Introduction
In our recent post on the Merion Construction case (here), we were pretty critical of New Jersey’s Superior Court, Appellate Division, for reversing a trial court decision confirming a modified arbitration award, finding it should have been vacated and the original award confirmed. Today’s post takes a brief look at a decision by another state’s Appellate Division—New York’s Supreme Court, Appellate Division, First Department—which held that another construction-industry award should be vacated.
In Merion Construction the New Jersey Appellate Division thought the arbitrator had no authority to correct his award to reflect the rulings he intended to make on two issues the parties had submitted to him. Re Colorado Management, LLC v. Lea Power Partners, LLC , ___ A.D.3d ___, ___, 2014 N.Y. Slip Op. 01253 at 1-3 (1st Dep’t Feb. 20, 2014), held that a final arbitration award had to be vacated because the arbitrator had no authority to rule upon an issue that was not presented to him in light of the parties’ submissions and a ruling made in the same proceeding by a predecessor arbitrator.
While Merion Construction got an “F,” Colorado Management gets at least an “A-,” and perhaps even an “A.”
Colorado Management
Colorado Management concerned a dispute arising out of an Engineering, Procurement and Construction (“EPC”) Agreement (the “Agreement”) between Lea Power Partners, LLC (the “Owner”) and Colorado Energy Management, LLC (the “Contractor”)), which provided for arbitration administered by the American Arbitration Association (“AAA”). The Owner demanded arbitration, alleging that the Contractor was guilty of “gross negligence consisting of nine alleged breaches” of the Agreement. Slip op. at 1.
According to the Owner’s demand, the Contractor “failed to perform in a manner of a qualified and experienced EPC Contractor,” and that Contractor’s “gross negligence result[ed] in the project construction costs increasing from $272,000,000 to $415,000,000 currently.” The Owner sought damages consisting of cost overruns and consequential damages.
The Contractor counterclaimed, seeking a $12,596,173 cost bonus incentive fee, which the Contractor claimed was due under the Agreement; a $1 million development fee the Owner allegedly owed it under a separate, Joint Development Agreement (the “Development Agreement”); and damages for defamation.
An arbitrator was selected (the “First Arbitrator”) and the Contractor moved to dismiss Owner’s claim. The Contractor contended that the Agreement: (a) set forth the Owner’s sole remedy for damages in excess of the contract price; (b) provided that the Contractor’s sole obligation was to share responsibility for cost overruns; and (c) capped at $22,043,302 the Contractor’s aggregate liability for cost overruns not attributable to gross negligence. Dismissal was warranted, said the Contractor, because, absent gross negligence, Contractor’s liability was limited to: (a) $9,447,129 in incentive fees, which it had already forfeited; and (b) forfeiture of the $12,596,173 cost bonus incentive fee for which it had counterclaimed.
Owner opposed the motion, and cross-moved to dismiss the Contractor’s counterclaims, contending:
Assuming the veracity of these factual allegations, as is required, the [First] Arbitrator can only conclude that LPP’s claims are sufficient to fit within a cognizable legal theory of gross negligence. Given [the Contractor’s] experience and the assurances provided to [the Owner] about its capabilities, [the Contractor’s] failures meet the defined standard of gross negligence.
The First Arbitrator denied both motions to dismiss. As to the Contractor’s motion, he explained:
The allegations in [the Owner’s] demand for arbitration, which must be taken as true at this stage of the case, state a claim for gross negligence which, if proven, could form the basis for the recovery of causally related damages notwithstanding the limitations on liability and damages in the EPC contract.
As respects the Owner’s motion, he determined that the Contractor’s counterclaim for the $1,000,000.00 fee allegedly due under the Development Agreement was arbitrable.
The First Arbitrator passed away before the conclusion of the arbitration, and a successor arbitrator was appointed (the “Second Arbitrator”). After a hearing the Second Arbitrator issued a reasoned award, ruling that the cost overruns were not attributable to gross negligence on the Contractor’s part.
But the Second Arbitrator ruled that the Contractor had breached the Agreement, which caused cost overruns in an amount in excess of the Agreement’s $22,043,032 damage cap. The Second Arbitrator awarded the Owner damages in the capped amount of $22,043,032 and awarded the Contractor $1,000,000 on its Development Agreement counterclaim. He apparently said nothing about the Contractor’s contention that its maximum liability under the Agreement was already satisfied by its forfeiture of the incentive fees and its counterclaim for cost bonus incentive fees.
The trial court granted the Contractor’s motion to vacate the $22,043,032 award and confirm the $1,000,000.00 Development Agreement Award. On appeal, the Supreme Court, Appellate Division, First Department affirmed.
Noting that the parties had “invoke[d]” the Federal Arbitration Act (the “FAA”), the Court explained that, under Section 10(a)(4) of the FAA, arbitrators exceed their powers when they “rule on issues not presented to them by the parties. . . .” Slip op. at 2-3. The Court held that the $22,043,032 award against the Subcontractor had to be vacated because “[t]he arbitration demand, the prehearing motion practice and [the First Arbitrator’s] decision [on the Contractor’s motion to dismiss] ma[d]e it clear that gross negligence was the only claim by [the Owner] that was presented to [the Second Arbitrator] for a hearing.” Slip op.at 3. The Court nevertheless “reject[ed] [the Contractor’s] arguments that [the Second Arbitrator’s] determination was in manifest disregard of the law[,] or that it was affected by an evident material miscalculation [which would have provided a basis for modifying the award under Section 11(a) of the FAA].” Slip op. at 3; see 9 U.S.C. § 11(a).
The Court rejected the Owner’s argument that the Second Arbitrator did not have “jurisdiction over [i.e., the authority to decide] [the Contractor’s] [counter]claim” under the Development Agreement, because the Owner waived it by failing to raise it in the trial court proceeding. The Court also explained that, “[i]n any event, [the Second Arbitrator] properly found the claim to be arbitrable because it involved the parties and arose under a contract that was related to the EPC Agreement.” See Slip op. at 3.
Finally, the Court held that the Owner’s “argument that [the Contractor] lacked standing to maintain this [FAA enforcement] proceeding was rendered moot by the unopposed intervention of [the Contractor’s] guarantor, Centennial Energy Holding, Inc. [the “Guarantor”].” The Owner, said the Court, conceded in the trial court proceeding that the Guarantor “had standing to seek relief from the arbitration award.” See Slip op. at 3.
Analysis
The Court’s affirmance of the trial court’s judgment vacating the award against the Contractor was based in large part on the long-established rule that the parties’ submission defines and circumscribes the scope of an arbitrator’s authority. See, e.g., Ottley v. Schwartzberg, 819 F.2d 373, 376 (2d Cir. 1987). (See, e.g., L. Reins. & Arb. L. Forum posts here and here.)
But there was a twist. The Owner’s arbitration demand could probably be interpreted to present to the First Arbitrator both a claim for grossly-negligent breach of contract and one for ordinary breach of contract. Any ambiguity on that score was resolved by the Contractor’s motion to dismiss, which addressed both of those claims and thus presented them to the First Arbitrator for decision.
While the Court’s brief opinion does not say, there may not have been any material dispute about the meaning or scope of the damage cap provision, or the entitlement of the Contractor, in the absence of a grossly-negligent breach, to the already-forfeited incentive fee, and to the cost bonus incentive fee. That was the whole point of the motion to dismiss: if there was no grossly-negligent breach, then the net award to the Owner under the Agreement would be zero, thereby justifying a summary dismissal of the Owner’s’ claim.
Even assuming there was a dispute about the damage cap and the offsetting claims, the Court effectively found that the First Arbitrator’s Award resolved that dispute in favor of the Contractor. The First Arbitrator’s Award denied the motion to dismiss on the sole ground that the Owner’s allegations in its arbitration demand, if proved, “could form the basis for the recovery of causally related damages notwithstanding the limitations on liability and damages in the EPC contract.” (emphasis added). The Court explained in a footnote that “[w]e take the [First Arbitrator’s] statement that gross negligence, if proven, could form ‘the basis’ rather than ‘a basis’ for recovery as a clear indication that [the First Arbitrator] found gross negligence to be the only theory upon which LPP would have been entitled to an award in arbitration.” See slip op. at 3 n.1.
On balance, the Court’s decision was correct. That said, depending on what the record on appeal shows, one might argue that the First Arbitrator’s award was ambiguous, and that, accordingly, the Second Arbitrator should have been allowed to interpret the Award. The problem with that argument is that the Second Arbitrator’s Award was also ambiguous when construed in light of the First Arbitrator’s award and the surrounding circumstances.
Based on the Court’s description of the Second Arbitrator’s award, the Second Arbitrator simply denied the Owner’s gross negligence claim, awarded breach of contract damages in the amount of the damage cap, and awarded $1,000,000 on the Contractor’s Development Agreement counterclaim. Presumably, the Arbitrator said nothing about the already-forfeited incentive fees or the Contractor’s counterclaim for the cost bonus incentive fee.
If the Contractor’s right to be credited for those fees was undisputed or at least indisputable under the terms of the Agreement, then the Award would have been subject to vacatur because it did not draw its essence from the Agreement. See 9 U.S.C. § 10(a)(4); Stolt-Nielsen, S.A. v. AnimalFeeds Int’l Corp., 559 U.S. 662, 668, 672-73 (2010). On the other hand, even if there was some legitimate doubt about the Contractor’s right to be credited for the incentive and cost bonus incentive fees, then the Award would still have to be vacated because it, combined with the First Arbitrator’s Award, and the other surrounding circumstances, raised a serious question whether the Second Arbitrator decided all the issues submitted to him, which would require vacatur and warrant a remand to the Second Arbitrator to complete the Award by ruling on the incentive-fee and cost-bonus-incentive-fee issues. See 9 U.S.C. § 10(a)(4) (authorizing vacatur where the arbitrators “so imperfectly executed [their powers] that a mutual, final, and definite award upon the subject matter submitted was not made”); 9 U.S.C. § 10(b); cf. Stolt-Nielsen, 559 U.S. at 673 (panel “exceeded its powers[]” and “[a]s a result, under §10(b) of the FAA, we must either ‘direct a rehearing by the arbitrators’ or decide the question that was originally referred to” arbitration).
Depending on what the record on appeal shows, this case might have been a little closer than the Court’s opinion suggested it was. If there was some doubt about the incentive- and cost-bonus-incentive-fee issues, perhaps an FAA “purist” might say that the Court should have vacated and remanded the case to the Arbitrator, even if the most likely outcome on the merits would be essentially the same as the one the Court reached in its decision, and even though deciding the case that way would, in all likelihood, impose a significantly greater time and monetary cost on the parties and the court system then the Court’s decision imposes.
Even if the record could be read to cast doubt on the viability of the Contractor’s incentive- and cost-bonus-incentive-fee claims, we suspect that the doubt was not a very serious one, and even if the Court might technically have erred as a result, we suspect the Court did so in favor of a pragmatic resolution. And that’s why we are pretty confident the Court’s decision was either right on the money, or even if technically it was not, the Court wisely resolved the problem before it without creating any precedent that might be harmful to the effectiveness of arbitration in future cases.
C’est la vie. . . or perhaps more precisely: telle est la loi de l’arbitrage (“such is arbitration law,” at least according to Google Translate). . . .
Tags: Agreement to Arbitrate Arbitrability, American Arbitration Association, Arbitrability, Arbitral Power, Arbitrate Arbitrability, Authority of Arbitrators, Breach of Contract, Collateral Agreement, Construction Industry Arbitration, Counterclaims in Arbitration, FAA, FAA Section 10(a)(4), FAA Section 10(b), Federal Arbitration Act, Motion to Dismiss, New Jersey Appellate Division, New York Appellate Division, Ottley v. Schwartzberg, Predecessor Arbitrator, Scope of Authority, submission, Successor Arbitrator
