The article is reprinted below with permission, and I would like to thank Elaine Song, a member of the New York Law Journal’s editorial staff, for her assistance and work in getting this published in New York’s leading legal trade publication.  

Reprinted with permission from the May 18, 2011 edition of the New York Law Journal© 2010 ALM media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877-257-3382, reprints@alm.com or visit www.almreprints.com:

Outside Counsel

Arbitrator Evident Partiality Standard Under Scrutiny in ‘Scandinavian Re’

Philip J. Loree Jr. ContactAll Articles

New York Law Journal

May 18, 2011

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Philip J. Loree Jr.

Section 10(a)(2) of the Federal Arbitration Act (FAA) authorizes federal district courts to vacate arbitration awards “where there was evident partiality…in the arbitrators….”¹ Just as 28 U.S.C. §455 imposes impartiality requirements on federal judges, so too does Section 10(a)(2) on arbitrators.

To implement Section 10(a)(2)’s arbitral impartiality standards, courts have imposed on neutral arbitrators a duty to disclose circumstances that establish evident partiality. The scope of the duty to disclose relationships and interests that disqualify a neutral on evident partiality grounds, and what types of interests and relationships can establish evident partiality, are topics muddled by unclear, semantically malleable standards, which sometimes baffle judges, arbitrators, and in-house and outside counsel.

The pending appeal in Scandinavian Reinsurance Co. v. Saint Paul Fire & Marine Ins. Co.² presents the U.S. Court of Appeals for the Second Circuit with an opportunity to provide additional, meaningful guidance on arbitral impartiality standards, including arbitrator disclosure obligations. There the district court vacated a final arbitration award on evident partiality grounds even though none of the arbitrators had personal or financial relationships with the parties or interests in the outcome. The district court said the award had to be vacated because two of the arbitrators did not disclose to the parties facts about their involvement in an allegedly related proceeding—facts that would have no bearing on whether a similarly situated federal judge was impartial under much stricter judicial impartiality standards.

The question the court will decide is whether FAA Section 10(a)(2) authorized the district court to vacate the award under these circumstances. The answer should be “no,” and here’s why.

The District Court Decision

Scandinavian Re arose from a petition to vacate a final award issued by three experienced, well-known and respected industry arbitrators appointed to resolve a reinsurance dispute. The district court vacated the award because two arbitrators (one neutral, one party-appointed) did not disclose their temporally overlapping service on another arbitration panel hearing a case the district court characterized as concerning: (a) a common witness; (b) “similar” issues; (c) “similar” contract terms; (d) “the same type of reinsurance business”; and (e) a party that was the successor-in-interest to reinsurance business the prevailing party in the Scandinavian Re arbitration had assumed. (The parties dispute the accuracy of these findings, but, as we shall see, that doesn’t matter.)

The district court held that the arbitrators’ undisclosed, overlapping service in the other arbitration created “a material conflict of interest” establishing evident partiality:

[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 [a party in the other arbitration which had purchased reinsurance business originally 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 [arbitrations, 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. 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….³

Analysis

The case turns on whether the Scandinavian Re arbitrators met arbitral impartiality standards, which are more demanding than judicial impartiality standards.⁴ While federal judges are disqualified for partiality “in any proceeding in which [their] impartiality might reasonably be questioned”—a/k/a the “appearance of bias” standard—in the Second Circuit “an arbitrator is disqualified [for evident partiality] only when a reasonable person, considering all of the circumstances, ‘would have to conclude that [the] arbitrator was partial to one side.’”⁵

Conventional wisdom suggests the Second Circuit should simply determine whether “a reasonable person…would have to conclude” the arbitrators were partial. But the Second Circuit can (and should) decide Scandinavian Re under explicitly defined standards set forth by statute and interpreted by U.S. Supreme Court and other federal courts: the judicial impartiality standards.

Chief Judge Frank H. Easterbrook of the U.S. Court of Appeals for the Seventh Circuit has demonstrated that initially considering whether arbitrators met judicial impartiality standards can greatly simplify the resolution of many evident partiality (and certain contractual, arbitrator-qualification) questions, because doing so not only avoids the philosophical debate and policy-oriented analysis that the “reasonable person would have to conclude” test invites, but in many cases, including Scandinavian Re, can provide added assurance about the validity of the outcome. For if arbitrators satisfy judicial impartiality standards, they necessarily satisfy arbitral ones, which are less demanding.⁶

What Are the Judicial Standards? The statute, 28 U.S.C. Section 455, sets forth the judicial impartiality standards that a federal judge must meet in each case over which he or she presides. Section 455(a) describes a “catchall,” “appearance of bias” 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.”⁷ 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 personal, financial or professional relationships or interests that are presumed to conflict with the parties’ interest in having an impartial decision maker.⁸

Judges who do not meet these demanding judicial impartiality standards in any given case are obligated to recuse themselves, that is, to step aside and let another judge hear the matter. If they do not do so, and an appellate court rules they should have, then their orders and judgments may be vacated.

Were the ‘Scandinavian Re’ Arbitrators Disqualified Under §455(b)? The best way to assess impartiality under §455 is to consider first whether the arbitrators—were they federal judges—would have been disqualified on §455(b) grounds. The only §455(b) ground that might provide even a barely plausible basis for challenging impartiality in a case like Scandinavian Re is §455(b)(1), which requires judges to disqualify themselves “[w]here [they have]…a personal bias or prejudice concerning a party, or personal knowledge of disputed evidentiary facts concerning the proceeding.”⁹ But the Scandinavian Re arbitrators did not violate subsection 455(b)(1).

In Liteky v. United States,¹⁰ the Supreme Court explained that predispositions judges reach based on information obtained in an adjudicative capacity do not evidence Section 455(b)(1) “bias” or “prejudice,” except in extraordinary circumstances. The Court said the terms “bias” and “prejudice” “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…or because it is excessive in degree….”¹¹ Under the so-called “extrajudicial source doctrine,” alleged “bias” or “prejudice” generally cannot be based on knowledge obtained from participation in judicial proceedings, or on predispositions reasonably formed as a result, because there is nothing wrongful or inappropriate about judges having such knowledge or predispositions.¹²

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 absent “deep-seated favoritism or antagonism that would make fair judgment impossible,” those predispositions are not “wrongful” or “inappropriate” and thus do not establish bias or prejudice.¹³

Assuming for argument’s sake that the district court’s factual findings were accurate, 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. Even if there were no “extrajudicial source doctrine,” those facts would hardly suggest §455(b)(1) “bias” or “prejudice.”

But assuming (in the absence of evidentiary support) the arbitrators’ service in the other arbitration influenced their thinking in the Scandinavian Re arbitration, there is nothing wrongful or inappropriate about a judge—or by extension, an arbitrator—having or using in proceeding B knowledge or experience properly obtained in an adjudicative capacity from proceeding A.¹⁴ And nobody—including the district court judge—says that the arbitrators’ participation in the other arbitration resulted in “deep-seated favoritism or antagonism that would make fair judgment impossible.”¹⁵

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

But that doesn’t mean they obtained personal knowledge of the facts established or advocated in the other arbitration and thus could testify as fact witnesses in that arbitration, let alone in the Scandinavian Re arbitration. No one claims they were involved in or had personal knowledge of the disputed transactions; whatever knowledge they had was obtained solely in an adjudicative capacity.

Were the ‘Scandinavian Re’ Arbitrators Disqualified Under §455(a)? The only remaining question is whether the arbitrators were disqualified under §455(a)’s catchall, “appearance of bias” standard. Liteky provides an easy 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.¹⁶

Was There Any Legitimate Basis for the District Court’s Decision? The answer is “no.” Even if the strict judicial impartiality standards applied to the Scandinavian Re arbitrators, they satisfied them, and that necessarily means they satisfied the more lenient ones imposed by §10(a)(2).

The district court’s conclusion that the arbitrators had a “material conflict of interest” was therefore 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.”¹⁷ But a decision maker cannot have a “conflict of interest” unless he or she has a personal or financial interest in the outcome of the matter that conflicts with the parties’ interest in the decision maker’s impartiality.¹⁸ Liteky forecloses any argument that a decision maker’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.¹⁹

The risk that the arbitrators might “influence each other’s thinking on” allegedly similar, common issues likewise does not create a conflict of interest or otherwise establish evident partiality. That risk is present to some degree in appellate courts that use rotating, three-judge panels, and is particularly high in the U.S. Supreme Court, where the same nine justices generally hear each case. But nobody thinks that federal judges or Supreme Court justices must recuse themselves in matter B simply because they served together on the Court when it heard related matter A, and thus might influence each other’s thinking in matter B.

But Didn’t the Arbitrators Fail to Disclose Their Service on the Other Arbitration Panel? Some may think that the Second Circuit should affirm the district court because the arbitrators did not disclose their involvement in the other arbitration. They may think that the arbitrators’ failure to disclose their service amounted to evident partiality because it allegedly evidenced some deceptive motive on the arbitrators’ part that somehow spoiled the award. Alternatively, some may, like the district court judge, think 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,”²⁰—even though an evident-partiality conclusion does not follow from that doubtful premise.

These arguments are misplaced for several reasons, but it is enough to say that accepting them would impose on arbitrators impartiality standards far more onerous than those federal judges must meet.

In the Second Circuit, courts may vacate awards for evident partiality where arbitrators fail to disclose a “material relationship with…a party” or a material interest—financial or personal—in the outcome of the arbitration.²¹ There is nothing controversial about that, for an arbitrator’s material relationship with a party or person or material financial interest in the outcome would establish partiality under both judicial and arbitral impartiality standards.

But in Scandinavian Re the undisclosed circumstances provided no basis for disqualification under Sections 455(a) or (b), which means that not even a federal judge would have been obligated to disclose them.²² The Scandinavian Re arbitrators were not required to disclose anything that a similarly situated federal judge would not have to disclose, and the Second Circuit should so rule.

Philip J. Loree Jr. is a partner at Loree & Loree in Manhasset.

Endnotes:

1. 9 U.S.C. §10(a)(2).

2. No. 09 Civ. 9531(SAS), 2010 WL 653481 (S.D.N.Y. Feb. 23, 2010).

3. Scandinavian Reinsurance Co. v. Saint Paul Fire & Marine Ins. Co., No. 09 Civ. 9531(SAS), 2010 WL 653481, at *8 (S.D.N.Y. Feb. 23, 2010), appeal pending No. 10-910-cv (2d Cir.).

4. See Applied Indus. Materials Corp. v. Ovalar, 492 F. 3d 132, 137 (2d Cir. 2007); Morelite Constr. Corp. v. New York City Dist. Council Carpenters Benefit Fund, 748 F.2d 79, 83-84 (2d Cir. 1984).

5. Ovalar, 492 F.3d at 137 (quoting Morelite, 748 F.2d at 84 (emphasis added)).

6. See Trustmark Ins. Co. v. John Hancock Life Ins. Co. (U.S.A.), No. 09-3682, 2011 WL 285156 (7th Cir. Jan. 31, 2011) (Easterbrook, C.J.); Sphere Drake Ins. Co. v. All American Life Ins. Co., 307 F.3d 617 (7th Cir. 2002) (Easterbrook, J.).

7. 28 U.S.C. §455(a).

8. 28 U.S.C. §455(b).

9. 28 U.S.C. §455(b)(1).

10. 510 U.S.540, 550 (1994) (Scalia, J.).

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

12. 510 U.S. at 550.

13. 510 U.S. 550-51 & 555-56 (citations omitted).

14. See 510 U.S. at 550.

15. 510 U.S. at 555.

16. 510 U.S. at 552.

17. 2010 WL 653481 at *8.

18. See, generally, Trustmark, 2011 WL 285156, at *3.

19. See Liteky, 510 U.S. at 550-51 & 552-55; Trustmark, 2011 WL 285156, at *3.

20. See 2010 WL 653481, at *8.

21. Applied Indus. Materials, 492 F.3d at 137 (material financial relationship with a party); see also Pitta v. Hotel Assoc. of New York City, 806 F.2d 419, 423-24 (2d Cir. 1986) (material personal interest in the outcome); Morelite, 748 F.2d at 84-85 (father-son relationship with a party).

22. See Sphere Drake, 307 F.3d at 622.

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.]

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.] 

Regular readers have heard us preach about the importance of knowing arbitration law cold (here), understanding and identifying when an arbitration award is final (here), and being keenly aware of Federal Arbitration Act deadlines (here).  The United States Court of Appeals for the Seventh Circuit recently decided a case that illustrates these points well.  See Board of Trustees of the University of Illinois v. Organon Teknika Corp. LLC, ___ F.3d ___, slip op. (7^th Cir. July 27, 2010) (Easterbrook, C.J.). 

The Court held that, in the circumstances, an arbitration award was final notwithstanding a provision in the award that said the arbitrator reserves his right to change his mind.  But there is more to it than that. 

B.   Background

 Organon Teknika Corp. LLC (“Teknika”) is a subsidiary of Merck & Co, Inc. and licenses from the University of Illinois (“the University”) certain intellectual property rights necessary to manufacture a cancer drug.  The royalty is tied to Teknika’s sale price for the drug and the contract allows Teknika to sell to its affiliates. 

Recognizing that Teknika’s affiliate sales could reduce royalties in the event Teknika offered insider prices, the contract allows the University to reopen its royalty rate if Teknika charges its affiliates prices less than it would charge unrelated buyers in arms’-length transactions.  The contract contains an arbitration agreement that requires an arbitrator to determine, based on comparable transactions, whether Teknika is charging its affiliates arms’-length prices.   Because the issue of arms’-length pricing can repeatedly arise throughout the life of the license, the clause necessarily contemplates the possibility that the same pricing issue may have to be determined on various occasions, all based on contemporaneous and comparable sales to affiliates and non-affiliates.       

The University concluded that Teknika’s sales to its affiliates were not at arms’-length prices and demanded arbitration.  The parties selected an arbitrator who was a member of an intellectual-property-asset-management consulting firm.  He heard evidence concerning 39 allegedly comparable transactions, all of which were supposedly negotiated at arms’-length.  The University argued that they were not comparable transactions. 

The arbitrator selected four of these as benchmarks, found they had been negotiated at arms’-length, and concluded that they showed that the University was not entitled to a royalty-rate adjustment.  He entered an award closing the proceeding without changing the royalty rate.  A cover letter accompanying the award said it was “final,” and the arbitrator’s firm sent a “final” invoice for his services. 

But the award said:

The foregoing opinions and conclusions contained in this report are based on the documents, information and research undertaken as of the date of this report.  I reserve the right to revisit my analysis and amend my conclusions, should additional information become available for review. 

The University waited six months without seeking arbitral reconsideration or judicial review.  It then asked the arbitrator to reconsider, seizing on the proviso quoted above.  It argued that two of the four benchmark transactions had not been negotiated at arms’-length. 

The arbitrator asked his firm’s lawyers whether he could reconsider the award, and the lawyers told him he could, provided both parties agreed.  He sought consent from the parties and Teknika refused. 

The University moved in federal district court to compel arbitration, requesting an order compelling Teknika to resume with the arbitration.  Teknika responded that it had honored its obligation to arbitrate, the arbitration was over, the University lost, and that Federal Arbitration Act Section 12’s 90-day (actually three-month) period to vacate or modify the award had elapsed. 

In a move that took both parties for surprise, the district court said there was no dispute to resolve because the arbitrator had not made a final award.  The matter therefore remained before the arbitrator, leaving the court with nothing to do but dismiss Teknika’s action without prejudice. 

That left things in a state of semi-stasis.  Teknika had prevailed, but was troubled by the terms of the district court’s order, which stated the award was not final.  The University had lost, but might have been able to persuade the arbitrator to render a revised award on terms more favorable to Teknika than the original, perhaps without Teknika’s participation in the proceeding. 

So Teknika, technically the prevailing party, appealed.  The University, technically the losing party, did not. 

In a characteristically terse, well-written and well-reasoned opinion, Chief Judge Frank H. Easterbrook, joined by Circuit Judges William J. Bauer, and David F. Hamilton, reversed the district court and declared that the arbitration was over.      

C.   The Seventh Circuit’s Opinion

The Court initially had to resolve an appellate jurisdiction problem.  A prevailing party can’t appeal from a judgment in its favor on the ground it did not agree with the court’s opinion.  But the Court said Teknika could appeal this one. 

Teknika had a problem with the terms of the judgment, not the language of the opinion.  Teknika wanted a judgment dismissing the University’s claim with prejudice, conclusively resolving the royalty dispute, but what it got was one dismissing the University’s action without prejudice.  Armed with that judgment, the University could resume its suit against Teknika when it saw fit, or perhaps even persuade the arbitrator to modify his award despite Teknika’s continuing refusal to participate in the arbitration.  “No matter[,]” said the Court, for “[i]t was enough to say that Teknika is aggrieved by the terms of the judgment as well as the language of the opinion and is therefore entitled to appellate review.”  Slip op. at 5 (citations omitted). 

Turning to the merits, the Court held that the “district court plainly erred in thinking that [the arbitrator’s] award was not final.”  The award

resolves the parties’ dispute; it was accompanied by a cover letter calling it the final decision; the parties paid their final bills; nothing further happened for six months – and neither side suggested to the other that something should have been happening to get the proceeding wrapped up.  It had been wrapped up already. 

Slip op. at 5-6 (citations omitted; emphasis in original). 

The language in the arbitrator’s opinion contemplating possible revision of the award did not impugn its finality.  The Court said that language was “the arbitral equivalent of Fed. R. Civ. P. 60(b)(2), which allows a judgment to be reopened to consider ‘newly discovered evidence that with reasonable diligence, could not have been discovered in time to move for a new trial under Rule 59(b).’”  Slip op. at 6 (quoting Fed. R. Civ. P. 60(b)(2)).  But just as the ever-present risk of Rule 60(b)(2) relief does not render a judgment non-final, so too the arbitrators’ reference to his right to reconsider the award did not render the award non-final: 

No one thinks that the possibility of reopening a district court’s judgment under Rule 60(b)(2) six months after its entry makes the judgment non-final and hence precludes an appeal.  Likewise no one should think that the equivalent language in the arbitrator’s opinion makes the decision non-final. 

Slip op. at 6 (citations omitted). 

The Court noted that “[t]he parties have regaled us with discussions of the ‘functus officio doctrine’ and other technicalities of arbitration law, but none of them matters[,]” because “[t]he situation is as simple and straightforward as we have described it.”  Slip op. at 6. 

Having drawn an analogy to Rule 60(b)(2), the Court had to deal with a timing issue.  While Rule 60(c)(1) sets a one-year deadline on a Rule 60(b)(2) application, the arbitrator imposed no deadline on a request for reconsideration.  The Court said the default rule was not Rule 60(c)(1)’s one-year deadline, but Federal Arbitration Act Section 12’s  90-day (actually three-month) deadline for a party to move to vacate or modify an award.  The parties, noted the Court, “did not supersede that rule by contract[:]”  “They bargained for a final and conclusive decision, not for perpetual arbitration.”  Slip op. at 6. 

Because the University waited six-months before commencing an action to compel arbitration, its “request came too late.”  So, as Chief Judge Easterbrook succinctly put it, “[t]his arbitration is over.”  Slip op. at 7. 

D.   Analysis

Teknika shows that courts resolve doubts in favor of finality.  And it shows that litigants need to assume that courts will do exactly that. 

We obviously do not know all of the details about this case, let alone what motivated each party’s conduct in connection with it.  We also have the benefit of 20/20 hindsight – something the parties obviously did not.  But the result might have been different had the University treated the award as final, and not waited six months to seek arbitral relief. 

Courts tend to resolve doubts in favor of finality for at least two reasons.  First, finality of awards is necessary to ensure that arbitration works.  One of the avowed purposes of the Federal Arbitration Act is to enable parties to resolve disputes in a speedy and efficient manner.  When awards that otherwise appear to be final and conclusive are deemed non-final for technical reasons, disputes are not resolved, let alone in a timely and efficient manner.        

Second, parties almost always agree that awards should be “final and binding,” and judicial interpretations of the Federal Arbitration Act generally seek to enforce the parties’ arbitration agreement.  Just as the parties in Teknika bargained “for a final and conclusive decision, not for perpetual arbitration [,]” so it is with most other parties that agree to arbitrate.   The Court’s decision enforced that bargain. 

The principal reason that litigants should assume that courts will resolve doubts in favor of finality is that finality determines whether time limits for judicial review have begun to run.  Federal Arbitration Act Sections 9, 10, and 11 all have been held applicable only to final awards (or awards intended to be final, but for some technical reason are not).  The reason is that these judicial-review provisions contemplate the possibility that a court will enter a final judgment confirming the award, and a judgment confirming a non-final award would not conclusively resolve the rights and obligations that are the subject of the award any more than the non-final award did.  Such a judgment would therefore not be final.  

Parties – like the University – who assume that an award is not final, and forgo seeking judicial review, risk being time-barred if they let the applicable limitation period expire before seeking review.   If there are doubts about whether an award is final, then the safer course is to treat it like it is, and act accordingly.  

We conclude with a couple of other observations and a caveat.  We wonder why Teknika did not cross-move to confirm the award in response to the University’s motion to compel arbitration.  While that would likely not have changed the outcome in the district court, a denial of a motion to confirm without prejudice would have provided a firmer basis for appellate jurisdiction, and the end result of the appeal would have been a judgment confirming the award, which probably would also have stated that it was too late to seek reconsideration.  Perhaps that’s just a picayune point of Federal Arbitration Act practice and procedure; in all likelihood Teknika’s rights will be as fully protected as they would have been had it cross-moved to confirm.  Things would probably have proceeded a little more smoothly had the cross-motion been made, but we say that solely with the benefit of 20/20 hindsight, and not knowing what (if anything) motivated Teknika not to cross move.    

We were also somewhat surprised that the Court deemed Section 12’s three-month time limit for certain types of judicial review to be the applicable limitation period for arbitral review, particularly when that period has nothing to do with reconsideration of an award  — something a court has no power to grant.  We suspect it was because the Court chose not to address the functus officio question of whether reconsideration by the arbitrator would have been proper in the circumstances — despite what the award said – and so needed an (elapsed) time limit to rely upon, so that functus officio would not – as the Court put it — “matter.” Section 12 supplied a limitation period by analogy that allowed the Court to dispose of the case while avoiding nettlesome functus officio questions. 

But even though Section 12 was, as we read it, intended solely to set a time limit on seeking certain types of judicial relief, it provided an acceptable analogue for filling a gap in the Federal Arbitration Act.  If a party is time-barred from seeking judicial relief that might result in a modified award or a remand to the arbitrator, then it at least arguably follows that a party should likewise be precluded from seeking arbitral relief from a final award.  In any event, as discussed in more detail below, there may be cases where state law would provide an even better analogue. 

As the previous sentence implies, our caveat is “beware of state law.”  The Court in Teknika suggested that the University could have made a timely request to the arbitrator for reconsideration, provided it was made within the three-month period provided by Federal Arbitration Act Section 12.  Apparently there was no potentially applicable state law better suited to fill the gap. 

Even where an arbitration is governed by the Federal Arbitration Act, and the parties have not agreed that state arbitration law applies, a court might look to state law for a more specific gap filler than Federal Arbitration Act Section 12.  New York State’s arbitration law provides, for example, that an application to the arbitrators to modify an award must be made “within twenty days after delivery of the award to the applicant. .  .  .”  See New York Civ. Prac. L & R § 7509.  Although this rule permits modification only to the extent a court could grant it pursuant to an application for modification made under New York Civ. Prac. L & R. § 7511(c) – Section 7511(c) authorizes modification on limited grounds similar to those set forth in Federal Arbitration Act Section 11 and, like Section 11, does not authorize an application for reconsideration – it would still be a better analogue for a default rule than Section 12.  For Section 12 sets the time limit for applying to a court to vacate or modify an award, whereas CPLR 7509 expressly sets a time limit for making an application for modification to an arbitrator.  Section 12 would therefore arguably not preempt Section 7509, and a New-York-based court faced with a situation like that in Teknika might find that it supplied a better default rule. 

Since state law may (like CPLR 7509) impose a time limit shorter than three months on applications to arbitrators to modify or reconsider awards, to make reasoned strategy decisions, counsel faced with an issue like that presented in Teknika must have a grasp on what state arbitration law has to say (if anything) about this subject.

Lecture over and class dismissed (with prejudice, of course…). 

[Editor’s Note:  For a different analysis of Teknika, and one more critical of the Court's than ours, see our friend Marc Goldstein’s excellent post here.] 

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.

So far the United States Supreme Court has agreed to hear only one arbitration case governed by the Federal Arbitration Act:  Stolt-Nielsen, S.A. v. AnimalFeeds Int’l Corp., 548 F.3d 85 (2d Cir. 2009), petition for cert. granted June 15, 2009 (No. 08-1198), which has been set for oral argument at 10:00 a.m. Eastern Standard Time, December 9, 2009.   (See Russ Kunkel’s LawMemo Arbitration Blog  here.)  We have written extensively on Stolt-Nielsen, which concerns whether class arbitration may be imposed on parties whose contracts are silent on that point.  (Posts available here,  here, here, here, here, here, here, here and here.)

The Supreme Court has also agreed to hear two labor arbitration cases.  The first is Union Pacific Railroad Co. v. Brotherhood of Locomotive Engineers & Trainmen (08-604), which is governed by the the Railway Labor Act (“RLA”), 45 U.S.C. §§151 et seq.  The RLA, among other things, requires arbitration before the National Railroad Adjustment Board (“the Board”) of labor disputes involving railway workers.  Union Pacific, for all practical purposes, is therefore not a contractual arbitration case, but an administrative law one, and the outcome will likely have  little or no effect on Federal Arbitration Act jurisprudence.  The Court held oral argument on October 7, 2009.  (Oral argument Tr. here) 

The second is Granite Rock Co. v. International Brotherhood of Teamsters (08-1214), which arises under Section 301 of the Labor Management Relations Act.  The Court is expected to set argument for later this Fall.  (See Russ Kunkel’s LawMemo Employment Law Blog here.)   Though not governed by the Federal Arbitration Act, Granite Rock, unlike Union Pacific, is a contractual arbitration case.  And the outcome may be relevant to cases falling under the Federal Arbitration Act. 

We briefly summarize below the issues the Court will presumably address in these labor arbitration cases and discuss why Granite Rock may be more controversial than it appears at first blush.   

Union Pacific Railroad Co. v. Brotherhood of Locomotive Engineers & Trainmen (08-604)

Union Pacific, which arose under the RLA, concerns an administrative law question.  The RLA provides that the Board’s decisions “shall be conclusive … except … for”: (1) “failure … to comply” with the Act, (2) “failure … to conform or confine” its order “to matters within … the [Board’s] jurisdiction,” and (3) “fraud or corruption” by a Board member. 45 U.S.C. §153 First (q).  The Board denied certain employee grievance claims because the claimants had not complied with a Board rule requiring them to prove that the pre-grievance, statutory requirement of a “conference” between the parties had been met.  See 45 U.S.C. §152.  The United States Court of Appeals for the Seventh Circuit vacated the decision of the Board, holding that it violated due process by adopting a “new,” retroactive interpretation of the standards governing its proceedings.   

Before the Supreme Court are two questions: 

1. Whether the RLA includes a fourth, implied exception that authorizes courts to set aside final arbitration awards for alleged violations of due process; and
2. Whether the Seventh Circuit erroneously held that the Board adopted a new, retroactive interpretation of the standards governing its proceedings in violation of due process.

You can read the briefs here and the oral argument transcript here. 

Granite Rock Co. v. International Brotherhood of Teamsters (08-1214)

Granite Rock concerns a dispute between an employer and a union over whether the parties entered into a collective bargaining agreement containing a no-strike clause.  The disputed CBA contains an arbitration agreement, which requires arbitration of all disputes “arising under” the agreement.  The union’s position on the merits is that it never ratified the CBA.

The employer brought an action in district court to enforce the CBA, and the union argued that the dispute over whether the CBA was concluded was subject to arbitration.  In response to the union’s contention, the employer argued that the question whether the CBA was concluded was one of arbitrability for the court to decide.

The Ninth Circuit held that there was no dispute over whether the arbitration agreement – as opposed to the CBA as a whole – was entered into because:  (a) the employer sued to enforce the CBA, which contained the arbitration agreement; and (b) the union sought to enforce the arbitration agreement, albeit not the rest of the CBA.  The Ninth Circuit also held that the dispute over the formation of the CBA fell within the terms of the arbitration agreement.   

The case presents an interesting twist on the severability doctrine.  Ordinarily, where a party contends that a contract containing an arbitration agreement was never concluded, the argument applies equally to the arbitration agreement, which means the court must decide whether the parties agreed to arbitrate before it can order arbitration.  Presumably for this reason, in Buckeye Check Cashing v. Cardegna, 546 U.S. 440, 444 n.1 (2006) (citations omitted), the Supreme Court did not extend the doctrine of severability to require arbitration when there is an issue concerning whether the contract containing the arbitration agreement  — and thus the arbitration agreement itself — was ever concluded:       

The issue of the contract’s validity is different from the issue whether any agreement between the alleged obligor and obligee was ever concluded. Our opinion today addresses only the former, and does not speak to the issue decided in the cases cited by respondents (and by the Florida Supreme Court), which hold that it is for courts to decide whether the alleged obligor ever signed the contract, whether the signor lacked authority to commit the alleged principal, and whether the signor lacked the mental capacity to assent.  

But the unusual procedural posture of the case lends support to the Ninth Circuit’s holding because the parties’ respective litigation positions, taken together, and divorced from the dispute on the merits, indicate that the parties do not dispute that an arbitration agreement agreement was concluded.  And because the severability doctrine posits that an arbitration agreement is severable from the contract in which it is contained, the notion that an arbitration agreement came into existence without the parties entering into the CBA is not all that farfetched. 

On the other hand, the union appears to be taking inconsistent positions in an effort to gain what it apparently perceives to be a tactical advantage.  In response the Ninth Circuit has effectively said that the union can have its cake and eat it,  too.  It held that after the employer sued to enforce the contract, the union, through its own litigation position, could ratify the arbitration agreement while rejecting the balance of the agreement, including the no-strike provision.  It seems questionable whether the severability doctrine was designed to allow a party to argue on the one hand that a CBA containing an arbitration agreement was never concluded, and yet reap the benefits of that arbitration agreement by effectively “accepting” one aspect of the other party’s litigation position – the arbitration agreement’s existence – while rejecting the rest of it – the existence of a binding CBA containing a no-strike clause. 

It will be interesting to see how the Supreme Court decides this case.  Copies of petitioner’s briefs and amicus briefs in support of petitioner can be found here.

The Court held that, under the circumstances of the case, Party B forfeited its challenge to the replacement procedure by failing to raise it immediately under Section 5 of the Federal Arbitration Act.  In so doing it provided some clarity in an area sorely in need of it.  Its approach to the problem was straightforward and based on the text of Federal Arbitration Act Section 5.  The Court’s reasoning also raises some questions that other courts, including Courts in the Seventh Circuit, will need to address if faced with different facts.  And the decision is a helpful springboard for a discussion of the somewhat different arbitrator replacement rules adopted by the United States Court of Appeals for the Second Circuit.

So let us take a brief look at what transpired in Wellpoint and how the Court resolved the problem.  In a future post we shall analyze the decision in light of Second Circuit precedent, and give some thought to how it might influence future courts, including courts within the Seventh and Second Circuits.    

Background

WellPoint arose out of an October 1996 transaction in which WellPoint agreed to purchase various Group Business Operations of Hancock  (the “GBO Transaction”).  As in most purchase and sale transactions, several contracts were involved, including a Purchase and Sale Agreement (“PSA”), a Coinsurance Agreement (which in this context refers to a proportional life reinsurance agreement), and an Administration Agreement (collectively, the “GBO Transaction Agreements”).  Each GBO Transaction Agreement contained an arbitration clause, the arbitrator selection provisions of which provided, in pertinent part:

A panel of three (3) arbitrators will decide any dispute or difference between the parties.  All arbitrators must be (a) disinterested officers or retired officers of life insurance or life reinsurance companies other than the parties to this Agreement or their Affiliates, or (b) disinterested persons of comparable experience.  Each of the parties agrees to appoint one of the arbitrators.  In the event that either party should fail to appoint its arbitrator within twenty (20) Business Days following receipt of the notice demanding arbitration set forth in Section 15.2 hereof, the party demanding such arbitration may appoint the second arbitrator before entering upon arbitration.  The two party-appointed arbitrators shall select a third arbitrator. In the event that the two party-appointed arbitrators shall not be able to agree on the choice of the third arbitrator within twenty (20) Business Days following their appointment, the parties may agree on a third arbitrator within the next twenty (20) Business Days, and if they have not then so agreed, the Denver, Colorado office of the American Arbitration Association shall, at the request of either party, appoint as such third arbitrator a person who meets the qualifications specified in the second sentence of this Section 15.3.

A dispute arose concerning WellPoint’s obligations under three unprofitable books of life insurance business: (1) Fiduciary Administration Services Company (“FASCO Business”); (2) James E. Hackett Reinsurance Corporation (“Hackett Business”); and (3) JEH Re Underwriting Management Bermuda Ltd. (“Bermuda Business”).  The principal question was whether, as part of the GBO Transaction, WellPoint was obligated to make certain payments to Hancock.

WellPoint demanded arbitration and requested the arbitrators to (1) compel Hancock to disclose certain information about the three books of business; and (2) declare WellPoint’s rights and obligations under the GBO Transaction Agreements.  Hancock cross-demanded arbitration for $42.4 million that it claimed WellPoint owed it under the GBO Transaction Agreements.

The parties appointed their arbitrators, who were unable to agree on an umpire.  An umpire was appointed by the American Arbitration Association pursuant to the parties’ arbitration agreement.  During a two-year period leading up to the hearing, the parties conducted extensive discovery, including 29 depositions.  The Panel resolved several discovery disputes and other procedural issues. 

But in July 2005, Hancock sent WellPoint a letter stating that it was increasing its damages demand to $464.6 million.  WellPoint subsequently appointed new counsel, presumably in response to the ten-fold increase in Hancock’s damage claim.  At the same time, WellPoint requested its party-appointed arbitrator to resign.  WellPoint’s party-appointed arbitrator requested the Panel to authorize his resignation, and the Panel accepted it, advising the parties that the “the [remaining] Panel [members] will await WellPoint’s advancing of a candidate for disclosure in accord with the affirmed ‘vetting.’”  Slip op. at 4 (quoting Panel).

WellPoint proposed two replacement candidates, but Hancock objected to both.  Hancock’s party-appointed arbitrator proposed that the remaining Panel members nominate three replacement arbitrators and that WellPoint select an arbitrator from one of the three.  WellPoint initially objected to the proposal, while Hancock appeared to support it.  Hancock’s counsel stated at one point that he “believe[d] there is case law that will support this . . . .”  Slip op. at 4 (quoting Hancock’s counsel). 

WellPoint ultimately agreed, the Panel proposed three candidates, and WellPoint selected a retired Chief Justice of the Nebraska Supreme Court who also had served as an officer of a life insurance company.  During the disclosure and vetting process, Hancock renewed its objections to the resignation of WellPoint’s party-appointed arbitrator, but agreed that his replacement arbitrator met the arbitrator qualifications set forth in the arbitration agreement.  The Panel then declared itself “duly constituted.”   Slip op. at 5 (quoting umpire). 

The arbitration proceeded as scheduled and was conducted in two phases.  Phase I concerned issues relating to liability and the categories of potential damages.  The Panel determined in Phase I that WellPoint had assumed 100 percent of the Hackett Business and 100 percent of the FASCO business, but that it had not purchased the Bermuda Business.  Hancock’s party-appointed arbitrator dissented from the Bermuda Business portion of the ruling. 

Phase II was limited to the quantification of damages. The Panel issued a Phase II award directing WellPoint to pay Hancock $26 million in damages (later revised with the consent of the parties to $26.4 million), plus $2.9 million in “offsetting balances and interest assessments.”  As the outcome was effectively a victory for WellPoint, it filed a petition seeking confirmation of the award, and Hancock cross-petitioned to vacate.  Hancock contended that the panel was not selected as provided in the arbitration agreement.

The district court confirmed the award, understanding the issue to be “whether the panel has authority to render an award when an arbitrator has been duly selected by a party but subsequently withdraws, and the arbitration agreement does not expressly provide for this contingency.”  Slip op. at 6 (quoting district court).  The district court held that the arbitration award required only that arbitration proceed before a panel comprised of an arbitrator selected by each party and one neutral arbitrator and, because that is what happened, the Panel did not exceed its authority under Federal Arbitration Act Section 10(a)(4).  The district court rejected WellPoint’s alternative argument that Hancock had waived its challenge to the composition of the Panel by not seeking relief under Section 5 of the Federal Arbitration Act, which allows the Court to determine whether an arbitrator has been appointed in the manner provided for in the parties’ agreement, and to appoint replacement arbitrators under appropriate circumstances. 

The Court’s Decision

The Court held that “Section 5 of the FAA expressly gave the district court the authority to resolve any issue about the way the parties handled a vacancy on the arbitral panel.  .  .  .  [and that] Hancock’s failure to use that tool, under the circumstances of this case, resulted in its forfeiture of this challenge.  No ‘reservation of right’ to challenge the issue on appeal absolves Hancock from this requirement.”  Slip op. at 12.  

Hancock contended that the arbitration agreement does not “’permit either party to remove an arbitrator or to appoint a replacement. . . . [and] the District Court . . . misconstrued the Arbitration Agreement in a way that significantly departed from the intent of the parties . . . .’”  Slip op. at 7 (quoting Hancock’ submissions).   Relying on what it characterized as the “general rule,” Hancock argued that the arbitration must begin anew because the arbitration agreement did not expressly address the contingency of a vacancy on the panel.  It relied on the Second Circuit’s decision in Marine Products  Export Corp. v. M.T. Globe Galaxy, 977 F.2d 66, 68 (2d Cir. 1992) (here), which held that the death of a member of a tri-partite arbitration panel prior to the rendering of an award requires the arbitration to commence anew before a newly-appointed panel, unless the parties’ agreement expressly provides for the contingency of a vacancy, or there are special circumstances warranting the court’s appointment of a replacement arbitrator.   

The Court rejected this argument, finding “no such inflexible and wasteful rule in the law of arbitration.”  The Court said that Section 5 of the Federal Arbitration Act expressly provides a “rule that applies to the mid-stream loss of an arbitrator.”  Section 5, provides, in pertinent part, that:

If 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; but if no method be provided therein, or if a method be provided and any party thereto shall fail to avail himself of such method, or if for any other reason there shall be a lapse in the naming of an arbitrator . . . or in filling a vacancy, then upon the application of either party to the controversy the court shall designate and appoint an arbitrator . . .who shall act under the said agreement with the same force and effect as if he or they had been specifically named therein. . . .

9 U.S.C. § 5 (emphasis added). 

The Court observed that Section 5 expressly authorizes a court to appoint a replacement arbitrator in the event of a “vacancy,” and that provision of authority “would never have any room to operate.  .  .  if every time an unanticipated vacancy occurred, the clock were automatically set back to zero.”   Slip op. at 9.  The Court said it would be “inconsistent with the purpose of the FAA, which is designed to facilitate efficient resolution of commercial disputes, to permit a party like Hancock to sit silently by while a substitute arbitrator is selected according to the procedure proposed by its own representative on the panel, and then raise an objection to the process only after it has lost before the panel and it is attempting to oppose confirmation of the award.”  Slip op. at 9-10. 

The Court rejected Hancock’s argument that the FAA provided two avenues for contesting the appointment of an arbitrator:  (a) pre-award under Section 5; and (b) post-award under Section 10(a)(4), which permits a court to vacate an 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.”  9 U.S.C. § 10(a)(4); see slip op. at 10.  The Court said: 

What Hancock fails to appreciate, however, is that this approach does not give full effect to each part of the statute.  If the statute were read to permit an objecting party to take a “wait and see” approach, no one would ever have an incentive to use § 5.  Instead, each party could hold back and await the outcome of the proceeding.  If that outcome were to its liking, then it would defend the substitution; if that outcome were not to its liking, then it could attack the method either the court or the parties used to nominate the new arbitrator.  Moreover, if there really were a general rule that substitutions are forbidden once the arbitration is underway (as long as the agreement is silent), then there would never be a case in which a court could fill a vacancy upon the application of a party. We decline to read the FAA in a way that effectively deletes this part of § 5, nor will we interpret it as creating a ‘heads I win, tails you lose” system.’

Slip op. at 10.  

The Court stopped short, however, of imposing a rule requiring resort to Section 5 in all circumstances, acknowledging that “[t]here may be some situations where a motion under § 5 cannot address the problem,” and that “there may be times when a party can show good cause to overcome a forfeiture of the § 5 process and can raise its objections at the § 10(a)(4) stage.”  Slip op. at 11.  But the Court declined to speculate as to what those situations might be, because it considered “this case.  .  . [to be] so far from any plausible scenario:”

Hancock’s equivocal behavior—starting with the fact that the substitution procedure actually used was proposed by.  .  . its own party-arbitrator, continuing with its legal argument supporting.  .  .  .  [the] suggestion, and ending with its acknowledgment that [WellPoint’s replacement arbitrator].  .  . met the qualifications required in the agreement—coupled with its decision to wait until the arbitration was concluded, was a ‘transparent attempt to preserve a threshold procedural issue in case. . . [it] eventually lost the arbitration on the merits.’  Nothing in the FAA requires us to endorse this behavior.

Slip op. at 11 (quoting  Dow Corning Corp. v. Safety National Cas. Corp., 335 F.3d 742, 748-49 (8^th Cir. 2003) (here)).  Alternatively, observed the Court, “Hancock’s own participation in the substitution process should estop it from complaining now about it, and so even if we thought that § 5 could be bypassed (which we do not), this would not be an appropriate case for relief.”  Slip op. at 12-13.  

The Court also rejected Hancock’s argument that requiring resort to Section 5 would be inefficient because it would breed interlocutory appeals.  The Court said that “while an interlocutory motion to challenge an appointment does temporarily affect the arbitration, it is far less efficient for the court to hold at the § 10 stage that the appointment was improper.  In fact, if anything risks too much judicial involvement, it is Hancock’s proposed system, under which judges would second-guess the arbitral panel’s own approach toward solving an interim procedural issue.”  Slip op. at 12.  

We shall provide in a future post our critical analysis of WellPoint, and compare it to Second Circuit law on arbitrator vacancy.  So stay tuned until then.  .  .  .