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How Will Stolt-Nielsen, S.A. v. Animalfeeds Int’l Corp. Change Reinsurance Arbitration Practice?

May 25th, 2010 Arbitrability, Arbitration Practice and Procedure, Authority of Arbitrators, Awards, Class Action Arbitration, Class Action Waivers, Consolidation of Arbitration Proceedings, Grounds for Vacatur, Practice and Procedure, Reinsurance Arbitration, United States Court of Appeals for the Second Circuit, United States Supreme Court Comments Off on How Will Stolt-Nielsen, S.A. v. Animalfeeds Int’l Corp. Change Reinsurance Arbitration Practice? By Philip J. Loree Jr.

Part I

A.     Introduction 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Section 10(a)(4) of the Federal Arbitration Act authorizes courts to vacate an arbitration award “where the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made.”  Prior to Hall Street Assoc. v. Mattel, Inc., 552 U.S. ___ (2008), courts interpreted Section 10(a)(4) in at least two different ways.  Some courts interpreted Section 10(a)(4) as limited to challenges based on whether the matter decided fell within the scope of the parties’ arbitration agreement or submission.  That begged the question whether, and, if so, to what extent, the outcome of a commercial arbitration award on an issue within the parties’ submission was subject to any review at all. 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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


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

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

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