The Seventh Circuit recently decided an important case concerning what happens when Party A asks its party-appointed arbitrator to resign, the agreement is silent on how the vacancy should be filled, the remaining two arbitrators devise and implement a procedure for appointing a replacement, Party B (whose arbitrator did not resign) reserves its right to challenge the replacement procedure, and the Panel ultimately renders an award in favor of Party A. The Court held that the Panel did not exceed its powers by adopting and implementing — in the face of the agreement’s silence, and in the absence of Party B seeking court intervention under Federal Arbitration Act Section 5 – a procedure that allowed Party A to replace its party-appointed arbitrator and continue with the arbitration. See WellPoint, Inc. v. John Hancock Life Ins. Co., ___ F.3d ___, slip op. (7th Cir. August 7, 2009) (Slip op. 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 (8th 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. . . .
Tags: arbitrator replacement, arbitrator selection, Federal Arbitration Act, resignation of arbitrator, Section 10(a)(4), Section 5, Seventh Circuit, WellPoint Inc. v. John Hancock
