Just as SCOTUS held its nose and confirmed an arbitration award it thought stunk in Sutter, the Supreme Court of Alabama has confirmed an arbitration award made after only the claimant presented evidence and grounded in a possible misunderstanding of Alabama law.  Tucker v. Ernst & Young, __ So.3d__, 2014 WL 2619860 (Ala. June 13, 2014).

In Tucker, shareholders of HealthSouth Corporation (in the name of the company) asserted claims against HealthSouth’s accountants, Ernst & Young, alleging that E&Y should have discovered accounting fraud at HealthSouth.  The shareholders’ case-in-chief took almost two years.  They presented testimony from 14 live witnesses and 61 video witnesses over the course of 81 days, plus thousands of pages of exhibits.  At least five months before the shareholders rested their case, E&Y sought and received permission to file a dispositive motion based on E&Y’s affirmative defenses at the end of the shareholders’ evidence.  The panel allowed the shareholders to add any relevant evidence and witnesses they wanted to their case-in-chief to address the affirmative defenses.

After the shareholders rested, and the panel heard arguments on the motion, the panel granted E&Y’s motion, dismissing all claims.  The gist of the motion was this: the fraud at HealthSouth was widespread and knowledge of it must be imputed to the company, therefore the company should not be allowed to blame others for its own misconduct.  The panel cited Alabama common law (the Hinkle rule), as well as the doctrines of in pari delicto and contributory negligence to support the dismissal.

The shareholders moved to vacate the award under Section 10(a)(3) and 10(a)(4) of the Federal Arbitration Act.  They argued the arbitrators committed misconduct in granting a motion for judgment as a matter of law and that the arbitrators exceeded their power by ignoring Alabama precedent.  The Alabama courts disagreed and confirmed the award.

The Tucker court found no misconduct because the panel had authority to allow a dispositive motion and it allowed the shareholders every opportunity to present evidence relating to the affirmative defenses.  The court also found the panel had not exceeded its authority in applying Alabama law.  Citing extensively from Sutter, the court characterized the shareholders’ arguments as indistinguishable from “manifest disregard of the law,” a basis which Alabama has concluded is unavailable under the FAA.  In any case, the court found the panel “arguably and in apparent good faith” applied Alabama law to resolve the dispute and therefore its award must stand.  Finally, with respect to the shareholders’ argument that affirmative defenses were not within the scope of the parties’ arbitration agreement, the court found the shareholders had waived that basis for vacatur by not raising it to the panel (and by asserting the same affirmative defenses against E&Y’s counterclaims).

Although no justices dissented, one wrote a separate concurrence.  After setting forth why the arbitrators mis-interpreted Alabama law about imputing conduct, the concurrence states “further reflection has caused me to question whether arbitrators who willfully ignore applicable state law are not, in fact, ‘exceeding their power’ or acting ‘beyond their authority’ within the contemplation of” Section 10(a)(4).  He concurred, though, because that view is clearly precluded by SCOTUS’s interpretation of the FAA.

The U.S. Supreme Court issued its decision in Sutter today, unanimously holding that as long as the arbitrator bases a decision to allow or disallow class arbitration on the text of the parties’ agreement, her “construction holds, however good, bad, or ugly.”  Oxford Health Plans LLC v. Sutter, 569 U.S. ___ (June 10, 2013).  The case resolved a circuit split on how to interpret SCOTUS’ Stolt-Nielsen decision.  It also proved me right (yahoo!).  (I predicted the Court would affirm the Third Circuit both when it granted review, and when it heard the argument.)

As you may recall, this case involves a putative class of doctors who sued a health insurer over allegedly inadequate payments for services.  The case was brought in state court, the insurer successfully compelled arbitration, and the parties then agreed that the arbitrator should decide whether the contract authorized class arbitration.  The contract did not explicitly allow or disallow class actions in arbitration.  The arbitrator construed the text of the arbitration agreement and found that the parties’ intent was to allow class arbitration.

In the District of New Jersey, the Third Circuit and again the Supreme Court, the insurer argued that the arbitrator had “exceeded [his] powers” within the meaning of Section 10(a)(4) of the FAA by allowing class arbitration.  In its decision, the Supreme Court firmly refused to look behind the curtain of an arbitration.  Because it was clear that the arbitrator was given authority to determine whether the contract authorized class arbitration, and he based his decision on the text of the arbitration clause, the Supreme Court would not consider whether “he performed that task poorly.”

This is a big defeat for opponents of class arbitration.  Not only does the Sutter decision do away with the Fifth Circuit’s interpretation of Stolt-Nielsen, which was essentially that class arbitration was precluded unless the parties agreement explicitly allowed it, it also refuses to create any kind of exception for really bad contract interpretations.  The insurer argued strongly that the arbitration agreement at issue in this case was “garden-variety” and contained no indicia that the parties intended to use class procedures in arbitration, so the arbitrator’s decision was wrong.  But, Justice Kagan, writing for the Court, declined the insurer’s invitation to consider the merits of the arbitrator’s decision.  Once the court is satisfied that the arbitrator was “arguably construing the contract,” his or her decision will be affirmed even in the case of “grave error.”  Indeed “[t]he potential for those mistakes is the price of agreeing to arbitration.”  In that regard, this decision is not limited to class arbitration at all, but is a strong decision for affirming arbitration awards in general.  It further calls into question whether “manifest disregard of the law” is a legitimate basis for vacating an arbitration award.

This decision opens the door to more arbitrators authorizing class actions.  Arbitrators now have the confidence that as long as the class arbitration decision is grounded in the text of the parties’ agreement, it will not be overturned.  (Of course, if the parties’ arbitration agreement explicitly precludes class actions, an arbitrator would exceed his or her power by authorizing a class.)  Even an arbitrator who believes as a matter of public policy that plaintiffs with small-dollar claims should be able to assert those claims as a class in arbitration will be affirmed, as long as the official decision is based in the language of the contract.

There are two issues that the Court left for another day, and those could eventually be the death knell of class arbitrations.  First, a long footnote suggests that the availability of class arbitration could be one of the gateway questions of arbitrability that are presumptively for courts (not arbitrators) to decide.  Second, Justices Alito and Thomas wrote a concurrence suggesting that there may be no satisfactory procedure for conducting class arbitrations — because the absent members cannot consent to the arbitrator’s authority and opt-out notices are not effective.  However, because the insurer agreed to have the arbitrator decide the issues of class arbitration, neither of these issues was before the Court in Sutter.

In a dispute over whether an arbitrator has authority to grant a video game developer and publisher a perpetual license in the intellectual property as a remedy for the developer’s fraud and breaches of contract, the Fifth Circuit found that the arbitrator’s creative award must be upheld under the Federal Arbitration Act, and set forth new guidance for courts confronting similar issues.  Timegate Studios, Inc. v. Southpeak Interactive, LLC, __ F.3d __, 2013 WL 1437710 (5th Cir. April 9, 2013).

The developer and publisher had a 35-page contract setting out the terms of their work to create “Section 8,” a “futuristic military-style video game” (not one about affordable housing).  The contract called for arbitration.  It also gave the developer exclusive ownership of the game’s intellectual property, with the publisher only having a license to market, publish and distribute the game.  It prohibited the publisher from preparing “derivative works.”

The game bombed.  Soon, the parties found themselves in arbitration over their cross-claims for breach of contract, fraud, and copyright infringement.  The arbitrator found that the developer had committed multiple breaches of the contract and had fraudulently misrepresented critical information.  It awarded the publisher over $7 million.  However, because the arbitrator found the monetary remedy would not fully compensate the publisher, it also “amended” the contract to give both parties a perpetual license for the game’s intellectual property, without any obligation to pay future royalties and without any restrictions on creating sequels, “add-ons” or competing products.

The district court vacated the arbitrator’s award, finding the arbitrator “exceeded [his] powers” within the meaning of Section 10(a)(4) of the FAA.  The district court focused on the “perpetual license” granted to both parties, and found that was not a remedy authorized by the contract.

The Fifth Circuit reversed the district court and reinstated the arbitration award.  Notably, the Fifth Circuit cited a case it issued almost 20 years ago for the proposition that “the arbitrator’s selection of a particular remedy is given even more deference than his reading of the underlying contract.”  That remedy can be vacated only if the remedy is not “a logical means of furthering the aims of the contract.”  In this case, the Fifth Circuit found the perpetual license furthered the general aims of the parties’ contract.  In particular, because their relationship had become so contentious that future collaboration on sequels and licensing was impossible, the court found the arbitrator’s solution fit “the fundamental goal of the Agreement: mutual access to financial benefits derived from their joint creation and distribution of Section 8.”  The court did remind readers that there are other limits on creative arbitration remedies.  An arbitrator may not decide an issue that the contract reserves for another decision maker or removes from anyone’s discretion.

There are two key take home points from this case.  First, for advocates trying to challenge an arbitration award, this case shows that attacking the remedy provided may be the most difficult basis for vacating an award under Section 10.  And second, for drafters of arbitration clauses, think carefully about whether there are some remedies you want to exclude from the arbitrator’s authority and do that explicitly in the arbitration clause.

 

While the oral argument before the United States Supreme Court in Sutter today was ostensibly about whether to affirm an arbitrator’s decision that the parties’ contract authorized class arbitration, the decision really turns on how the Court will review all arbitration decisions.  (Transcript here.)  Multiple Justices expressed an unwillingness to create a special standard for reviewing arbitrator decisions involving class arbitration.  (Info on the underlying case here.)

Appellant’s counsel tried valiantly to express some standard of review that fit within the Court’s past jurisprudence, but also allowed for vacatur of this particular result.  In response to questions like “how wrong does an arbitrator’s decision have to be to become an issue of law?” (from Justice Sotomayor), counsel advocated that Stolt-Nielsen and Concepcion established a “presumption” that there is no consent to class arbitration without a “very clear statement of a meeting of the parties’ minds.”  However, Justice Kagan quickly noted that the Court had never suggested such a presumption in either of those cases.  Appellant’s counsel later advocated for a slightly different formulation: a reviewing court may vacate the arbitrator’s decision to allow class  arbitration if the contractual language “leaves no room for a conclusion that the parties agreed to” arbitrate on a classwide basis.  Justice Kennedy, who often casts a deciding vote in close cases,  expressed skepticism about whether the Court’s repeated and highly deferential standard of review for decisions by arbitrators allowed any kind of inquiry into the merits of the arbitrator’s contractual analysis.

Respondent’s counsel, of course, emphasized the very limited grounds for vacating an arbitration award.  He noted that Appellant argues the arbitrator “exceeded his power,” but because Appellant consented to giving the arbitrator authority to determine whether the arbitration could proceed as a class, the only way the arbitrator could have exceeded his power was by basing his award on something other than an interpretation of the contract.  This led to a series of amusing hypotheticals in which Justice Breyer asked Respondent’s counsel to assume that an arbitrator made her decision based on consulting a “magic 8-ball” (Justice Scalia pretended not to know the reference) and then asked whether that would constitute “manifest disregard” of the law or otherwise serve as grounds for vacating the award.  Justice Breyer’s questions hint that the Court may give “manifest disregard of the law” new life as a separate basis for vacating arbitration awards, and that the Court is looking for a backstop beyond just the four bases in the FAA for parties to rely on if arbitrators get the law or facts really, really wrong.

Curiously, from a Court that has vigorously enforced arbitration agreements for all types of cases, the Justices appeared skeptical of arbitrators’ capability to handle class actions, and questioned whether arbitrators were wrongly incentivized.  Justices asked how the arbitrator was compensated in this case, whether he was experienced, how many class actions were handled in arbitration (neither side could answer, since that information is not public), and whether an arbitrator would be incentivized by his own fees to create a class action after seeing a case like Sutter drag on for eleven years.  To that, Respondent’s counsel gave a good soundbite: “if we trust arbitrators to handle such important issues as civil rights issues and other very important matters [], we have to expect that they will follow the precepts of this Court and the FAA as to what constitutes grounds for class arbitration.”