Commercial Litigation and Arbitration

Current Arbitration Issues in Federal Practice

Current Arbitration Issues in Federal Practice

Gregory P. Joseph*

The Supreme Court rendered six major arbitration decisions in 2008 and 2009. This article analyzes each, and it explores other significant arbitration issues percolating in the Circuits.

Court May Entertain Only Attack on Agreement to Arbitrate Specific Issue in Dispute

An attack on the enforceability of a contract containing an arbitration clause is for the arbitrator to resolve, under the Supreme Court’s decision in Rent-A-Center, West, Inc. v. Jackson, 2010 U.S. LEXIS 4981 (U.S. June 21, 2010). Only an attack on the enforceability of the arbitration clause itself is subject to judicial determination. The Court considered that this followed from (1) the mandate of Section 2 of the Federal Arbitration Act that a “written provision ... to settle by arbitration a controversy ... shall be valid, irrevocable, and enforceable,” because Section 2 so provides “without mention of the validity of the contract in which it is contained” (Court’s emphasis), and (2) its prior holdings that “‘[a]s a matter of substantive federal arbitration law, an arbitration provision is severable from the remainder of the contract.’”

Rent-A-Center was an employment discrimination action, and the arbitration agreement was a stand-alone contract In addition to requiring arbitration of all disputes arising out of the plaintiff’s employment, it included a provision (unusual in commercial contracts) that “[t]he Arbitrator, and not any federal, State, or local court or agency, shall have the exclusive authority to resolve any dispute relating to the interpretation, applicability, enforceability or formation of this Agreement, including, but not limited to any claim that all or any part of this Agreement is void or voidable.” The Court held that this proviso (the “delegation clause”) was itself separable from the contractual agreement to arbitrate all claims arising out of the plaintiff’s employment — i.e., the rest of the contract —and must be separately attacked to permit judicial intervention.

While the doctrine applied by the Court is easy enough to summarize, its implications are fuzzy. If the arbitration agreement signed by the employee in Rent-A-Center were not a stand-alone agreement but a provision in a larger agreement, one would have thought it sufficient to attack that provision as unenforceable to obtain judicial review. Now, however, there is an argument that every dependent, “including” clause in an arbitration provision in a contract must be considered a separate agreement to arbitration and must be specifically attacked if a judge is to decide the issue of the enforceability of the agreement to arbitrate.

Non-Signatory May Compel Arbitration

Arthur Andersen LLP v. Carlisle, 129 S.Ct. 1896 (2009), addresses the interplay between the Federal Arbitration Act, 9 U.S.C. § 1 ff., and state law. First, it holds that federal courts look to state law (or, presumably, whatever law is governing) to determine whether a binding agreement to arbitrate exists. Second, Carlisle concludes that, if state law permits a non-signatory to an arbitration agreement to compel arbitration and seek to stay litigation, the FAA permits it as well. Technically, the holding is that “‘[S]tate law’ ... is applicable to determine which contracts are binding under § 2 and enforceable under § 3 ‘if that law arose to govern issues concerning the validity, revocability, and enforceability of contracts generally.’” Third, Carlisle permits such a non-signatory to appeal a denial of arbitration under § 16 of the FAA because, under that provision, “any litigant who asks for a stay under § 3 is entitled to an immediate appeal from denial of that motion — regardless of whether the litigant is in fact eligible for a stay.”

The most evocative part of the opinion is footnote 5, which reads:

We have said many times that federal law requires that "questions of arbitrability ... be addressed with a healthy regard for the federal policy favoring arbitration." *** Whatever the meaning of this vague prescription, it cannot possibly require the disregard of state law permitting arbitration by or against nonparties to the written arbitration agreement.

The latter sentence has implications for other intersections of state and federal law. For example, under the intertwining doctrine, a party to an arbitration agreement may in some circumstances compel a non-party affiliated with a party to arbitrate. See, e.g., JLM Indus., Inc. v. Stolt-Nielsen S.A., 387 F.3d 163, 177 (2d Cir. 2004). Intertwining is a federal equitable doctrine. To the extent that applicable state law is more inclusive than federal law, Carlisle sanctions the state-law approach. State law may also bind a non-party to an arbitration award that has been rendered against an affiliate. Query whether that is within the purview of Carlisle.

Carlisle applies only to domestic arbitration governed by the FAA. The Fifth Circuit has extended it to international arbitrations governed by the Convention on the Recognition and Enforcement of Foreign Arbitral Awards. Todd v. Steamship Mut. Underwriting Ass’n, 601 F.3d 329 (5th Cir. 2010) reasoned that, "in both FAA and [New York] Convention cases, courts have largely relied on the same common law contract and agency principles to determine whether nonsignatories must arbitrate, and not law derived from statute or treaty." Consequently, choice of governing law — often given little attention by drafters — has ramifications as to the identity of potential parties to a future arbitration that are not necessarily apparent on the face of the arbitration clause.

Classwide Arbitration Requires Contractual Consent

Silence in an arbitration agreement is an insufficient basis on which to proceed with classwide arbitration, under the Supreme Court's ruling in Stolt-Nielsen S. A. v. Animalfeeds Int’l Corp., 130 S. Ct. 1758 (2010). Stressing that "the contractual nature of arbitration that parties may specify with whom they choose to arbitrate their disputes," the Supreme Court held that "[a]n implicit agreement to authorize class-action not a term that the arbitrator may infer solely from the fact of the parties' agreement to arbitrate." There is some tension between Stolt and Arthur Andersen LLP v. Carlisle, 129 S.Ct. 1896 (2009), in which the Court held that, if state law permits a non-signatory to an arbitration agreement to compel arbitration, the Federal Arbitration Act (FAA) permits it as well. Under Carlisle, the arbitration clause, which ostensibly permits the parties to determine "with whom they choose to arbitrate," does not necessarily limit arbitration to the named parties.

Federal Jurisdiction over Petition to Compel Arbitration

The Federal Arbitration Act does not confer jurisdiction but requires an independent jurisdictional basis before a motion to compel or stay arbitration may be filed in federal district court. The question in Vaden v. Discover Bank, 129 S.Ct. 1262 (2009), was whether, in determining jurisdiction, the court looks at the parties and dispute before it or “looks through” to the underlying substantive dispute to determine whether federal jurisdiction exists. All of the Justices agreed that the latter, look-through approach was correct. There was a 5 to 4 split, however, on what it is that the court looks at to ascertain whether jurisdiction exists.

The majority held that the district court looks through to the existing state court pleadings. It held that, because the underlying complaint was a state-law debt collection action, there was no jurisdiction. The majority acknowledged that a counterclaim had been filed that was subject to complete preemption. It relied on the well-pled complaint rule, however, holding that the counterclaim cannot confer federal jurisdiction. The dissent argued that the state court pleadings were essentially irrelevant because the district court was directed, by § 4 of the FAA, to consider the “controversy” between the parties, and that should be construed to be the subject matter of the arbitration, not the posture of the pleadings in the state court litigation.

“Manifest Error” & Standard of Review

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., 552 U.S. 576 (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 592, and “manifest disregard” nowhere appears in those sections.

One would have thought that Hall Street thus precludes any argument that “manifest disregard of the law” remains a viable ground for vacating or modifying an arbitration award independent of the statutory grounds set forth in 9 U.S.C. § 10 and 11. That was the conclusion of the First and Fifth Circuits in Ramos-Santiago v. United Parcel Serv., 524 F.3d 120, 124 n.3 (1st Cir. 2008), and Citigroup Global Mkts. Inc. v. Bacon, 562 F.3d 349 (5th Cir. 2009). The Sixth Circuit held that “manifest disregard” does survive Hall Street as an independent ground for vacatur of an arbitration award in Coffee Beanery, Ltd. v. WW, LLC, 300 F. App’x 415, 2008 U.S. App. LEXIS 23645 (6th Cir. Nov. 14, 2008) (unpublished). The Second and Ninth Circuits more or less agree with the Fifth, holding that “manifest disregard” maintains vitality only as shorthand for 9 U.S.C. § 10(a)(4) (which authorizes vacatur “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”). See Stolt-Nielsen SA v. AnimalFeeds Int'l Corp., 548 F.3d 85, 93-95 (2d Cir. 2008); Comedy Club Inc. v. Improv West Assocs., 553 F.3d 1277, 1290 (9th Cir. 2009). The better rule is the “manifest disregard” does not survive Hall Street in any way distinct from the content of §§ 10 and 11 of the FAA.

Equally important as its ruling on “manifest disregard,” 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.

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 formulation: “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. 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.

Importantly, if the parties seek to achieve expanded review under state law, a clear agreement to that effect is required. The Third Circuit held in Oberwager v. McKenchnie Ltd., 2009 U.S. App. LEXIS 23006 (3d Cir. Oct. 20, 2009), that a generic choice of law provision is insufficient to opt out of the FAA and expand the scope of appellate review pursuant to state law.

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 & Risks in Adopting Arbitral Rules

The Supreme Court’s second 2008 arbitration decision, Preston v. Ferrer, 552 U.S. 346 (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.

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 362. 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.

Determining the Amount in Controversy: Circuit Split

The Federal Arbitration Act empowers the federal courts to confirm or vacate arbitration awards that fit the statutory criteria, but the FAA does not confer federal jurisdiction. Therefore, an independent ground of jurisdiction must exist. When diversity jurisdiction is invoked under 28 U.S.C. § 1332(a), the Court must determine the amount in controversy. There is a three-way split of authority concerning how to do so — the demand approach, the award approach and the remand approach.

Under the demand approach, the Court looks to the amount sought in the arbitration demand. Under the award approach, the demand is ignored and the Court looks to the amount actually awarded. Under the remand approach, which applies if the petition includes a request to remand and reopen the arbitration proceeding, a Court that would otherwise apply the award approach determines looks to the amount asserted in the demand that the claimant seeks to arbitrate on remand. The most recent decisions to address this issue, Karsner v. Lothian, 532 F.3d 876, 882-883 (D.C. Cir. 2008) and U-Save Auto Rental of Am., Inc. v. Furlo, 2009 U.S. Dist. LEXIS 26341 (S.D. Miss. Mar. 31, 2009) both adopt the demand approach and collect the authorities.

Post-Award Modification under Fed.R.Civ.P. 60(b)

Once an arbitration award is reduced to judgment, the FAA alone no longer governs judicial power. The judgment is subject to at least limited judicial modification, pursuant to Fed. R. Civ. P. 60(b). In AIG Baker Sterling Heights, LLC v. Am. Multi-Cinema, Inc., 579 F.3d 1268 (11th Cir. 2009), while acknowledging that “that courts cannot use Rule 60(b) to modify or vacate an arbitration award or, perhaps, to grant relief from a judgment confirming an award for reasons covered in sections 10 or 11 of the FAA,” the Eleventh Circuit affirmed a district court’s modification of a judgment based on an arbitration award to account for partial satisfaction after entry of the award, pursuant to Rule 60(b)(5).

Arbitrators’ Power to Issue Sanctions

The power of arbitrators to award sanctions was the focus of the Second Circuit in ReliaStar Life Ins. Co. v. EMC Nat’l Life Co., 564 F.3d 81 (2d Cir. 2009). It ruled that, if the parties sign a broad arbitration clause, the panel is authorized to impose monetary sanctions, including attorney's fees, even if the arbitration agreement otherwise excludes the power to award fees.

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.)

Following the Supreme Court’s decision in Arthur Andersen (discussed supra at 1), the Tenth Circuit adopted a bright-line approach to § 16(a) of the FAA and held that, “in order to properly invoke appellate jurisdiction under the Act, the movant must either explicitly move to stay litigation and/or compel arbitration pursuant to the Federal Arbitration Act, or it must be unmistakably clear from the four corners of the motion that the movant seeks relief provided for in the FAA.” Conrad v. Phone Directories Co., 585 F.3d 1376, 1379 (10th Cir.. 2009).


* Gregory P. Joseph Law Offices LLC, New York. President Elect, American College of Trial Lawyers. Chair, American Bar Association Section of Litigation (1997-98). Member, U.S. Judicial Conference Advisory Committee on the Federal Rules of Evidence (1993-99). Author, SANCTIONS: THE FEDERAL LAW OF LITIGATION ABUSE (4th ed. 2008; Supp. 2010); CIVIL RICO: A DEFINITIVE GUIDE (3d ed. 2010); MODERN VISUAL EVIDENCE (Supp. 2010). Editorial Board, MOORE’S FEDERAL PRACTICE (3d ed. 1995 - present). © 2010 Gregory P. Joseph

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