By Gordon P. Katz
The bloom is off the arbitration rose - or at least off some of the petals.
Arbitration holds out the promise of a speedy and less costly dispute resolution mechanism. To some degree, the use of arbitration is responsible for the reduced number of civil cases being tried. See, M. Galanter, "The Vanishing Trial: An Examination of Trials and Related Matters in Federal and State Courts," 1 J. Empirical Leg. Stud. 459, 462 (2004) (number of federal jury trials declined to 3,006 in 2002 from 4,279 in 1992).
Arbitration has also been blessed and cursed for the finality that an arbitration award offers. As practitioners know, an award may be vacated under either the Federal Arbitration Act (FAA) or Massachusetts' version of the Uniform Arbitration Act, G.L.c. 251, sec.12, only on the basis of a handful of grounds (for example: evident partiality, fraud, corruption, failure to receive evidence).
An arbitration award will stand even if the facts found by the arbitrator were clearly erroneous or the law was wrongly applied.
When a party believes that an arbitrator's decision was wrongly decided on the law, arbitration leaves a bitter aftertaste. What can be more frustrating than spending substantial effort in arbitrating a matter only to be left with the belief that the decision is contrary to law?
This stark possibility has sometimes led arbitration agreement drafters, or litigation counsel, to stipulate that courts or others may review an arbitrator's award and overturn it, if necessary, when the arbitrator has made legal mistakes.
The theory underlying such provisions is that just as the parties can select both the claims to be arbitrated and the procedures to be used by the arbitrators, parties should have the freedom to choose the level of scrutiny to be applied in the arbitral review process.
Not so fast.
Last month's U.S. Supreme Court decision, Hall Street Associates LLC v. Mattel Inc., __S. Ct. __, 2008 WL 762537 (2008), determined that the Federal Arbitration Act does not permit judicial review for an arbitrator's legal errors - even where the parties agreed that the award would be reviewable on that basis.
In so deciding, the court seriously undercut the ability to obtain review of legal errors in arbitration. But while making it more difficult for arbitration awards to be reviewed for legal error, the Supreme Court's decision does not necessarily make such review impossible.
'Hall Street'
Hall Street owned a factory site in Oregon leased by tenant Mattel. Well water on the property was badly contaminated, and testing, which was apparently required under the Oregon Drinking Water Quality Act (ODWQA), had not taken place.
Hall Street filed suit against Mattel in Oregon state court seeking declaratory relief, injunctive relief and damages for the contamination. It alleged, among other things, that the lease required Mattel to indemnify it from all actions relating to the condition of the property.
Relying on diversity jurisdiction, Mattel removed the case to federal District Court.
After taking a separate issue to trial, the parties submitted, and the court approved, an agreement to arbitrate the remainder of the case. The agreement provided for de novo judicial review of the arbitrator's legal rulings - a more expansive scope of review than provided by the FAA, which limits review to: (1) awards procured by corruption, fraud or undue means; (2) cases in which the arbitrators are obviously partial or corrupt; (3) where there is misbehavior prejudicing a party's rights; and (4) where the arbitrators exceed their power, or so imperfectly executed their power that no "mutual, final, and definite award" was made.
The arbitrator ruled that Mattel did not need to indemnify Hall Street. Underlying this decision was the finding that Mattel had not violated "any applicable environmental laws," an exception to the indemnity requirement under the property lease.
Hall Street moved to vacate the proceeding in District Court. The court granted the motion and remanded the case to the arbitrator, deeming erroneous the arbitrator's conclusions that the ODWQA was not an applicable environmental law and that the exception to indemnification applied.
On the next round, the arbitrator ruled in Hall Street's favor, and the District Court, in turn, upheld the award.
On appeal, the 9th U.S. Circuit Court of Appeals reversed the District Court's decision vacating the initial arbitral award, reasoning that the arbitration agreement's provision expanding judicial review was unenforceable.
In the 9th Circuit's view, courts must enforce an arbitration award "unless [they] determine [] that the award should be vacated [modified or corrected] on the grounds allowable under [the FAA]."
Back to the District Court, the initial arbitration award was again vacated on the basis that the arbitrator exceeded his power within the FAA with an "implausible interpretation of the contract."
Then up once more to the 9th Circuit, the Appeals Court again reversed the District Court, holding that "implausibility is not a valid ground for voiding an arbitration award" under the FAA. The Supreme Court, in due course, granted certiorari.
In the Supreme Court's decision last month, Justice David H. Souter, writing for a 6-3 majority, agreed with the 9th Circuit that the FAA's grounds for vacatur and modification of awards may not be expanded.
Hall Street had argued that the parties' agreement to allow review for legal error should prevail because arbitration is a creature of contract, and the parties had freely agreed that the arbitration award was to be reviewable for legal error.
Rejecting the argument, Souter stated that the FAA's text did not permit parties to add new grounds for FAA review of arbitration awards. "Instead of fighting the text, it makes sense to see the three provisions [of the FAA] as substantiating a national policy favoring arbitration with just the limited review needed to maintain arbitration's essential virtue of resolving disputes straightaway."
The Supreme Court, however, left open one window for review for legal error of the arbitration award in Hall Street.
Under the particular facts of Hall Street, the parties' arbitration agreement had been made following commencement of the parties' litigation in the District Court. Moreover, the parties' agreement - containing the review for legal error provision - had been entered as an order of the District Court.
Accordingly, the Supreme Court sent the case back to the 9th Circuit for further proceedings to determine whether the court's order endorsing the parties' agreement permitting judicial review of the arbitrator's decision could be a basis for review under the District Court's authority to manage its cases, per Rule 16 of the Federal Rules of Civil Procedure.
That will be the next stage of Hall Street's complicated procedural history.
'Hall Street' and the future
Hall Street and a number of amici vigorously urged that the court rule that the FAA permits the statutory grounds for vacatur and modification of an award to be supplemented by contract. They predicted that the court's ruling otherwise would deter parties, particularly corporate parties, from choosing arbitration in the first place.
Only time will tell if this prediction is correct. But what are parties to do if they wish to design an arbitration proceeding where the arbitrator's legal conclusions will be reviewable?
If their arbitration agreement comes after the filing of suit, and if the agreement (with expanded review provisions) is incorporated into a court order, then, like the parties in Hall Street, these contracting parties may be able to avail themselves of judicial review via Rule 16.
But what if you are the lawyer drafting an arbitration agreement in a contract, and you wish to provide some protection against legal error in the proceeding?
Some have suggested that the court's holding in Hall Street does not sound the death knell for heightened review under the FAA, because parties to an arbitration might guard against legal error by agreeing that the arbitrator must follow the law or by adopting rules (e.g., the National Arbitration Forum's Code of Procedure) that require the arbitrator to follow the law. That way, if the arbitrator disregards or misapplies the law, the award is arguably subject to vacatur on the statutory basis that the arbitrator has exceeded his powers.
Another approach might be to provide for a contractual arbitration appeal process: design a two-stage arbitration.
In step 1, arbitration as usual. In step 2, provide in the parties' agreement a single arbitrator, or a panel of three, to review the arbitration award for legal errors (and possible other deficiencies). More costly, to be sure, this two-stage arbitration provides some measure of security that legal principles will be properly followed in arbitration without running head-on into the court's holding in Hall Street.
But what about arbitration agreements providing for legal review sitting on the shelf?
Parties should review these agreements and consider whether changes are needed to preserve expanded judicial review, if desired, consistent with Hall Street. MLW
Gordon P. Katz is a litigation partner at Holland & Knight in Boston. He occasionally serves as an arbitrator.
May 12, 2008
