Resolving Conflict through Contractual Arbitration and Compulsory ADR

JOSEPH LIPARI

THE SULTZER LAW GROUP, P.C.

SEPTEMBER 2011

“Arbitration” Generally defined as a process of private dispute resolution in which a neutral third party arbitrator renders a decision after a hearing in which both parties have had an opportunity to be heard.

Arbitration is a creature of contract and is presided over by a non-judicial arbitrator.

Contractual arbitration is binding as parties are allowed to waive their rights to a jury trial.

The Advantages of Arbitration

1) affords the parties a greater degree of privacy than litigation 2) expeditious exchange of discovery between the parties; 3) discovery rules are more flexible and can be tailored in a way that is suitable for the particular dispute;

4) arbitrators can decide not to rigidly adhere to the rules of evidence; 5) parties can oftentimes informally communicate with the arbitration panel rather than filing costly and complex motions;

6) the types of hearings can vary to accommodate the parties and the witnesses;

7) establishing rules and protocols may be a collaborative process between the arbitrators and the parties

8) the entire arbitration process may last a few months instead of a few years

Federal Arbitration Act (“FAA”)

Promulgated in 1925 in order to abrogate the general common law rule against specific enforcement of arbitration agreements.

Prior to the FAA, courts either did not enforce arbitration provisions or would only award nominal damages for the breach of an agreement to arbitrate.

Congress intended to place arbitration agreements “upon the same footing as other contracts.”

Arbitration Clauses Arbitration clauses typically specify the applicable law and procedural rules that will govern.

In construing an arbitration agreement, every doubt is to be resolved in favor of arbitration.

The FAA provides that courts shall decide the issue of arbitrability based upon their interpretation of the contractual intent of the parties; courts should, however, defer to arbitration between commercial entities unless there is clear intent that the arbitration clause does not apply; doubts as to parties' intent are to be resolved in favor of arbitration

Any interpretation of the scope of an arbitration clause is governed by two guiding legal principles: (1) as there is strong federal policy favoring arbitration, any doubt concerning the scope of arbitrable issues should be resolved in favor of arbitration; and (2) that an order to arbitrate a particular grievance should not be denied unless it may be said with positive assurance that the arbitration clause is not susceptible of interpretation that covers asserted dispute.

Separability Even if the underlying contract is deemed void ab initio as a result of fraud, a court will sever or separate the arbitration clause in order to allow the arbitrator to decide all issues in dispute, including arbitrability

Mitsubishi Motors Corp v Soler Chrysler Plymouth, Inc., 473 US 614 (1985)

The Court held that determining whether a dispute is subject to arbitration involves a two step inquiry: 1) whether the arbitration agreement covers an issue in dispute; and 2) whether an external legal constraint forecloses the arbitration of those claims.

As to the first prong, the Court explained that the parties intention controls, but those intentions are generously construed as to issues of arbitrability.

As to the second prong, the Court held that almost any type of claim is arbitrable and the party opposing arbitration must show a clear congressional intent to exclude a claim from arbitration before the courts will deny a motion to compel.

FAA §16 In 1988, Congress amended the FAA to add § 16. This section allows for the appeal of district court orders refusing to compel arbitration and denies the appeal of orders compelling arbitration.

The circuits are split as to whether a party may appeal an order compelling arbitration when the issue arises within a broader action that includes other claims and the court has dismissed the remaining claims.

The majority of courts have held that orders compelling arbitration in an “embedded proceeding” are always interlocutory and thus not “final decisions” subject to appeal under to § 16.

The majority of courts have held that orders denying arbitration are “final decisions” subject to appeal.

The Significance of Situs

Courts in the arbitral situs can vacate the award and declare it a nullity.

Accordingly, where the arbitration provision is silent as to situs, the situs should not be selected simply for convenience of counsel.

Consideration should be given to the arbitral caselaw of the “vacating courts.”

Consideration should be given to the “circuit splits” with respect to arbitration clause and arbitration procedure issues.

Interim Rulings that have been deemed “Final Awards” Subject to Judicial Review

An order requiring the posting of security to protect a possible final award is itself a "final award” subject to judicial review.

An order requiring defendant to post an interim letter of credit was reviewable award under the FAA.

Temporary equitable orders calculated to preserve assets or performance needed to make a potential final award meaningful.

Vacating an Arbitration Award

◦ STATUTORY

1) where the award was procured by corruption, fraud or undue means;

2) where there was evident partiality or corruption;

3) where the arbitrators were guilty of misconduct in refusing to postpone the hearing, upon sufficient cause shown, or in refusing to hear evidence pertinent and material to the controversy; or of any other misbehavior by which the rights of any party have been prejudiced; or

4) 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.

◦ JUDICIAL

1) manifest disregard of the law; or

2) violation of public policy.

What is Manifest Disregard of the Law?

Judicially created standard not found in section 10 of the FAA.

All Circuits agree that it is something more than mere legal error or misinterpretation.

The standard is derived from the 1953 Supreme Court ruling Wilko v Swan 346 U.S 427 (1953), rev’d on other grounds, Rodriguez de Quijas v Shearson/American Express, Inc. 490 U.S 477 (1989).

In Wilko v Swan, the Court explained, in dicta, that “in unrestricted submissions, such as the present margin agreements envisage, the interpretations of the law by the arbitrators in contrast to manifest disregard are not subject, in the federal courts, to judicial review for error in interpretation.”

As an example of one Circuit’s interpretation of the judicially created standard, in Merrill Lynch v Bobker, 808 F.2d 930 (2d, Cir. 1986), the Second Circuit stated that “although the bounds of this ground have never been defined, it clearly means more than error or misunderstanding with respect to the law. The error must have been obvious and capable of being readily and instantly perceived by the average person qualified to serve as an arbitrator. Moreover, the term ‘disregard’ implies that the arbitrator appreciates the existence of a clearly governing legal principle but decides to ignore or pay no attention to it…the governing law alleged to have been ignored by the arbitrators must be well defined, explicit and clearly applicable.

Judicial Review The FAA maintains only four limited grounds for vacatur that a party may pursue, in a federal district court, if dissatisfied with the arbitrator's decision. A party can use the FAA to ask a federal district court to vacate the arbitration award, but that party will succeed only if one of the statutory or judicially created grounds were violated by the arbitrator or the arbitration panel.

The FAA was intended to encourage parties to exercise their freedom to contract for arbitration rather than litigation.

The argument has been made that the parties should be free to agree on everything affecting their arbitration, including a standard of judicial review.

Whether parties can contractually demand that a federal district court review the arbitration award for grounds not mentioned in the FAA split the federal Circuit Courts of Appeals.

Can Parties Contract to Expand their Right to Judicial Review of an Arbitral Award?

Prior to Hall Street Associates, LLC v Mattel, Inc., the circuit split was:

◦ YES

Third Circuit

Fourth Circuit

Fifth Circuit

◦ NO

Eighth Circuit

Ninth Circuit

Tenth Circuit

Hall Street Associates, L.L.C. v. Mattel, Inc.

The Court Held:

“The Federal Arbitration Act…provides for expedited judicial review to confirm, vacate, or modify arbitration awards. The question here is whether statutory grounds for prompt vacatur and modification may be supplemented by contract. We hold that the statutory grounds are exclusive.”

However the Court Limited its holding:

“We do not purport to say that they exclude more searching review based on authority outside the statute as well. The FAA is not the only way into court for parties wanting review of arbitration awards: they may contemplate enforcement under state statutory or common law, for example….But here we speak only to the scope of the expeditious judicial review under §§ 9, 10, and 11.”

The Hall Circuit Split: Manifest Disregard

Does manifest disregard still exist as a judicial, non-statutory ground for vacatur of arbitration awards?

The Court Stated:

“Maybe the term ‘manifest disregard’ was meant to name a new ground for review, but maybe it merely referred to the § 10 grounds collectively, rather than adding to them. Or, as some courts have thought, ‘manifest disregard’ may have been shorthand for § 10(a)(3) or § 10(a)(4), the subsections authorizing vacatur when the arbitrators were ‘guilty of misconduct’ or ‘exceeded their powers.’”

The Court left the question open. As of August, 2011, the 1st, 2nd, 3rd, 5th, 6th, and 9th Circuit Courts have commented on Hall.

Does Manifest Disregard Still Exist?

◦ YES

Second Circuit Sixth Circuit Ninth Circuit

◦ Unclear

Third Circuit

NONO

First CircuitFirst Circuit

Fifth CircuitFifth Circuit

Compulsory ADR Strategies

Most states have enacted legislation that encourages or compels litigants to participate in some form of ADR.

Mediation

Non-Binding Arbitration