main image

Faithful to the “First Principle” of Arbitration Law, the Texas Supreme Court Shores up the “Cornerstone of the Arbitral Process”

August 5th, 2014 American Arbitration Association, Appellate Practice, Arbitration Agreements, Arbitration as a Matter of Consent, Arbitration Practice and Procedure, Arbitration Provider Rules, Arbitrator Selection and Qualification Provisions, Authority of Arbitrators, Awards, Confirmation of Awards, Contract Interpretation, Drafting Arbitration Agreements, Grounds for Vacatur, Judicial Review of Arbitration Awards, Party-Appointed Arbitrators, Practice and Procedure, State Courts, Texas Supreme Court Comments Off on Faithful to the “First Principle” of Arbitration Law, the Texas Supreme Court Shores up the “Cornerstone of the Arbitral Process” By Philip J. Loree Jr.

Introduction  

Anyone versed in arbitration-law basics knows that “arbitration is a matter of consent, not coercion.” Stolt-Nielsen, S.A. v. AnimalFeeds Int’l Corp., 559 U.S. 662, 678-80 (2010) (citation and quotations omitted). That is the “first principle” of arbitration law (the “First Principle”) set forth in the Steelworkers’ Trilogy.[1] See, e.g., Granite Rock Co. v. International Brotherhood of Teamsters, 561 U.S. 287, 295 & n.7, 294 n.6 (2010); AT&T Technologies, Inc. v. Communications Workers, 475 U. S. 643, 648 (1986).

The First Principle is integrally intertwined with “the central or primary purpose of the [Federal Arbitration Act (“FAA”)][,]” which is “to ensure that  private agreements to arbitrate are enforced according to their terms.” Stolt-Nielsen, 559 U.S. at 679 (citations and quotations omitted). To “enforce” an arbitration agreement “courts and arbitrators must give effect to the contractual rights and expectations of the parties.” Id. When courts do not give effect to the parties’ contractual rights and expectations, they violate the First Principle.

Courts and arbitrators are supposed to apply the First Principle faithfully and rigorously whenever  they interpret or apply material arbitration-agreement-terms, and in “doing so [they] must  not lose sight of the purpose of the exercise: to give effect to the intent of the parties.” See Stolt-Nielsen, 559 U.S. at 679-81. And if that admonition applies with special force in any particular context, it would be in the interpretation and enforcement of arbitrator selection and qualification provisions.

Arbitrator selection provisions are what Circuit Court Judge Richard A. Posner once dubbed the “cornerstone” of the parties’ agreement: “Selection of the decision maker by or with the consent of the parties is the cornerstone of the arbitral process.” Lefkovitz v. Wagner, 395 F.3d 773, 780 (2005) (Posner, J.); see, e.g., 9 U.S.C. § 5 (“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.  .  .  .”); Convention on the Recognition and Enforcement of Foreign Arbitral Awards, Art. V(1)(d), June 10, 1958, 21 U.S.T. 2519, T.I.A.S. No. 6997 (a/k/a the “New York Convention”) (implemented by 9 U.S.C. §§ 201, et. seq.) (award subject to challenge where “[t]he composition of the arbitral authority or the arbitral procedure was not in accordance with the agreement of the parties”); Stolt-Nielsen, 559 U.S. at 668, 670 (one of the FAA’s “rules of fundamental importance” is parties “may choose who will resolve specific disputes”) (emphasis added; citations omitted); Encyclopaedia Universalis S.A. v. Encyclopaedia Brittanica, Inc., 403 F.3d 85, 91-92 (2d Cir. 2005) (vacating award by panel not convened in accordance with parties’ agreement); Cargill Rice, Inc. v. Empresa Nicaraguense Dealimentos Basicos, 25 F.3d 223, 226 (4th Cir. 1994) (same); Avis Rent A Car Sys., Inc. v. Garage Employees Union, 791 F.2d 22, 25 (2d Cir. 1986) (same).

Americo Life, Inc. v. Myer

On June 20, 2014, a divided Texas Supreme Court in Americo Life, Inc. v. Myer, ___ S.W.3d __, No. 12-0739, slip op. (Tex. June 20, 2014), adhered to and correctly applied the First Principle by holding that an arbitration award had to be vacated because it was made by a panel not constituted according to the parties’ agreement.  Five Justices of the nine-member Court determined that the parties had agreed that party-appointed arbitrators need not be impartial, only independent. Because the American Arbitration Association (the “AAA”) had, contrary to the parties’ agreement, disqualified the challenging party’s first-choice arbitrator on partiality grounds, the panel that rendered the award was not properly constituted and thus exceeded its powers. See Slip op. at 10.

Americo arose out of a tripartite arbitration agreement the parties entered into in 1998, which followed the traditional, industry model under which each party appoints an arbitrator and the two appointed-arbitrators appoint a third. The FAA presumes that, in the absence of an express agreement to the contrary, parties to such agreements consent to each other’s appointment of partial arbitrators, or arbitrators under their control (whether or not impartial).

The agreement incorporated by reference  the Commercial Rules of the American Arbitration Association (the “AAA Commercial Rules”).  At the time the parties agreed to arbitrate, the AAA Commercial Rules provided that, unless otherwise agreed, party-appointed arbitrators were not required to be neutral (i.e., impartial and independent) and the AAA could not disqualify them for partiality or lack of independence; only the third arbitrator had to be neutral and could be disqualified if not. The then-in-effect version of the AAA Commercial Rules thus expressly adopted the judicially-recognized presumption that, unless otherwise agreed, parties consent to the appointment of partial party-appointed arbitrators, as well as ones under the control of one of the parties. The AAA Commercial Rules, however, also  provided that when parties agree to arbitrate under the AAA Commercial Rules, they agree to do so under whatever version of the Rules might be in effect at the time arbitration is commenced.

As respects whether the parties expressly agreed that appointed arbitrators must be impartial, the arbitration agreement required  each of the three arbitrators to “be a knowledgeable, independent businessperson or professional.” (emphasis added) The agreement did not specify that the arbitrators had to be impartial or neutral, that is, impartial and independent.

In 2005, approximately five years after the parties agreed to arbitrate, a dispute arose and one of the parties demanded arbitration. By that time, the AAA Commercial Rules had been amended to reverse the traditional presumption that the parties consented to each other’s appointment of partial party-appointed arbitrators. Under the new version of the Rules, party-appointed arbitrators were presumed to be neutral— that is, both impartial and independent—unless the parties otherwise agreed, and were deemed to be subject to AAA disqualification for partiality or lack of independence.

At the request of the party who ultimately prevailed in the arbitration (the “Award-Defending Party”), the AAA disqualified on partiality grounds the first two arbitrators the other party (the “Award-Challenging Party”) attempted to appoint.  The Award-Challenging Party sought to vacate the award the panel later rendered against it, arguing that that the panel was not constituted according to the parties’ agreement and therefore exceeded its powers by rendering an award purporting to resolve the parties’ dispute. The trial court vacated the award; the intermediate appellate court ruled that the challenge had been waived; the Texas Supreme Court reversed that decision in 2011, and remanded the matter back to the intermediate appellate court; the intermediate appellate court rejected the challenge on the merits, ruling that the parties did not consent to appointment of partial arbitrators; and the Texas Supreme Court, in a 5-4 decision,  reversed once again, holding that the award should have been vacated under 9 U.S.C. § 10(a)(4).

While the FAA ordinarily requires courts to confirm arbitration  awards, an award that is “fundamentally at war” with the parties’ agreement must be vacated, for confirming such an award would be the functional equivalent of not enforcing the parties’ agreement—the very antithesis of what the FAA commands. See, e.g., Stolt-Nielsen, 559 U.S. at 668, 672-73, 681-82. Upholding the award in this case would have required the Court to conclude, quite implausibly, that, at the time the parties entered into their agreement they (a) agreed to allow party-appointed arbitrators to be partial—provided they were independent—but they nevertheless (b) intended that their consent to party-appointed partial decision makers could be negated unilaterally by the AAA in the event the AAA decided to amend its Commercial Rules in a way that changed the whole premise of the parties’ arbitrator selection and qualification agreement.

The majority instead took a more practical view, which focused on what reasonable, similarly-situated businesspersons would have intended in like circumstances. It placed prime importance on what the parties’ agreed at the time they concluded their arbitration agreement. It interpreted the agreement in its proper context, correctly concluding that the parties were presumed to have consented to using partial party-appointed arbitrators, provided those arbitrators were “independent;” the term “independent” was not interchangeable with “impartial,” and did not necessarily imply impartiality; and the parties’ arbitration agreement expressly indicated that the parties intended “independent” to mean free from a relationship of dependence on any of the parties, but not necessarily free from the state of mind of impartiality. It correctly, and quite logically, concluded that a requirement that arbitrators be “independent”—but not necessarily impartial— conflicted with the requirement that the amended version of the AAA Commercial Rules later  imposed: that the arbitrators be “independent and impartial.” See AAA Commercial Rules R­17(a)(I) (2003)(emphasis added).

Finding such a conflict, it resolved it in a commonsense, businesslike  fashion, holding that the parties’ expressed intent at the time of contracting prevailed over a contrary expression of “intent” caused by the parties’ agreement to arbitrate under the AAA Commercial Rules—Rules which, at the time the parties agreed to arbitrate under them embraced the traditional presumption of party-appointed-arbitrator partiality, but which later changed course 180 degrees to embrace a presumption of party-arbitrator impartiality We think that was an exceedingly wise rule of contract construction to apply where, as here, a post-contract change in incorporated-by-reference arbitration-provider rules eliminated the whole premise upon which the parties presumably structured their agreement about arbitrator selection and qualifications.

The Dissent: a “Pig in the Poke” Theory of Contract Law?

According to the dissent, solely by incorporating by reference the AAA Commercial Rules into their arbitration agreement,  the parties assumed not only the risk that the AAA Commercial Rules might change, but might do so in a way that would cause the otherwise solid ground upon which they structured their agreement to cave in. That kind of thinking, however, is inimical to general contract-law principles, a point the California Court of Appeals made when it compared it to the medieval scam from which the idiom “pig in a poke” was derived. See Gilbert Street Developers, LLC v. La Quinta Homes, LLC , 174 Cal.App.4th 1185, 1194 (Cal. App. 4th Dist. 2009) (discussed here).

The award-defending party in La Quinta argued that the parties’ had clearly and unmistakably agreed to delegate arbitrability questions to the arbitrators because the agreement incorporated the AAA Commercial Rules. When the parties agreed to arbitrate the Rules were silent on delegation of arbitrability questions; but by the time of arbitration the rules were amended to clearly and unmistakably delegate such authority to arbitrators.

The California Court of Appeals held that “[i]ncorporating the possibility of a future rule by reference simply doesn’t even meet the basic requirements for a valid incorporation by reference under simple state contract law[,]” let alone the clear and unmistakable rule. Id.  (emphasis in original):

“Prediction,” said [physicist and Nobel Prize winner] Niels Bohr, “is very difficult, especially about the future.” A rule that does not exist at the time of incorporation by reference fails the elementary test of being known or easily available at the time of incorporation. To allude to that old medieval con game from which we get the expression “pig in a poke” — where an unsuspecting buyer would buy what he or she thought was a pig in a bag only to later discover that it was an inedible cat or rat — in both [California cases on which the award-defending party relied] there was at least something in the bag that the parties could [at the time the contract was formed]  look at [i.e., an AAA Commercial Rule delegating arbitrability questions to the arbitrators]. Here, by contrast, the bag was empty at the time of the transaction and might or might not, be later filled with a pig. Or a cat or rat or, for that matter, nothing.

Id.

The Americo dissent’s position arguably rests on even thinner ice. In Americo the AAA Commercial Rules in effect at the time of contracting provided that parties consent to partial party-appointed arbitrators unless otherwise agreed. The post-contract amendment to the Rules said the opposite was true.

In one or more later posts we’ll take a closer look at what transpired in Americo and perhaps offer some further thoughts on the majority and dissenting opinions and their implications.



[1] See Steelworkers v. American Mfg. Co., 363 U. S. 564, 567, 568 (1960); Steelworkers v. Warrior & Gulf Nav. Co., 363 U. S. 574, 582 (1960); Steelworkers v. Enterprise Wheel & Car Corp., 363 U. S. 593, 597 (1960).

 

 

         

Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

Comments are closed.