissible, because doing so is usually consistent with contract interpretation rules, and, in any event, reinsurance contracts are supposed to be interpreted in light of custom and practice.  An award that relies on custom and practice would presumably draw its essence from the reinsurance contract, provided that the interpretation has at least a barely colorable basis in the contract or applicable law. 

Honorable engagement clauses will continue to give arbitrators a degree of discretion to depart from the ordinary meaning of contract terms, and permit certain looser interpretations that are based on honorable engagement.  But, as we have pointed out in a prior post (here), in jurisdictions that have adopted outcome-based standards of review, interpreting an honorable engagement clause as a license to rewrite a contract would be tantamount to inviting a court to vacate the resulting award.  Now that Stolt-Nielsen has adopted a uniformly applicable, outcome-based  standard of review, that is now true in all jurisdictions. 

Labor-law precedent construing the “manifest disregard of the agreement” standard is now more relevant than before.  In jurisdictions that had not previously adopted the labor-law standard of review in the commercial context, such precedent was often distinguishable.   That is no longer necessarily the case, and labor-law precedent interpreting the standard will be at least persuasive authority for how the standard should be interpreted in the commercial context. 

The relevance of labor-law precedent cannot be discounted, for it confines the role of the arbitrator to the interpretation and application of the contract more strictly than does commercial-arbitration precedent.  In part that is because the Labor Management Relations Act says that “[f]inal adjustment by a method agreed upon by the parties is declared to be the desirable method for settlement of grievance disputes arising over the application or interpretation of an existing collective bargaining agreement.”  29 U.S.C. §173(d) (emphasis added); see, generally, Wright v. Universal Maritime Serv. Corp., 525 U.S. 70, 77-80 (1998).  While the Supreme Court had not previously suggested that the federal policy in favor of arbitration is limited to “disputes arising over the application or interpretation of” a commercial contract, the Supreme Court in Stolt-Nielsen nevertheless declared that: 

It is only when [an] arbitrator strays from interpretation and application of the agreement and effectively ‘dispense[s] his own brand of industrial justice’ that his decision may be unenforceable.  In that situation an arbitration decision may be vacated under § 10(a)(4) of the FAA on the ground that the arbitrator ‘exceeded [his] powers,’ for the task of an arbitrator is to interpret and enforce a contract, not to make public policy.

Stolt-Nielsen, Slip op. at 7 (emphasis added).   The language used by the Court strongly suggests that a commercial arbitrator’s powers are co-extensive with that of a labor arbitrator, no matter how broad the scope of the arbitration clause.    

But we believe that the standard will probably not be interpreted quite as strictly in the commercial context.  Commercial arbitration is not subject to the LMRA, and the policy considerations relevant to labor arbitration — including the need to maintain industrial peace, and to protect the rights of individuals arising out of a collective bargaining agreement that is negotiated and entered into by the union in a representative capacity only – do not apply in commercial arbitration. 

Interpreting Stolt-Nielsen too literally would lead to anomalous results.  For example in labor arbitration statutory claims are not presumed to be arbitrable because they concern the meaning of a federal statute, not the interpretation or application of the agreement.   See Wright, 525 U.S. at 78-79.  Courts therefore require clear and unmistakable of an intent to arbitrate statutory claims.  See 525 U.S. at 80-82.  But in commercial arbitration such claims are arbitrable provided the parties agree to a broad arbitration clause, because commercial contracts are usually negotiated and entered into in an individual or entity capacity, and the parties are thus able to directly protect their own interests in the bargaining process.  See, generally,  525 U.S. at 80-82.

So the upshot is that labor precedent will likely inform a court’s application of the standard in the commercial context, but that the courts will not blindly apply it when doing so would be inimical to the purposes of commercial arbitration as expressed by commercial-arbitration precedent, and would effectively import into commercial arbitration a special rule or standard that serves only policy considerations relevant to labor arbitration.  But based on the standard articulated in Stolt-Nielsen, and the way the Court applied the standard to the facts, the Court has effectively said that the decisions of commercial arbitrators have to be based on at least barely colorable interpretations of:  (a) the contract or (b) applicable law and norms.   

2.  The “Manifest Disregard of the Law” Standard May be Subsumed in Whole or in Part within the Court’s “Manifest Disregard of the Agreement” Standard

While the Court stopped short of deciding whether the “manifest disregard of the law” standard of review survived Hall Street Associates LLC. v. Mattel Inc., 552 U.S. 576 (2008), the Court’s dictum–and even its holding—strongly suggest that the standard is not only alive but thriving.  The Court criticized the arbitration panel for not “inquiring whether the FAA, maritime law, or New York law contains a ‘default rule’ under which an arbitration clause is construed as allowing class arbitration in the absence of express consent .  .  . ,” and instead applying its own public-policy-based rule derived from other arbitral decisions.

That alone may be read as an admonition to arbitrators to interpret and apply the law, not their own rules, but there is more.  While the Court recognized that it could have remanded the matter to the arbitrators under Federal Arbitration Act Section 10(b), it did not because it concluded that no outcome was permissible under the Federal Arbitration Act under the facts before it other than the one it set out to articulate later in the decision.  Stolt-Nielsen, slip op. at 12. 

The Court thus did not consider the arbitrators authorized to disregard — let alone manifestly disregard — what it considered to be the applicable rule under the Federal Arbitration Act.  Whether that means the Court has effectively endorsed vacatur for “disregard of the Federal Arbitration Act” only, or “manifest disregard” of any applicable law, is open to question. 

The opinion suggests that the court was effectively endorsing the broader, “manifest disregard of the law” standard.  The Court stated that the panel went astray when it disregarded whatever law there was on the applicable default rule when the parties’ contracts are silent on class arbitration, and instead based its decision on its own notions of public policy.  So however the Court might have characterized the standard of review, it appears to encompass at least some situations that might otherwise be characterized as “manifest disregard of the law.”  Indeed, the Court noted that vacatur would be required in Stolt-Nielsen had the Court decided to apply a “manifest disregard of the law” standard. 

3.  Stolt-Nielsen May be Construed as Making Certain Public-Policy-Related Matters Non-Arbitrable, Even Under a Broad Arbitration Clause

Stolt-Nielsen may be construed as rendering public policy-based issues nonarbitrable, even when the parties’ arbitration clause is arguably broad enough to encompass them.  Stolt-Nielsen said that the role of arbitrators was not to make public policy, but to interpret and apply the terms of the parties’ contract, and ruled that the arbitrators exceeded their powers by imposing class arbitration based on their own notions of public policy.  The Court pointed out that the arbitrators had effectively–and erroneously–assumed the role of a common-law court in ascertaining and applying what it perceived to be applicable public policy.

But it should follow that the arbitrators never had the authority in the first place to decide the question whether class arbitration should be imposed as a matter of public policy.  Suppose a party asks an arbitrator to determine whether a provision in a reinsurance contract violates state public policy, but there is no state law on the books articulating the applicable public policy or stating whether or not the public policy does or does not justify enforcing a contract provision identical (or at least similar) to the one the arbitrator has been asked to rule upon.  In that circumstance the arbitrator would have to:  (a) ascertain whether there was or was not a relevant policy; (b) determine what the policy was and whether the contract provision was inconsistent with it; and, if the policy was inconsistent with the contract provision, (c) determine whether the policy is sufficiently important that it should trump a countervailing state policy of enforcing contracts according to their terms. 

It seems to us that, after Stolt-Nielsen, the parties should not be required to submit the public-policy issue to arbitration under the circumstances in the hypothetical above, even if their arbitration agreement was broad enough to encompass the issue.  For the arbitrators would simply be making a public policy determination that the Supreme Court suggested must be made by a common-law court, at least in the absence of any clear statutory or case law guidance on which the arbitrator could base his or her decision.    

C.   Practical Implications of the Manifest Disregard of the Agreement Standard

The most obvious practical implication that the decision will likely have will be to increase the frequency of motions to vacate.    Stolt-Nielsen has certainly affirmed that Section 10(a)(4) can and should be construed broadly to encompass a challenge to an award’s outcome.  And it has resoundingly approved applying the labor-law based “manifest disregard of the contract” standard to commercial arbitration awards, and implied that the standard encompasses, for all practical purposes, the “manifest disregard of the law” standard.  With courts around the country now uniformly having greater discretion to review arbitration awards, lawyers and their parties will no doubt seek to reap the perceived benefits of that discretion and to test its scope.    

While we do not believe that the Supreme Court has opened the proverbial floodgates to outcome-based challenges of arbitration awards, we do think that more will be granted.  How many more remains to be seen, but it is safe to assume that final arbitration awards have probably become a tad less final. 

Reinsurance arbitrators will have to take careful note of Stolt-Nielsen’s standard of review.  To ensure finality, their awards will need to be grounded in the contract and governing law and norms.  While most good arbitrators generally render awards that are so grounded, Stolt-Nielsen appears to have upped the stakes a bit, slightly increasing the risk of vacatur.  Arbitrators need to be familiar with the Stolt-Nielsen standard of review to help mitigate the increased risk.  

Stolt-Nielsen’s heightened standard of review may be a welcome development to some parties.  There are those in the industry who have complained that reinsurance arbitrations have become too unpredictable, and there are some who complain that they have been on the losing end of what they consider to be arbitrary awards.  Some of these parties no longer agree to include arbitration clauses in their contracts. 

The heightened degree of judicial discretion that Stolt-Nielsen permits may allay some or all of these concerns.  And depending on how courts interpret Stolt-Nielsen, parties that no longer utilize arbitration clauses might eventually reconsider that strategy.    

But there are other parties whose principal concern about arbitration is its cost.  Stolt-Nielsen is likely to increase the frequency of motions to vacate, and more will probably be granted.  Obviously that will result in increased arbitration-related costs, and that may lead some of these parties not to include arbitration clauses in some or all of their new contracts.  Or those parties may seek alternative, and presumably less costly, ways of resolving disputes, such as mediation or negotiation. 

As we suggested in Part I, the choice of the standard of review involves a delicate balancing act between competing considerations.  It is unclear to us at this juncture whether the balance struck by Stolt-Nielsen will encourage or discourage arbitration of reinsurance disputes.  Arbitration may be a foregone conclusion as respects disputes on old business, but its continued use on new business will depend in part on how the courts interpret this new, uniformly applicable standard of review, and on whether the Supreme Court ultimately decides to change it.

Editor’s Note:  Here’s a list of links for Parts I through V of our Stolt-Nielsen reinsurance-arbitration series: 

Part I, Part II, Part III, Part IV, Part V.A, Part V. B, and Part V. C

A.     Introduction 

Shortly before the United States Supreme Court decided Stolt-Nielsen, S.A. v. AnimalFeeds Int’l Corp., ___ U.S. ___, slip op. (April 27, 2010), we wrote about the implications the case might have on reinsurance arbitration practice.  (See our post here.)  But since then, you have not heard much from us, other than our brief report (here) about the Supreme Court vacating and remanding to the United States Court of Appeals for the Second Circuit the American Express Merchants’ Litigation judgment for further consideration in light of Stolt-Nielsen.   One — but by no means the only — reason is that after Stolt-Nielsen was decided, we wrote a comprehensive article on it, which will be published in a subscription-only publication in June. 

But that article – while comprehensive in scope – is directed at folks interested in the Federal Arbitration Act in general, not necessarily those interested in reinsurance arbitration in particular.  And that’s what we want to cover in this multi-part series:  Stolt-Nielsen’s implications on reinsurance arbitration practice. 

Stolt-Nielsen affects reinsurance arbitration in two very important ways.   First, it has set a fairly liberal standard of review that now applies to commercial arbitration awards in cases where a party asserts that the arbitrators exceeded their powers under Federal Arbitration Act Section 10(a)(4) because of the award’s outcome.  That, as we shall see, has all sorts of implications for persons involved in reinsurance arbitrations.

Second, it has changed the rules applicable to consolidated-reinsurance-arbitration practice – or at least it requires a wholesale reevaluation of those rules.  That, too, has a number of important implications for reinsurance-arbitration practice.   

This Part I of the series explains why the standard for challenging an award based on its outcome is important in reinsurance arbitration practice.  And, after briefly reviewing pre-Stolt-Nielsen law on outcome-based standards of review, it explains how Stolt-Nielsen has established for the lower courts a fairly searching standard of review.  Part II (here) will delve into what the implications of that standard of review will likely be. 

Part III (here) will provide the background necessary to understand how Stolt-Nielsen affects the law applicable to consolidated reinsurance arbitration.  Part IV (here) will delve into the details of how Stolt-Nielsen changes – or at least requires reconsideration of – the legal status quo in this area.  And Part V will discuss the implications of all of this.   

We do not set out to discuss the background of Stolt-Nielsen in any detail or to provide a play-by-play of how the Court decided the case.  If you are a regular reader you probably already know the background in detail, and our upcoming article does a pretty good job of mapping out the Court’s reasoning.  Instead, we focus our attention on the aspects of the decision that are relevant to the two key subjects of discussion. 

But before we delve into what Stolt-Nielsen has to say about the standard of review, we pause briefly to address why the standard of review applicable to an outcome-based challenge is so important in reinsurance and other forms of commercial arbitration. 

B.     Why is the Outcome-Based Standard of Review under Section 10(a)(4) Important to Reinsurance Arbitration Practice? 

Those involved in, or who have responsibility for, reinsurance arbitrations have good reason to be concerned about the extent to which a Court can vacate an award based on its outcome.  For the standard of review is not merely legal “mumbo jumbo,” but delineates the degree of discretion that a judge has to vacate an arbitration award.  That degree of discretion effectively acts as a check on arbitral power and determines how final a final arbitration award really is. 

Reinsurance arbitrators should be (and usually are) interested in the standard of review because it bears on how much discretion they have to decide a case in a particular manner.  Since arbitrators have institutional, reputational and economic interests in ensuring that their awards will be confirmed, they need to know how much discretion a judge has to second-guess their decisions. 

Parties likewise have good reason to be concerned about the standard of review.  The end product of arbitration will (or, at least, should) determine their rights and obligations, making one or both parties winners or losers.  Winners want that determination to be final; losers do not – and the scope of the standard of review determines (however loosely) the odds that the loser might get another bite at the proverbial apple. 

Parties also have institutional interests in the standard of review because it factors into the risk-benefit calculus that informs their decision whether to arbitrate in the first place.  The less discretion a judge has to vacate an award, the greater the risk that a party who agrees to arbitrate might be saddled with an arbitration award that bears little or no resemblance to what one would expect given the clear and unambiguous language of the contract and applicable law, custom and practice.  The more discretion a judge has to overturn an award, the more likely it is that arbitration will be followed by litigation, thereby increasing costs. 

The risk of high expense is inversely proportional to the risk of a wacky but unreviewable outcome.  If reinsurers and cedents are going to make informed choices about arbitration, they need to know where along the continuum of standard-of-review choices the law has attempted to strike the balance between these risks.

Attorney interests are aligned with those of their clients.  But to advance their client’s interests attorneys need to know the contours of the standard of review so that they can tailor strategy to maximize the chances that the client will reap whatever benefits the standard of review may have to offer.  For example, if the standard of review provides the court with some discretion to vacate an award that conflicts with the clear and unambiguous terms of the reinsurance contract, and those terms support the client’s position, then the attorney must not only forcefully argue those terms are controlling, but also make clear (diplomatically, of course) that an award inconsistent with those terms will likely be vacated. 

C.     The Legal Landscape:  The Section 10(a)(4) Standard of Review Prior to Stolt-Nielsen

To better understand how Stolt-Nielsen changed the standard of review applicable to outcome challenges, it is helpful to review briefly the somewhat confused, pre-Stolt-Nielsen law on outcome-based standards of review. 

Section 10(a)(4) of the Federal Arbitration Act authorizes courts to vacate an arbitration award “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.”  Prior to Hall Street Assoc. v. Mattel, Inc., 552 U.S. ___ (2008), courts interpreted Section 10(a)(4) in at least two different ways.  Some courts interpreted Section 10(a)(4) as limited to challenges based on whether the matter decided fell within the scope of the parties’ arbitration agreement or submission.  That begged the question whether, and, if so, to what extent, the outcome of a commercial arbitration award on an issue within the parties’ submission was subject to any review at all. 

The Supreme Court had provided only indirect guidance on the subject.   The Steel Workers’ Trilogy cases, and their progeny, had ruled that, in labor arbitration cases governed by Section 301 of the Labor Management Relations Act (“LMRA”), the outcome of an award was subject to review to determine whether it drew “its essence from” the parties’ agreement, and was not based on the arbitrators’ “own notions of industrial justice.”  United Paperworkers Int’l Union v. Misco,  484 U.S. 29, 38 (1987);  United Steelworkers v. Enterprise Wheel & Car Corp., 363 U.S. 593, 597 (1960).   And, as respects commercial arbitration awards, the Court suggested in dicta in Wilko v. Swan, 346 U.S. 427 (1953), overruled on other grounds, Rodriguez De Quijas v. Shearson/American Express, Inc., 490 U.S. 477 (1989),  that an award could be vacated if it was in “manifest disregard of the law.”  This dicta was referred to with approval in First Options of Chicago v. Kaplan, 514 U.S. 938, 942 (1995).

Based on this somewhat obscure guidance, a number of courts that had interpreted Section 10(a)(4) of the Federal Arbitration Act as limited to challenges to arbitral authority developed independent grounds to review the outcomes of awards, whether for “manifest disregard of the law,” or failure of the award to draw its essence from the parties’ agreement, a standard that we shall refer to as “manifest disregard of the agreement.”  Some courts adopted both standards, some only one. 

But some other courts held that one or both of these “manifest disregard” standards were impliedly incorporated within Section 10(a)(4) and that vacatur under Section 10(a)(4) was not limited to situations where arbitrators ruled on an issue that was outside the scope of their authority.  These courts held that arbitrators exceeded their powers by manifestly disregarding the law, the agreement or both.   

Whether or not a court adopted one or both standards of review, and whether or not they deemed those standards of review to be within or without Section 10(a)(4), courts often articulated the standards of review differently, and applied them with varying degrees of strictness or laxity.  But for the most part, all courts were reluctant to grant relief based on them save in fairly unusual circumstances. 

In 2008 the Court decided Hall Street, which held that the Section 10 of the Federal Arbitration Act stated the exclusive grounds available to challenge a commercial arbitration award.  In dicta the Court discussed whether “manifest disregard of the law” might be encompassed within Section 10(a)(4), but did not decide whether that was so. 

Courts that had ruled that “manifest disregard of the law,” “manifest disregard of the agreement,” or both, were independent grounds for vacatur were forced to reconsider whether those standards were, in fact, independent, or whether they were subsumed within Section 10(a)(4).  This led to some conflicting authority, with some courts holding that one or both of those standards were subsumed within Section 10(a)(4) and others concluding that one or both of these outcome-based standards of review did not survive Hall Street .     

D.     What did Stolt-Nielsen Have to Say About the Outcome-Based Standard of Review? 

On June 15, 2009 the Supreme Court granted certiorari in Stolt-Nielsen to consider “[w]hether imposing class arbitration on parties whose arbitration clauses are silent on that issue is consistent with the Federal Arbitration Act, 9 U.S.C. §§ 1 et seq.”  As readers will recall, the parties had submitted to an arbitration panel the question whether the arbitration clauses contained in a series of charter-party agreements permitted or precluded class arbitration.  The Second Circuit held that the arbitration panel had not manifestly disregarded the law by imposing class arbitration on the parties even though their arbitration agreements were concededly silent on that score. 

On April 27, 2010, in a 5-3 decision authored by Associate Justice Samuel A. Alito, Jr., and joined in by Chief Justice John G. Roberts Jr. and Associate Justices Antonin Scalia, Anthony M. Kennedy and Clarence Thomas, the Court held that:  (a) the arbitration panel exceeded its powers under FAA Section 10(a)(4) by imposing class arbitration on the parties, because the panel’s decision was based solely on the arbitrators’ own notions of public policy rather than on the FAA, federal maritime, or New York State law; and (b) it was inconsistent with the FAA to impose class arbitration on the parties because it was undisputed that the parties had never consented to class arbitration, and implying such an agreement in the circumstances would drastically alter the nature of the parties’ agreement to arbitrate on a bilateral basis.

Although the Court could probably have decided the matter as one of arbitrability – the Stolt-Nielsen parties appeared to have reserved their rights to de novo review of the question whether the arbitrators had the power to render a binding decision on whether class arbitration was permitted in the face of silence – the Court initially addressed the question from the standpoint whether the award should be vacated based on the outcome.  And that determination required the Court to state the applicable standard of review for an outcome-based challenge to a commercial arbitration award. 

 The Court imported into the commercial context the labor-arbitration “manifest disregard of the agreement,” standard and found that it was subsumed within Section 10(a)(4).  It said that it was not deciding whether the “manifest disregard of the law” standard survived Hall Street (i.e., whether it was also part and parcel of Section 10(a)(4)), but declared that if it did, then it was satisfied here. 

Borrowing from the Steelworkers’ Trilogy line of labor arbitration cases decided about 50 years ago, and more recent labor-arbitration cases, the Court declared, “’It is only when [an] arbitrator strays from interpretation and application of the agreement and effectively ‘dispense[s] his own brand of industrial justice’ that his decision may be unenforceable.” Slip op. at 7 (quoting Major League Baseball Players Assoc. v. Garvey, 532 U.S. 504, 509 (2001) (per curiam)(quoting Enterprise Wheel & Car Corp., 363 U.S. at 597 (1960))).  

“In that situation,” said the Court, “an arbitration decision may be vacated under § 10(a)(4) of the FAA on the ground that the arbitrator ‘exceeded [his] powers,’ for the task of an arbitrator is to interpret and enforce a contract, not to make public policy.”  Applying that standard to the facts, the Court “conclude[d] that what the arbitration panel did was simply to impose its own view of sound policy regarding class arbitration.”  Slip op. at 7.

The Court explained that AnimalFeeds had made three arguments, one of which was that “the clause should be construed to permit class arbitration as a matter of public policy.”  Slip op. at 8 (quotation omitted).  Of the remaining two arguments, the panel had rejected one and said nothing about the other.  This led the Court to conclude that the arbitrators had accepted AnimalFeeds’ invitation to base its decision on public policy grounds.

The Court found further evidence that the panel based its decision on public policy in that the panel looked to previous arbitral decisions by other panels that had addressed the question and:  (a) “[p]erceiv[ed] .  .  . consensus among arbitrators that class arbitration is beneficial in ‘a wide variety of settings;’” and (b) considered “only whether there was any good reason not to follow that consensus .   .  .  .”  Slip op. at 9 (quotations omitted). 

The Court also found it relevant that the panel was not persuaded by Stolt-Nielsen’s unrebutted expert testimony — including testimony that there had never been a class arbitration under the form of charter party agreement used — or by pre-Green Tree Financial Corp. v. Bazzle, 539 U.S. 444 (2003) decisions holding that courts could not compel class or consolidated arbitration where the parties’ agreements were silent on that score.    Slip op. at 9; see, e.g., Glencore Ltd. v. Schnitzer Steel Products, 189 F.2d 264 (2d Cir. 1999); United Kingdom v. Boeing Co., 998 F.2d 68 (2d Cir. 1993); and Champ v. Siegal Trading Co., 55 F.3d 269 (7th Cir. 1995).

The Court said that because the parties had stipulated that they had reached no agreement on class arbitration, the arbitrators should have inquired whether the  FAA, maritime law, or New York Law contained a “default rule” that applied.  But instead, “the panel proceeded as if it had the authority of a common-law court to develop what it viewed as the best rule to be applied in such a situation.”

The Court was not persuaded by the “references to intent” in the panel decision, including a reference to the parties’ broad arbitration clause.  The Court pointed out that the parties stipulated, and the arbitration panel acknowledged, that the charter party agreement was silent on permitting or precluding class arbitration, and “that the charter party was ‘not ambiguous so as to call for parol evidence.’”  Slip op. at 11 (quoting panel decision).  The stipulation “left no room for an inquiry regarding the parties’ intent, and any inquiry into that settled question would have been outside the panel’s assigned task.”   Slip op. at 11.

The implications of the Court’s ruling on the standard of review are many, and shall be discussed in Part II (here).

Editor’s Note:  Here’s a list of links for Parts I through V of our Stolt-Nielsen reinsurance-arbitration series: 

Part I, Part II, Part III, Part IV, Part V.A, Part V. B, and Part V. C

Chief Judge Easterbrook’s “agency” model of arbitral authority is instructive.  Just as agents derive their authority by the consent of the principal (subject to the rules of apparent and implied authority), arbitrators derive their authority from the parties via the arbitration agreement and the submission.  Subject to any restrictions in the arbitration agreement, the arbitrators’ powers to resolve a dispute under a broad arbitration agreement are arguably co-extensive with those of the parties that appointed them. 

But the model is not perfect.  First, unlike agents, arbitrators are not subject to the control of their principals and owe them no fiduciary duties.  Second, analogizing arbitrators as agents of the parties in the way Chief Judge Easterbrook does effectively empowers arbitrators not only to decide cases, but to negotiate settlements that the parties could have entered into.  It therefore does not require arbitrators to even arguably interpret the contract or apply the law:  As long as the arbitrators do not require the parties to violate the law, and as long as the arbitrators are at least arguably faithful to the parties’ expressed choice-of-law, if any, they can reach whatever decision they wish, whether by application of facts to legal norms or by a compromise settlement that may or may not be rooted in the parties’ agreement.    That arguably does not comport with the parties’ presumed, legitimate expectations.  For the arbitrator’s job is to decide cases; settlement is a matter for the parties, and should be subject to the parties’ control. 

University of Chicago Law School Professor Tom Ginsburg has written an excellent white paper that argues that the deferential standard of review espoused by Watts and other courts does not necessarily make arbitration an attractive substitute for litigation.  See Tom Ginsburg, John M. Olin Law & Economics Working Paper No. 502 (2d Series), The Arbitrator as Agent: Why Deferential Review Is Not Always Pro-Arbitration  (Dec. 2009) (copy available here).  He argues that a more searching standard of review would make the market for arbitrators more transparent, and thus more effective.  He advocates using Chief Judge Easterbrook’s agency model as an analytical framework for allowing parties to choose whether they prefer a very deferential standard of review, like that prescribed in Watts; something akin to de novo review, like that available in litigation; or something in between the two.  Professor Ginsburg is in the process of publishing in the University of Chicago Law Review an article based on his white paper.

As respects the tie-in between the standard of review and the effectiveness of arbitration, Professor Ginsburg explains that arbitrators are frequently experts in the subject matter of dispute, but, unlike “generalist judges,” they are not necessarily experts on the law or on the application of law to facts, and therefore are “prone to make mistakes, or at least presumptively more prone to do so than are judges.”  Since arbitration is a surrogate for adjudication, the U.S. legal system has had to decide what level of scrutiny best advances the federal policy in favor of arbitration.  Most arbitration statutes and the Convention on the Recognition and Enforcement of Foreign Arbitral Awards have eschewed mere legal error as a ground for judicial review of arbitration awards.  Only a particularly egregious error will warrant vacatur, and even then, courts differ as to what – if anything – constitutes an egregious error amounting to manifest disregard of the law (or perhaps manifest disregard of the agreement).   Courts consider this deferential approach as the one best suited to implementing a policy in favor of arbitration. 

But, as Professor Ginsburg observes, there is “a spectrum of possible alternative regimes, ranging from de novo review to complete non-reviewability,” and choosing which one best promotes arbitration involves a “tradeoff:” 

If the standard of review is too rigorous, the benefits of arbitration in terms of speed, cost, and finality may be lost because parties will frequently appeal arbitral awards to the courts.  On the other hand, if review is too limited, arbitrators might deliver very poor quality decisions that undermine the attractiveness of arbitration as a whole.

 Professor Ginsburg argues that Watts, Hall Street Assoc., L.L.C. v. Mattel , Inc., 552 U.S. ___, slip op. (March 25, 2008), and other court decisions trade off  too much in favor of speed, cost and finality by adopting a standard of review that amounts to practically no review at all.  He assumes, for the sake of argument, that there are “good arbitrators” that “always interpret the law accurately,” and “bad” ones who “do so only with a probability p < 1.”  He assumes that, in selecting arbitrators, a sufficiently large number of purchasers will seek “good” arbitrators (or “bad” arbitrators whose probability of interpreting the law correctly is close to 1.)  Parties will attempt to mitigate the risk of choosing a “bad” arbitrator through screening, but market imperfections tend to make the screening process unreliable: 

Will screening serve to adequately reduce the agency problem of arbitrators?  If the market for arbitrators is sufficiently robust, it might.  But the market for arbitrators has certain imperfections.  For example, there are no public records of arbitrator performance.  Arbitrators need not produce publicly available opinions, and parties generally have no incentive to allow them to reveal the basis for the award.  Only when an arbitrator makes an egregious error leading to a vacatur petition (such as manifestly disregarding the law outside the Seventh Circuit) will there be a public record of performance.  Hence it is difficult for the parties to a contractual dispute to evaluate potential arbitrators in terms of their ability to interpret law.  Reputational considerations are, of course, a factor, but in the absence of reasoned decisions, even past users of a particular arbitrator cannot be sure their favorable outcome resulted from skilled arbitration or a combination of lazy arbitration and luck.  There will thus be certain informational asymmetries in the market for arbitrators, allowing bad arbitrators to remain in the market.

A heightened level of judicial monitoring might compensate for some of these imperfections, says Ginsburg.  But decisions like Hall Street and Watts allow for only perfunctory review.  And while those decisions were intended to make arbitration more attractive, and to promote judicial economy as a result, Professor Ginsburg says their practical effect may be quite the opposite: 

One perverse result of the Hall Street decision might be greater pressure on courts to resolve full contract disputes.  One rationale for not allowing parties to contract into higher levels of judicial scrutiny (though not fully articulated in the Hall Street decision which relied on a textual analysis of the FAA) would be to enhance judicial economy — the public should not have to subsidize private dispute resolution. But after Hall Street, parties who want a legally proper decision cannot submit to arbitration, or at least will be less likely to do so, because there can be only minimal ex post monitoring of arbitral awards.  Like Watts, Hall Street limits the scope of review. But unlike Watts, it does not follow an agency perspective.  By preventing courts from policing arbitrator interpretations of law, Hall Street may end up reducing the number of cases sent to arbitration and, perversely, shifting contract disputes to the courts, precisely because there is no alternative way for parties to ensure that arbitrators do follow the law.  The Hall Street logic may end up sacrificing judicial economy in an attempt to preserve it, and hurt arbitration in the name of helping it.  (footnotes omitted) 

But if the parties could “designate the standard of review,” that “would improve the functioning of the market for arbitrators by allowing good arbitrators to signal their status[:]”

The point is that the standard of review will affect the mix of agents in the labor pool.  A policy of no scrutiny will draw bad types.  A policy of minimal scrutiny, such as under the FAA, will keep some bad types out: it will prevent arbitrators, for example, from applying New York law when they are instructed to apply Wisconsin law.  But it will do nothing to hinder an arbitrator who applies Wisconsin law so poorly as to produce an obvious error.  Given the existence of agency problems, the hands-off approach of the FAA after Hall Street may end up undermining the arbitration regime by drawing bad arbitrators.

So, working within the framework of the Federal Arbitration Act, and decisions other than Hall Street interpreting it, how do we justify a more heightened standard of review of arbitration awards?  Professor Ginsburg says the agency model itself provides the answer: 

An agency perspective would allow the parties more freedom in stipulating legal grounds for review.  If parties want a decision that is accurate, they could require that arbitrators not make clear errors of law.  High quality arbitrator-agents could trade on their ability to interpret law by promising not to make clear errors.  Low quality arbitrator-agents would not want to make such enforceable promises and so might be driven from the market.  The Hall Street approach limits contractual freedom; the Watts approach might expand it, and in doing so, may in fact enhance arbitration. It might thus allay concerns about a possible ‘flight from arbitration.’  (footnotes omitted) 

.  .  .  . 

Arbitration is contractual dispute resolution, and this means that arbitrators are agents. The standard of review of arbitral awards sets the level of monitoring of the agents’ interpretation of law. Some agents will prefer not to be subject to monitoring of their performance, and these are the agents who are happy with Hall Street.  Other agents have no fear of monitoring.  While specifying a universal standard of review applicable for all cases may be an inherently unstable venture, it seems clear that allowing the parties to set the standard, and to choose higher levels of monitoring by contract, will reduce agency slack and allow parties to determine what type of arbitrator they are hiring. Deferential review, in short, is not always pro-arbitration. 

We have quoted extensively from Professor Ginsburg’s work, but do not let this post be a substitute for reading and studying his white paper and the upcoming University of Chicago Law Review article.  Professor Ginsburg is a second-generation law and economics theorist, and like the first generation – whose ranks include Associate Justice Antonin G. Scalia, Circuit Judge Richard A. Posner and Chief Judge Easterbrook – he writes clearly and well, and more importantly — like those of the first generation – his theories make good sense, which is all too uncommon these days.

Arbitration is not a perfect process for resolving disputes, but neither is court adjudication.  One advantage of court adjudication is a fairly rigorous standard of review:  appellate courts generally review the trial court’s factual findings for clear error and legal conclusions de novo.  By contrast, courts review arbitration awards under the very deferential standards of review prescribed by Sections 10 and 11 of the Federal Arbitration Act.  The trade-off is one of informality, speed and reduced expense for a heightened risk that the decision maker will commit unreviewable legal and factual errors — even some pretty egregious ones.   

But every so often an arbitration award can be so far off the mark that one of the parties is deprived of the benefit of the bargain it made when it agreed to arbitrate.  These are not cases where the arbitrators merely did a shoddy job, but ones where the arbitrators did not do the job the parties asked them to do.  These are the cases that Section 10(a)(4) of the Federal Arbitration Act was designed to address:  ones where “the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final award on the subject matter was not made.” 

Today we take a brief look at Raymond James Financial Serv., Inc. v. Bishop, ___ F.3d ___, No. 09-1038, slip op. (4^th Cir. Feb. 22, 2010), a recent example of one of those rare cases.  And we’ll see how how confusion about the scope of Section 10(a)(4) resulting – quite unintentionally – from the United States Supreme Court decision in Hall Street Assoc., L.L.C. v. Mattel , Inc, 552 U.S. ___, slip op. at __ (March 25, 2008) apparently motivated the United States Court of Appeals for the Fourth Circuit to decide the case solely on the ground that the arbitrators were not authorized to rule on the claim on which they admittedly based their award.  (See, generally, “Hall Street Meets Pearl Street: Stolt-Nielsen and the Federal Arbitration Act’s New Section 10(a)(4).”)

The Court reached the right result, but its decision is of limited utility in future cases.  For under many broad arbitration agreements and submissions the arbitrators have authority to rule on pretty much any claim that is related to the subject matter of the  parties’ dispute.  Abitrators may have the authority to resolve a claim, but may do so in a way that has not even a barely colorable justification under the law and facts.   

We would have liked to see the Court rule not only on the authority issue, but also on two other grounds relied upon by the district court:  manifest disregard of the law and the award’s failure to “draw its essence” from the parties’ agreements.  As we have said before, we believe that those grounds are statutorily permitted by Section 10(a)(4), and that they provide a useful safety valve for addressing those (thankfully) rare cases where the arbitrators resolve a dispute within the scope of their authority, but do so in a way that completely deprives one of the parties of the benefit of its arbitration agreement.   

II.  Background

Raymond James Financial arose out of three separate agreements between registered broker-dealer Raymond James Financial Services, Inc. (“Raymond James”) and registered representatives Bishop, Hamant and Scanlon, each of whom was a financial advisor.  Bishop left his former firm, entered into a written, “Independent Sales Associate” agreement with Raymond James and became the branch manager of Raymond James’ Richmond, Virginia office.  Apparently at Bishop’s urging, Hamant and Scanlon each entered into separate “Financial Advisor” agreements with Raymond James, and joined the Richmond Office managed by Bishop. 

Each of the agreements established an independent contractor relationship between the signatory and Raymond James, and contained the following provision permitting termination without cause on five-days’ notice:

Either party may terminate this Agreement by providing the other party no less than five (5) business days prior written notice of intent to terminate this Agreement.  Given the unique transactional nature of the securities business, there is no need for a liquidated damages provision should either party voluntarily terminate the Agreement before the end of its term as neither party would be significantly damaged by such termination.

 None of the agreements contained arbitration clauses, but by virtue of the parties’ status as registered members of the National Association of Securities Dealers (“NASD”) (now the Financial Industry Regulatory Authority, Inc. (“FINRA”)), NASD  Rule 10101 — now codified in FINRA’s “Code of Arbitration Procedure” – required them to arbitrate “any dispute, claim, or controversy . . . arising out of  .  .  .  employment or termination of employment .  .  .  .” 

In 2003 Raymond James received misconduct complaints from competing financial advisors concerning Bishop’s Richmond, Virginia office.   As a result, in April 2004 Raymond James issued five days’ notice of termination to Bishop, and advised him that it was closing the Richmond office.  Like notices were apparently also issued to Hamant and Scanlon. 

The termination notices left open the possibility that Bishop, Hamant and Scanlon could re-affiliate with Raymond James at a different Raymond James branch.  Raymond James issued a two-month extension to effect the branch closing, and in June 2004 Bishop, Hamant and Scalon voluntarily terminated their employment. 

Prior to the voluntary termination, arbitration proceedings arising out of certain of the complaints were instituted against Raymond James and the three financial advisors.  Bostic, an in-house lawyer in Raymond James’ legal department, assumed the defense of Raymond James and each of the three financial advisors, and continued to represent the financial advisors after the Richmond office was closed.  The proceedings against Scanlon were concluded in his favor, and the district court found that the proceedings against him were likewise concluded in Hamant’s favor.  Hamant did not contest that finding even though he contended in the subsequent arbitration against Raymond James that the third-party proceedings against him had resulted in a $10,000 award. 

Raymond James discovered that an unauthorized person had gained access to its computer system, and it believed that person to be Bishop based on an internal investigation.  As a result  Raymond James began contemplating legal proceedings against Bishop, and, in December 2004, while the third-party arbitration proceedings against Bishop were ongoing, Bostic withdrew his representation of Bishop because of the conflict of interest.  But a few days after Bostic withdrew, the parties to the arbitration against Bishop entered into a global settlement that resulted in Bishop having no liability. 

In July 2005 Bishop, Scanlon and Hamant demanded a consolidated arbitration against Raymond James.   They asserted claims for damages based on:  (1) wrongful discharge; (2) breach of contract; (3) tortious interference with contract; (4) common law and statutory conspiracy; (5) violation of the Virginia Retail Franchising Act; and (6) violation of “just and equitable principles of trade.”

In December 2006, after a several-day hearing, the arbitration panel ruled that Raymond James was liable on the following grounds: 

breach of fiduciary and legal duties; violation of just and equitable legal principles of trade; breach of promises and inducements; interference with, and unlawful termination of [the financial advisors’] .  .  .  prospective economic advantages; interference with the performance of contractual promises and inducements; tortious and deceitful termination of [the financial advisors’] .  .  . legitimate and high business expectations; violation of statutory Virginia public policy set forth in Virginia code § 13.1-558; and common law and statutory conspiracy.

The Panel awarded Bishop $156,050; Hamant $74,050; and Scanlon $72,050. 

The Panel’s award explained that Raymond James engaged in “unauthorized practice of law [sic] by employing staff counsel to advise and represent [the financial advisors] .  .  .  in their individual capacities” in the underlying, third-party arbitrations.  The Panel found that Raymond James did not warn the financial advisors that they would be subject to heightened scrutiny because of the complaints.  And the Panel found that Bostic’s withdrawal prejudiced “some or all [of the financial advisors’].  .  .  litigation interest and made their transfer to other Raymond James Services, Inc. branch offices impossible as a practical matter.” 

On Raymond James’ motion to vacate, the district court initially remanded the matter back to the arbitrators because it could not discern any basis for the award.   In April 2008 the Panel issued a letter explaining three bases for its award: 

(1) Raymond James provided legal representation to the [financial advisors] .  .  . “in a matter involving a business relationship between the employer and [the financial advisors] .  .  .  that was also adversarial with a clear conflict of interest;” (2) Raymond James’ “attorney favored the interest of [Raymond James] to the disadvantage of the [financial advisors].  .  .  who were also his clients;” (3) “if a corporation employs a lawyer to provide legal services that corporation is then engaged in the practice of law .  .  .  .  As such, it is held to the same standard as a law firm and owes to its client the highest degree of fiduciary duty.  If it chooses to engage in the business with such clients, it is obligated to place the interest of those clients ahead of its own. [Raymond James] failed in that obligation and the [financial advisors] .  .  .  suffered losses pertaining to the issues for which [Raymond James] provided its lawyer.”

In June 2008, the arbitrators supplemented their clarification letter by stating that “[t]he unauthorized practice of law was one among other factors considered by the panel and that considering the case as a whole [it] believes the liability decision to be just and appropriate.”

The Court’s discussion of the proceedings below was somewhat detailed, but for the purposes of this post, we need not dwell on it.  Suffice it to say the district court vacated the award on three independent grounds:  (1) the arbitrators exceeded the powers conferred upon them by Rule 1010 and the submission; (2) the arbitrators manifestly disregarded the law, because Florida law required a party to show damages to establish a breach of fiduciary duty claim and there were no damages; (3) the award did not “draw its essence” from the parties’ contracts because the “gravamen” of the claim was for wrongful termination, the parties’ contracts permitted termination without cause on five days’ notice, and in any event, the financial advisors ultimately voluntarily terminated their relationship with Raymond James.   

III.  The Fourth  Circuit’s Decision

The Fourth Circuit affirmed, but only on the ground that the arbitrators exceeded the authority granted to them by Rule 1010 and the parties’ submissions.  The Court also found that the remand to the arbitrators was proper insofar as the district court did not know what to make of the award, a point we need not address here.   

The Fourth Circuit’s rationale was based on Rule 1010, which required arbitration of “[a]ny controversy . . . arising out of the employment or termination of employment .  .  .  .” of registered representatives. Prior case law in the Fourth Circuit had construed this language broadly to mean “that a dispute ‘arises out of employment or termination of employment,’ where the claims ‘involve significant aspects of the employment relationship, including but not limited to explicit contractual terms.’”   The “’proper question is whether resolution of the claim depends upon evaluation of a party’s performance either as a broker or as an employer of brokers during the time of the contractual relationship.’”  Slip op. at 17 (citations omitted). 

The Fourth Circuit agreed with the district court that the gravamen of the financial advisors’ claims was for wrongful termination, but that the arbitrators, by their own admission, decided the case, and awarded damages, based on Raymond’s James’ alleged breach of fiduciary duty, a claim the parties neither submitted to arbitration  nor were required to arbitrate pursuant to Rule 1010:

As we have noted, here the arbitrators based their award on Raymond James’ alleged breach of “fiduciary and legal duties” in connection with their joint representation with Raymond James by Bostic, the inhouse lawyer.  Under the Zandford “significant aspects” test, the appropriate question here “is whether resolution of the claim depends upon evaluation of a party’s performance either as a broker or as an employer of brokers during the time of the contractual relationship.”  The panel’s assertion that Raymond James acted improperly as a “lawyer” is inconsistent with the notion that Raymond James was acting as an “employer of brokers during the time of the contractual relationship.”  There is nothing whatsoever in the serial explanations provided by the arbitration panel to support the conclusion that the legal theory the panel found sustained required an evaluation of any party’s “performance.”  Even after the district court ordered a remand to the panel, the panel simply reiterated what seemed inescapable from the original award: that the panel had adjudicated a tort claim that fell outside of the expansive interpretation of “arising out of employment” we adopted in Zandford.

Slip op. at 18 (citations omitted). 

IV.  Analysis

While we believe the Court’s excess of authority analysis was basically sound, it required the Court to parse the language of Rule 1010 pretty thinly.  The focus should have been on the parties’ submission rather than the language of Rule 1010.  Notwithstanding the Court’s statement that Raymond James’ purported activities as a “law firm” were inconsistent with it being an employer, Bostic’s provision of counsel to the financial advisors was something that, at least arguably, “arose out of employment . . . .” within the meaning of Rule 1010.  It would have been cleaner — and more consistent with an “expansive interpretation” of Rule 1010 to have simply ruled that the parties did not submit to the arbitrators the issue of Raymond James’ joint representation of the financial advisors in the third-party proceedings. 

The Court quietly took a pass on whether the award was in manifest disregard of the law or did not “draw its essence from” the parties’ contracts and simply explained in a footnote the controversy surrounding the continued viability of those theories in light of Hall Street.  See Slip op. at 18 n.13.  To address these two other bases relied on by the district court, the Fourth Circuit would have had to decide:  (a) whether Hall Street permitted vacatur on those bases to the extent that they were within the ambit of Federal Arbitration Act Section 10(a)(4); (b) whether they were in fact within the ambit of Section 10(a)(4); and (c) whether the facts justified vacatur under one or both of them. 

We are mindful that the principal purpose of the federal judiciary is to decide cases and controversies, and the Fourth Circuit fulfilled that purpose here, while avoiding the mire created by the manifest disregard dictum in Hall Street.  But we would have preferred a bolder approach under which the Court would have ruled on the manifest disregard and “essence of the agreement” challenges, simply because that would have given litigants more guidance in future cases, particularly ones in which arbitrators reach a ruling lacking a colorable basis in the course of deciding a claim within the scope of their authority. 

Had the Court opted to analyze the case from the standpoint of manifest disregard of the law and “essence of the agreement,” we believe that it might have affirmed the district court’s decision on those grounds as well.  There was simply no colorable basis for this award, and we believe the only reasonable conclusion one can reach is that the arbitrators decided to punish Raymond James for what they misperceived to be wrongful conduct on the part of Bostic — allegedly wrongful conduct that was not the basis of the financial advisors’ claims. 

Even if the breach of fiduciary duty claim were arbitrable, there was no basis for the damage awards.  Bostic’s withdrawal from the Bishop third-party proceedings had no affect on the third-party proceedings against the other two financial advisors – those proceedings were concluded before Bostic withdrew from the Bishop proceedings.  But apart from that, the Bishop proceedings resulted in a global settlement under which Bishop had no liability. 

 Even if we ignore what the arbitrators said in response to the district court’s remand order, and treat the arbitrators’ award as one for wrongful discharge, there could be no wrongful discharge because Raymond James complied with the termination provision in the contract, which allowed discharge on five days’ notice without a showing of just cause.  The termination clause also expressly acknowledged that there would be no meaningful damages in the event of a termination (wrongful or otherwise) in view of the transactional nature of the securities industry (in which compensation is largely based on commission). 

In any event, Raymond James’ compliance with the termination clause was irrelevant because each of the financial advisors voluntarily terminated their relationship with Raymond James after the expiration of a two-month extension of time to close the Richmond office.  A voluntary termination is by definition not wrongful.

While judicial restraint is generally a good thing, an affirmance on the three bases the district court relied upon would have resulted in a more meaningful and useful decision.

This is the final installment of our five-part series on the Stolt-Nielsen oral argument.  It addresses the fourth issue identified in Part I (here):  what the import of the agreements’ silence is or should be.  It assumes the Court reaches the merits; as explained in Parts III and IV (here and here), the United States Supreme Court may take another “pass” on the question presented (the first pass was taken in Bazzle), and hold that the predicate for granting certiorari was not established because the arbitrators ruled that the agreement was not silent on class arbitration.  

Part I identified two loose “coalitions” of Justices – the “Breyer Coalition”  consisting of Associate Justices John Paul Stevens, Stephen G. Breyer, and Ruth Bader Ginsburg, and the “Roberts Coalition,” consisting of Chief Justice John G. Roberts and Associate Justices Antonin G. Scalia and Samuel A.  Alito, Jr.  The Breyer Coalition appears to be leaning toward either taking a pass or affirming the decision of the United States Court of Appeals for the Second Circuit, which upheld the arbitrators’ award imposing class arbitration, while the Roberts Coalition appears to be leaning toward reversal.   We explore the import of the charter-party agreements’ silence on class arbitration from the standpoint of both coalitions. 

II.  Breyer Coalition

There are at least four outcomes that the Breyer Coalition might consider acceptable:  (a) a ruling that that the arbitrators acted within the scope of their authority in imposing class arbitration on the parties because the parties submitted that issue to arbitration (see Part II, here); (b) a ruling that the arbitrators acted within the scope of their authority by ruling that the broad arbitration clause, coupled with the parties’ failure to prohibit class arbitration procedures, evidenced the parties’ consent to class action arbitration; (c) a ruling that class arbitration may be imposed by arbitrators if state arbitration law permits courts or arbitrators to impose it; or (d) a ruling that the predicate for granting certiorari was not met because the arbitrators found that the contracts were not silent on class arbitration (see Part III, here).   In the event that the Breyer Coalition commands a majority – it appears to have the support of at least three Associate Justices – and the Court reaches the merits of the question presented, we believe that the Court will rule that arbitrators do not offend the Federal Arbitration Act by imposing class arbitration in the face of the agreement’s silence on that point. 

There would be some fundamental problems with such a ruling.  First, it would not be grounded in the Court’s prior jurisprudence providing that the purpose of the Federal Arbitration Act is to enforce arbitration agreements as written and according to their terms, even if the parties’ freely-bargained-for dispute resolution method may lead to inefficiency in the form of multiple arbitration proceedings. See, e.g., Volt Information Sciences, Inc. v. Board of Trustees of Leland Stanford Junior Univ., 489 U.S. 468, 479 (1989); Dean Witter Reynolds Inc. v. Byrd, 470 U.S. 213, 220 (1985).   For the reasons explained in Section IV., below, enforcing the Stolt-Nielsen charter parties as written means finding that consent to class arbitration cannot be implied. 

Second, allowing arbitrators to find consent to class arbitration based solely on the broad scope of an arbitration agreement allow arbitrators to make random, subjective, and virtually unreviewable public-policy-based judgments about whether class arbitration should be imposed in a given case.   Those judgments should either be made by the parties or Congress. 

Third, because arbitrators will likely continue to impose class arbitration frequently, a Court ruling encouraging them to do just that would effectively elevate a judicial public policy preference for efficient (and perhaps fairer) private  dispute resolution above the pro-enforcement policies of the  Federal Arbitration Act.  While this may be a laudable goal, it is one for Congress to implement, not the Court.  The Court’s role is limited to implementing the only public policy the Act was designed to foster:  promoting the enforcement of private agreements to arbitrate according to their terms. 

Fourth, potentially implicit in such a ruling would be the application of a default rule that class or consolidated arbitration is permitted when the parties’ contracts are silent on that score.  But the Court’s prior jurisprudence provides that the sole source of default rules of contract construction or interpretation is state law applicable to contracts generally.  No such rule exists in New York general contract law or federal maritime law (see Section IV), which means that the Court would have to create a federal one.  It is unclear to us on what basis such a rule could legitimately be formulated, and doing so would be inconsistent with — and potentially throw into disarray — established rules of Federal Arbitration Act preemption. 

The Breyer Coalition might avoid some of these problems by finding that state arbitration law permitting courts or arbitrators to impose class arbitration is not preempted by the Federal Arbitration Act, which is silent on whether courts or arbitrators can compel class or consolidated arbitration in the absence of the parties’ express or implied agreement.  But such a ruling would beg the question whether compelling class or consolidated arbitration is consistent with enforcing as written each individual arbitration agreement between each individual party, something that the Federal Arbitration Act requires.  Additionally, it would leave to the vagaries of state law the question whether class or consolidated arbitration may be imposed, and it might breed litigation over choice-of-law questions.   

If the Breyer Coalition commands a majority, these problems may persuade that majority to dispose of the case on a more narrow ground, such as a ruling that the parties submitted the issue of class arbitration to the arbitrators, or that the predicate for granting certiorari simply was not met.  For the reasons set forth in Parts II and IV (here and here), we believe that outcome would be unfortunate.  

III.   Roberts Coalition

The Roberts coalition appears to be willing to address the merits of the Stolt-Nielsen question, presumably because these Justices are not satisfied with the Bazzle status quo under which courts have effectively ceded to arbitrators a great deal of power to impose class or consolidated arbitration without meaningful review by courts.  These Justices, we suspect, are concerned that the practical effect of Bazzle is at odds with what the Court has repeatedly said is the principal purpose of the Federal Arbitration Act. 

We think the Roberts Coalition would favor a return to the pre-Bazzle regime under which class or consolidated arbitration was the exception, not the rule.  Relying on the “enforce as written” principle, the majority of pre-Bazzle decisions held that courts may not impose class or consolidated arbitration in the absence of the parties’ express (or at least implied) agreement.  See, e.g.,  Glencore, Ltd. v. Schnitzer Steel Products, 189 F.2d 264 (2d Cir. 1999); United Kingdom v. Boeing Co., 998 F.2d 68 (2d Cir. 1993); Champ v. Siegal Trading Co., 55 F.3d 269 (7th Cir. 1995).  These courts eschew the notion that the efficiency that might result from imposing consolidated or class arbitration justifies doing so in the absence of the parties’ consent. 

If the Roberts Coalition garners the support of five Justices – it appears to have at least three votes, and might have the support of Associate Justices  Anthony M. Kennedy and Clarence Thomas – we believe that the Court will hold that courts or arbitrators cannot impose class or consolidated arbitration in the absence of the parties’ express or implied agreement.  And in Stolt-Nielsen that would mean the arbitrators exceeded their powers by imposing class arbitration on the Stolt-Nielsen entities. 

In Section IV., below, we briefly explain some of the reasons why we believe that the Roberts Coalition would likely conclude that enforcing the Stolt-Nielsen charter-party contracts as written requires separate arbitration proceedings between each Stolt-Nielsen entity and AnimalFeeds under each individual charter party between them, and between each Stolt-Nielsen entity and each putative class member.   

IV.    Why Courts and Arbitrators Should Not Impose Class or Consolidated Arbitration when the Parties’ Agreements are Silent on that Point

There are two key provisions in the charter parties — and for that matter, in most arbitration agreements — which, if enforced as written, strongly suggest that the parties never authorized class or consolidated arbitration:  (a) the provisions of the agreement identifying the parties to the contract; and (b) the provisions governing arbitrator selection. 

A.  Provisions Identifying the Parties

The provisions denoting the parties to the Agreement are fundamental in Federal Arbitration Act cases because they determine who is obligated to whom and who is subject to the arbitrators’ jurisdiction.  For example, courts will not hesitate to vacate awards that purport to bind or confer a benefit in favor of a non-party to the agreement.  See, e.g.,  Nationwide Mutual Ins. Co. v. Home Ins. Co., 330 F.3d 843, 846-47 (6^th Cir. 2003); Orion Shipping & Trading Co., Inc. v. Eastern States Petroleum Corporation Of Panama, S.A., 312 F.2d 299, 300-01 (2d Cir. 1963).  And courts will not enforce arbitration agreements on behalf of, or against, non-signatories, unless state law applicable to ordinary contracts permits such enforcement.   See Arthur Andersen LLP v. Carlisle, 556 U.S. ___, 129 S. Ct. 1896, 1901-02 (2009); Ross v. American Express Co., 547 F.3d 137, 143 & n.3 (2d Cir. 2008); Ross v. American Express Co., 478 F.3d 96, 99 (2d Cir. 2007); Astra Oil Co. v. Rover Navigation, Ltd., 344 F.3d 276, 279-80 & n.2 (2d Cir. 2003); Thomson-CSF, S.A. v. American Arbitration Assoc., 64 F.3d 773, 776-80 (2d Cir. 1995). 

There is no reason that disputes concerning class arbitration should be decided under a different set of rules.  When parties A and B agree to arbitrate their disputes arising out of or relating to their contract, and do not provide for arbitration with parties C, D or E, or with respect to identical contracts that party A may have with parties C, D or E, parties A and B have evidenced an intent to limit the scope of their private dispute resolution mechanism to disputes between them.  It may be that parties A and B also intended to arbitrate disputes between them arising under contracts relating to the contract containing the arbitration clause (for example, a separate agreement to terminate or rescind the contract containing the arbitration clause), but they have not expressed an intent to arbitrate with C, D or E disputes that may relate in some way to the contract between A and B.  

Bazzle arguably allows arbitrators to impose class arbitration where party A is a party to identical, but separate, contracts between B, C and D.  Looking at each contract individually, A agreed to arbitrate in a single proceeding only with B, C or D, not all three.  But, where B, C or D all want to arbitrate in a single proceeding, and where A has selected the same arbitrator for its separate arbitrations with B, C, and D, that arbitrator, under Bazzle, can consolidate the proceedings or order class arbitration.  In other words, it allows the arbitrator to look past the reality that A entered into separate contracts with B, C, and D, and transform B, C and D’s collective desire to arbitrate in a single proceeding, and A’s appointment of the same arbitrator for all three proceedings, into consent by A to arbitrate with B, C, D and any putative class members in a single proceeding.  To justify escaping the reality that A never entered into a single contract to which B, C, D and the putative class members were all parties,  and that A does not consent to class or consolidated arbitration, Bazzle says that A, by granting broad authority to the arbitrator, effectively consented to the arbitrator imposing consolidated or class arbitration as a matter of “procedure.”   

We think the Roberts Coalition will conclude that such reasoning is not permitted by the “enforce as written” principle.  But even if the Roberts Coalition stops short of disapproving the plurality’s logic in Bazzle, the facts in Stolt-Nielsen are fundamentally different.  The Stolt-Nielsen defendants are not one but several separate entities, and, to our knowledge, there are separate, materially indentical contracts between each Stolt-Nielsen entity and AnimalFeeds.  There are also separate contracts between individual Stolt-Nielsen entities and individual, putative class members, but which are not identical to those the Stolt-Nielsen entities entered into with AnimalFeeds.  And as far we know: (a) the Stolt-Nielsen entities have not agreed to arbitrate together as a group against any individual class member, let alone with all of them; and (b) each Stolt-Nielsen entity does not have a contractual relationship with each and every putative class member (other than AnimalFeeds).   For the Court to imply consent to class arbitration of the type sought by AnimalFeeds, at a minimum, each Stolt-Nielsen entity must have agreed to arbitrate with each and every member of the putative class. But that does not appear to be the case.

1.  Relevance of New York State Law Applicable to Contracts Generally

New York State law applicable to contracts generally does not provide any support for implying consent to class arbitration.  First, under New York law, a contract’s silence on a given point ordinarily does not mean that the contract is ambiguous, and thus subject to interpretation and construction.  To ascertain whether a contract is ambiguous, courts focus on what is said, not what is omitted:

An omission or mistake in a contract does not constitute an ambiguity [and]. . . the question of whether an ambiguity exists must be ascertained from the face of an agreement without regard to extrinsic evidence.

Reiss v. Financial Performance Corp., 97 N.Y.2d 195, 199 (2001) (citations and quotations omitted).  This rule should preclude a finding that the agreements’ silence enables the court (or enabled the arbitration panel) to rule that the agreements can be reasonably construed as permitting class or consolidated arbitration.

Second, where, as here, parties omit to provide for a contractual contingency, New York law generally prohibits courts from adding implied terms to the contract, and always forbids courts from departing from the plain meaning of the words used:

Even where a [contractual] contingency has been omitted, we will not necessarily imply a term since courts may not by construction add or excise terms, nor distort the meaning of those used and thereby make a new contract for the parties under the guise of interpreting the writing.

Reiss, 97 N.Y.2d at 199 (citations and quotations omitted); see also Vermont Teddy Bear Co. v. 538 Madison Realty Co., 1 N.Y. 3d 470, 475 (2004).  While implying a term may be appropriate under certain limited circumstances, New York courts “will not imply a term where the circumstances surrounding the formation of the contract indicate that the parties, when the contract was made, must have foreseen the contingency at issue and the agreement can be enforced according to its terms.”  97 N.Y.2d at 199.

Implying into the parties’ agreements consent to class or consolidated arbitration would violate this principle.  During the pre-Bazzle period the contract were entered into, the majority rule under the Federal Arbitration Act prohibited courts from compelling class or consolidated arbitration in the face of an agreement’s silence.  These cases – including two in the Second Circuit — made clear that parties had to expressly agree to consolidated or class arbitration.  And while the notion of class arbitration in the maritime context was unheard of, attempts to compel consolidated arbitration were not.  The parties were therefore on notice that, if they wished to arbitrate on a class or consolidated basis, they would have to provide for that contingency in their agreement.  But they did not.

2.  Relevance of Federal Maritime Law

Federal maritime law must also be considered because the arbitration clauses are contained in charter-party contracts, which are maritime contracts governed by a combination of federal maritime and state law.  But to the extent that federal maritime law is relevant, it provides no support for implying consent to class arbitration.

Federal maritime law requires courts to interpret maritime contracts in light of custom and usage.  See Stolt-Nielsen, 435 F. Supp 2d at 385-86 (citing authority).  The district court held that the arbitrators manifestly disregarded this principle because the undisputed evidence of custom and usage showed that there had never before been a class arbitration arising out of charter-party agreements.  To the extent it finds that federal maritime law is relevant, the Supreme Court should find that its application would preclude the Court from implying consent to class arbitration.

 B.  Imposing Class Arbitration would Deny the Parties the Benefit of their Freely-Bargained-For Arbitrator Selection Provisions 

Perhaps no provisions in arbitration agreements are more sacrosanct than those governing arbitrator selection.  Circuit Judge Posner put it well when he said: “Selection of the decision maker by or with the consent of the parties is the cornerstone of the arbitral process.”  Lefkovitz v. Wagner, 395 F.3d 773, 780 (7^th Cir.), cert. denied, 546 U.S. 812 (2005).

Chapters 1 and 2 of the Federal Arbitration Act expressly provide for court enforcement of arbitrator selection provisions.  Federal Arbitration Act § 5 provides that, “[i]f in the agreement provision be made for a method of naming or appointing an arbitrator or arbitrators or an umpire, such method shall be followed.  .  .  .”   Article V(1)(d) of the Convention on the Recognition and Enforcement of Foreign Arbitral Awards ( here) provides a defense to recognition and enforcement of an award where “[t]he composition of the arbitral authority or the arbitral procedure was not in accordance with the agreement of the parties.”  Courts will not hesitate to vacate domestic or non-domestic awards if arbitrator selection procedures were not followed. See, e.g.,  Encyclopaedia Universalis S.A. v. Encyclopaedia Brittanica, Inc., 403 F.3d 85, 91-92 (2d Cir. 2005); Cargill Rice, Inc. v. Empresa Nicaraguense Dealimentos Basicos, 25 F.3d 223, 226 (4^th Cir. 1994); Avis Rent A Car Sys., Inc. v. Garage Employees Union, 791 F.2d 22, 25 (2d Cir. 1986).

The arbitrators have effectively determined that the parties did not agree that they would have the benefit of selecting different arbitrators for each dispute that might arise under each individual arbitration agreement.  As Chief Justice William H. Rehnquist said in his dissent in Bazzle (which Associate Justice Anthony M. Kennedy joined):

[P]etitioner had the contractual right to choose an arbitrator for each dispute with the other 3,734 individual class members, and this right was denied when the same arbitrator was foisted upon petitioner to resolve those claims as well.  Petitioner may well have chosen different arbitrators for some or all of these other disputes; indeed, it would have been reasonable for petitioner to do so, in order to avoid concentrating all of the risk of substantial damages awards in the hands of a single arbitrator.

539 U.S. at 458-59.

 Although Stolt-Nielsen does not press the issue before the Court, the conflicting arbitrator qualifications specified by the two arbitration agreements raises, what we believe can be a vitally important issue in class arbitration cases.  The arbitrator selection provisions of the Vegoilvoy charter-party arbitration agreements between Stolt-Nielsen and AnimalFeeds, provide that each party shall appoint “an arbitrator, who shall be a merchant, broker or individual experienced in the shipping business; the two thus chosen, if they cannot agree, shall nominate a third arbitrator who shall be an Admiralty lawyer.”   The arbitration agreements governing certain transactions between Stolt-Nielsen and putative class members (which were not parties to the Second Circuit appeal), are contained in the Asbatankvoy charter-party agreement, and provide that arbitration shall proceed ”before a board of three persons, consisting of one arbitrator to be appointed by the Owner, one by the Charterer, and one by the two so chosen.”  But the arbitrators in Stolt-Nielsen appear to have effectively decided that, for the merits phase of a class arbitration, both parties must either: (a) appoint merchants, brokers or other individuals experienced in the shipping business as party-appointed arbitrators, who will, in turn, select an admiralty lawyer as a third arbitrator; or (b) appoint whomever they please as party-appointed arbitrators, who will, in turn, appoint whomever they please as the third arbitrator.  But no matter what the arbitrators might have intended, results (a) and (b) are both in derogation of the unambiguous terms of one of the two form arbitration clauses.

We look forward to a decision in this fascinating and very important case, and shall keep readers apprised of developments as and when they occur.  .  .  .

Back in January the Ninth Circuit decided United States Life Ins. Co. v. Superior National Ins. Co., ___ F.3d ___, slip op. (9^th Cir. Jan. 4, 2010), a Federal Arbitration Act Section 10(a)(3) procedural misconduct decision that affords reinsurance and other arbitrators a good deal of leeway to devise and implement nontraditional procedures for resolving complex problems.   The case centered around a rather unusual procedure the arbitrators ordered and implemented to determine whether the cedents improperly handled some 12,604 contested workers compensation claims.  It also concerned the authority of arbitrators to interpret the scope of the submission and to award a disgorgement of investment income remedy in addition to pre-award interest. 

While we shall be publishing in the not too distant future Part IV of our Nuts & Bolts vacatur series focusing on Section 10(a)(3), United States Life is worthy of its own discussion, even though we will no doubt circle back to it in Part IV.  The focus of this post will be on the Section 10(a)(3) aspects of the case.  We’ll deal with the excess of powers aspects of the decision in Part V of our Nuts & Bolts vacatur series, which will deal with Federal Arbitration Act Section 10(a)(4).   

II.        Background

U.S. Life arose out of a reinsurance dispute between U.S. Life Insurance Co. and five cedents (the “Cedents”) who later became the subject of liquidation proceedings in California.  Prior to the commencement of liquidation proceedings, and continuing thereafter, U.S. Life and the Cedents became embroiled in a long-running, two-phase arbitration proceeding.  Phase II concerned whether the Cedents engaged in improper claims handling that resulted in increased reinsurance billings to U.S. Life.  The parties each appointed an expert who testified at the Phase II hearing concerning a sample of 500 of 12,604 disputed claims.  After a thirteen-day hearing the arbitrators informed the parties that they could not reach a decision whether the claims were improperly handled, and, if so, what the effect of the allegedly improper claims handling, if any, was on U.S. Life’s obligations under the reinsurance contract. The panel said that it would retain two workers’ compensation experts to assist it in reaching its decision. 

Following extensive correspondence between the panel and the parties, the panel announced it would implement the following expert-review procedure:

1. The  reviewers would review 162 of the 500-claim sample of.  .  . [contested claims];
2. The reviewers would meet [ex parte] with the panel for three days .  .  . and no transcript would be prepared of the .  .  .   meeting;
3. The reviewers would provide their conclusions in writing to the panel and the parties;
4. The parties could submit briefs responding to the reviewers’ conclusions;
5. A two-day hearing would be held during which the parties could question the reviewers, under oath, for five hours each as to their qualifications and the reasons for their conclusions, but not as to to the ex parte meeting; and
6. The parties could submit post-hearing briefs to the panel. 

Slip op. at 90. 

The Panel used this procedure to resolve the impasse and subsequently issued a Final Arbitration Award that, among other things, required U.S. Life to pay all reinsurance bills “submitted before December 6, 2008,” and to “pay all post-December 6, 2008 bills within thirty-days of receipt.”  Slip op.  at 91.   

U.S. Life sought to vacate the award, and alleged, among other things, that the Panel committed procedural misconduct under Section 10(a)(3)  by:  (a)  refusing to hear “pertinent and material evidence” concerning whether the Cedents’ claims handling was appropriate; and (b) engaging in prejudicial misbehavior that rendered U.S. Life unable to respond to evidence presented against it ex parte by the independent experts.  The Court rejected both of these challenges. 

III.  The Court’s Holdings and Analysis

A.  Refusing to Hear Pertinent and Material Evidence

To address the arbitrators’ alleged refusal to hear pertinent and material evidence, the Court  needed to consider whether Section 10(a)(3) required U.S. Life to demonstrate prejudice.  Section 10(a)(3) provides, with parenthetical text helpfully added by the Court: 

[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[.]

Slip op.. at 95 (parenthetical material in original).

The Court noted that the text was arguably ambiguous as to whether ground (2) — “of any other misbehavior by which the rights of any party have been prejudiced” —  implied that ground (1) — a refusal “to hear evidence pertinent and material to the controversy” —  likewise required the movant to demonstrate prejudice.  But the Court ruled there were two reasons why it “need not resolve this textual ambiguity, if any.  .  .  .”  Slip op.. at 95.  First, the Court concluded that “refusing to hear evidence pertinent and material to the controversy” “necessarily implies prejudice to the rights of a party, without regard to the final catch-all phrase.  .  .  .  ” of ground (2).  Slip op.. at 95.  Second, the Court held that U.S. Life had not established that the panel had refused to hear any evidence “pertinent and material to the controvery” by precluding the parties from attending the meeting or questioning the experts about it.  Slip op.. at 95.

The procedure adopted by the panel, said the Court, “allowed the parties to present material evidence because the parties were allowed to address why the reviewers’ conclusions were incorrect:”

It was only after the panel listened to, and considered, the parties’ experts’ opinions and other evidence that the panel determined it needed additional information to resolve the Phase II dispute: U.S. Life’s obligations under the reinsurance contract. The panel advised the parties of its dilemma and determined what process to use only after receiving input from counsel through extensive and detailed correspondence. The process employed ensured due process by allowing the parties to present their respective arguments regarding the reviewers’ conclusions by 1) reviewing the written conclusions, 2) submitting briefing addressing these conclusions, 3) questioning the reviewers about their qualifications and conclusions, and 4) submitting post-hearing briefing.  Although the parties were not privy to what occurred during the ex parte meeting, the panel gave the parties ample opportunity to discover and critique the reviewers’ conclusions.

Slip op. at 95-96 (footnote omitted). 

According to the Court, “the panel appropriately exercised .  .  .  [its] wide discretion” “to require the exchange of evidence, and to admit and exclude evidence, how and when they see fit.”  Slip op. at 96 (citation and quotation omitted). The Court said “[t]he extensive correspondence reflects that the panel’s intent was to accord due process – and it did.”  Slip op. at 97.  The Court distinguished the case from ones where:  (a) “the arbitrator misled a party into believing that evidence was admitted, but then ruled against the party because it failed to present evidence on the very point to which the excluded evidence was central;”  or (b) ”the party was not given an opportunity to complete its presentation of proof prior to the arbitration decision.”  Slip op. at 97 (distinguishing Gulf  Coast Industrial Workers Union v. Exxon Co., 70 F.3d 847 (5^th Cir. 1995) and Warehousemen and Helpers, Local Union No. 506 v. E.D. Clapp Corp., 551 F. Supp. 570, 578 (N.D.N.Y. 1982)). 

B.  Prejudicial Misbehavior

U.S. Life also argued that the ex parte meeting and cross-examination limitation was prejudicial misbehavior that prevented it from responding to evidence presented during the meeting.  But the Court held that the panel’s procedures did not constitute prejudicial misbehavior. 

First, the Court rejected the Fifth Circuit’s broad dictum in Totem Marine Tug & Barge, Inc. v. North America Towing, Inc., 607 F.2d 649, 653 (5^th Cir. 1979) that “[a]rbitrators cannot conduct ex parte hearings or receive evidence except in the presence of each other and of the parties, unless otherwise stipulated.”  (quotations and citation omitted)  Noting that Totem Marine’s “prohibition was too broad” because “the FAA does not expressly prohibit ex parte contact,” the Ninth Circuit ruled that “ex parte conduct by an arbitration panel requires vacatur of an award only if the ex parte contact constitutes misbehavior that prejudices the rights of a party.”  Slip op. at 98. 

Second, the Court observed that that “the ex parte contact was not with a party, but with neutral experts,” and “both parties were aware of the ex parte contact, submitted suggestions as to the process to be used, and had the opportunity to contest the reviewers’ conclusions.” Slip op. at 98.   The Court said that “the panel presented far less risk of prejudicial misbehavior than if one arbitrator was used,” because the tripartite arbitration panel featured two party-appointed arbitrators, and there was “extensive evidence of [the panel’s].  .  . efforts to provide due process to both parties” and to “resolve the dispute in a relatively efficient manner.  .  .  .”  Slip op. at 98-99.  The Court found it “noteworth that U.S. Life’s party arbitrator agreed to this process and that he did not mention arbitral misconduct or misbehavior in his dissent.”  Slip op.. at 99.   

Third, the Court held there was no misbehavior because the parties bestowed ”broad authority” on the panel through their agreed, procedural protocols.  While the parties “did not stipulate to the ex parte meeting,” the parties expressly authorized the panel to “adopt such other processes and procedures as it deems fair and expedient to resolve issues before it to the extent that the issues are not expressly or implicitly addressed by.  .  .” the procedural protocols agreed by the parties.   Slip op.. at 99. 

The Court also determined that, in any event,  U.S. Life did not establish that the panel’s ex parte procedure prejudiced it.  The panel ruled against U.S. Life, but U.S. Life “failed to establish that it was denied an opportunity to present its case or to contest [the Cedents’s] .  .  . evidence or the reviewers’ conclusions.”  U.S. Life may not have received “a perfect hearing[,] but it did receive a fair” one, having had “notice.  .  ., the opportunity to be heard and to present relevant and material evidence” to “decisionmakers [that] were not infected with bias.”  Slip op. at 99-100 (citation and quotation omitted). 

IV.  Our Analysis

We were initially somewhat concerned about the United States Life and its potential ramifications on arbitral procedure.  The scheme the panel adopted was unusual, at least in reinsurance cases, and it is not difficult to imagine arbitration panels crafting like ex parte procedures to resolve other seemingly difficult, technical problem, some of which might not include all the checks and balances present in United States Life. 

Yet the Ninth Circuit got it right under the facts and circumstances of the case.  Its  opinion evidences careful consideration of the Section 10(a)(3) standard and attention to the facts and practical realities of the situation in which the the panel and the parties found themselves.  

But we read the decision as being fairly narrow in scope and largely driven by its peculiar facts.   To ascertain its applicability to similar and not so similar panel-adopted ex parte procedures, we think it important to remember the following points emphasized by the Court: 

1. Before adopting the procedure, the panel attempted in good faith to resolve the issues through traditional hearing procedures;
2. The parties expressly authorized the panel to “adopt such other processes and procedures as it deems fair and expedient to resolve issues before it to the extent that the issues are not expressly or implicitly addressed by” procedural protocols agreed by the parties;  
3. The parties had an opportunity to be heard concerning the nature and scope of the ex parte procedure; 
4. The panel provided extensive “due process” in an effort to mitigate the disadvantages to the parties attendant with the ex parte procedure;
5. The parties utilized tripartite arbitration with party-appointed arbitrators, which, at least in theory, provided some assurance that the parties’ interests would be looked after in the absence of their attorney representatives;
6. U.S. Life’s party-appointed arbitrator did not suggest in his dissent that the panel’s procedures prejudiced U.S. Life;
7. The ex parte contact was not with a party, but with the claims experts; and
8. The ex parte procedure did not preclude the parties from presenting pertinent and material evidence.

Not every case in which a nontraditional procedure is adopted is likely to feature all of these factual predicates, and courts in future cases should pay the same careful consideration to the facts and circumstances as did the Ninth Circuit in this one. 

Part III.A of the evident partiality segment of this series discussed the parties’ reasonable expectations of neutrality.  Today we consider how those expectations are enforced. 

“Evident partiality” challenges typically arise out of one of two scenarios.  First, there are “presumed bias” cases in which the arbitrator’s relationship to the parties or the controversy would lead a reasonable person to conclude that the arbitrator was biased, even though the challenger cannot prove actual bias.    Second, there are evident partiality challenges based on allegations of actual bias.  For example, suppose a neutral said on the record during the proceedings prior to deliberations:  ”Party A, frankly I have distrusted your company’s business motives for many years, but hearing your witnesses’ testimony has simply confirmed what I’ve suspected all along.”  While the chances of an arbitrator making such a statement (let alone on the record) are exceedingly slim to non-existent, it would provide the basis for an evident partiality challenge (which would probably succeed) based on proof of actual bias. 

The difference between “presumed” and “actual” bias is simply one of proof.  One is based on circumstantial evidence and the other on direct evidence.  Our focus will be on “presumed bias” cases, because they arise with greater frequency.  Actual bias is very difficult to prove, and if it or something approaching it can be established, then that proof would in any (or most any) event meet the standards necessary to establish evident partiality.   

Enforcement of the Parties’ Expectations of Neutrality Through the Disclosure Process

There are three procedural problems with presumed bias cases.  First, courts generally cannot entertain an evident partiality challenge until the arbitrators issue a final award and the challenging party makes a timely motion to vacate, and the Federal Arbitration Act does not expressly provide procedures designed to ensure the parties’ expectations of neutrality are protected during the arbitrator selection process or any other time prior to a final award.  Second, the selection process is the juncture at which the parties’ expectations of neutrality are most vulnerable to frustration and the period during which the parties are best positioned to protect those expectations.  Third, the arbitrators themselves have the most ready access to the information the parties need to protect their expectations of neutrality. 

To protect the parties’ expectations of neutrality during the selection process, the United States Supreme Court imposed the now-familiar requirement that arbitrators disclose at the outset of the proceedings non-trivial conflicts of interest (such as ongoing business relationships with one of the parties) and any other relevant information bearing on the arbitrator’s ability to meet the parties’ expectations of neutrality.   See Commonwealth Coatings Corp. v. Continental Cas. Co., 393 U.S. 145 (1968).  At least two circuits have added to that disclosure requirement an affirmative duty on the part of a neutral arbitrator to investigate when there is reason to believe a nontrivial conflict might exist.  See Applied Materials Indus. Corp. v. Ovalar Makine Ticaret ve Sanayi, A.S., 492 F.3d 132, 138 (2d Cir. 2007) (2d Cir. 2007); New Regency Productions,  Inc. v. Nippon Herald Films, 501 F.3d 1101, 1111 (9th Cir. 2007). 

A neutral arbitrator’s failure to disclose a conflict of interest of which he or she is deemed to have knowledge can result in vacatur of an award on evident partiality grounds without any showing that the arbitrator was actually biased or that the award resulted from bias.  Indeed, as the Seventh Circuit observed, if an arbitrator unduly frustrates a party’s access to information pertinent to whether he or she has the requisite degree of neutrality, there may be grounds for vacatur based not only on evident partiality, but also on the arbitrator exceeding his or her powers: “[f]ailure to comply with a[n] [express or implied] contractual requirement designed to facilitate the search for an acceptable neutral might imply that the neutral exceeded his authority, spoiling the award under 9 U.S.C. § 10(a)(4).”  Sphere Drake Ins. Co. v. All American Life Ins. Co., 307 F.3d 617, 623 (7th Cir. 2002), reh’g denied, Nov. 4, 2002, cert. denied, 538 U.S. 961 (2004).   

The flip side of the disclosure rule is that it provides an opportunity for the parties to vet and waive at the outset conflicts of interest that might otherwise provide the basis for a losing party to challenge the award.  If the arbitrator discloses a potential conflict, and a party fails to object, that party usually waives its right to challenge a later award based on the disclosed conflict.  See, e.g., Kiernan v. Piper Jaffray Cos. 137 F.3d 588, 593-94 (8th Cir. 1998); Cook Indus. v. Itoh & Co., 449 F.2d 106, 107-08 (2d Cir. 1971), cert. denied, 405 U.S. 921 (1972).   

Early vetting coupled with the waiver rule reduces the risk that time and expense will be invested in a proceeding that yields an award subject to vacatur.   Before the parties know the outcome of the arbitration, they are more likely to consider a potential conflict to be trivial and waive it.  But if undisclosed and not discovered until after an award has been issued, the losing party may understandably perceive the potential conflict to be more serious than it was, and move to vacate the award.  The motion may not be successful, but it may not be utterly frivolous either, and the parties and the court will end up incurring time and money costs. 

Disclosure by Appointed Arbitrators

At least in reinsurance arbitrations, appointed arbitrators are generally expected to disclose their relationships with the parties even though they are usually expected to be, at least to some degree, partial to the appointing party.  Whether or not these disclosures are required by Commonwealth Coatings is an open question and at least one circuit has suggested the answer is “no.”  See Winfrey v. Simmons Foods, Inc., 495 F.3d 549, 552 (8^th Cir. 2007). 

Because the parties’ expectations of party-appointed arbitrator neutrality are not very high (absent contract language or agreed arbitration rules to the contrary), party-appointed arbitrator disclosures  will ordinarily not yield anything to support a successful evident partiality challenge.  And a  party-appointed arbitrator’s nondisclosures will generally not deprive the other party of information relevant to arbitrator selection, since appointed arbitrators are unilaterally and privately selected by the appointing party, and the other party generally has no say in matter as long as the arbitrator is otherwise qualified to serve. 

But at least one important purpose is arguably served by party-arbitrator disclosure.  The information the appointed-arbitrators disclose may be useful to their colleagues – especially the neutral – in determining what to make of the positions taken by the arbitrators in deliberations.  A failure to disclose that information might, in appropriate circumstances, establish that the arbitrator exceeded his powers under Section 10(a)(4) of the FAA.  Cf. Sphere Drake, 307 F.3d at 623 (“We have not been given any reason to think that umpire Huggins wanted more information from [party-appointed arbitrator] Jacks in order to know what to make of Jacks’ arguments during deliberations.”); Winfrey, 495 F.3d at 552 (“Simmons presents no evidence indicating that Butler’s partiality deceived or misled the other two arbitrators.”). 

Asserting Evident Partiality

In presumed bias cases there are typically two scenarios that give rise to a motion to vacate.  First, an arbitrator may disclose a conflict of interest that one of the parties considers indicative of evident partiality.  Assuming that a party timely objects to the conflict, the arbitrator does not voluntarily step down, the arbitrators make an award adverse to the objecting party, and the party timely moves to vacate, then the objecting party can legitimately challenge the award on evident partiality grounds.   

Second, an arbitrator may fail to disclose an actual or potential conflict of interest, which is subsequently discovered by one of the parties who promptly objects.  That party may also legitimately move to vacate the award based on evident partiality grounds.     

Establishing Evident Partiality:  Applicable Standards

Whether the case involves disclosure or nondisclosure, the potential conflict and its surrounding circumstances must be assessed to determine whether the award should be vacated.  Defining a workable standard to assess evident partiality challenges is difficult, and perhaps impossible.  The circuits have formulated various “tests” running the gamut from “a reasonable person, considering all the circumstances, would have to conclude” the arbitrator was partial, to a standard which, for all intents and purposes, permits vacatur where the alleged conflict creates an “appearance of bias.”  Compare Schmitz v. Zilveti,  20 F.3d 1043, 1047-48 (9^th Cir. 1994) (adopting “reasonable impression of partiality” test which it construed as functional equivalent of “appearance of bias”) with Ovalar,  492 F.3d at 137-38 (“[A]rbitrator is disqualified only when a reasonable person, considering all of the circumstances, would have to conclude that an arbitrator was partial to one side;” test satisfied where the “arbitrator knows of a material relationship with a party and fails to disclose it.”); see also Philip J. Loree Jr. & Costas Frangeskides,  Arbitration Practice and Procedure in U.S. and U.K. Reinsurance Disputes: Is the Grass any Greener on the Other Side of the Pond?, AIRROC Matters, Vol. 4 No. 1, at 24, 42-43 n.21-22 (Spring 2008) (Part 1) (citing cases) (copy available here). 

None of these “tests” is a consistently useful indicator of the outcome of a given case.  Reasonable people applying the tests may reach different conclusions based on the same facts, and outcomes may be influenced by fact-dependant policy considerations.  The relative strictness or laxity of a test, however, may indicate how predisposed a circuit might be toward granting relief on evident partiality grounds. 

But irrespective of how each test may be worded, whether the parties’ expectations of neutrality have been thwarted is a significant, underlying, and sometimes unspoken, consideration.  For example, as discussed in Part III.A, when the parties use tripartite arbitration without agreeing on whether, and if so, to what extent, the party-appointed must be neutral, disinterested or independent, then a court will likely conclude that the parties expected the party-appointed arbitrators to be non-neutral and (a) conclude vacatur is inappropriate even if the arbitrator would be deemed evidently partial were he or she a neutral; (b) require the challenging party to show prejudice resulting from the evident partiality; or (c) figure into the evident partiality calculus the parties’ diminished expectations of partiality.  (See Part III.A., here, and cases cited.) 

One important caveat is that a conflict remains a conflict whether or not it is disclosed, and irrespective of what the arbitrator’s subjective state of mind might be.  Suppose a neutral arbitrator owned a 25% equity interest in one of the parties, a closed corporation.  The neutral discloses the conflict and says his ownership will not affect his ability to act as a neutral.  And suppose that the neutral firmly believes what he says despite his rather significant financial interest in the matter over which he is asked to preside.  One of the parties objects, the panel rules against the objecting party, and – although no one can prove or disprove it – the umpire acts completely impartially and gives the losing party the benefit of every doubt.   Under these facts the party challenging the award would have a strong (some might say surefire) motion to vacate under the law of every (or virtually every) circuit. 

Conversely, failure to disclose a potential conflict does not provide a basis for an evident partiality challenge unless the potential conflict turns out to be an actual conflict or something awfully close to one.  We hedge here because there may be relationships between an arbitrator and a party that are material to the evident partiality calculus, but which, in and of themselves, may not qualify as actual conflicts.  The United States Court of Appeals for the Second Circuit indicated that the test for evident partiality can be satisfied where the arbitrator “knows of a material relationship with a party and fails to disclose it,” because “[a] reasonable person would have to conclude that an arbitrator who failed to disclose under such circumstances was partial to one side.”  See Ovalar, 492 F.3d at 137-38.  That suggests to us that the Second Circuit (and perhaps other circuits) will place some weight on the circumstances surrounding the non-disclosure itself in determining whether, based on all of the circumstances, the test for evident partiality is satisfied.

We hope we have provided you with some useful, general information concerning evident partiality.  In Part IV. of this series we address Federal Arbitration Act Section 10(a)(3), which authorizes vacatur where a party was prejudiced by an arbitrator’s procedural misconduct.

Stolt-Nielsen turns on the allocation of power between courts and arbitrators.   No matter how thoroughly and neatly you parse the issues, the question that repeatedly and continuously begs for an answer is:  who decides?  Answer that question as it relates to one issue and it pops up again in relation to the next. 

Up until Bazzle the Supreme Court did an admirable job of delineating the bounds of arbitral versus judicial authority.  The lines were blurred in Bazzle, where under the peculiar facts there was a question whether the agreement precluded class arbitration.  (See our Disputing guest post here.)  The question required interpretation of ambiguous contract language – a task arbitrators have both the authority and the competence to perform – so it was remanded to the arbitrators.  The four-Justice plurality said the question was not one of arbitrability, but concerned the “kind” of arbitration to which the parties agreed.  

But many of the lower courts — including the United States Court of Appeals for the Second Circuit — read Bazzle to mean that arbitrators have the authority under a broad arbitration agreement to determine whether the parties agreed to class arbitration when their agreements say nothing about class or consolidated arbitration.   That is a very different question from whether an arbitration agreement precludes class arbitration, and it is not one that the parties in Stolt-Nielsen clearly and unmistakably submitted to the arbitrators.      

Stolt-Nielsen presents the United States Supreme Court with a unique opportunity to draw a sharper and stronger line between the arbitrable and non-arbitrable in cases concerning class or consolidated arbitration.  Whether or not the Court will seize it is an open question, because, as explained in Part III, AnimalFeeds has articulated a plausible argument that Stolt-Nielsen has not established the predicate for the Court’s grant of certiorari:  that the parties’ agreements were silent on class arbitration.  If at least five justices are satisfied with the (we believe, unsatisfactory) status quo concerning class arbitration, or otherwise believe that the best course is to allow class arbitration to continue (and even flourish), then AnimalFeed’s argument may provide an interpretive path for a ruling that the case is not properly before the Court.   

Today we explain why accepting AnimaFeeds’ argument would contravene the letter and spirit of the Federal Arbitration Agreement, breed further litigation, and undermine confidence in arbitration as an effective alternative dispute resolution mechanism.   More to the point, we discuss why and how the Court can reach the merits of Stolt-Nielsen consistently with how Stolt-Nielsen presented the question.    

The United States Supreme Court Should Address the Question Presented In Stolt-Nielsen

If the Supreme Court rules that the predicate for granting certiorari was not established, its decision would effectively endorse a scheme that permits arbitrators to:  (a) decide, subject only to deferential review, whether the parties authorized class arbitration in any case having a reasonably broad arbitration clause; and, if the answer is “yes”,  (b) rule, subject only to deferential review, that class arbitration is permissible based solely on the parties having agreed to a reasonably broad arbitration clause.  That would effectively immunize nearly all arbitral decisions concerning class arbitration from judicial review.   

The result would be more litigation.  If the Court simply finds that Stolt-Nielsen did not establish the predicate for certiorari, it would presumably not revisit Bazzle and explain that it was expanding the scope of arbitral power delineated by its prior decisions.  That would be tantamount to the Court answering the very question for which it would be purporting to find no predicate:  whether imposing class arbitration when the parties’ contract is silent on class arbitration is consistent with the Federal Arbitration Act.  Since the law would technically remain unchanged, parties would continue to press for judicial decisions concerning the scope of arbitral power to order class arbitration in the face of contractual silence.  And, after witnessing Stolt-Nielsen’s fate,  parties resisting class arbitration would understandably balk at agreeing to submit the Bazzle contract interpretation issue to arbitration.   Eventually yet another group of parties would be before the Court requesting an answer to the question asked but not answered in Bazzle and Stolt-Nielsen. 

The negative ramifications of this unfortunate state of affairs might extend beyond class arbitration and into the realm of commercial arbitration generally.  The private benefit of arbitration is that it allows parties to construct their own unique mechanism of private dispute resolution and to better manage the risk associated with business conflict.  The public quid pro quo is that arbitration shoulders a significant burden that would otherwise be borne by the courts; without it, the courts would likely need significant, additional public funding to continue delivering adjudicative services efficiently and effectively.      

When courts freely enforce arbitration agreements in a manner consistent with the parties’ reasonable expectations, they provide certainty not only to the parties, but also to others who might consider using arbitration.  When courts do not so enforce arbitration agreements — or effectively cede to arbitrators powers that the parties reasonably expected courts to retain – then participants (current or prospective) may lose confidence in the system and, in all likelihood, be reluctant to use it in the future.    

Can the Court Answer the Question Even Though the Arbitrators Said the Contract was not Really Silent on Class Arbitration?

Whether or not the Court can legitimately reach the merits brings into play the third of the four issues identified in Part I of this series:  whether the agreements in Stolt-Nielsen are, in fact, silent on class arbitration.  And that question cannot be answered unless the Court defines what “silence” means in light of the facts and question presented.   

Defining what “silence” means is by no means easy.  The word is susceptible to various definitions, a point Stolt-Nielsen zeroed in on at oral argument:      

[M]aybe the ambiguity here is the fluidity of the term ‘silence.’  ‘Silence’ can mean there is no express provision. ‘Silence’ could also mean, well, if you look at other words in the text of the contract, you can’t work your way through to conclude that there was in fact an intent.  It also may mean — and this is the sense that I am using it in, and I think the sense that the arbitrators have authority to do, is to say: Well, let’s look and see, for example, if there is custom and practice that would inform the backdrop against which the parties negotiate[d].

(Tr. 18) (emphasis added)

The agreements in Stolt-Nielsen were silent if “silence” means there is nothing in the contract that expressly addresses whether the parties permitted or precluded class arbitration.  But they are not silent if silence means that the arbitrators cannot work their way through the contract and find intent to permit class arbitration – the arbitrators found such intent inherent in the broad scope of the arbitration agreement. 

As Stolt-Nielsen suggested the key lies in the scope of the arbitrators’ interpretative authority:  Do arbitrators have the authority to interpret the scope provision of an arbitration clause to determine whether the parties agreed to class arbitration?  If not, the arbitrators’ finding concerning the parties’ intent to permit class arbitration was in excess of their powers and cannot be relied upon to establish whether or not the agreements were silent.  

Questions concerning the scope of an arbitration agreement itself are ordinarily reserved to the court, including whether “an arbitration clause in a concededly binding contract applies to a particular type of controversy. . . .”  Howsam v. Dean Witter Reynolds, Inc., 537 U.S. 79, 84 (2002).  When a court decides that type of question, it – not the arbitration panel – applies state law rules of contract interpretation to the scope provision of the arbitration agreement (and sometimes other provisions, as well) to determine what the parties agreed to submit to arbitration.  See, generally,  Mastrobuono v. Shearson Lehman Hutton, Inc., 514 U.S. 52, 58-63 (1995). 

But here the arbitrators made the call and the Court need not and should not abide by it.  That means that the arbitration agreements are in fact silent on class arbitration, the predicate for establishing certiorari has been satisfied, and the Court should rule on the issue of whether imposing class arbitration was consistent with the Federal Arbitration Act. 

In Part V we shall address the fourth issue:  what the import of the silence was or should be as respects class arbitration.  .  .  .