As expected attendance was modest – no doubt the result of the cost-cutting mandated by economic conditions, coupled with reduced reinsurance-dispute frequency and severity — but the conference was nevertheless a great success.  The presentations were thoughtful, interesting and professionally useful, and the smaller group of attendees not only facilitated robust – and sometimes, spirited – discussions during the program, but also provided a relaxed atmosphere conducive to networking during the breaks.  I, for one, returned home with “fresh perspectives” on a number of reinsurance-related issues, and those perspectives have proved to be good fodder for brainstorming.

Conference co-chairs Edward K. Lenci (Partner, Hinshaw & Culbertson LLP, New York, NY), Leslie J. Davis (Vice President & Assistant General Counsel, Gen Re; Senior Vice President & General Counsel, United States Aviation Underwriters, Inc.), and Wendy R. Taylor (Vice President and Associate Counsel, Chubb & Son, a division of Federal Insurance Company), outdid themselves on this one.  All three devoted a great deal of time and effort into organizing and implementing the conference over a several month period.  Ed spearheaded the effort and was the event’s chief moderator, while Wendy did double duty as a co-manager and faculty member.   Wendy also had the honor of introducing the keynote speaker, Commissioner Thomas B. Considine of the New Jersey Department of Banking and Insurance (Commissioner Considine also chairs the National Association of Insurance Commissioners‘ Reinsurance Task Force).  Ed’s, Wendy’s and Leslie’s hard work and devotion paid great dividends to all who attended.

Conference-sponsor HarrisMartin Publishing likewise did a superb job organizing, implementing, and promoting the event, and handling all of the administrative, technical, and CLE-related details.  The three key players were Conference Director Vicki Gilbreath; Reinsurance Report Editor Marcy Kowalchuk, whom I’ve known since she was a Mealey’s Reinsurance Reports editor some years back; and Editorial Director Jeff Andrus.  All three worked diligently and intensely on the project, and demonstrated their impressive editorial, publishing, promotional and event-management skills in the process.  They were quick with an effective solution whenever there was a problem.

Of course, the conference might have been a rather mind-numbing and painful way to earn CLE credit were it not for the superb faculty, all of whom delivered and facilitated interesting and thought provoking discussion and debate on several diverse reinsurance-related topics, and did so with great enthusiasm, skill and aplomb.  Their credentials and reputations speak for themselves:

Finally, I’d like to thank Richard D. Faulkner, a name partner at the Richardson, Texas-based firm of Blume, Faulkner, Skeen & Northam, who traveled all the way from the Dallas, Texas area to join me as a co-panelist on “The Judicial Scrutiny of Arbitration Awards” panel.   Rick — who was recently appointed Fifth Circuit appellate counsel for Michael Motor Company, Inc. in Dealer Computer Svcs., Inc. v. Michael Motor Co., No. H-10-2132, slip op. (S.D. Tex. December 29, 2010), appeal pending No. 11-20053 (5^th Cir.) — is an experienced commercial litigator who handles commercial and insurance arbitrations here and abroad, a Chartered Institute of Arbitrators certified arbitrator in commercial and insurance cases, a frequently sought-after mediator, a member of the Texas House of Representatives Judiciary & Civil Jurisprudence Committee’s Arbitration Advisory Group, and a member of the International Institute for Conflict Prevention and Resolution (“CPR”)’s Arbitration Committee.  He was a contributing author to the American Bar Association publication, Elkouri & Elkouri, How Arbitration Works (6th Ed.), served as a trial judge in Louisiana, and is a former professor of Alternative Dispute Resolution law who has taught in Texas, England and Asia.

At the conference Rick and I discussed, among other things, some of the key differences between Scandinavian Reinsurance Co. v. Saint Paul Fire & Marine Ins. Co., 732 F. Supp.2d 293 (S.D.N.Y. 2010), appeal pending No. 10-910-cv (2d Cir.), and Dealer Computer, both of which concern arbitrator nondisclosure of alleged conflicts of interest (Dealer Computer also raises arbitrator qualification issues governed by Section 10(a)(4) of the Federal Arbitration Act.)

We were very happy with the presentation, which was well-received by attendees and other faculty members.  It was quite an honor to share the podium with Rick, and I hope we’ll collaborate on future projects.

Part I (here) briefly discussed Chief Judge Frank H. Easterbrook’s decision in Trustmark Ins. Co. v. John Hancock Life Ins. Co. (U.S.A.), No. 09-3682, slip op. (7^th Cir. Jan. 31, 2011), and its implications on the pending Second and Fifth Circuit appeals 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), and Dealer Computer Svcs., Inc. v. Michael Motor Co., No. H-10-2132, slip op. (S.D. Tex. December 29, 2010).  This Part II examines in some detail Trustmark’s background and rationale, and Part III will focus on Trustmark’s implications on the Scandinavian Re and Dealer Computer appeals.

II.  Trustmark Background

The following facts were gleaned from both the district court and Seventh Circuit opinions (the district court opinion is reported at 680 F. Supp. 2d 944 and can be found here):

Pursuant to several contracts, Trustmark Insurance Company (“Trustmark”)  agreed to reinsure John Hancock Insurance Company (U.S.A.) (“Hancock”), but not with respect to “London Market Retrocessional Excess of Loss Treaties,” which were excluded from the contracts.  Each contract was subject to a broad arbitration agreement (the “arbitration agreement”), which said the arbitrators had to be “disinterested in the outcome.”

A.  The First Arbitration and Confidentiality Agreement

A dispute arose concerning the scope of the “London Market Retrocessional Excess of Loss Treaties” exclusion, and the parties submitted the dispute to arbitration as required by the arbitration agreement.  Pursuant to the agreement, each party selected an arbitrator, and the two arbitrators selected a neutral umpire.

As is customary in reinsurance arbitration, the parties entered into a confidentiality agreement during the arbitration, which was executed by the parties and the panel members, and which prohibited Trustmark and Hancock from disclosing information concerning the proceedings and award, including evidence adduced.  The confidentiality agreement did not contain an arbitration clause.  (An example of a form of confidentiality agreement frequently used in reinsurance arbitration can be found here.   Parties frequently amend this form to suit the needs of the case, and, in any event, the Trustmark opinions do not say whether the confidentiality agreement was based on this particular form.)

In March 2004 the arbitration panel ruled in favor of Hancock, and the United States District Court for the Northern District of Illinois, Eastern Division, confirmed the award a few months later.  Hancock, relying on its interpretation of the award, billed Trustmark for balances allegedly owed under the treaties, but Trustmark refused to pay.

B.  The Second Arbitration

Hancock commenced a second arbitration in October 2004 to resolve the dispute that had arisen over the prior award and its reinsurance claims based on the award.  As one would expect, Hancock selected the same arbitrator it had appointed in the prior arbitration.  Trustmark, which had lost the prior arbitration, appointed a new arbitrator.  The two arbitrators appointed a neutral umpire, who, like Trustmark’s arbitrator, had not served in the first arbitration.

The parties knew from the outset that resolution of their dispute potentially implicated the confidentiality agreement, which Hancock’s arbitrator had signed, but which the umpire and Trustmark’s arbitrator had not.  At an organizational meeting in 2005 Trustmark expressed concern about whether Hancock’s arbitrator could abide by the confidentiality agreement.  Hancock’s arbitrator replied that although he “would scrupulously abide by confidentiality,” it might be “hard to segregate, difficult to deal with” knowledge obtained during first proceeding, which the other two panel members did not have.  Trustmark asked some further questions and consented to the appointment of Hancock’s arbitrator.

Not surprisingly, Hancock asserted that the panel should base its decision on the record of the prior arbitration.  It asked the panel to “expressly authorize the use of all materials [from the prior arbitration], without limitation.  .  .  .”  Hancock argued that the confidentiality agreement prohibited disclosures to the outside world, but not disclosures in subsequent arbitration proceedings between the parties, even proceedings involving attorneys and arbitrators who were not parties to the agreement.  Trustmark argued that the agreement covered all disclosures, including those made in subsequent proceedings to lawyers and arbitrators not involved in the original arbitration.

The umpire and Hancock’s arbitrator, over the dissent of Trustmark’s arbitrator, ruled that the panel “accept[ed] and extend[ed] the confidentiality of [the prior arbitration] to the two members of the current arbitration.  .  .  who were not parties to the previous arbitration.”

Hancock also requested that the Panel prohibit Trustmark from litigating nineteen issues that Hancock contended had been decided in the first arbitration.  A majority of the panel, over the dissent of Trustmark’s arbitrator, ruled that Trustmark was barred from relitigating several issues, including whether the retrocessional business on which Hancock’s claims arose was excluded from the treaties.  (“Retrocessional business” is the reinsurance of other reinsurance business.)

C.  Trustmark Seeks an Injunction

In 2009 Trustmark belatedly attempted to vacate the prior arbitration award, but presumably Trustmark recognized that the three-month deadline for vacating the award had expired long-ago, and that Fed. R. Civ. P. 60(b) did not authorize reopening the confirmation judgment.  It accordingly recast its claim as one for injunctive relief.

Trustmark argued that Hancock had obtained the prior award by fraudulently failing to produce four documents during discovery, and that the panel’s preclusion order was thus tainted by fraud.  Trustmark requested an order enjoining further arbitration to prevent Hancock from furthering its alleged “fraudulent scheme.”  Trustmark also sought an order enjoining:  (a) further alleged breaches of the confidentiality agreement; (b) Hancock’s alleged obstruction of access to relevant documents; and (c) further arbitration before any members of the panel.

In light of the four new documents Trustmark said should have been produced in the first arbitration, Hancock agreed to withdraw its preclusion claim and to participate in further discovery.  This mooted in part Trustmark’s claims for injunctive relief, leaving for judicial resolution its confidentiality-agreement-based claim and its claim that no further arbitration should proceed before any of the panel members.

As to the confidentiality agreement, Trustmark said the panel had no authority to resolve disputes concerning that agreement, including the dispute it had already purported to resolve, and therefore an injunction was necessary to ensure that the panel would not continue to exceed its authority by deciding confidentiality-agreement issues.  As to the constitution of the panel, Trustmark said Hancock’s arbitrator was no longer “disinterested” because he:  (a) allegedly breached the confidentiality agreement by participating in the deliberations that resulted in the confidentiality-agreement order; and (b) served as Hancock’s arbitrator in the prior arbitration.  According to Trustmark, Hancock’s arbitrator’s interest in the outcome “infect[ed]” the other two panel members, rendering them unfit to serve.

D.  The District Court Enjoins Arbitration

The district court enjoined the parties’ participation in the arbitration for as long as Hancock’s arbitrator remained on the panel.  The district court held that Hancock’s arbitrator was not “disinterested” within the meaning of the arbitration agreements, and that the panel had no authority to resolve confidentiality-agreement disputes.

As respects Hancock’s arbitrator, the district court said he was not “disinterested” in the arbitration’s outcome because he had breached the confidentiality agreement, and Trustmark may seek to hold him liable for that breach.  The district court also said the knowledge he obtained from the first arbitration made him “a fact witness not subject to examination.”  680 F. Supp. 2d at 948.  Acknowledging that courts “typically operate under the presumption that judges and arbitrators can disregard what they already know[,]” the district court concluded that Trustmark rebutted the presumption:

[Hancock’s arbitrator] has already demonstrated that he may well be unable to do this if he continues to serve on the second panel.   In Trustmark’s vetting of [Hancock’s arbitrator] as part of the Second Arbitration, [Hancock’s arbitrator] expressed some doubt that he would be able “to segregate” information he had from the First Arbitration, and stated that he would find it “difficult to deal with where the other panel members did not have the same full knowledge.” Trustmark points to one instance where, in a conference related to the Second Arbitration, Hancock made a point about a disputed issue in the First Arbitration, and [Hancock’s arbitrator], in support of Hancock, described his recollection of the First Arbitration. In response to Trustmark’s objection, [Hancock’s arbitrator] commented with regard to characterizations of certain claims made in the First Arbitration, “I feel it is my duty to correct the record as best as I understand in that regard.” The hypothetical posited by [Hancock’s arbitrator] during the organizational meeting became realized, and by his actions, he rebutted the presumption that he could disregard knowledge he already had.

680 F. Supp. 2d at 948-49.

The district court also held that the panel had no authority to resolve confidentiality-agreement disputes because that agreement did not contain an arbitration clause and because those disputes were not within the scope of the parties’ arbitration agreements.  See 680 F. Supp. 2d at 949.

Hancock appealed and the Seventh Circuit reversed.

III.  Chief Judge Easterbrook’s Decision

The Seventh Circuit was reviewing an order granting injunctive relief, which must be supported by, among other things, irreparable injury on the part of the party seeking relief.   The Court said there were “two principal problems” with the district court’s analysis of irreparable injury, the “entire discussion” of which the Court said was contained in the following passage from the district court’s opinion:

‘Trustmark cannot be forced to arbitrate issues that it did not agree to arbitrate. Forcing a party to arbitrate a matter that the party never agreed to arbitrate, regardless of the final result through arbitration or judicial review, unalterably deprives the party of its right to select the forum in which it wishes to resolve disputes, causing irreparable harm. This is a harm faced uniquely by Trustmark if it is denied relief and such harm tips the scale in favor of granting injunction. This irreparable harm, coupled with Trustmark’s success on the merits, militates in favor of granting an injunction in this case.’

Slip op. at 4 (quoting 680 F. Supp. 2d at 949; other quotations and citations omitted).

First, said the Court, “Trustmark did agree to arbitrate the question whether the contracts provide reinsurance for certain risks[,]” but “the district court blocked, rather than enforced that contractual understanding.”  Slip op. at 5 (emphasis in original).  Second, a party seeking injunctive relief is not “’unalterably’” denied of its right to select the forum.  Federal Arbitration Act Section 10(a)(4) expressly authorizes courts to vacate awards where arbitrators have “exceeded their powers,” so in cases where arbitrators purport to decide issues outside the scope of their authority, the problem can be addressed when the arbitrators issue a final award.  That, in turn, allows the litigation to proceed in the proper forum.  See slip op. at 5.

The Court said the only “injury” Trustmark might suffer (assuming it was correct that the confidentiality issue was not arbitrable) was “the delay and.  .  . out-of-pocket cost of paying the arbitrators and legal counsel.”  Slip op. at 5.  But the United States Supreme Court has “held that the delay and expense of adjudication are not ‘irreparable injury’.  .  .  . [,]” and the Seventh Circuit has held that Trustmark’s argument to the contrary is “frivolous.”  Slip op. at 5 (citing Petroleum Exploration, Inc. v. Public Service Commission, 304 U.S. 209, 222 (1938); Renegotiation Board v. Bannercraft Clothing Co., 415 U.S. 1, 24 (1974);  FTC v. Standard Oil Co., 449 U.S. 232, 244 (1980); PaineWebber Inc. v. Farnam, 843 F.2d 1050 (7th Cir. 1988); and Graphic Communications Union v. Chicago Tribune Co., 779 F.2d 13 (7th Cir. 1985)).

Having held that the district court improperly granted injunctive relief, the Court acknowledged it could dispose of the case without more.  But the Court explained that “the district court’s decision leaves a cloud over this arbitration and the reputation of [Hancock’s] arbitrator.  .  .  , a reputation that Trustmark seems determined to tarnish.”  Slip op. at 6.  The Court decided to remove the cloud, and ruled “that the district court erred on the merits in addition to mistakenly believing that Trustmark has established irreparable injury.”  Slip op. at 6.

Turning to whether Hancock’s arbitrator was “disinterested” within the meaning of the arbitrator qualification provisions of the agreements, the Court said “disinterested” means “lacking a financial or other personal stake in the outcome.”  Slip op. at 6 (citing by way of general example  Caperton v. A.T. Massey Coal Co., 129 S. Ct. 2252 (2009)).  Citing ARIAS•U.S., Practical Guide to Reinsurance Arbitration Procedure §2.3 (rev. ed. 2004), the Court said “[n]orms of insurance industry arbitration track this understanding.”  Slip op. at 6.

The Court concluded that Hancock’s arbitrator had no “stake in the outcome of this arbitration.”  Slip op. at 6.  The Court acknowledged that he has “a reputational interest:  if his decision disappoints the person who put him on the panel, he is less likely to be selected as an arbitrator in the future.”  Slip op. at 6.  But, according to the Court, such reputational interests are “endemic to arbitration that permits parties to choose who will decide.”  Slip op. at 6 (citing  Sphere Drake Ins. Co. v. All American Life Ins. Co., 307 F.3d 617, 622 (7th Cir. 2002) (Easterbrook, J.), reh’g denied, Nov. 4, 2002, cert. denied, 538 U.S. 961 (2004).  Noting that parties sometimes agree that arbitration-providers select the arbitrators, here “Trustmark and Hancock reserved the power of appointment.”  Slip op. at 6-7.  The Court concluded that “[a] court cannot properly deem the interest in reemployment created by this arrangement a disqualifying event.”  Slip op. at 7.

The Court rejected the district court’s conclusion that Hancock’s arbitrator was not “disinterested” because “he had knowledge of the dispute,” something the district court viewed as “a form of prohibited interest.”  Slip op. at 7.  The Court explained that “private parties often select arbitrators precisely because they know something about the controversy.”  Slip op. at 7 (citing Sphere Drake, 307 F.3d at 620):

Arbitration need not follow the pattern of jury trials, in which a factfinder’s ignorance is a prime desideratum. Nothing in the parties’ contract requires arbitrators to arrive with empty heads.

Slip op. at 7.

Gently rebuking the district court, the Court said “[f]ederal judges, of all people, should not confuse knowledge with disqualifying ‘interest[:]’”

For judges 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.

Slip op. at 7.

But ethical rules applicable to federal judges did not require recusal, because “[k]nowledge acquired in a judicial capacity does not require disqualification.”  Slip op. at 7 (citing Liteky v. United States, 510 U.S. 540 (1994)).  And that, said the Court, is also true of “knowledge acquired in arbitration.”  Slip op. at 7.

The Court concluded that Hancock’s arbitrator was as “disinterested” as “the district judge himself, and just as entitled to participate.”  Slip op. at 8.  And, to the extent there was “any difference between the two adjudicators, [Hancock’s arbitrator] has the stronger entitlement to participate in the second round, because, as [the Court] stressed in Sphere Drake, it takes more to disqualify an arbitrator than to disqualify a judge.”  Slip op. at 8 (citing Sphere Drake, 307 F.3d at 621; and Merit Ins. Co. v. Leatherby Ins. Co., 714 F.2d 673 (7th Cir.), cert. denied, 464 U.S. 1009 (1983) (Posner, J.):

No party in federal court is entitled to pick his judge, but contracts allowing parties to choose their arbitrators are common; these parties’ arrangement instantiates the practice. When one party is entitled to choose its own arbitrator, and in doing so follows all contractual requirements, a court ought not to abet the other side’s strategy to eject its opponent’s choice.

Slip op. at 8.

The Court also rejected the district court’s conclusion that Hancock’s arbitrator was not “disinterested” because he had allegedly breached the confidentiality agreement.  Hancock’s arbitrator had executed the agreement “as an adjudicator,” and was therefore similarly situated to the district court judge, who “himself implemented the confidentiality agreement, in a similar adjudicatory capacity, when confirming the first panel’s award.”  Slip op. at 8.

As to whether the panel had authority to interpret the confidentiality agreement, the Court invoked the procedural arbitrability doctrine.  While the Court acknowledged that the confidentiality agreement did not contain an arbitration agreement, it pointed out that “the parties did agree to arbitrate their disputes about reinsurance.”  Slip op. at 8.  Citing Howsam v. Dean Witter Reynolds, Inc., 537 U.S. 79, 84 (2002), the Court said “[a]rbitrators who have been appointed to resolve a commercial dispute are entitled to resolve ancillary questions that affect their task.”  Slip op. at 8.  The confidentiality agreement, which was executed when the first arbitration was underway, “is closely related to the substance of the first arbitration and presumptively within the scope of the reinsurance contracts’ comprehensive arbitration clauses, which cover all disputes arising out of the original dispute.”  Slip op. at 8-9.   The arbitrators were therefore “entitled to decide for themselves those procedural questions that arise on the way to a final disposition,” including disputes concerning the confidentiality agreement, and “the preclusive effect (if any) of an arbitration award.”  Slip op. at 9-10.

The Court went out of its way to inform the arbitrators that, in addition to having the power to resolve the confidentiality agreement issue, they had a great deal of discretion to decide how to resolve those issues.  Acknowledging that the district court could review those determinations under Section 10(a)(4)’s “excess-of-powers” provision, the Court reminded the arbitrators and parties that the district court’s standard of review would be exceedingly deferential:

[a]mong the powers of an arbitrator is the power to interpret the written word, and this implies the power to err; an award need not be correct to be enforceable. See, e.g., Major League Baseball Players Ass’n v. Garvey, 532 U.S. 504 (2001). It is enough if the arbitrators honestly try to carry out the governing agreements. “[T]he question for decision by a federal court asked to set aside an arbitration award . . . is not whether the arbitrator or arbitrators erred in interpreting the contract; it is not whether they clearly erred in interpreting the contract; it is not whether they grossly erred in interpreting the contract; it is whether they interpreted the contract.” Hill v. Norfolk & Western Ry., 814 F.2d 1192, 1194–95 (7th Cir. 1987) [(Posner, J.)]. See also, e.g., Operating Engineers Local 139 v. J.H. Findorff & Son, Inc., 393 F.3d 742 (7th Cir. 2004) [(Easterbrook, J.)].

Slip op. at 10.

And lest there be any lingering doubt, the Court – apparently speaking principally for the panel’s benefit – said “[w]hen this arbitration resumes, the panel is entitled to follow its own view about the meaning of the confidentiality agreement; it need not knuckle under to the district court’s prematurely announced understanding.”  Slip op. at 10.

Keep your eyes out for the upcoming discussion in Part III of Trustmark’s implications on Scandinavian Re and Dealer Computer.

[Editor’s Note:  We have published a materially identical version of this post on the Disputing blog (you can find Part I here and Part II here).]

The Chief Judge’s latest contribution to Federal Arbitration Act jurisprudence is Trustmark Ins. Co. v. John Hancock Life Ins. Co. (U.S.A.) , No. 09-3682, slip op. (7^th Cir. Jan. 31, 2011), and it is a welcome one.  In a characteristically terse and well-written ten-page opinion, the Chief Judge articulated at least eight Federal Arbitration Act rules pertinent to reinsurance and other forms of commercial and industry arbitration.  A few of these have been set forth before, while others are new:  

1. For the purposes of enjoining an  arbitration proceeding, a party does not suffer “irreparable harm”  simply because it must await the arbitration’s outcome  before obtaining judicial resolution of arbitrability or arbitrator-qualification  questions, see slip op. at 5-6; 
2. An arbitration agreement requiring arbitrators to be “disinterested” means the arbitrators must lack a “financial or other personal stake in [the arbitration’s] outcome,” see slip op. at 6;
3. An “arbitrator’s interest in reemployment created” by an arbitration clause that allows parties to choose their own arbitrators is not a “personal stake in the outcome” disqualifying an arbitrator, see slip op. at 6-7;
4. An arbitrator’s “knowledge about the dispute” is not a “disqualifying interest” in the arbitration’s outcome, see slip op. at 7-8;
5. Courts should not “abet [a party’s] .  .  .  strategy to eject the other party’s chosen arbitrator when that party is entitled to choose its own arbitrator, and in doing so follows all contractual requirements.  .  .  .,” see slip op. at 8;
6. Under the procedural-arbitrability doctrine, an arbitration panel in a subsequent arbitration has the authority to interpret and apply the terms of a confidentiality agreement reached during a prior arbitration proceeding, even if the confidentiality agreement does not contain an arbitration clause, see slip op. at 8-10;
7. Arbitrators have the authority to determine “the preclusive effect (if any) of an earlier [arbitration award,” see slip op. at 9-10; and
8. The question whether arbitrators exceeded their powers based on the outcome of an award is not whether they interpreted the contract correctly, but whether they interpreted it at all.  See slip op. at 10.  

Senior Circuit Judge Richard D. Cudahy and Circuit Judge Ilana Diamond Rovner joined in the Chief Judge’s opinion. 

Trustmark’s implications are many, particularly on the often interrelated topics of arbitrator qualifications and evident-partiality standards.  The author believes the Chief Judge’s opinion should influence the outcome of  pending appeals of two district court decisions vacating awards on the ground one or more arbitrators allegedly did not disclose (or fully disclose) service on a prior arbitration panel involving similar issues and contracts, or the same witness.   One of these is the appeal of the controversial decision 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), which is pending in the United States Court of Appeals for the Second Circuit, and which was fully briefed and argued before Trustmark was decided.  The other is the recently-filed appeal of Dealer Computer Svcs., Inc. v. Michael Motor Co., No. H-10-2132, slip op. (S.D. Tex. December 29, 2010), which is pending in the United States Court of Appeals for the Fifth Circuit. 

Trustmark strongly suggests that the Second and Fifth Circuits should reverse the district court decisions in both Scandinavian Re and Dealer Computer.   In each of those cases the district court vacated an award because one or more arbitrators, through their service in other cases, had access to information or ruled on issues that were allegedly relevant to the proceedings that led to the challenged award. 

Trustmark undermines the district courts’ reasoning in Scandinavian Re and Dealer Computer because it demonstrates that even had the arbitrators in those cases been federal judges -- and therefore subject to more onerous neutrality requirements than those applicable to arbitrators --  the knowledge and experience they obtained from hearing cases involving the same or similar issues or a common witness would not have rendered them “interested” in the outcome, partial to one of the parties, or otherwise unfit to serve.   And if they could have served as federal judges in those matters, then the district courts unquestionably erred by holding that they lacked the requisite neutrality to serve as arbitrators. 

Scandinavian Re and Dealer Computer involved alleged non- or incomplete disclosure of arbitrator service on arguably similar or related matters, while Trustmark did not.    But the disclosure issue is a red herring.  Trustmark, construed in conjunction with Sphere Drake Insurance Ltd. v. All American Life Insurance Co., 307 F.3d 617, 622 (7th Cir. 2002) (Easterbrook, J.) – a case which the Chief Judge relied heavily on in Trustmark – demonstrates that the arbitrators in Scandinavian Re and Dealer Computer  were not required to disclose their service in other arbitrations allegedly involving similar issues or a common witness. 

To fully understand the implications of Trustmark on other cases, one must first understand the background of, and rationale for, the decision. Part II of this post will therefore discuss in some detail what transpired in Trustmark, and Part III will explain in more detail why, in light of Trustmark, the Second and Fifth Circuits should reverse the district court judgments in Scandinavian Re and Dealer Computer.     

[Editor’s Note:  The author is also publishing a materially identical version of this post in the Disputing blog.] 

An arbitration panel acting under a broad, unrestricted arbitration agreement can generally impose sanctions on a party.  But if a federal district court compels arbitration, and retains jurisdiction, can it impose sanctions on counsel who allegedly misbehave during the arbitration proceedings?  On September 13, 2010 the United States Court of Appeals for the Fifth Circuit held 3-0 that the answer is “no,” unless the conduct was in direct defiance or disobedience of the district court’s orders or otherwise threatened the district court’s own judicial authority or proceedings.  See Positive Software Solutions Inc. v. New Century Mtg. Corp., No. 09-10355, slip op. (5^th Cir. September 13, 2010). 

Background

Positive Software Solutions arose out of arbitration between Positive Software Solutions, Inc. and New Century Mortgage Corp.  A district court in Texas compelled arbitration and retained jurisdiction.  Positive Software lost, and sought to vacate the award on evident partiality grounds, which were ultimately rejected by the Fifth Circuit en banc.  See Positive Software Solutions Inc. v. New Century Mtg. Corp., 476 F.3d 278 (5^th Cir. 2007) (en banc).  After the Fifth Circuit remanded the award for confirmation, New Century declared bankruptcy, the parties settled, and the American Arbitration Association administratively closed the proceedings. 

As part of the settlement, New Century waived the attorney-client privilege, and turned over to Positive Software its arbitration files, which Positive Software would use in support of a motion in the district court for sanctions against New  Century’s arbitration counsel, Ophelia Camiña, a partner at Susman, Godfrey, LLP (“Susman Godfrey”); Susman Godfrey; and Barry Barnett (apparently another lawyer who represented New Century).   On March 2008 Positive Software filed its motion for sanctions pursuant to Fed. R. Civ. P. 37, 28 U.S.C. § 1927, and the court’s inherent power. 

In February 2009 the district court imposed pursuant to its inherent power $10,000 in sanctions against Camiña, which represented a portion of Positive Software’s attorney fees incurred during arbitration.  The district court ruled that the sanctions were for conduct that “took place in connection with the arbitration, not in connection with discovery under the Court’s supervision.” 

Camiña appealed, and the Fifth Circuit reversed.

The Fifth Circuit’s Decision

The Fifth Circuit held that “the district court lacked inherent authority to sanction Camiña for her conduct during the arbitration.”  Slip op. at 8.  The Court acknowledged that a district court has the inherent power to “control the litigation before it,” and to “sanction conduct in direct defiance” or “disobedience” of the district court or its orders.  Slip op. at 3-4 (citations and quotations omitted). 

But that “power.  .  . may be exercised only if essential to preserve the authority of the court.”  Slip op. at 4 (citation and quotation omitted).  And “[b]ecause Camiña’s conduct was neither before the district court nor in direct defiance of its orders, the conduct [was] beyond the reach of the court’s inherent power to sanction.”  Slip op. at 5. 

In FDIC v. Maxxam, Inc., 523 F.3d 566, 593 (5^th Cir. 2008), the Fifth Circuit ruled “that the inherent power does not extend to collateral proceedings that do not threaten the court’s own judicial authority or proceedings.”  Id. (quotation omitted).  Positive Software attempted to distinguish Maxxam by arguing that the arbitration proceedings were not collateral, but an “annex” to the litigation.    

The Court rejected this argument on the ground that arbitration is not an “annex” to litigation, but an alternative to it:  “Treating arbitration as if it were an appendage to adjudication is a mistake that would undermine the very purpose of arbitration – the provision of a relatively quick, efficient and informal means of private dispute settlement.”  Slip op. at 4-5 (citation and quotation omitted; emphasis in original).  One of the purposes of arbitration, after all, is to avoid litigation. 

Nobody contended that a court would have the power to impose sanctions in a private arbitration proceeding that the court had not compelled.  And the Court rejected the notion that the rule is any different when a district court does compel arbitration.    

The Court also found that the sanctions order was “in serious tension with the Federal Arbitration Act.  .  .  .”  Slip op. at 6.  Noting that the Federal Arbitration Act gave the district court the power to compel arbitration, stay litigation, and confirm, vacate or modify an award, the court said these “narrowly defined procedural powers” represented the extent of a court’s power to “interfere with an arbitration proceeding.”  Slip op. at 6.  Because the parties apparently agreed that the arbitrator had the power to sanction Camiña – a dubious proposition since Camiña was not a party to the arbitration – “the FAA counsels against the district court’s assigning itself that task.”  Slip op. at 6. 

Finally, the Court ruled that “the sanctions order threatens unduly to inflate the judiciary’s role in arbitration.”  Courts are supposed to have only limited, narrowly-defined and mostly procedural involvement with arbitration proceedings.  Exercising its power to impose sanctions would enable “a court to seize control over substantive aspects of arbitration.  .  .  . ,” and “in effect, become a roving commission to supervise a private method of dispute resolution and exert authority that is reserved, by statute, caselaw, and longstanding practice, to the arbitrator.”  Slip op. at 7.  That supervision cannot be squared with “the scope of inherent authority and with federal arbitration policy, which aims to prevent courts from delaying the resolution of disputes through alternative means.”  Slip op. at 7. 

Positive Software argued that the district court’s involvement was necessary here because Camiña’s alleged misconduct was not discovered until after the settlement and administrative closure of the arbitration, which meant there were allegedly no other means to redress Camiña’s alleged wrongdoing.  But the Court said that the parties could have requested the American Arbitration Association to reopen the arbitration to allow Positive Software to make its sanctions claim, or requested the state bar to discipline Camiña. 

In fact, Positive Software did file a grievance, which was rejected by the state bar for lack of just cause.  But the Court nevertheless directed the Clerk to send a copy of its opinion to the Office of General Counsel of the State Bar of Texas, noting:

We do not condone Camiña’s complained of actions as they are alleged to have occurred.  .  .  . We are mindful that the State Bar declined to act on this matter in response to Positive Software’s request, and we express no view on whether the State Bar should consider this matter further or, if it does, on what action it should take.  We opine only that the federal courts are without power to issue sanctions under these particular facts.   

Slip op. at 8, n.2.  Perhaps the Court referred the opinion simply as part of its function of keeping the Texas State Bar informed of possible ethical violations committed by attorneys appearing before it, but unless the State Bar’s rejection of the grievance was, or appeared to be, based on the availability of court-imposed sanctions, one wonders why the Court took this action.   

Discussion

The Fifth Circuit decided this case correctly based on the facts before it.  One wrinkle practitioners should keep in mind is that the parties apparently agreed the arbitrators had the power to sanction Camiña in her personal capacity.  Ordinarily, arbitrators do not have this authority — at least in the Second Circuit — because counsel are usually not parties to the arbitration agreement, and arbitrators can order relief only against parties.  See Porzig v. Dresdner, Kleinwort, Benson, North Am. LLC, 497 F.3d 133, 140-41 (2007). 

But even had the parties not agreed that the arbitrators had the authority to impose sanctions against counsel, the result would likely have been the same.  The principal ground for the decision was that courts do not have inherent power to sanction conduct that takes place in private arbitration proceedings, unless it somehow constitutes direct defiance or disobedience of the court or its orders, or otherwise threatens the court’s authority or proceedings.  Attorney misconduct in arbitration does not ordinarily meet that standard, and did not here.    

Two additional points deserve a word.  First, the Court did not rule that attorney misconduct before an arbitration panel can never be the subject of district-court-imposed sanctions.  The Court noted that:  

New Century affirmatively sought the entry of a protective order governing discovery both before the district court and in the arbitration proceedings; New Century also petitioned the court for sanctions against Positive Software on multiple occasions.  Accordingly, had the alleged conduct arisen in connection with discovery before the district court or the protective order or preliminary injunction, it might have threatened the court’s own judicial authority or proceedings.” 

Slip op. at 8 n.3.  But the Court expressed “no ultimate view on this hypothetical, which [was] not before” it.   Id. 

Second, note how New Century, after declaring bankruptcy, was willing to turn over its arbitration files to its former adversary, including attorney-client privileged materials (a decision presumably made by the bankruptcy trustee).  We lawyers must remember that the attorney-client privilege belongs to the client, and when a bankruptcy trustee is appointed, all bets are off.  Be careful what you say, because you never know how a third party might interpret it.  And consider the old adage that both inside and outside counsel should follow:  think long and hard before you say or write anything you would be uncomfortable seeing on the front page of The New York Times.

I am delighted to be invited to guest-blog today by Philip J. Loree Jr. of the Loree Reinsurance and Arbitration Law Forum.  I was thrilled that Phil jumped right on it when I suggested that we should guest-post on each others blogs in the near future. 

Phil did an outstanding job discussing the Arbitration Fairness Act of 2009 (read the post here) last week as a guest-blogger at Disputing.  He suggested that I  explore the topic of “manifest disregard of the law,” in light of the United States Supreme Court decision Hall Street Associates, LLC v. Mattel, Inc. 128 S.Ct. 1396 (2008), and the Fifth Circuit ruling in Citigroup Global Markets, Inc. v. Bacon, ___ F.3d ___ (5^th Cir. 2009).  So, after conquering some initial, mild trepidation about my first guest-blogging experience, here I am. 

 Discussion: Hall Street and Citigroup

In Hall Street, the Supreme Court concluded that the Sections 10 and 11 provide the exclusive bases for vacatur and modification of arbitration awards under the Federal Arbitration Act (“FAA”).  Under Section 10, the grounds to vacate an arbitration award are:

(1) where the award was procured by corruption, fraud, or undue means; 

(2) where there was evident partiality or corruption in the arbitrators, or either of them;

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

(4) 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.

 9 U.S.C. § 10(a).

The Court stated that “manifest disregard” of the law was not an independent ground for vacating awards.  The Court, however, observed that in the past it may have used the term “manifest disregard” to refer collectively to all  FAA Section 10 grounds, or as a “shorthand” for situations where the arbitrators were “guilty of misconduct” under Section 10(a)(3), or “exceeded their powers” under Section 10 (a)(4).  Over the past year, the circuit courts have differed over whether the “manifest disregard” doctrine survives the Supreme Court’s holding in Hall Street.

Recently, in Citigroup, it was the Fifth Circuit’s turn to decide the doctrine’s fate.  There, Debra Bacon discovered that her husband had made five fund withdrawals from her Citigroup Individual Retirement account without her authorization.  Bacon notified Citigroup as soon as she discovered what happened, but this notification was seven months after her husband had withdrawn $50,000, and five months after her husband had withdrawn another $150,000.  Bacon filed for divorce.  Citigroup refused to reimburse Bacon, and in 2004, she submitted her claim to an arbitration panel as required by her contract with Citigroup. The panel ordered Citigroup to pay Bacon $256,000 ($218,000 in damages and $38,000 in attorneys’ fees).

Citigroup petitioned to vacate the award claiming that the arbitration panel had “manifestly disregarded” the law.  The United States District Court for the Southern District of Texas vacated the award on the ground that the arbitration panel “manifestly disregarded” the law.  According to the District Court: 

1. Bacon was not harmed by the fund withdrawals because her husband used the money for their benefit and subsequently promised to pay her back;
2. Bacon’s claims were barred by Texas law, which permits such claims only if the customer reports unauthorized transactions within thirty days of the withdrawal; and
3. Texas law requires apportionment among liable parties, which in this case, includes Bacon’s husband.

The District Court said that although Citigroup “briefed and argued the requirements of Texas’s law on [bank] accounts, the panel ignored its contents obdurately.”  The court concluded that “[a] lawless award must be vacated.”  When the District Court decided the case (Aug. 2, 2007), Hall Street had not been decided.

On appeal, the Fifth Circuit, citing Hall Street, held that Sections 10 and 11 provide the exclusive grounds for vacatur and modification of arbitral awards.  Citing case law within the Fifth Circuit, the Court observed that the Fifth Circuit was “among the very last [of the circuit courts] to adopt manifest disregard,” and added that case law reflected that the narrow doctrine had a “standard difficult to satisfy.”  The Court also stated that “the term itself, as a term of legal art, is no longer useful in actions to vacate arbitration awards.”  The court ultimately ruled that “to the extent that manifest disregard of the law constitutes a nonstatutory ground for vacatur, it is no longer a basis for vacating awards under the FAA.” 

 Manifest Disregard in the Fifth Circuit: the Future

In Citigroup, the Fifth Circuit rejected “manifest disregard” as an independent, nonstatutory ground for setting aside an award.  Nevertheless, the court remanded the case to the District Court to determine whether vacatur is available under any of the FAA statutory grounds.  

While “manifest disregard” is no longer an independent ground for vacatur in the Fifth Circuit, Citigroup may be able to use Section 10(a)(4) of the FAA as an alternative basis for relief.  The court in Brabham v. A.G. Edwards & Sons, Inc., 376 F.3d 377 (5th Cir. 2004) clarified that the “essence of the agreement” test — under which an arbitration decision can be vacated if it does not  draw its essence from the contract — is not a separate nonstatutory ground for vacatur but is part of Section 10(a)(4) of the FAA.  Citigroup may have a legitimate argument that the arbitrators “exceeded their powers” to the extent that the award failed to draw its essence from the contract.

To establish that the arbitrators’ decision did not draw its essence from the contract, Citigroup will have to show that the decision effectively deprived it of the benefit of its bargain with Bacon.  Absent contract language to the contrary, parties to every arbitration agreement presumably expect that their dispute will be decided according to some set of applicable legal rules.  That is so even when the parties’ agreement does not contain a choice-of-law clause.  The parties cannot expect that the arbitrators will construe the contract and apply the law in precisely the same way a court would.  Mistakes of law and contract interpretation are risks that parties assume when they agree to arbitrate, and parties sometimes resort to arbitration because they want a decision based more on “rough justice” than strict compliance with legal technicalities.  On the other hand, the parties arguably have the right to expect that the arbitrators’ award be based on at least a plausible or colorable interpretation of the applicable law and the contract, even if a court might reach a different conclusion on the same facts.  

To illustrate this point, let’s look at an extreme example.  Suppose that the umpire of a three-person arbitration panel said to the other two arbitrators during deliberations:  “This is a tough case and I don’t have a clue how we should decide it.  Let’s have a round of golf between you two party-appointed arbitrators and whoever wins gets to make the call on the arbitration.”  To the extent the parties reasonably contemplated that the arbitrators would decide their case according to applicable law rather than on the golfing prowess of their party-appointed arbitrators, then the resulting award would probably exceed the panel’s powers because it did not draw its essence from the agreement — indeed, it drew its essence from the results of a golf match.   

If Citigroup can establish that inherent in its contract with Bacon was the understanding that the arbitrators would resolve their disputes in a manner that was at least plausibly derived from applicable Texas Law, and if Citigroup can likewise demonstrate that the arbitrators’ decision had no plausible basis in the law or in the contract, then perhaps Citigroup may be entitled to relief under Section 10(a)(4).  For example, Bacon appears to have suffered little or no actual damage because her husband shared the withdrawn money with her and promised to pay it back in any event.   Bacon’s claims were barred by the Texas thirty-day statute of limitations period because Bacon notified Citigroup seven months after the first withdrawal and five months after the second withdrawal.  In addition, the arbitrators failed to apportion as required by Texas law responsibility for the loss between Citigroup and Bacon’s husband.  It may be that the arbitrators exceeded their powers by refusing to follow all of these clear principles of Texas law, provided there was no other plausible basis for their decision, and provided that the parties’ agreement contemplated that the resolution of any dispute be at least grounded in Texas law, even if not perfectly in accord with it.   

It remains to be seen whether the Fifth Circuit will reconceptualize “manifest disregard” of the law within the specific statutory ground of  FAA section 10(a)(4), perhaps under the rubric of the “essence of the agreement” test.  The circuit’s prior case law articulating that test suggests that the court may have an alternative vehicle for addressing problems created by the rare arbitral award that is clearly erroneous, unjust and lacking any plausible basis in the law or the parties’ contract.   

Finally, it will be interesting to see what happens on the Citigroup remand.  Whatever the result, you will hear about it in Disputing and here at the Forum.

Victoria is an up and coming young attorney who works for Dispute Resolution Expert Karl Bayer.  Based in Austin, Texas, Karl’s team focuses on litigation, arbitration, and mediation of intellectual property, environmental, and health care disputes.  (Learn more about Karl Bayer’s practice here and read Victoria’s bio here.)  Victoria, a graduate of the University of Texas School Of Law, is currently pursuing a degree in computer science, and is a member of several ADR and other legal-services-oriented associations.  Victoria has done a wonderful job keeping Disputing loaded with up-to-date cases, legislation, and relevant articles on matters pertinent to arbitration and other forms of dispute resolution.  Her efforts are particularly impressive when you consider that she graduated from law school only a few years ago, is an active networker and business developer, and is pursuing a computer science degree on top of all of that.  Keep your eyes on this rising star!

Ever since the Fifth Circuit handed down Citigroup Global Markets, Inc. v. Bacon, ___ F.3d ___ (5^th Cir. 2009), in which the Court held that manifest disregard of the law is no longer an independent ground for vacatur under the Federal Arbitration Act, we have wondered whether existing Fifth Circuit case law on Federal Arbitration Act Section 10(a)(4) might be flexible enough to permit courts in appropriate cases to vacate awards where the arbitrators’ decision has no colorable basis in the contract or in applicable law, and where there is evidence that the arbitrators knew, but disregarded, controlling contract provisions or unambiguously applicable law.  And assuming that flexibility is not already inherent in the Fifth Circuit’s Section 10(a)(4) jurisprudence, we have wondered to what extent, if at all, is the Fifth Circuit likely to expand its interpretation of Section 10(a)(4) to provide itself and the district courts under it with a safety valve of sorts for addressing unusual situations of this type.  

Victoria’s post addresses these questions, so read on.  .  .  .