In today’s post I recount an epic battle between the Rules of Professional Conduct (tagline: saving clients from unscrupulous lawyers for over 100 years!) and the Uniform Arbitration Act (tagline: saving arbitration from hostile judges for 60 years!) in the Supreme Court of California.  Spoiler alert: the Rules of Professional Conduct win.

The story in Sheppard, Mullin, Richter & Hampton, LLP v. J-M Manufacturing Co., 2018 WL 4137103 (Cal. Aug. 30, 2018), begins with a “large law firm” [ed: with too many names] taking over the defense of J-M in a qui tam action in federal court in March of 2010.  The problem was that one of the public entities that had been identified as a real party in interest in the qui tam case was also a client of the firm (for employment matters).  Because both clients had signed engagement letters with general language waiving potential conflicts, the firm concluded it could take on the qui tam action.

The SMRH firm defended J-M for just one year before its employment client moved to disqualify it.  In that time, the firm had put in 10,000 hours defending J-M, and was still owed over one million dollars in fees.  The district court disqualified the firm based on the firm’s failure to adequately inform the employment client and J-M of the adversity before obtaining waivers, as required by the Rules of Professional Conduct.

At that point, the law firm sought its million dollars of unpaid fees from J-M in a state court action, and J-M in turn sought disgorgement of the two million dollars it had already paid.  The law firm successfully moved to compel arbitration, with the trial court dismissing J-M’s argument that the conflict of interest made the whole contract illegal and unenforceable. (And, the Court of Appeals refused a discretionary review which could have avoided the wasted fees of the arbitration.)

A panel of arbitrators awarded the law firm more than $1.3 million.  The parties were then back in state court with cross-motions to confirm and vacate the award.  The trial court confirmed the award.  However, the Court of Appeal reversed.

On appeal, the Supreme Court of California agreed that the arbitration award must be vacated.  It rested its decision on precedent from 1949, noting that “an agreement to arbitrate is invalid and unenforceable if it is made as part of a contract that is invalid and unenforceable because it violates public policy.”  In this case, the court found that the Rules of Professional Conduct were an expression of public policy, such that a violation of those rules could render an arbitration agreement void.  And it also found that the firm’s failure to give both of its clients notice of the actual adversity, and obtain informed consent of the representation, was a violation that tainted the entire contract and made it illegal.  (For you ethics geeks, the rule violated was 3-310(C)(3).)

Because the contract between the law firm and J-M was unenforceable, the court found the firm was “not entitled to the benefit of the arbitrators’ decision” and the parties could resume “where they were before the case took its unwarranted detour to arbitration.”  (Not sure why the court refused to say it was vacating the arbitration award.)  But, don’t shed too many tears for the lawyers.  The law firm will be able to argue in the trial court regarding whether it is entitled to any of its fees under the equitable doctrine of quantum meruit.  (Two judges dissented from that last part, finding that the ethical conflict should prevent the firm from recovering at all.)

I leave it to other blogs to discuss the ethical issues for lawyers present here, and to therapists and firm counsel to address the rising panic that lawyers may feel when reading this opinion.  For my purpose, this case is further demonstration that the type of arbitration agreement that is most susceptible to arguments of invalidity is the one between an attorney and client.  (Recall the recent decision in Maine.)  It is also interesting in that it does not discuss whether J-M “waived” its objection to arbitrability at all by participating in the arbitration, indeed there is no discussion of whether or how often J-M raised its objection during the arbitration.  That is a sharp contrast to the rule cited by the 9th Circuit in the Asarco decision (summarized last post), and an example of how inconsistent the rules are regarding waiver.

I have saved up six opinions that considered whether to vacate an arbitration award over the summer.*  Only one of those opinions vacated the award; the other five confirmed.  To get a flavor of what types of arguments are winning and losing motions to vacate, here is a summary of those six.

Vacated

The lone vacatur came in Hebbronville Lone Star Rentals, LLC v. Sunbelt Rentals Industrial Services, LLC, 2018 WL 3719682 (5th Cir. Aug. 6, 2018). The issue in that case was whether the arbitrator exceeded his power by reforming the parties’ contract.  Sunbelt had purchased the assets of Lone Star, and agreed to later pay earnouts based on the post-sale revenue from Lone Star’s customers.  The asset purchase agreement provided that disputes over the amount of earnouts would be decided by the parties “jointly [selecting] the Accounting Firm to resolve any remaining dispute over Seller’s proposed adjustments…which resolution will be final.”  (If that doesn’t sound like an arbitration clause to you, be sure to read this post.)   A dispute arose over whether the revenues from certain Lone Star customers exceeded a target number established in the agreement.  The parties submitted that dispute to an accounting firm.

The arbitrator found that Sunbelt should have included the revenue of two additional customers, which would have resulted in a payment to Lone Star of $6.4M.  However, the arbitrator also concluded that the parties made a mutual mistake in calculating the target number in the agreement, and if the corrected target number was used, Lone Star was actually entitled to nothing.  Lone Star moved to vacate the portion of the arbitrator’s award that reformed the target amount based on mutual mistake.  The district court granted the vacatur, and the Fifth Circuit affirmed.  Oddly, the opinion is not framed in terms of vacatur at all; it does not reference Section 10(a) of the FAA.  Instead, the opinion framed the question as “who decides” the question of mutual mistake.  The court interpreted the language of the parties’ arbitration clause and found it too narrow to encompass the mutual mistake issue.  Therefore, that issue was remanded to the district court for determination.  (Also odd is the absence of any discussion of waiver in this opinion.   My sense is if the arbitrator had been a lawyer instead of a CPA, the analysis may have been quite different.)

Confirmed

The courts found the arguments for vacatur insufficient in five other cases:

  • In another case regarding earnout payments after an asset purchase, an accountant/arbitrator was appointed to hear the seller’s claim that the buyer was manipulating sales to ensure no earnout was owed.  DFM Investments, LLC v. Brandspring Solutions, LLC, 2018 WL 3569353 (8th Cir. July 25, 2018).  After reviewing documents and hearing arguments, the arbitrator found the seller not entitled to any revisions.  The seller moved to vacate, arguing the arbitrator had refused to consider material evidence.  The district court and Eighth Circuit disagreed, noting that the arbitrator concluded the additional evidence was not material.  “An arbitrator’s reasoned decision to forgo analyzing additional evidence does not, without more, provide grounds for vacating the decision.”
  • In a case that reminds all advocates to carefully preserve objections, the Ninth Circuit confirmed an award because the complaining party did not properly preserve its objection. Asarco LLC v. United Steel, 2018 WL 3028692 (9th Cir. June 19, 2018).  Like in Sunbelt, the issue was whether the arbitrator had the power to reform the parties’s labor agreement based on mutual mistake, despite a provision in the contract depriving the arbitrator of “authority to add to, detract from or alter in any way the provisions of” the contract.  The district court concluded the arbitrator had authority to reform the labor agreement.  The Ninth Circuit found Asarco had conceded the issue by arguing the arbitrator lacked authority, instead of preserving that issue for the courts by refusing to address jurisdiction with the arbitrator (0r seeking injunctive relief at the outset).  (Wow – what a harsh rule.)  Even so, the court analyzed the merits and found the arbitrator had authority to reform the agreement.  However, one dissenting judge wrote that he would vacate the award based on the arbitrator exceeding the scope of his powers.
  • In another case from the Eighth Circuit, the court refused to vacate an arbitration award, even though the arbitration award was nearly three times the contractual liability limit.  Beumer Corp. v. Proenergy Services, 2018 WL 3767135 (8th Cir. Aug. 9, 2018).  The arbitrator found the provision limiting damages to the “Contract Sum” was enforceable, but that attorneys fees and interest did not count as “damages” for the purpose of that provision.  The court found that, even if the arbitrator had overlooked Missouri decisions finding attorneys fees count as damages, it did not matter because manifest disregard of the law is not a valid basis to vacate an award.
  • Speaking of “manifest disregard,” Maryland’s high court took the opportunity to clarify that it lives on as a basis for vacating awards under Maryland’s Uniform Arbitration Act.  WSC/2005 LLC v. Trio Ventures Assoc., 2018 WL 3629441 (Md. July 30, 2018).  However, the arbitrator in Trio did not manifestly disregard the law, because he did not make “a palpable mistake of law or fact appearing on the face of the award.”  In fact, the arbitrator identified relevant principles of Maryland law, analyzed the parties’ contract, and issued damages that were “reasonably consistent” with principles of Maryland law.
  • Finally, the Supreme Court of Rhode Island confirmed an arbitration award, despite allegations that the arbitrator manifestly disregarded the law, in Prospect Chartercare LLC v. Conklin, 2018 WL 2945664 (R.I. June 13, 2018).  The arbitrator awarded 18 months of severance to an executive employee, and the employer moved to vacate the award based on the arbitrator’s alleged manifest disregard of the law by relying on “erroneous facts” and disregarding the contract language.  On appeal, the high court noted that even if the arbitrator had based his decision on a factual error, “such a mistake would not be a proper basis upon which to vacate the arbitration award.”  Furthermore, the arbitrator’s award was based upon a “passably plausible interpretation” of the parties’ agreement.

 

* There were more than six judicial opinions on whether to confirm an arbitration award over the summer, of course.  I focus on federal appellate courts (circuits and SCOTUS) as well as the highest court of each state.

Okay, folks, we are still combating the summer slide here.  Today’s refresher rule is this: If an arbitrator fails to disclose a substantial relationship, the resulting award can be vacated under 9 U.S. C. 10 (a)(2).  But, not all relationships are substantial, as the cases today make clear.

Beginning in my backyard,  the appellant in Ploetz v. Morgan Stanley Smith Barney LLC, 2018 WL 3213877 (8th Cir. June 12, 2018), sought to vacate a FINRA arbitration award due to an alleged failure to disclose.  The chairperson disclosed that he was currently serving as an arbitrator in two other cases where Morgan Stanley was a party and had served in 8 previous cases involving Morgan Stanley or an affiliated company.  However, he did not disclose he had once served as a mediator in a case involving Morgan Stanley, and the FINRA rules require disclosure of past service as a mediator.  After the three-person panel dismissed appellant’s claims, she moved to vacate the award.  The district court denied the motion, and the 8th Circuit affirmed that result.  After noting the test for evident partiality is unclear in this circuit and refusing to clarify it (srsly??), the court found no evidence that the lack of disclosure “creates even an impression of possible bias.” Instead, the court found it “represented at most a trivial and inconsequential addition to that relationship.”  It also faulted appellant for failing to seek discovery into the earlier mediation.

The D.C. Circuit reached a similar result in Republic of Argentina v. AWG Group Ltd., 2018 WL 3233070 (D.C. Cir. July 3, 2018).  There, the losing party in arbitration (Argentina) argued the award should be vacated because one of the three arbitrators failed to disclose her service on a board of directors.  Three years into a twelve-year arbitration, this arbitrator was named to UBS’s board of directors, and UBS managed investments in two of the other parties in the arbitration (the “opposing parties”).  The arbitrator did not know of UBS’s investments, and they did not turn up in a conflict check run by UBS when she joined the board.  Argentina asked her to recuse due to her service on the UBS board, but the other arbitrators rejected the challenge.   After the award, both the district court and D.C. Circuit found this did not rise to the level of evident partiality.  Critically, while the arbitrator had “some degree” of interest in Argentina’s opposing parties, it failed to show she had a “substantial interest.”  In addition, there was no proof that the opposing parties had “more than trivial” import to UBS, a passive investor (though it had invested more than $2 billion).  The court raised public policy concerns about how many disqualifications and vacaturs could result if this type of financial relationship was sufficient to establish evident partiality.

In Certain Underwriting Members of Lloyds of London v.  Florida, 2018 WL 2727492 (2d Cir. June 7, 2018), the issue was what disclosure standards apply to party-appointed arbitrators.  In the reinsurance arbitration at issue, one party (ICA) had appointed Campos as its arbitrator.  Campos failed to disclose that he was president of a human resources firm that officed out of the same suite as ICA, and used a former director of ICA as a vendor, and had just hired a former director of ICA as its CFO.  The district court vacated the award based on evident partiality, citing the number and depth of relationships.  The Second Circuit remanded, finding that a different test should apply to party-appointed arbitrators.  It noted that reinsurers seek arbitrators with industry expertise, who are often “repeat players with deep industry connections”, and courts should be “even more indulgent” of undisclosed relationships for party-appointed arbitrators who are expected to serve as advocates.  Therefore, the Second Circuit followed the lead of four other circuits, and set a different standard for evident partiality by a party-appointed arbitrator.  It clarified that nondisclosure by a party-appointed arbitrator is only fatal if it violates the “contractual requirement” (here, “disinterested”) or “prejudicially affects the award.”  On remand, the district court must determine whether Campos was disinterested (had a personal or financial stake in the outcome) and whether his failure to disclose had a prejudicial impact on the award.

The Fourth Circuit issued an opinion yesterday in an under-developed area of arbitration law: when are awards “mutual, final, and definite”?  This is an important issue because under Section 10(a)(4) of the Federal Arbitration Act, arbitration awards can be vacated if they don’t meet the standard of “mutual, final and, definite.”

In Norfolk Southern Railway Co. v. Sprint Communications Co., 2018 WL 1004805 (4th Cir. Feb. 22, 2018), the parties’ lease agreement called for a three-person appraisal panel to establish the price for the renewal period.  Each party selected their own appraiser, and those two appraisers chose a third appraiser.  (Let’s just call him the Chair.)  In December of 2014, the Chair issued a “majority decision,” setting a payment amount and identifying two critical assumptions underlying that payment amount.  The majority decision clarified that  “[i]f either of these extraordinary assumptions are found to not be true, [the Chair] … reserves the right to withdraw his assent.”   A panel of AAA arbitrators then determined the Majority Decision was final and binding.

Norfolk Southern then moved to confirm the Majority Decision and the district court granted the motion.  The Fourth Circuit reversed, finding the Majority Decision was not “final”.  It cited cases for the proposition that “[a]n award is not ‘final’ under the FAA if it fails to resolve an issue presented by the parties to the arbitrators.”  The court focused on the Chair’s reservation of his right to withdraw his assent as the key aspect of the Majority Decision that made it lack finality.  It wrote: the Chair “did not merely base his assent on certain assumptions, but rather reserved the right to withdraw his assent if his assumptions proved to be incorrect. This outcome cannot be squared with any conception of ‘finality.'”

The Fourth Circuit remanded to the district court with instructions to vacate the award, and told the parties to go back to arbitration for “an arbitration award that is “final” and otherwise complies with the FAA and this opinion.”

This is an important case for arbitrators to read in order to be sure they issue awards that are final and can be confirmed.

 

What could be a better subject for a Black Friday weekend post than the Cabbage Patch Kids??!  Especially if you are old enough to remember the 1980s…  Whether you loved or hated the smushed-face dolls, the point of this post is that the 11th Circuit confirmed an arbitration award in their favor, showing significant deference to the arbitrator.  Original Appalachian Artworks, Inc. v. Jakks Pacific, Inc., 2017 WL 5508498 (11th Cir. Nov. 17, 2017).

The dispute was between the company that owns the Cabbage Patch Kids (CPK) brand and a company to which it licensed the intellectual property during 2012-2014 (the licensee).  As the end of the license agreement was approaching, CPK selected a new company to receive the license in 2015, and let them get started creating the new line of toys, so that the new line could launch right away in 2015.  The licensee claimed that was a breach of the agreement and started an arbitration.

The arbitrator concluded that CPK had not breached the agreement and ordered that the licensee had to repay CPK over a million dollars in unpaid royalties.  The licensee moved to vacate the award.  Curiously, it made arguments under both the Georgia Arbitration Code and the FAA, and the 11th Circuit considered them all.  [Maybe showing that New Hampshire was onto something in declaring the FAA does not preempt state law on vacatur?]

Under the Georgia Code, the licensee argued the arbitrator had manifestly disregarded the law by ignoring the parol evidence rule (and accepting extrinsic evidence regarding the agreement).  [Manifest disregard is a statutory basis for vacatur under the Georgia act, unlike the federal act.]  The court found there was no concrete evidence that the arbitrator purposely disregarded the law, which is the standard.  Instead, the transcript and award showed the arbitrator had understood Georgia law as instructing that the purpose of contract interpretation is to effectuate the parties’ intent, and that’s what he tried to do in reviewing the extrinsic evidence.  So, even “assuming the arbitrator incorrectly applied the parol evidence rule,” the court found he “simply made a mistake.”  That does not rise to the level of manifest disregard.

Under the FAA, the licensee separately argued that the arbitrator had exceeded his powers.  After quoting the standard from Sutter, the court quickly concluded that because the arbitrator did interpret the parties’ contract, it does not matter “whether he got its meaning right or wrong,” the award must be confirmed.

In a decision that is very skinny on the facts, a unanimous Nevada Supreme Court recently un-vacated a significant arbitration award in a dispute over dental franchises.  In Half Dental Franchise, LLC v. Houchin, 2017 WL 3326425 (Nev. Aug. 3, 2017), the court found the arbitrators did not exceed their power in exercising authority over non-signatories.

The dispute began when Half Dental Franchise filed an arbitration demand against Precision Dental Professionals and Robert Houchin (among others).  They asserted breaches of contract and tort claims (including tortious interference with contract and usurping corporate opportunities).  A three-arbitrator panel found that both those respondents were proper parties, and granted Half Dental about $6.7M in damage.  Houchin filed a motion to vacate the arbitration award  The district court granted the motion, finding that the arbitrators exceeded their power in finding authority over Houchin, and vacated the award.

On appeal, the Nevada Supreme Court found that the district court improperly conducted a de novo review of the arbitrator’s decision finding Houchin bound to the arbitration agreement by estoppel.  (Precision Dental was also a non-signatory to the franchise agreement that the arbitrator found was bound to arbitrate based on estoppel.)  The court noted that under Nevada’s state arbitration statutes, the district court should have asked simply whether there was “colorable justification for the outcome.”  Finding that the arbitrator’s citation to contemporaneous documents provided at least colorable justification for estoppel, the appellate court found no basis for vacatur.  The “colorable justification” standard was especially appropriate because the parties’ arbitration agreement contained a delegation clause, authorizing the arbitrator to “decide any questions relating in any way to the parties’ agreement or claimed agreement to arbitrate.”  (Otherwise, the question of whether non-signatories are bound is presumptively for a court to determine.)  For those reasons, the supreme court reversed the district court’s decision.

What’s the lesson here?  It might be that dentistry is a very competitive field, but it is also that if an award is vacated at the trial court, it’s usually worth bringing an appeal.

 

So you’ve got an arbitration award, what next? In other types of civil cases, the Federal Rules of Civil Procedure (Rules) control service, and they have greatly reduced the role of U.S. Marshals in serving parties. See Fed. R. Civ. P. 4(c). But enter the Federal Arbitration Act § 9 and § 12 (FAA). When a party seeks to confirm, vacate, or modify an arbitration award, § 9 and § 12 say that a nonresident party must be “served by the marshal of any district within which the adverse party may be found in like manner as other process of the court.” Which set of requirements controls here?

Since adequate service is necessary for the court to have personal jurisdiction, the question of service has been litigated in a few district courts, but no federal appellate courts. See Logan & Kanawha Coal Co.v. Detherage Coal Sales, LLC, 789 F. Supp. 2d 716, 718 (2011) (chronicling the courts that have analyzed the issue). Some courts, like the D.C. District Court in VentureForth Holdings LLC v. Joseph, have found that service consistent with the Rules also satisfies FAA § 9 and § 12. Those courts rely on the final phrase of § 9 or § 12 that says, “in like manner as other process of the court.” They read that phrase as indicating that arbitration award confirmation or modification service should follow the same rules as other civil suits. They derisively dismiss the requirement in §§ 9 and 12 as an artifact or an anachronism.

However, some courts, like the Southern District of West Virginia in Logan & Kanawha v. Detherage Coal Sales, require service by U.S. Marshal. The first and primary argument for those courts is that the plain language of the FAA §§ 9 and 12 requires service by U.S. Marshal. When confronted with the apparent tension between the Rules and the FAA, they point to the fact that Congress has not yet repealed the marshal requirement in the FAA even if the new Rules reduce the role of U.S. Marshals. The Rules, in fact, still retain the option of using U.S. Marshals to serve other parties, so a court could order service by U.S. Marshal without violating Rule 4.

All in all, there are some district courts—but not circuit courts—talking about the potential conflict between the service requirements in the Rules and the FAA, and they do not all agree. There is no circuit law on it yet, but at least some of the district courts seem content to allow Congress’ anachronism to control current outcomes. The safest bet for any party seeking to confirm, vacate, or modify an arbitration award in federal court is to use a U.S. Marshal for service, or to get an express waiver of that requirement from the opposing party.

ArbitrationNation thanks Claire Williams, a law student at the University of Minnesota Law School, for researching and drafting this post.

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A nonexhaustive list of courts not requiring marshal service

  • VentureForth Holdings LLC v. Joseph, 80 F. Supp. 3d 147, 148 (D.D.C. 2015) (“[T]his Court holds that service of a nonresident complies with § 9 of the FAA if service is provided in accordance with Rule 4 of the Federal Rules of Civil Procedure.”)
  • United Cmty. Bank v. Campbell, No. 1:10 CV 79, 2011 WL 815684, at *2 (W.D.N.C. Mar. 1, 2011) (The Court finds that the Bank properly effected service pursuant to Rule 4(e).)
  • Elevation Franchise Ventures, LLC v. Rosario, No. 1:13-CV- 719 AJT/JFA, 2013 WL 5962984, at *4 (E.D. Va. Nov. 6, 2013) (“Service of process upon an individual is governed in this court by Fed. R. Civ. P. 4(e)(1) . . . .”)
  • Hancor, Inc. v. R &R Eng’g Prod., Inc., 381 F. Supp. 2d 12, 15 (D.P.R. 2005) (relying on Reed & Martin, Inc. v. Westinghouse Elec. Corp.)
  • Litigants in the Second Circuit should be aware of Reed & Martin, Inc. v. Westinghouse Elec. Corp., 439 F.2d 1268, 1277 (2d Cir. 1971). In it, the Second Circuit analyzed the same phrase “in like manner” that courts point to when arguing that service in accordance with Rule 4 is sufficient. The court held that “[t]he phrase ‘in like manner as other process of the court’ found in § 9 of the Arbitration Act refers to Fed. R. Civ. P. 4 on the accomplishment of appropriate service, not to Fed. R. Civ. P. 12(a). . . .” While this quote appears to support service in accordance with the Rules, there are two big caveats. First, the court was addressing an issue on which the FAA is silent (time to answer). Second, this case was decided in 1971 when Rule 4 required “[s]ervice of all process shall be made by a United States marshal . . .” so at the time there was no conflict between the Rules and the FAA and therefore the court could not have addressed the current tension between the FAA and the Rules.

 

A nonexhaustive list of courts requiring marshal service:

  • Johnson v. Drake, No. 3:16-CV- 1993-L, 2017 WL 1173275, at *6 (N.D. Tex. Mar. 30, 2017) (“[C]ourts cannot simply disregard the plain language of 9 U.S.C. § 9 . . . .”)
  • PTA-FLA, Inc. v. ZTE USA, Inc., No. 3:11-CV- 510-J- 32JRK, 2015 WL 12819186, at *6 (M.D. Fla. Aug. 5, 2015) (“[S]ervice on nonresidents must be made via marshal. . . “)
  • Logan & Kanawha Coal Co. v. Detherage Coal Sales, LLC, 789 F. Supp. 2d 716, 722 (S.D.W. Va. 2011)
  • Nu-Best Franchising, Inc. v. Motion Dynamics, Inc., No. 805 CV 507T27TGW, 2006 WL 1428319, at *3 (M.D. Fla. May 17, 2006) (“Plaintiffs were required to serve notice through the United States Marshal.”)
  • Int’l Union of Operating Engineers Local 825 Employee Benefit Funds v. Getty Contracting LLC, No. CIV. 2:14-7799 KM, 2015 WL 4461512, at *2 (D.N.J. July 20, 2015) (“If it is a nonresident of New Jersey, Getty must be served via the U.S. Marshal in its home district.”)
  • Dobco, Inc. v. Mery Gates, Inc., No. CIV. 06-0699 (HAA), 2006 WL 2056799, at *2 (D.N.J. July 21, 2006) (“Rather, Dobco had an obligation to have Mery Gates served by a marshal, as the strict language of the statute provides.”)

Three state supreme courts tackled arbitration law in recent weeks: Alabama, North Carolina, and Rhode Island.  Rhode Island reversed a construction arbitration award because it disagreed with the arbitrator’s analysis.  North Carolina found that an arbitration agreement in a doctor-patient setting was unenforceable as a breach of the doctor’s fiduciary duty.  And Alabama strictly enforced an arbitral venue, even though that precluded class action.

Continuing its streak of hewing closely to the lead of federal courts on arbitration, the Supreme Court of Alabama held that plaintiffs have to arbitrate with the Better Business Bureau, even though the BBB does not conduct class action arbitration proceedings.  University Toyota & University Chevrolet Buick GMC v. Hardeman, _ So. 3d __, 2017 WL 382651 (Ala. Jan. 27, 2017).  The plaintiffs were a putative class of customers harmed by two car dealerships’ decision to stop honoring their earlier agreement to provide free oil changes.  The arbitration clause between the dealerships and purchasers called for arbitration of all disputes pursuant to the FAA, and said “either party may demand arbitration by filing with the Better Business Bureau.”  When the plaintiffs filed their demand, the BBB responded that it did not conduct class arbitrations.    The plaintiffs then withdrew their demand and filed in court, asking either to keep their fight in court or go to a forum that allowed class arbitration.  The trial court sent the plaintiffs to the AAA to decide whether class actions were available.  On appeal, the supreme court reversed in a 7-1 decision.  The majority quoted heavily from SCOTUS decisions stating that arbitration agreements should be enforced according to their terms, and found that the BBB forum was an integral part of the arbitration agreement that must be given effect.  The lone dissenter argued that, because the availability of class arbitration was for the arbitrator, it should be decided by a forum that at least retains that option.

Without any consideration of the Federal Arbitration Act, the Supreme Court of Rhode Island vacated an arbitration award.  Nappa Construction Management, LLC v. Flynn, __ A.3d __, 2017 WL 281812 (R.I. Jan. 23, 2017). (Maybe an allergy to the FAA is contagious… remember nearby New Hampshire last year?)  In a dispute between the owners of a automobile repair facility and the construction company that was hired to build it, the arbitrator issued an award that analyzed the parties’ contract and found the construction company was owed money.  The trial court refused to vacate the award, finding the arbitrator grounded his analysis in the contract and did not manifestly disregard the law.  On appeal, the Supreme Court of Rhode Island cited only cases from its own court, including labor cases, and found that the arbitrator had exceeded his authority (and the award failed to draw its essence from the agreement) by finding that the owners had effectively terminated the contract, when there was no evidence that the owners actually terminated the contract.  The court also accused the award of reaching an “irrational result.”  Two justices dissented, noting the “exceptionally deferential standard of review” for arbitration awards.  They did not, however, cite to the line from Sutter, as I would have, that even “grave error” by an arbitrator is not sufficient to vacate an award if the arbitrator in fact analyzed the contract.  (Maybe no one argued the FAA applied?  A commercial construction contract would almost certainly involve interstate commerce…)

Finally, the Supreme Court of North Carolina refused to enforce the arbitration agreement between a doctor and patient, finding that the agreement “was obtained as a result of defendants’ breach of fiduciary duty that they owed to” the patient.  King v. Bryant, __ S.E.2d __, 2017 WL 382910 (N.C. Jan. 27, 2017).  The patient had brought a medical malpractice action against his surgeon, and the surgeon tried to enforce the arbitration agreement between them.  The arbitration agreement called for application of the FAA and arbitration under health care procedures of the AAA.

The N.C. trial court refused to compel arbitration, finding the agreement was only an “agreement to agree,” and started off a crazy game of appeals court-district court ping pong involving this case.  The court of appeals reversed and remanded.  On second thought, the trial court refused to enforce the agreement because the surgeon had a fiduciary duty to disclose the arbitration agreement to his patient as a material term, and because he did not it was unenforceable.  The court of appeals affirmed, noting the application of the FAA, but finding the agreement unconscionable.  The supreme court then remanded to the trial court for further findings of fact regarding the existence of a physician-patient relationship when the agreement was signed, and the trial court complied.  Finally, the case returned to the supreme court, which held that the doctor owed a fiduciary duty to the patient and breached it “by failing to make full disclosure of the nature and import of the arbitration agreement to him at or before the time that it was presented for his signature.”  Recognizing the possibility of an argument that its holding is preempted by the FAA, the court noted “we would have reached the same result on these facts with respect to any agreement that substantially affected [the patient’s] substantive legal rights.”  However, the opinion cites no N.C. cases to support that statement, which may be fatal under the DirecTV analysis.  Two justices wrote separate dissents, based largely on FAA preemption.  (“This jiggery-pokery is precisely the type of impermissble ‘rationalization’ admonished by the United States Supreme Court. Such a tortured attempt to obviate the FAA fails.”)

What is the take away here?  It is that there is still a huge amount of variation in how a given arbitration dispute will be handled, depending on what court hears the dispute.  And the preemption rules set out in Concepcion and DirecTV are either not well understood, or are being intentionally avoided.

The Second Circuit reminded us yesterday that judicial review of arbitration awards is “among the most deferential in the law.”  And when district courts are not sufficiently deferential, their decisions are likely to be overturned.  That happened recently in Tom Brady’s “deflate-gate” arbitration, and in an arbitration over how much a pedestrian was owed after a car accident.

In the pedestrian’s dispute, the arbitrator was assigned to determine the extent of the pedestrian’s injury and what compensation should flow from that injury.  Lemerise v. The Commerce Ins. Co., 2016 WL 1458213 (R.I. April 13, 2016).  The arbitrator determined the pedestrian was entitled to $150,000 in damages plus interest of $47,550.  The insurance company moved to modify the arbitration award down to $100,000 – the limits of the policy.  The trial court granted that motion, and the pedestrian appealed.  The Supreme Court of Rhode Island reinstated the full arbitration award.  It found that the trial court had erred by considering the limits of the policy, when the insurance company had not introduced that policy as an exhibit in the arbitration.  Furthermore, the court found the limited statutory grounds for modifying the arbitrator’s award were not present.

In a case that garnered much more news coverage, the four-game suspension against Tom Brady was also reinstated yesterday by the Second Circuit Court of Appeals.  Although the district court had found the arbitration hearing lacked fundamental fairness, in a 2-1 decision the Second Circuit found the arbitrator met the low bar required by the LMRA: he acted within his authority and he was at least arguably construing the parties’ contract.

Perhaps not surprisingly, the appellate court’s description of the Brady arbitration sounds like an entire different proceeding than the one described by the district court.  This opinion describes the evidence against Brady to support the conclusion that he participated in the scheme to deflate game balls (not just was “generally aware”).  It makes ten hours of testimony and 300 exhibits sound exorbitant.  And it places significant emphasis on the cell phone destruction.

The opinion also went out of its way to emphasize that this process was what the players association bargained for, even if it “may appear somewhat unorthodox” to have the Commissioner first impose discipline and then preside over a challenge to his discipline in arbitration.  As a result, the players’ remedy “is not judicial intervention, but” to negotiate a different deal next time.  In an example of the snarky tone used for many of the arguments made on behalf of Brady, the majority wrote (about the comparison to substance abuse) that even if Brady “may have been entitled to notice of his range of punishment, it does not follow that he was entitled to advance notice of the analogies the arbitrator might find persuasive in selecting a punishment within that range.”

Today’s lesson is that famous athletes are not entitled to a less deferential standard of review for arbitration awards than the rest of us.  And, if an arbitration award in your favor is vacated by a trial court, it may be worth your while to appeal.

The Supreme Court of Hawaii ruled recently that if a neutral arbitrator fails to meet disclosure requirements, it constitutes “evident partiality” as a matter of law, and requires the vacatur of the arbitrator’s award.  Furthermore, Hawaii interpreted its disclosure requirements broadly, and in this case found an arbitrator’s failure to disclose the “concrete possibility” of his attorney-client relationship with the claimant’s counsel was enough to create a reasonable impression of partiality and demand vacatur.  Noel Madamba Contracting, LLC v. Romero, __ P.3d __, 2015 WL 7573420 (Haw. Nov. 25, 2015).
The underlying dispute involved homeowners who claimed their contractor had abandoned the construction of their new home.  After the homeowners demanded arbitration and the parties filed their ranked lists of neutrals, a retired judge, Patrick Yim, was appointed as the arbitrator in May of 2011.  The hearing took place in November of 2012, and Yim issued a partial award for the homeowners of about $155,000 on January 26, 2012.  In April of 2012, Yim also awarded the homeowners $42,000 in attorneys’ fees.  The homeowners were represented by lawyers from Cades Schutte LLP.

During that same time period, Yim’s retirement accounts needed some legal attention.  He used a third party (PSC) to manage his retirement accounts, and PSC decided it was time for an attorney to ensure those accounts complied with ERISA (and other laws).  In May of 2011, Yim was told that either Cades or another firm would be chosen to handle that review.  In December of 2011, PSC told Yim the approximate cost for the review and that his file was being sent to an unspecified law firm.  At the end of January, just days before the partial award was issued, PSC told Yim that Cades would likely do the work.  Yim first spoke with a Cades attorney in February of 2012, but Cades had not yet done any work for him and there was no engagement letter.

Within a day or so of the February meeting, which was a month after the partial award for the homeowners, Yim first disclosed his potential client relationship with Cades to the parties in the arbitration.  The contractor objected and requested more information, which resulted in two further supplemental disclosures.  In those disclosures, Yim said he had not yet actually engaged Cades and instead had instructed PSC to send his file to another firm.  The contractor was not satisfied, but the administrator affirmed Yim’s role.  The contractor then moved to vacate the award, arguing evident partiality under the Hawaii Uniform Arbitration Act.  Both the trial court and the intermediate appellate court refused to vacate the award, largely due to their analysis that arbitrators only have to disclose current or past relationships, not potential future relationships.

The Supreme Court of Hawaii remanded the case with instructions to vacate the arbitration award.  It concluded that “Yim’s failure to disclose his relationship with Cades created a reasonable impression of partiality, and as such, resulted in a violation of the disclosure requirements” in the Uniform Arbitration Act, necessitating vacatur of the award.  In its analysis, the court noted that while one subsection of the UAA requires disclosure of an arbitrator’s “past or present relationships,” the more general rule in the UAA is that arbitrators must disclose “any known facts that a reasonable person would consider likely to affect the impartiality of the arbitrator.”  The court cited to Ninth Circuit case law holding that the failure to disclose a “concrete possibility” of a connection between an arbitrator and a party or a party’s law firm can result in a reasonable impression of partiality.  Therefore, Yim’s failure to  disclose his anticipated relationship with Cades constituted evident partiality, even without any showing that Yim was “actually biased.”  The court grounded its decision in policy: “because review of an arbitration award is limited, an arbitrator’s impartiality and appearance of impartiality is paramount.”

This is an interesting opinion for many reasons, but here are a few.

  • Why is this entire case decided under the Hawaii Uniform Arbitration Act?  Was that written into the parties’ contract?  The arbitration agreement is not quoted and there is no analysis in this decision of whether the parties’ transaction involved interstate commerce.  That could have been dispositive, as many federal cases require actual proof of bias.
  • The high court did not reach the issue of whether the trial court should have allowed the contractor’s attorney to depose Yim about his contacts with the Cades firm.  However, it did say that Yim was “not immune” from testifying under the UAA, because the contractor had established prima facie grounds to vacate the award.  I would have liked to see the Hawaii court tackle this issue because there is little good analysis of that issue.
  • Yim’s status as a 24-year member of the Hawaii state courts is likely a critical, but unaddressed, factor in how this decision came out.  Did the lower courts not want to embarrass their former colleague by finding that he failed to disclose?  Conversely, did the high court want to be especially firm with former judges, to avoid any allegation that it was soft on them?  This is not unique to Hawaii — many retired judges become active arbitrators, making it awkward when their former judicial colleagues have to pass on the soundness of their decisions as arbitrators.  Maybe the rule should be that the arbitrator is never named in motions to vacate?  (Ironic…worrying about “evident partiality” by the judges who are considering whether the arbitrator showed “evident partiality.”)