Alternative Dispute Resolution
September 05, 2007
IP Litigator, September/October 2007
High Court to Consider Expanded Review of Arbitrators' Legal Decisions
One of the main benefits of arbitration is early finality. Even an adverse decision in arbitration may be preferable to the high costs and uncertaity involved in the process of litigation and appeal and relitigation after remand. To achieve the benefit of early finality, however, an arbitrator's decision is generally deemed final, even if the underlying legal reasoning is wrong, unless the decision is so egregiously biased or irrational as to present truly exceptional circumstances.
The Federal Arbitration Act ("FAA") codified the policy of finality by specifying very limited grounds for rejecting an arbitrator's award. A court may vacate an award for corruption, fraud, "undue means" or "evident partiality," or 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." [9 U.S.C. § 10.] It may modify an "evident material miscalculation of figures or an evident material mistake in the description of any person, thing, or property referred to in the award," or where the decision was on a material matter not submitted to arbitration, or where the award "is imperfect in matter of form not affecting the merits of the controversy." [9 U.S.C. § 11.]
Otherwise the parties must live with the result, even if incorrect, as a consequence of their bargain to have their dispute resolved extra-judicially. The "failure of an arbitrator to correctly apply the law is not a basis for setting aside an arbitrator's award." [Kergosien v. Ocean Energy, Inc., 390 F.3d 346, 356 (5th Cir. 2004).]
But what if the parties want arbitration of the facts of their specific dispute, but also want a judicial determination of the law, reviewable and binding in subsequent controversies? This is a reasonable objective when important legal questions affecting a business or industry are uncertain or unsettled. Must parties litigate every detail of their dispute in court in order to get a judicial statement of the law?
Although parties can conceivably arrange to bifurcate their disputes, first arbitrating the facts and then litigating on a stipulated factual record, such an arrangement is complex and rarely done in practice. May parties not follow a simpler course and refer a dispute to arbitration, reserving the right to have legal errors corrected later in court?
Up until now the unsatisfactory answer, for federal courts, is that it depends on the circuit. The majority rule, followed in the First, Third, Fourth, Fifth, and Sixth Circuits, is that parties may structure an arbitration agreement to allow a district court to correct legal error in the award. These circuits hold that the review procedures of the FAA are default provisions, not jurisdictional limitations: They govern if the arbitration provision is silent, but do not "prohibit parties who voluntarily agree to arbitration from providing contractually for more expansive judicial review of the award." [Gateway Technologies, Inc. v. MCI Telecommunications Corp., 64 F.3d 993, 997 n.3 (5th Cir. 1995).]
Under the majority rule, the FAA "sets out a substantive rule applicable in state as well as federal courts, but its rule is simply that courts must enforce the terms of private arbitration agreements." [Roadway Package System, Inc. v. Kayser, 257 F.3d 287, 288 (3d Cir. 2001) (citation omitted).] Where "parties contractually agreed to expand judicial review, their contractual provision supplements the FAA's default standard of review and allows for de novo review of issues of law embodied in the arbitration award." [Gateway, 64 F.3d at 997.]
Even in majority circuits, the expanded review provision needs to be explicit - a "generic" choice of law clause is not enough by itself to supplant the FAA's criteria. [See, e.g., Puerto Rico Telephone Co., Inc. v. U.S. Phone Mfg. Corp., 427 F.3d 21, 29 (1st Cir. 2005).] This assumes that there is an independent jurisdictional basis allowing a federal court to decide the question - jurisdiction can of course not be conferred by consent. But the majority finds nothing in the FAA to prevent parties from providing for expanded review, or any public policy requiring enforcement of arbitrators' legal errors against the wishes of the parties.
The Ninth Circuit at one time sided with the majority, [see LaPine Technology Corp. v. Kyocera Corp., 130 F.3d 884 (9th Cir. 1997)] but later in the same complicated litigation reversed its former precedent en banc and now holds it is impermissible to allow substantive review of an arbitrator's legal conclusions, even by agreement. [See Kyocera v. Prudential-Bache Trade Services, Inc., 341 F.3d 987 (9th Cir. 2003).] The court states both a policy basis and a jurisdictional basis for this position.
Broad judicial review of arbitration decisions could well jeopardize the very benefits of arbitration, rendering informal arbitration merely a prelude to a more cumbersome and time-consuming judicial review process. Congress's decision to permit sophisticated parties to trade the greater certainty of correct legal decisions by federal courts for the speed and flexibility of arbitration determinations is a reasonable legislative judgment that we have no authority to reject. [Id. At 998.]
Moreover,
parties have complete freedom to contractually modify the arbitration process by designing whatever procedures and systems they think will best meet their needs - including review by one or more appellate arbitration panels. Once a case reaches the federal courts, however, the private arbitration process is complete, and because Congress has specified standards for confirming an arbitration award, federal courts must act pursuant to those standards and no others. Private parties' freedom to fashion their own arbitration process has no bearing whatsoever on their inability to amend the statutorily prescribed standards governing federal court review. Even when Congress is silent on the matter, private parties lack the power to dictate how the federal courts conduct the business of resolving disputes. [Id. at 1000. The Tenth Circuit shares this view - see Bowen v. Amoco Pipeline Co. 254 F.3d 925 (10th Cir. 2001).]
A recent case has brought the problem of legal review of arbitration decisions into high focus. Hall Street Associates owned an industrial building in Portland, Oregon, which it leased to the toymaker Mattel. Toxic chemicals had contaminated a well on the property, arguably not during Mattel's tenancy, but neither Mattel nor its predecessors had tested the well's water as the Oregon Drinking Water Quality Act required. Hall Street sued Mattel in state court, seeking damages and declaratory and injunctive relief. Mattel removed to federal court on diversity grounds. There was no arbitration agreement in the lease, but after a trial on one of the issues in the case, and an unsuccessful mediation, the parties agreed to arbitrate the rest of their dispute, provided the district court retained authority to review the arbitrator's factual findings for substantial evidence and his legal conclusions for error. Based on LaPine, the court approved this agreement.
The arbitrator found for Hall Street, holding that although the lease required Mattel to obey applicable environmental laws, as a matter of law the Oregon Drinking Water Quality Act was not "applicable" because it was a public health measure and did not regulate property interests. Mattel sought review of this point in the district court, as the arbitration agreement allowed. The court held the arbitrator was wrong on the law and vacated the award. On remand the arbitrator changed his ruling and found for Mattel. This time the district court upheld the award, and both sides appealed aspects of the court's decision.
But in the meantime the Ninth Circuit reversed LaPine, so the expanded review, which the district court had allowed was no longer permissible. In an unreported decision, the Court of Appeals disapproved the earlier vacatur on this basis. On remand the district court vacated the award again, this time on the ground that the arbitrator's construction of the lease was "implausible." In another unreported decision, the Ninth Circuit held this improper under the FAA and ordered the arbitrator's earlier erroneous decision reinstated.
Hall Street won when LaPine was the law in the Ninth Circuit, but then lost when LaPine was superseded by Kyocera. The correctness and justice of the final result (including the deliberate enforcement of decision known to be in error) thus obviously turned on whether Kyocera was right to disallow agreed-on expanded review of an arbitrator's legal decision. On May 29, 2007, the Supreme Court granted certiorari in Hall Street Associates, LLC v. Mattel, Inc., [No. 06-989] presumably to decide this question. It is an important question for intellectual property cases, which often present complex and detailed case-specific factual issues well suited for arbitration, but also far-reaching legal questions better resolved by a court and subject to appellate review. Hall Street's certiorari petition [2007 WL 128611 at *19-20] put the issue succinctly:
In very large cases, the parties may not want to take the risk that an arbitrator will make a legal error, which is not correctable through judicial review. While these parties may very well have good reason to choose the flexibility, economy and speed which arbitration may offer with regards to the factual issues of the case, they may not be willing to give up the right to meaningful and searching judicial review on the controlling principles of law. The narrow default standards of the FAA simply do not meet their needs.
Given earlier Supreme Court decisions allowing parties to opt in to state arbitration rules [see Volt Information Sciences, Inc. v. Board of Trustees of Leland Stanford Junior University, 489 U.S. 468 (1989)] and even into private systems varying state rules [see Mastrobuono v. Shearson Lehman Hutton, Inc., 514 U.S. 52 (1995) (NASD system allowing arbitral awards of punitive damages)] it seems more likely than not that the Court will uphold the majority rule. "It is not clear that the cost and speed of dispute resolution should be considered if parties truly indicate that they prefer to partially sacrifice those interests for more reliable decision making." [Lee Goldman, "Contractually Expanded Review of Arbitration Awards," 8 Harvard Negotiation Law Review 171, 183 (2003).]
If the Supreme Court does uphold the majority rule, some observers expect reservations for expanded review of legal decisions to become more common in arbitration agreements, which could change the dynamic of IP litigation. Variations might include, for example, provisions assigning review costs to the moving party if review does not change the result.
Briefing in Hall Street will begin this summer and the case will be argued sometime next term. The certiorari briefing is already on Westlaw; links to the merits briefing and transcripts of oral argument will appear at www.supremecourtus.gov/index.html. For a good discussion of the background and the issues involved, see Milana Koptsiovsky, "A Right to Contract for Judicial Review of an Arbitration Award: Does Freedom of Contract Apply to Arbitration Agreements?", 36 Connecticut Law Review 609 (2004).
Stephanie Skaff is a partner at Farella Braun + Martel LLP and is a member of the Intellectual Property & Technology group.