Room for Error

By Thomas E.L. Dewey and Kara Siegel

GC New York

May 15, 2008

Arbitration of commercial disputes has become increasingly common, due in part to the widely held perception that arbitration is a less expensive and more expeditious method of dispute resolution. Recent court decisions, however, have underscored the fact that those perceived benefits come at a price: the U.S. Supreme Court ruled last month that parties cannot agree to a higher standard of judicial review of arbitration awards, and appeared to question the validity of a long-standing doctrine that does permit courts to overturn arbitration awards that are in "manifest disregard" of the law. The net result: parties who agree to arbitrate their disputes should understand that it will be very difficult to obtain relief from an erroneous arbitration award.

The 'Hall Street' Decision

The U.S. Supreme Court recently held in Hall Street Associates, LLC v. Mattel Inc., No. 06-989, 552 U.S., 2008 WL 762537 (March 25, 2008), that parties cannot expand by contract the scope of judicial review of arbitration awards under the Federal Arbitration Act (FAA). In a 6-3 decision, the Court held that the statutory grounds for vacating or modifying an arbitral award, laid out in §§10 and 11 of the FAA, respectively, are the sole grounds for judicial review of an award. 2008 WL 762537, at *4. In so doing, the Court also appeared to question a doctrine called "manifest disregard of the law." That doctrine has been applied by federal courts in various circuits, including the U.S. Court of Appeals for the Second Circuit in New York, to provide substantive judicial review of last resort to arbitration awards that willfully and clearly depart from well-established law.

Sections 10 and 11 of the FAA explicitly provide for federal judicial review of an arbitration award. A district court faced with evidence that the arbitration was tainted by "corruption, fraud, or undue means," that the arbitrators were "guilty of misconduct" or partiality, or that they "exceeded their powers" can vacate the award entirely. 9 USC §10. A court may also modify the award in case of "evident material miscalculation" or "evident material mistake," or in an instance where an award is granted upon a matter not submitted to arbitration, or is "imperfect in matter of form not affecting the merits of the controversy." 9 USC §11. The Supreme Court clarified in Hall Street that §§10 and 11 provide "the FAA's exclusive grounds for expedited vacatur and modification." 2008 WL 762537, at *4.

Hall Street involved a waste cleanup dispute in federal district court in Oregon between landlord Hall Street Associates and tenant Mattel. The parties proposed that Hall Street's indemnification claim be submitted to arbitration, and the district court approved and entered as an order the arbitration agreement drawn up by the parties. That agreement provided in part that:

[t]he United States District Court for the District of Oregon may enter judgment upon any award, either by confirming the award or by vacating, modifying or correcting the award. The Court shall vacate, modify or correct any award: (i) where the arbitrator's findings of facts are not supported by substantial evidence, or (ii) where the arbitrator's conclusions of law are erroneous. Id. at *3.

The parties had thus contracted for a broader scope of judicial review than the grounds set forth in the FAA.

The district court twice reviewed decisions of the arbitrator on motion by the parties, vacating the first award and modifying the second, each time applying the standard of review provided in the arbitration agreement, which included review for legal error. Id. The U.S. Court of Appeals for the Ninth Circuit reversed the district court, finding unenforceable the provision of the arbitration agreement controlling the mode of judicial review. Id.

The Supreme Court agreed (but vacated and remanded for other reasons). Id. at *4. The Court rested its decision in large part on the language of the statute, particularly insofar as it comports with congressional policy underlying the FAA. Justice David Souter, writing for the majority, emphasized the language of §9 of the FAA, which provides that a court "must grant" an order confirming an arbitration award "unless the award is vacated, modified, or corrected as prescribed in sections 10 and 11," noting that "[t]here is nothing malleable about 'must grant,' which unequivocally tells courts to grant confirmation in all cases, except when one of the 'prescribed' exceptions applies." 2008 WL 762537, at *6.

The Court read §§9, 10 and 11 together "as substantiating a national policy favoring arbitration with just the limited review needed to maintain arbitration's essential virtue of resolving disputes straightaway." Id. at *7. The Court further warned that "[a]ny other reading opens the door to the full-bore legal and evidentiary appeals that can render informal arbitration merely a prelude to a more cumbersome and time-consuming judicial review process, and bring arbitration theory to grief in post-arbitration process." Id. at *7 (quotation and citations omitted).

Thus, in holding that §§10 and 11 provide the sole basis for judicial review of arbitration awards under the FAA, and that the provision in the parties' arbitration agreement for an expanded scope of judicial review was therefore unenforceable, the Court underscored that any other ruling could threaten the very purpose of the FAA - the speedy resolution of disputes. Even as it wrote in defense of the FAA, however, the Court may have diminished the appeal of the swift results attainable through federal arbitration. Responding to one of Hall Street's contentions, the Court called into question the established doctrine of judicial review of arbitration awards for manifest disregard of the law.

'Manifest Disregard'

Hall Street argued that judicial review under the FAA not only can be expanded, but has already been expanded by the courts, citing the Supreme Court's decision in Wilko v. Swan, 346 U.S. 427 (1953). Indeed, Wilko's distinction between an arbitrator's "manifest disregard" of the law and his interpretation of the law, which that court explicitly stated was not subject to judicial review for error, id. at 436-37, has been read by most Circuit Courts of Appeals to create a further ground for vacating an arbitral award. As the Second Circuit explained in Hoeft v. MVL Group Inc., "[t]he Supreme Court has supplemented the FAA with an additional ground not prescribed in the statute: manifest disregard of the law." 343 F.3d 57, 64 (2d Cir. 2003).

The Supreme Court in Hall Street acknowledged this interpretation of Wilko, citing Hoeft as well as recent opinions from the First, Fifth and Eleventh circuits. However, rather than explicitly accepting or rejecting this "supposed judicial expansion" of review under the FAA, the Court highlighted myriad possible meanings of "manifest disregard" which could reasonably be taken from "the vagueness of Wilko's phrasing":

Maybe the term "manifest disregard" was meant to name a new ground for review, but maybe it merely referred to the §10 grounds collectively, rather than adding to them. Or, as some courts have thought, "manifest disregard" may have been shorthand for §10(a)(3) or §10(a)(4), the subsections authorizing vacatur when the arbitrators were "guilty of misconduct" or "exceeded their powers." Id. at *5 (citations omitted).

The Court's brief treatment of manifest disregard leaves open several possibilities. Perhaps manifest disregard does provide an additional ground for a district court to vacate an arbitral award. In that case, the Court may have been merely unwilling "to accord [Wilko] the significance that Hall Street urges," id. - that is, the Court was unwilling to make the "leap" proposed by Hall Street, which argued that "if judges can add grounds to vacate (or modify), so can contracting parties." Id. at *5.

On the other hand, perhaps the Court has interred the doctrine entirely by sleight of hand. If so, parties to an arbitration, limited to the procedurally focused review afforded by §§10 and 11 of the FAA, would be left with no way to seek substantive review of an award clearly contrary to the law.

More likely, given the Court's noncommittal language, the Courts of Appeals, which currently permit review for manifest disregard of the law, may continue to do so with the understanding that they are applying "the §10 grounds collectively, rather than adding to them." Id. at *5. Indeed, while the U.S. Court of Appeals for the First Circuit recently interpreted Hall Street as having eliminated manifest disregard altogether, Ramos-Santiago v. United Parcel Serv., No. 07-1024, 2008 WL 1822430, at *2 n. 3 (1st Cir. April 24, 2008) (interpreting Hall Street to say "that manifest disregard of the law is not a valid ground for vacating or modifying an arbitral award" in FAA cases), other courts, including the New York Supreme Court, have disagreed, instead treating manifest disregard as encompassing the review afforded by §10 of the FAA. See Chase Bank USA v. Hale, No. 601011/07, 2008 WL 1746984, at *5 (Sup. Ct. New York Co. March 31, 2008) (noting that "the Hall Street Court has done nothing to jettison the 'manifest disregard' standard," and accordingly applying it as "judicial interpretation of the section 10 requirements, rather than as a separate standard of review").1

In any case, the Supreme Court's questions concerning the doctrine may well make those Courts of Appeals that have recognized it even more reluctant to apply it - and suggest that parties aggrieved by erroneous arbitration awards may want to try a different tactic.

Remand to Arbitration Panel

Even under existing case law, a party seeking to show "manifest disregard of the law" by an arbitrator had a heavy burden: in the Second Circuit, for instance, manifest disregard of the law is a "doctrine of last resort" whose "use is limited only to those exceedingly rare instances where some egregious impropriety on the part of the arbitrators is apparent, but where none of the provisions of the FAA apply." Wallace v. Buttar, 378 F.3d 182, 189 (2d Cir. 2004).

Even where a court agrees to review an award for evidence of manifest disregard of the law, the standard of review is highly deferential. "An arbitral award may be vacated for manifest disregard of the law only if a reviewing court . . . finds both that (1) the arbitrators knew of a governing legal principle yet refused to apply it or ignored it altogether, and (2) the law ignored by the arbitrators was well defined, explicit, and clearly applicable to the case." Id. (citations and quotations omitted).

Manifest disregard, then, is not mere ignorance or error. Nor does it encompass the situation in which the arbitration panel makes "the wrong call" on the law. Id. at 190. Rather, a party must show that the arbitrator or panel has knowingly "refus[ed] or neglect[ed] to apply a governing legal principle." Id. at 189. Indeed, an arbitrator need only offer "a barely colorable justification" for his decision to avoid vacatur of the award. Banco de Seguros del Estado v. Mut. Marine Office Inc., 344 F.3d 255, 260 (2d Cir. 2003).

Not surprisingly, few parties have succeeded in demonstrating manifest disregard before the Second Circuit. Wallace, 378 F.3d at 191. In four of the five cases in which the Court of Appeals has found manifest disregard, the court also found that the arbitrators had exceeded their powers, and thus (arguably) could have vacated the award pursuant to §10(a)(3) of the FAA. Duferco Int'l Steel Trading v. T. Klaveness Shipping A/S, 333 F.3d 383, 389 (2d Cir. 2003).

Recent case law suggests that parties challenging an arbitration award, rather than relying solely on the manifest disregard doctrine, will likely find it more productive to seek remand to the panel that crafted the award. Earlier this year the Second Circuit considered a challenge to an arbitral award on grounds that the arbitrators exceeded their powers - permitting vacatur under §10(a)(4) - and that they demonstrated manifest disregard for the law. Rich v. Spartis, 516 F.3d 75 (2d Cir. 2008). While acknowledging that both §10 of the FAA and the doctrine of manifest disregard provided means to challenge an arbitral award under Second Circuit law, id. at 82, the court held that the arbitral panel had not provided sufficient information for a court to evaluate such a challenge, and remanded the award to the panel to "explain their indefinite, incomplete, and ambiguous award in a way sufficient to allow effective judicial review." Id. at 83.

Nor is this a new phenomenon in the Second Circuit. In Hardy v. Walsh Manning Securities, LLC, the court similarly remanded an award to the panel "to seek a clarification of whether an arbitration panel's intent in making an award evidences a manifest disregard of the law." 341 F.3d 126, 134 (2d Cir. 2003) (citation and quotation omitted). The Appellate Division, First Department, has recently taken this approach as well. See Sawtelle v. Waddell & Reed Inc., 304 AD2d 103, 118, 754 NYS2d 264, 277 (1st Dept. 2003) (remanding to original panel for consideration of "grossly excessive" punitive damages).

Courts are perhaps more comfortable with this approach, which gels with the highly deferential standard of review afforded arbitrators. Given that remand to the original panel also enables the court to avoid deciding whether the panel has demonstrated manifest disregard of the law, this approach may prove increasingly common given the Supreme Court's dicta in Hall Street.


Thomas E.L. Dewey is a partner and Kara Siegel is an associate at Dewey Pegno & Kramarsky.

Endnotes:

1. See also E. Seaboard Concrete Constr. Co. v. Gray Constr. Inc., No. 08-37-P-S, 2008 WL 1803781, at *4 n. 3 (D. Me. April 18, 2008) (reading Hall Street to say that manifest disregard "is really a shorthand reference to the statutory grounds for vacatur listed in §§10(a)(3) and 10(a)(4) of the FAA"); Jimmy John's Franchise, LLC v. Kelsey, No. 08-2040, 2008 WL 1722188, at *2 (C.D. Ill. April 10, 2008) (noting that manifest disregard provides additional basis for review, but emphasizing the Seventh Circuit's particularly narrow interpretation of the doctrine); Halliburton Energy Servs. Inc. v. NL Indus., Nos. H-05-4160, H-06-3504, 2008 WL 906037, at *13 (S.D. Tex. March 31, 2008) (applying manifest disregard under Fifth Circuit law because Hall Street did not expressly dictate otherwise).