This article analyzes recent developments in the field of arbitration, including two U.S. Supreme Court decisions, one of which illustrates perhaps unexpected implications of incorporating the arbitral rules of the American Arbitration Association or other organization.
“Manifest Error” Manifestly Erroneous. Although prevailing wisdom since Wilko v. Swan, 346 U.S. 427 (1953), had been that federal courts are empowered under the Federal Arbitration Act to vacate awards issued in “manifest disregard” of the law, the Supreme Court found that view erroneous in Hall Street Assocs. LLC v. Mattel, Inc., 128 S.Ct. 1396 (2008). Hall Street holds that the FAA “confines its expedited judicial review to the grounds listed in 9 U.S.C. §§ 10 and 11,” id. at 1408, and “manifest disregard” nowhere appears in those sections.
Unalterable Standard of Judicial Review. Equally important, Hall Street holds that, because the statutory grounds for judicial review of arbitration awards are exclusive, parties may not by agreement confer jurisdiction on a federal court to apply an expanded scope review. Id. at 1404-05.
After Hall Street, arbitration clauses should be revisited to build in protection against arbitrary awards. The best defense is a good panel; selection should not, therefore, be delegated to any organization. Arbitrators should be required to decide the matter under law (one formulations: “The arbitration panel shall decide in law and not as ‘amiables compositeurs’ or ex aequo et bono”). The arbitration clause should require a “reasoned decision.”
Broader judicial review is not necessarily precluded under state law, and Hall Street indicates that parties may wish to draft their agreements to afford review under hospitable state law. Id. at 1406. This is not an unproblematic alternative, however. If the FAA applies and a court, on application of the prevailing party, therefore “must” confirm it under 9 U.S.C. § 9, then the arbitration clause must be drafted around Section 9 of the FAA. For example, it could preclude any party from seeking enforcement, and could specify that “a judgment of the court shall not be entered upon the award made pursuant to the arbitration” (negating a predicate of Section 9), until the state court review process has occurred.
If the drafting does not successfully circumvent Section 9, it may make little difference to a judge that the motion to confirm is brought in violation of a contract because the judge’s determination of the motion is statutorily compelled. The contract could provide for a right to specific performance to prevent the motion to compel, but at some point the original goal of expediting dispute resolution via arbitration would seem to be lost.
Note that Hall Street leaves open the possibility that, after a federal litigation has commenced, the parties might be able to achieve arbitration with a broader scope of review if they obtain a Court order to that effect, under Fed.R.Civ.P. 16. This seems needlessly awkward and uncertain. If the parties are already in court, why not simply designate the arbitrator a special master under Rule 53? The parties can determine the scope of factual review (including barring it altogether), and legal review will be de novo. See Fed.R.Civ.P. 53(f)(3)-(4). Any difference in the standard of review between “manifest error” and de novo would appear modest relative to the certainty that the procedure affords.
Arbitration Trumps Administrative Forum. The Supreme Court’s other arbitration decision, Preston v. Ferrer, 128 S.Ct. 978 (2008), holds that the FAA overrides not only state statutes that refer disputes initially to a court, but also state statutes that refer disputes initially to a state administrative agency. Id. at 987.
Risks of Incorporating Arbitral Rules. The interesting part of the Preston decision is not that holding, which seems largely inescapable (technicalities aside, why would an administrative agency be due greater deference than a judge?), but the Court’s reliance on American Arbitration Association Rules as reinforcing its result. The arbitration clause before the Court incorporated the AAA Commercial Arbitration Rules, and AAA Rule R-7(b) provides that “[t]he arbitrator shall have the power to determine the existence or validity of a contract of which an arbitration clause forms a part.”
This Rule, the Court held, “weigh[ed] against inferring” that the California administrative procedure was contemplated simply because the contractual choice of law provision designated California law. Id. at 989. Rather, the state law chosen in the contract “govern[s] the substantive rights and obligations of the parties,” but the arbitral rules take precedence over the state’s “special rules limiting the authority of arbitrators.” Id.
The first lesson of Preston is not to incorporate any arbitral rules without reading them. It is dubious that the drafter of the contract at issue in Preston knew what the AAA Rules provided because contracts are usually drafted not by litigators but by corporate lawyers, who are unfamiliar with the rules they incorporate and may just be following a form.
The second lesson of Preston is that there is no need to incorporate any arbitral rules — the parties may select rules at the time a dispute arises or, if they cannot agree at that time, the arbitrators will determine them. It is essential only to build into the contract the methodology for selecting the arbitrators. In any event, contract drafters should not select rules without ascertaining their treatment of discovery, punitive damages, injunctive relief and other issues important to the parties.
Appealability: Motion to Compel vs. Motion to Dismiss. If a party commences litigation despite an arbitration clause, the counterparty may move to compel arbitration or simply move to dismiss the litigation. If a motion to compel is denied, it is appealable under 9 U.S.C. § 16(a)(1)(C). But if a motion to dismiss is denied, there is a Circuit split as to whether the denial is appealable as tantamount to denial of a motion to compel. The Second Circuit in Wabtec Corp. v. Faiveley Trans. Malmo AB, 525 F.3d 135 (2d Cir. 2008) (an opinion that collects the cases on both sides of the issue), concluded that denial of a motion to dismiss is an unappealable interlocutory order. Given the risk of a motion to dismiss, because any motion can be lost, the motion to compel will ordinarily be the more prudent alternative. (Query whether a motion to compel arbitration in Wabtec would still be available on remand.)
Appealability: Motion to Stay by Non-Party. The question in Carlisle v. Curtis, Mallet-Prevost, Colt & Mosle, LLP, 521 F.3d 597 (6th Cir. 2008), was whether non-parties to an arbitration agreement could appeal the denial of their motion to stay a federal litigation pending arbitration between the plaintiff and a co-defendant who had signed an arbitration agreement. There is a split in the Circuits on this issue. Denial of a stay, under 9 U.S.C. § 3, is generally appealable under 9 U.S.C. § 16. But Carlisle, after reviewing the split of authorities, concludes that a non-party has no right to appeal because Section 3 requires "an agreement in writing " to be entitled to a stay. Carlisle, like Wabtec, teaches that appellate courts construe appealability in arbitration cases.
Waiver of Arbitration by Motion in the Alternative. The D.C. Circuit ruled in Khan v. Parsons Global Servs., Ltd., 521 F.3d 421 (D.C. Cir. 2008), that the right to arbitrate was waived by a party’s inclusion in its motion to compel a motion for summary judgment in the alternative. The Court reasoned that “filing a motion for summary judgment based on matters outside of the pleadings is inconsistent with preserving the right to compel arbitration ... [because] the movant takes the risk that the district court will choose to rule on the motion for summary judgment, thereby preventing the movant from subsequently seeking arbitration.”
One would have thought that the alternative motion for summary judgment was an efficient means of teeing up an issue that need not be reached if the threshold issue of arbitrability were decided adversely. Note that any potentially dispositive motion in the alternative is subject to this analysis. Given that an arbitration clause is a form of venue selection clause, this decision should give one pause in filing alternative motions not only in the arbitration setting but any time that there is a dispute over the choice of forum.
Sua Sponte Dismissal Based on Arbitration Clause. The District Judge in Auto. Mechs. Local 701 v. Vanguard Car Rental USA, Inc., 502 F.3d 740 (7th Cir. 2007), noticed that the parties’ cross-motions for summary judgment arose out of a contract with an arbitration clause that neither side had invoked, and dismissed the action sua sponte. The Seventh Circuit reversed because parties are entitled to waive arbitration. “Enforcement of a forum selection clause (including an arbitration clause) is not jurisdictional; it is a waivable defense....” Consequently, “District courts should not, as a matter of general practice, dismiss sua sponte either for improper venue or for failure to follow a forum selection clause.”
Failure to Rule on Discovery Motion within Arbitrator’s Discretion. In Halim v. Great Gatsby’s Auction Gallery, Inc., 516 F.3d 557 (7th Cir. 2007), the losing party contended that “the arbitrator ‘manifestly disregarded the law’ by declining to formally rule on a discovery dispute.” Putting aside the subsequent demise of the “manifest error” doctrine, the opinion is important because the Seventh Circuit concluded that the failure to decide the discovery dispute was consistent with the goal of arbitration — expeditiously and economically resolving disputes — and with a generic order entered by the arbitrator pursuant to AAA Rule L-4 “instructing the parties to complete discovery in good faith and without micromanagement.” Calculated dormancy affirmed.
* Mr. Joseph, of Gregory P. Joseph Law Offices LLC in New York, is a fellow of the American College of Trial Lawyers and former Chair of the Section of Litigation of the American Bar Association. He can be reached at email@example.com. © 2008 Gregory P. Joseph
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