I am told “papalote” is a Spanish word meaning “kite” or “hang glider.” It also appears in the name of a party to a recent decision of the U.S. Court of Appeals for the Fifth Circuit concerning narrow arbitration clauses, Papalote Creek II, L.L.C. v. Lower Colo. River Auth., No. 17-50852, slip op. (5th Cir. Mar. 15, 2019) (“Papalote II”). The party was Papalote Creek II, L.L.C. (“Papalote”). It won the appeal.
What was the appeal about? Narrow arbitration clauses, and in particular whether a dispute about maximum, aggregate liability under a wind-energy purchase and sale contract was a dispute “with respect to performance” within the meaning of the parties’ narrow arbitration clause.
The appeal was not the first, but the second, and the procedural history was tangled, both in terms of what transpired in the disputed arbitration and in the district court. The first appeal, Papalote I, resulted in a remand because at the time the district court compelled arbitration, the district court lacked subject matter jurisdiction. The issue on which the arbitration proponent sought arbitration was not ripe, even though it became ripe during the time Papalote I was pending. See Lower Colo. River Auth. v. Papalote Creek II, L.L.C., 858 F.3d 916 (5th Cir. 2017) (“Papalote I”).
By the time Papalote I was decided, the arbitration panel had ruled against Papalote, the arbitration opponent. But Papalote I obligated the district court to vacate the arbitration award and to reconsider the issue of whether arbitration should be compelled under the narrow arbitration clause.
On remand the district court adhered to its previous decision that the dispute fell within the scope of the narrow arbitration clause, which resulted in another order to compel arbitration and the second appeal, Papalote II.
On the second appeal the Fifth Circuit reversed the district court’s decision on arbitrability, ruling that the dispute was not about “performance,” but about “interpretation.” Going forward that means that the parties will either have to settle their dispute or litigate it in court, even though they’ve both no doubt already spent not only a good deal of time, but money, litigating about arbitration, and arbitrating a dispute they did not mutually consent to arbitrate. (Perhaps for Papalote that’s not necessarily a bad outcome, but it’s just speculation on our part.)
Bottom line: Irrespective of whether the parties considered the potential consequences associated with their narrow arbitration clause, at least one of them (and perhaps even both) may, at least to some extent, now feel like they’re up that proverbial creek without a paddle—or even a papalote….
This post takes a closer look at Papalote II, focusing exclusively on the issue whether the dispute fell within or without the scope of the parties’ narrow arbitration clause.
Narrow Arbitration Clauses: Papalote II Background
In Papalote II the Fifth Circuit held that a narrow arbitration clause that covered disputes about the “performance” of a contract did not cover a dispute concerning the meaning of an aggregate liability provision in a wind-energy contract. That dispute, said the Court, concerned the interpretation of the contract, not its performance, and therefore the arbitration opponent was not required to submit it to arbitration.
Papalote I and II have an interesting (and tangled) procedural history, which might provide fodder for another post about ripeness as it applies to Section 4 applications. But for the limited purposes of this post we can ignore that. (If you’re curious, you can review both of the decisions, which are linked to the full-case citations above.)
Papalote II arose out of a dispute between the Lower Colorado River Authority (“LCRA”) and Papalote. LCRA is an Austin, Texas-based conservation and reclamation district, and a political subdivision of Texas. Papalote constructs and operates wind farms.
In 2009 LCRA and Papalote entered into a purchase and sale contract under which LCRA agreed to purchase, at a fixed price and for an 18-year term, all energy to be produced by a wind-farm facility Papalote planned to construct.
One provision of the agreement, Section 4.2, entitled “Liquidated Damages Due to [LCRA’s] Failure to Take,” sets forth a formula for calculating liquidated damages in the event LCRA did not take all the energy produced by Papalote’s facility. That formula was in part based on the difference between the fixed price LCRA agreed to pay and the price that Papalote was able to obtain in selling the energy to others. The “remedy” of liquidated damages was characterized in that provision as “exclusive.”
Another provision of the agreement, Section 9.3, entitled “limitation on Damages for Certain Types of Failures,” provides that “[Papalote’s] aggregate liability for [failing to to construct and operate the facility by the stipulated date] shall be limited in the aggregate to sixty million dollars ($60,000,000). [LCRA’s] damages for failure to perform its material obligations under [the Agreement] shall likewise be limited in the aggregate to sixty million dollars ($60,000,000).”
The parties agreed to arbitrate “[i]f any dispute arises with respect to either Party’s performance hereunder….”
In 2010 Papolote constructed the facility. For a period LCRA satisfied its obligation to take all the energy the facility produced. Ignoring for the time being the ripeness-related events that led to Papalote I, LCRA ceased taking energy and sought arbitration of the parties’ dispute whether LCRA’s maximum, aggregate liability for its refusal to take the energy was limited to $60,000,000. Papalote claimed that the dispute was not arbitrable because the arbitration clause covered only disputes about performance of the contract, not disputes concerning its interpretation.
The district court agreed with Papalote, holding that the dispute was about performance, and therefore was arbitrable. But the Fifth Circuit agreed with LCRA and held that the dispute was about interpretation, not performance, and thus was not arbitrable.
Papalote II Analysis
The starting point for the Fifth Circuit was that ascertaining the scope of an arbitration clause “is a matter of contract.” Slip op. at 6 (citations omitted). And “[u]nder [applicable] Texas law, the primary object of contract interpretation is to ascertain and give effect to the intent of the parties as that intent is expressed in the contract.” Slip op. at 6 (quotation and citation omitted).
Acknowledging that “both federal law and Texas law create a presumption in favor of arbitrability,” the Court explained that “unambiguous language controls when the question is the scope of an arbitrator’s power, and the policy that favors resolving doubts in favor of arbitration cannot serve to stretch a contractual clause beyond the scope intended by the parties.” Slip op, at 6 (citations and quotations omitted).
The Court explained how interpreting a broad arbitration clause differs from interpreting a narrow clause. Broad arbitration agreements, said the Court, “typically require arbitration of ‘[a]ny controversy or claim arising out of or relating to [the] contract’ or ‘any dispute . . . with respect to the interpretation or performance[]’” of the agreement. Slip op. at 6-7. When parties opt for a broad arbitration clause, said the Court, “only … the most forceful evidence of a purpose to exclude the claim from arbitration would render the dispute non-arbitrable.” Slip op. at 7 (citation and quotation omitted).
Broad or Narrow Arbitration Clause?
The arbitration clause at issue, explained the Court, applies only to disputes concerning the “performance” of the contract and therefore is a narrow clause. The Court noted it had previously ruled that where “an arbitration clause restricts [the arbitrator’s] power to an interpretation of the contract, it leaves the arbitrator powerless to decide matters on which the agreement is silent.” Slip op. at 7 (citation and quotations omitted).
Narrow arbitration clauses, by contrast, typically “limit[] arbitration only to a subset of disputes that may arise out of the contract.” Slip op. at 7. “If,” said the Court, parties “limit arbitration to a specific category of disputes, at the exclusion of other categories of disputes, then the arbitrators’ power is limited to those disputes to which the parties expressly consented.” Slip op. at 7.
The Court illustrated this principle by discussing Beckham v. William Bayley Co., 655 F. Supp. 288, 291 (N.D. Tex. 1987), which involved “a contract for delivery of ‘standard’ insect screens” and an arbitration clause which “required arbitration of ‘[a]ny disagreement . . . as to the intent of [the] contract’—i.e., interpretation of the contract.” Slip op. at 7 (quoting 655 F. Supp. at 291). The Court explained that “[h]ad parties disputed whether the screens, as delivered, were in fact ‘standard’ screens, the arbitration clause would have required that the intent as to the meaning of the term ‘standard’ be resolved by arbitration.” Slip op. at 8 (citation omitted). “But,” said the Court, “the parties agreed on what ‘standard’ insect screens meant, and the dispute was simply over whether the delivered insect screens were damaged.” Slip op. at 8 (citation omitted). That dispute, the Court explained, “concerned performance,” and was thus outside the scope of the arbitration clause. Slip op. at 8 (citation omitted).
That principle, said the Court, applies equally to clauses which, like the one in Papalote II apply simply to “performance” disputes. Slip op. at 8. “Here,” the Fifth Circuit explained, “Papalote and LCRA agreed to submit to binding arbitration “[i]f any dispute arises with respect to either Party’s performance.’” Slip op. at 8. The parties’ arbitration “clause clearly signifies the parties’ intent to limit arbitration to performance-related disputes only, and the arbitration clause neither requires nor authorizes arbitration of disputes that are not performance related disputes, such as disputes related to the interpretation of the Agreement.” Slip op. at 8-9.
Narrow Arbitration Clauses: Interpretation or Performance?
The court concluded that the dispute between the parties—“whether the Agreement limits LCRA’s liability to $60 million—is arbitrable only if it constitutes a dispute with respect to either LCRA’s or Papalote’s performance.” The Court held “that LCRA’s dispute is a dispute related to the interpretation of the Agreement, not a performance-related dispute, and thus does not fall within the scope of the arbitration clause.” Slip op. at 9.
The Court explained that ‘[i]interpretative disputes arise when the parties disagree over a text’s meaning,” citing Black’s Law Dictionary’s definition of “interpretation.” Slip op. at 9 (citing Interpretation, Black’s Law Dictionary (10th ed. 2014) (“The ascertainment of a text’s meaning[.]”).
The Court based its conclusion that “LCRA’s dispute is squarely in the realm of interpretation[],” slip op. at 9-10, on the following:
- LCRA’s arbitration demand “frames LCRA’s dispute as an interpretative dispute: The [demand] states that “[t]he dispute is whether LCRA’s liability is limited to $60,000,000 under [Section 9.3 of the Agreement].” Slip op. at 9.
- “LCRA’s brief on appeal observes that this dispute is ‘about the meaning of the [Agreement’s] liability limitation.’” Slip op. at 9 (quoting LCRA’s Br. at 35) (emphasis in original).
- “[O]ne needs only to examine the Agreement to determine what the Agreement says and means, and what LCRA and Papalote had intended while drafting the Agreement.” Slip op. at 9 (citation omitted).
- “The issue in this case can be answered without any reference to factual allegations of failure to perform.” Slip op. at 9 (citation omitted).
The Court concluded that even though “Papalote and LCRA contractually committed “to have someone—other than a judge—decide” performance-related disputes, they did not agree to have an arbitrator decide matters of contract interpretation.” Slip op. at 10 (citation omitted).
The Court rejects LCRA’s Contrary Arguments
LCRA’s argument focused on the scope provision’s modifying phrase “with respect to.” Recall that the parties agreed to arbitrate “if any dispute arises with respect to either Party’s performance hereunder….” LCRA argued that the “interpretative dispute ‘relat[es] to LCRA’s ongoing and future performance under the [Agreement],’” and was therefore a dispute “with respect to” “performance.” Slip op. at 10 (quoting LCRA’s Br.) (emphasis in original).
But Section 9.3 of the Agreement, said the Court, was a “damages provision, not a provision about performance, and LCRA’s interpretative dispute is with respect to damages, not performance.” Slip op. at 10 (emphasis in original). The arbitration clause therefore did not require arbitration of the parties’ dispute.
Want to learn more about arbitrability?
Read Loree Reinsurance and Arbitration Law Forum posts here, here, here, and here.
Photo Acknowledgments
The photos featured in this post were licensed from Yay Images and are subject to copyright protection under applicable law.
Tags: Arbitrability, Arbitrable, Damage Cap, interpretation, Interpretative, Liability Cap, Limitation of Liability Clause, Narrow Arbitration Clause, Narrow Clause, Papalote, performance, Ripeness, Subject Matter Jurisdiction, U.S. Court of Appeals for the Fifth Circuit, With respect to
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