First You Say You Do and Then You Don’t and Then You Say You Will and Then You Won’t

First You Say You Do and Then You Don’t and Then You Say You Will and Then You Won’t

July 1, 2008

By Gregory T. Spalj


Some might say that the above quoted song lyrics from the Ames Brothers’ 1951 hit, Undecided, comes from the construction contractor’s theme song. What people say and do often differ dramatically, depending on the circumstances presented to them at the time their action is required. Some think that even the courts might be accused of such “situational ethics.” Most recently, after decades of singing the praise for arbitration as a preferred method of dispute resolution, the Supreme Court seemingly dealt a blow to the cause of party-crafted arbitration agreements by refusing to enforce two parties’ agreement on the circumstances under which an arbitration decision could be challenged in the courts. So is arbitration favored or what? The recent Supreme Court case pitted freedom to contract against the limited jurisdiction of the federal courts.

Arbitration is Favored in the Law But the Parties’ Freedom to Contract has its Limitations

While arbitration received a chilly reception by the courts when it was first used by private citizens to resolve disputes many decades ago, modern courts have for the most part encouraged, supported, and favored arbitration as a technique for private dispute resolution. As the courts’ calendars filled to the point of bursting, arbitration was seen as a mechanism for relieving the courts from the burden of resolving a large segment of private party disputes where parties agreed to private dispute resolution techniques. In fact, in many jurisdictions, some form of private dispute resolution, referred to as Alternative Dispute Resolution (“ADR”), which can and usually does include arbitration, is mandatory before you can have a trial before a judge and jury. Some legal commentators are saying that a recent United States Supreme Court decision (Hall Street Associates, L.L.C. v. Mattel, Inc., No. 06-989, slip op (March 25, 2008)) refusing to enforce limitations that the parties agreed to should govern their appeal rights after an arbitration, signals a sea change, undermining the efficacy of arbitration. After all, why should parties not be able to craft their own arbitration rules?

While at first glance this conclusion may appear to be warranted, the parties can, I believe, through a more extensive and far reaching arbitration agreement, could accomplish what the Supreme Court recently said private parties could not do. As a testament to the principle that there is more than one way to “skin a cat,” this briefing paper will discuss what Hall Street prohibits and the rationale therefor, and suggest a “work around” for those that are interested in limiting or expanding judicial review of arbitration decisions.

The Federal Arbitration Act

The arbitration in the Hall Street decision was governed by and subject to the Federal Arbitration Act. To understand the significance of a decision involving the Federal Arbitration Act, one must consider the fact that most construction projects are subject to it. The Federal Arbitration Act is, in many respects, similar to the Uniform Arbitration Act adopted by many State legislatures, including Minnesota. While each state may have its own arbitration act, the United States Supreme Court ruled in the case of Volt Information Serv., Inc. v. Stanford Univ., 489 U.S. 468 (1989), that the Federal Arbitration Act, when it applies, pre-empts any conflicting state law on the subject of arbitration. Thus, on any construction project that affects or involves interstate commerce, the Federal Arbitration Act will apply. This is why decisions on the Federal Arbitration Act are important to construction contractors.

Parties Cannot Change Federal Law

The Supreme Court took another step this spring in “pre-empting” the field when it ruled that the parties to an arbitration agreement could not craft an appellate process that differed from the one set out in the Federal Arbitration Act. The parties in Hall Street were a landlord and tenant under a commercial real estate lease. They agreed to an arbitration of a dispute over a provision of their lease and agreed that the Court would have the power to overturn the arbitrator’s decision if (i) the arbitrator’s findings of facts were not supported by substantial evidence, or (ii) if the arbitrator’s conclusions of law were erroneous. The parties even obtained the District Court’s approval of the arbitration agreement.

The tenant prevailed in the arbitration but the landlord appealed arguing that the arbitrator did not correctly apply the law. The District Court agreed and sent the case back to the arbitrator for a decision based on a correct statement of the law. The arbitrator then changed his decision, this time ruling in favor of the landlord. As one might expect, the tenant, who had initially won but lost on the remand, decided it liked the first result and argued that the agreement they had entered into, allowing the Court to overturn the decision if it was not in accordance with the law, was unenforceable. Therefore, it argued, the original arbitration decision should stand.

The United States Supreme Court agreed with the Ninth Circuit that the bases for judicial review of an FAA arbitration decision are only those grounds stated in Sections 10 and 11 of the Act and may not be expanded, even by agreement of the parties. An error of law is not one of the stated grounds. Therefore, the Court concluded, the District Court erred in overturning the initial arbitration decision (which reversal was based on the District Court’s conclusion that the arbitrator had made an error of law). The Supreme Court held that because the grounds under the federal arbitration act for modifying or overturning an arbitrator’s decision do not include the two bases upon which the parties agreed that the arbitrator’s decision could be overturned, the parties’ agreement to allow modification or reversal on other grounds was unenforceable.

The Court stated that, under Section 9 of the FAA, a court “must” confirm an arbitration award “unless the award is vacated, modified, or corrected as prescribed in sections 10 and 11 of this title.” The Court acknowledged that there was a split in the Courts of Appeals regarding whether Sections 10 and 11 contain the exclusive grounds for vacation, modification, or correction of an arbitration award, or whether the parties could tailor their arbitration agreements to allow for broader judicial review of arbitration provisions. The Court concluded, however, that Sections 10 and 11 do provide the exclusive grounds for reversal of an arbitration decision.

The Court still vacated and remanded the case, however, for consideration of other issues. The primary issue on remand is whether, given that the agreement in this case was accepted and issued by the District Court as a formal Order, the District Court’s authority to manage its cases under Fed. R. Civ. P. 16, might permit that District Court to expand the grounds for the District Court’s reversal of the arbitrator’s award.

On the heals of this decision, Judge Richard Kyle, United States District Court Judge, District of Minnesota, recently ruled that the oft cited “judicial ground” for reversing an arbitrator’s decision because of an arbitrator’s manifest disregard of the law, is no longer a valid basis to overturn an arbitration award. See, Prime Therapeutics, LLC v. Omnicare Inc., May 21, 2008. Many courts have, over the years concluded that in addition to the statutory grounds listed in the FAA, the Court has the right to overturn an arbitrator’s award if it is contrary to some fundamental principle of law. Judge Kyle reasoned that the Hall Street decision rejected the notion that there were extra-statutory grounds for modifying or vacating an arbitration award and reasoned that because the manifest disregard of the law standard was a judicially created doctrine that is not a listed basis for modifying or overturning an arbitrator’s award under the FAA, it is no longer a viable basis on which to attack an arbitration award.

Proposal for a “Work-Around”

Some commentators have taken the Hall Street decision as meaning that the parties may not define the standards on which an arbitrator must base the award, but I believe that this is too broad a reading. The Supreme Court looked at the Hall Street case as one involving an attempt to expand what Congress had laid down as the grounds for modifying or vacating an arbitrator’s award. However, the Court did not say that the parties could not dictate the standards upon which the arbitrator’s authority would be defined. In other words, one of the FAA’s grounds for vacating an arbitrator’s award is when it exceeds the arbitrator’s authority to render it. Thus, if your arbitration agreement provides that the arbitrator only has the authority to decide the case in accordance with the principals of law governing the dispute, one could then argue that if the arbitrator did not correctly apply the law, the arbitrator exceeded his or her authority.

Although the Hall Street Court rejected a direct approach to attacking an arbitration award by means of an agreement on the grounds for judicial reversal or modification, the result could be achieved by different means than what was attempted in Hall Street. Under the law, it is often the means, and not the result, which is of primarily importance. The Court in Hall Street appeared to be concerned with private parties expanding judicial review. Restricting the arbitrator’s authority does no such thing. The parties are not instructing the Courts on what they can and cannot do, they are so instructing the arbitrator. The Courts would exercise their stated authority under the FAA to make sure that the arbitrator does not exceed the authority of the arbitrator as granted by the parties.

Whether and to what extent such a tactic will succeed in those cases in which the parties desire to limit or otherwise define what an arbitrator can do, will be decided no doubt in subsequent case law. But if the courts want to promote arbitration as a way to unclog the court’s calendars, it must find a way to allow the parties to define what they want in arbitration. If the courts do not allow the flexibility for the parties to choose their own rules to govern the arbitration award, those who would otherwise turn to arbitration but who want some limits on the decision-maker’s power to ignore the law, the court docket will be the preferred choice.

This discussion is generalized in nature and should not be considered a substitute for professional advice. © FWH&T