Arbitration of commercial disputes has many advantages. It is generally faster than litigation in either federal or state court. Since discovery tends to be far more circumscribed, the prehearing process is much less expensive than litigation in court. Arbitration also enables the parties to select the decision-makers and to ensure their controversy will be resolved by those with relevant expertise.
Another advantage of arbitration is that the decision is normally "final." The same term is used in court cases, but it means only that the decision at the trial level, once fully complete, simply sets the stage for an appeal. By contrast, in most arbitrations, the decision of the arbitrators truly is final.
Nevertheless, courts do have some role in assuring that the arbitral award meets at least minimal standards of procedural fairness and, perhaps, substantive reliability before they affix their imprimatur. This narrow but important role for judicial review raises significant tactical issues for parties to arbitration in the relatively small number of cases that are taken to court. The choice of the forum in which review is sought, either to enforce an award or to overturn it, may determine whether the award stands or falls.
If the underlying agreement involves interstate commerce, the arbitration will be governed by the Federal Arbitration Act, 9 U.S.C. §§1 et seq. This statute spells out the procedure for seeking judicial enforcement or review of an arbitration award. Under 9 U.S.C. §9, the forum for seeking judicial enforcement is the federal court specified in the parties' agreement, if any. For reasons later explained in this discussion, counsel drafting commercial agreements that contain arbitration clauses should consider carefully whether to prescribe such a forum and to make it exclusive.
If the contract is silent on the forum, §§9, 10 and 11 provide that the federal court for the district "within which the arbitration award was made" may confirm and enforce it, vacate or modify, and "correct it in certain ways and under limited conditions. These sections imply that the local forum in which the arbitration proceeding was held and the award rendered is the exclusive forum for confirming, modifying, or vacating an arbitral award. Nothing in the Federal Arbitration Act expressly authorizes resort to any other forum in order to seek judicial review.
Several years ago, however, the U.S. Supreme Court rejected that implication, holding that the repeated references to the powers of the federal court in the district in which the award was rendered merely provide a "permissive" choice of venue. In addition, an action to confirm, modify or vacate may be filed in any district in which there is personal jurisdiction over the adverse party (the losing party in a confirmation proceeding or the prevailing party in a vacatur proceeding) and in which venue is otherwise permissible under general venue principles. See
Cortez Byrd Chips v. Bill Harbert Constr. Co., 529 U.S. 193, 197-204 (2000).
This ruling vastly expands the range of permissible venue choices and, as discussed below, presents corporate and litigation counsel with important tactical options that may determine the outcome of the proceeding. Under the general federal venue statute, 28 U.S.C. §1391, venue exists in any district in which "substantial part of events or omissions giving rise to claim occurred" or in which a corporate defendant is subject to personal jurisdiction.
Many commercial transactions that may give rise to an arbitral dispute traverse many federal districts, each of which may be a plausible candidate for post-arbitration judicial review. More significantly, any major national or multinational corporation may have adequate contacts with dozens of federal districts around the country, thus making that corporation subject to in personam jurisdiction in a diverse array of potential forums. This means that, in many substantial arbitrations, each side will be able to choose among many possible U.S. Courts of Appeals in which to seek to enforce or to vacate the arbitral award.
Section 10 of the Federal Arbitration Act specifies that a reviewing court may vacate an award, where:
- The award was "procured by corruption, fraud or undue means"
- The arbitrators were guilty of "evident partiality or corruption"
- The arbitrators were guilty of procedural "misconduct," such as "refusing to postpone the hearing" despite sufficient cause or "refusing to hear" pertinent evidence
- The arbitrators "exceeded their powers" or failed to make an award on a matter submitted to them.
Section 11 provides that a court may "modify or "correct" an award in order to effectuate its intent under limited circumstances
Each of these statutory provisions, narrow as they are, is the source of potential litigation by parties and counsel determined to challenge the "finality" of an arbitral award.
What is more interesting, however, is what the federal courts have done with a nonstatutory doctrine of judicial review: the inquiry whether the award reflects a "manifest disregard of the law." This is the concept that allows varying degrees of judicial review in virtually every circuit court, even though all but one disclaim the power to set aside arbitral awards that are otherwise "arbitrary and capricious." See
Brabham v. A.G. Edwards & Sons, Inc. (5th Cir. No. 93-60679, June 28, 2004) (slip op. 9-10 discussing circuits' "disarray" on availability of arbitrary-and-capricious review).
'Manifest Disregard' More than 50 years ago, the Supreme Court suggested that a federal court's refusal to enforce an arbitral award — apart from any other objection — involves a "manifest disregard of the law." See
Wilko v. Swann, 346 U.S. 427, 436-37 (1953). It gave no guidance for pouring judicially manageable standards into this flexible container of judicial authority.
More recently, the Court reaffirmed this font of judicial power in
First Options, Inc. v. Kaplan, 514 U.S. 938, 942 (1995), again without attempting to define the scope and limits of this authority.
The crucial, unstated premise of this concept is that arbitrators must apply governing law and — unless the parties have agreed otherwise — are not free simply to do what they consider "just" or "equitable." The "manifest disregard" inquiry allows the courts to enforce that duty.
That is where the tactical issue for clients and lawyers arises. Left bereft of guidance from the Supreme Court, the circuit courts have formulated a dizzying variety of "tests" for their district judges to use when called on to review arbitral awards. This disarray makes forum selection crucial, because some awards may survive the prevailing test in one circuit but flunk a more intrusive inquiry in another. A brief survey of some illustrative cases will make the point.
In the U.S. Court of Appeals for the Seventh Circuit, an arbitral award fails the test only if the arbitrators "directed the parties to violate the law."
George Watts & Sons v. Tiffany & Co., 248 F.3d 577, 579-80 (2001). This test is borrowed from federal labor law, where the courts have allowed arbitrators handling employment grievances to order virtually any relief that does not require the employer to violate some specific command of the law. Thus, under this highly deferential inquiry, commercial arbitrators may compel anything not affirmatively forbidden by law.
In the Fifth Circuit, the test is almost as difficult to flunk. An award may be set aside only if the "award indisputably runs contrary to clearly applicable law known to the arbitrators."
Brabham v. A.G. Edwards & Sons, Inc., (No. 03-60679, June 28, 2004) (slip op 15). Even if it is "manifest" that arbitrators acted contrary to law, their award must be upheld unless upholding the award "would result in significant injustice," considering the arbitrators' power to establish norms for the relationships between the parties.
State Concern Turkmenneft v. Bridas S.A.P.I.C., 345 F.3d 347 (2003), cert denied, March 22, 2004 (turning down the opportunity to reduce the inter-circuit confusion).
Thus, courts in the Fifth Circuit will enforce an award that is contrary to law, unless it is also "unjust" to do so.
Fourth Circuit Approach The Fourth Circuit takes a different approach in fashioning a test that also makes it hard to overturn an arbitral award. There, the issue is whether "the award, however arrived at, is rationally inferable from the contract."
Apex Plumbing Supply Inc. v. U.S. Supply Co., 142 F.3d 188, 193 n.5 (1998). Accordingly, in that circuit, a reviewing court may supply valid rationale for the award, even if the arbitrators' stated grounds for reaching their result conflicts with governing law.
The First Circuit articulates the most tendentious "test." An award may be vacated if it was "(1) unfounded in reason and fact; (2) based on reasoning so palpably faulty that no judge or group of judges ever could conceivably have made such a ruling; or (3) mistaken based on a crucial assumption that is concededly a non-fact."
Prudential-Bache Sec. Inc. v. Tanner, 72 F3d 234, 238 (1995).
This appears to confine review very narrowly, looking for palpable error of law or fact. Opening the door this way, however, actually provides disappointed clients and their counsel with a little elbow room. For example, anyone who has read recent Supreme Court decisions will realize that many dissenting justices are prepared to say that "no reasonable justice "could possibly reach the result ordained by the majority. Thus, this test gives the party challenging an arbitral award the rhetorical weapon to lambaste the arbitrators for getting it "so wrong" that a court should step in to clean up the mess.
Searching Inquiry Approach The Second Circuit uses a more searching inquiry, one that the D.C. Circuit and Sixth Circuit follow. Under that test, a reviewing court may vacate an award if the arbitrators (1) "knew of a governing legal principle yet refused to apply it or ignored it altogether" and (2) such legal principle was "well defined, explicit and clearly applicable."
Hardy v. Walsh Manning Sec. LLC, 341 F.3d 126, 129 (2nd Cir. 2003); see also
Nationwide Mut. Ins. Co. v. Home Ins. Co., 330 F3d 843, 847 (6th Cir. 2003);
LaPrade v. Kidder Peabody & Co., 246 F.3d 702, 706 (D.C. Cir. 2001). This test allows vacatur if arbitrators committed a "fundamental mistake of law" and is close to the standard that appellate courts use for reviewing decisions of trial judges, although the Second Circuit applies the standard more circumspectly in arbitration cases than in court trials.
This kind of standard of review prompts the question whether the "manifest disregard" standard requires arbitrators to write opinions that reflect their analysis of the law and its application to the facts.
Appellate courts insist that lower courts trying cases must file formal findings of fact and conclusions of law in order to lay out the basis for the ruling under review. See Rule 52(a), Fed. R. Civ. P. (requiring trial judge in all non-jury cases to "find the facts specially and state separately its conclusions of law thereon').
Traditionally, arbitrators have not been bound to write opinions, and many simply render a conclusory award.
Second Circuit Reflecting its more intrusive approach to reviewing arbitral awards, the Second Circuit has formulated an interesting twist in applying the "manifest disregard" standard.
When the court's independent review of the record leads it to believe that the arbitrators' decision appears to conflict with "strong evidence" to the contrary, the court has warned that — while arbitrators need not "write opinions in every case or even in most cases" — the "absence of an explanation may reinforce the reviewing court's confidence that the arbitrators engaged in manifest disregard."
Halligan v. Piper Jaffray, Inc., 148 F.3d 197, 204 (1998) (vacating award). The message is plain: If the arbitral award is not accompanied by a reasoned opinion, the Second Circuit considers itself free to engage in highly intrusive, independent review of the record.
Moreover, under any of the varying tests for judicial review, the circuits are divided over whether arbitrators' "disregard" of the law must be "intentional" or "willful" or whether it is sufficient that they simply "ignored" the applicable law — in the sense that they reached a result that the reviewing court believes the court itself would not have reached, if the court had been making the decision.
In sum, although one of the key advantages to arbitration is that it provides a vehicle for getting quickly to a "final" resolution of a commercial dispute, courts have a small but important role in reviewing arbitral awards. The current divergence among the circuits provides lawyers for parties to arbitrations with intriguing tactical choices when they seek either to confirm the award or to attack it.
Philip Allen Lacovara, a mediator and arbitrator with JAMS, The Resolution Experts, is senior counsel at Mayer Brown Rowe & Maw.