Another Reason To Choose Your Arbitrator Carefully: Possible Sanctions

Tuesday, August 1, 2006 - 01:00

"[T]his Court is exasperated by those who attempt to salvage arbitration losses through litigation [T]o protect arbitration as a remedy we are ready, willing, and able to consider imposing sanctions[.]"

Introduction

On February 28, 2006, the Eleventh Circuit issued a pointed opinion that makes choosing your arbitrator ever the more important. The opinion, B.L. Harbert International, LLC v. Hercules Steel Co.,1 urged district courts to impose sanctions against parties appealing arbitration awards with no firm legal basis. A party can rarely establish error sufficient to overcome the broad deference courts show arbitration awards, and thus a party will rarely have a firm legal basis for vacating the award. Harbert therefore makes judicial challenges to arbitration awards riskier by increasing the potential costs of a motion to vacate, increasing the importance of selecting a good arbitrator in the first place.

Arbitration Generally

The popularity of arbitration has increased steadily since President Coolidge enacted the Federal Arbitration Act ("FAA") in 1925. Once a seldom used vehicle for resolving disputes, arbitration now is the preferred method to resolve many disputes including international, labor, and commercial contract disputes. Arbitration has even become a popular method for resolving employment and consumer class actions in light of the Supreme Court's 2003 ruling in Green Tree Financial Corp. v. Bazzle 2 that arbitrators, not courts, decide whether class arbitration is permitted.

Selecting an arbitrator has always been an important task because the arbitrator will decide all procedural and substantive issues throughout the proceeding, including all pretrial motions, discovery issues, and the merits. The process of choosing an arbitrator varies depending on the parties' contract and the governing rules. Some contracts, for example, may specifically provide that the parties will submit the dispute to a three-person arbitration panel, of which each side will select one "party arbitrator" who will confer with the other party arbitrator to choose the final arbitrator. If the contract does not address the issue, then the arbitration rules that govern the controversy ( e.g. , Rules of the American Arbitration Association) provide the procedure for selecting the arbitrator(s).3 Under the rules of several organizations, like the American Arbitration Association, the organization itself will send the parties a list of potential arbitrators.4 Each party can strike a set number of individuals from the list and then rank the remaining arbitrators in order of preference.5 The organization then picks the arbitrator from the remaining individuals based on the parties' rankings.6

Judicial Review Of Arbitration Awards

Once the arbitration award issues, the losing party has the right to ask a court to vacate the award under either the limited grounds stated in the FAA and similar state statutes, or those established by the common law.7 The grounds for vacatur under the FAA are that: (1) the award was the product of fraud or corruption, (2) the arbitrator was partial or corrupt, (3) the arbitrator refused to delay the arbitration hearing or hear evidence, or (4) the arbitrator exceeded his powers.8 The additional grounds for vacatur created under the common law are: (1) that the award reflects a "manifest disregard" for the law,9 or (2) that the award violates public policy.10 The Eleventh Circuit also permits vacatur if the award is "arbitrary and capricious."11 Because the grounds for vacatur under the FAA are very restrictive, the losing party generally challenges the award under one of the common-law grounds, e.g. , manifest disregard.

These standards for vacatur are extremely high. For example, the manifest disregard standard requires more than proof that the arbitrator misread, misinterpreted, or misunderstood the law.12 The party must show that the arbitrator appreciated the existence of a clearly governing principle but nevertheless ignored or paid no attention to it.13 The party must also show that the governing law ignored by the arbitrator was well-defined, explicit, and clearly applicable.14 The public policy standard similarly requires that the policy violated be explicit, well-defined, and dominant.15 The Supreme Court has stated that it "must be ascertained by reference to the laws and legal precedents and not from general considerations of supposed public interests."16 And under the arbitrary and capricious standard, there must be no possible basis for the award.17

B.L. Harbert International v. Hercules Steel (11th Cir. 2006)

Compounding this rigorous standard for vacatur is the Eleventh Circuit's recent ruling in Harbert . In that case the court threatened to impose sanctions on parties seeking to vacate arbitration awards in the future. In Harbert the arbitrator issued an award of nearly $500,000.18 The losing party, Harbert, filed a motion in federal district court to vacate the award, asserting that the arbitrator's reasoning reflected a manifest disregard for the applicable law based on the arbitrator's supposed misinterpretation of a contract provision.19 The district court found evidence to support the arbitrator's interpretation and readily denied Harbert's motion.20 Harbert appealed.

Harbert re-urged the same arguments supporting its interpretation of the contract to the Eleventh Circuit, which flatly rejected them. The court called this a typical contract dispute in which both sides had competing contract interpretations and stated that even if it were to agree with Harbert's interpretation, "that would not be nearly enough to set aside the award."21 Instead the Eleventh Circuit repeated the long-standing rule that the arbitrator must have actually recognized a clear rule of law and deliberately ignored it to satisfy the manifest disregard standard.22 Merely arguing that the award contradicted an express term of the contract, which is equivalent to saying the arbitrator clearly erred, is not sufficient for vacatur, the court reasoned.23

The Eleventh Circuit then went further, expressly finding that it was Harbert who had exhibited a manifest disregard of controlling law by challenging the arbitration award in light of the heavy standards for vacatur.24 Harbert's actions in continuing to litigate the case deprived Hercules and the judicial system of the benefits of arbitration: a cheaper, faster resolution than the judicial route provides.25 The court reasoned that baseless motions to vacate, which it termed Harbert's motion to be, discourage arbitration.26

The Harbert opinion concluded by stating that a party who attacks an award in court "without any real legal basis for doing so" should pay sanctions.27 The court went on to speculate that a realistic threat of sanctions would discourage baseless litigation over arbitration awards.28 This in turn would make arbitration more attractive to potential litigants, furthering the pro-arbitration policy found in the FAA and the very decisions applying it.29 The court stopped short, however, of actually imposing sanctions, but only because Harbert did not have the benefit of the opinion; the court, however, sounded a clear warning to all future litigants.30

The Increased Threat Of Sanctions

Although the Federal Rules of Civil Procedure have long permitted sanctions against parties for filings that seek only to delay or that are not supported by existing law or by a good-faith argument for an extension of existing law, the Eleventh Circuit is the first appellate court to expressly endorse and encourage sanctions for unsuccessful motions to vacate arbitration awards.31 Federal Rule of Civil Procedure 11 permits a court to order sanctions in the amount of the attorneys' fees and expenses incurred as a result of the sanctionable violation.32 Using this formula, the amount of sanctions for challenging an arbitration award could be substantial. The cost to prepare an opposition to a motion to vacate and the briefing for a subsequent appeal ( i.e. , the cost incurred as a result of the violation) can easily reach six figures, and in some complex cases may exceed a million dollars.

Should other circuits follow the Eleventh Circuit's lead and encourage imposing sanctions on losing parties, the number of parties pursuing a motion to vacate may very well diminish significantly. At the very least, the risk of appealing an award will increase substantially. This development emphasizes how critical it is to choose a good arbitrator.

Conclusion

The increased threat of sanctions posed by Harbert re-emphasizes the prudent measures parties should adopt in determining when and how to arbitrate:

Examine whether arbitration is the best forum to resolve your particular dispute. While many contracts contain arbitration clauses, often arbitration is not mandatory and you may want to pursue the claims before a court instead. Proceeding in court provides much broader appeal rights.

Spend additional time and effort reviewing potential arbitrators' past experiences and opinions so as to make a more informed decision. The more competent the arbitrator, the less likely an erroneous award.

Consider selecting a panel of arbitrators as opposed to a single arbitrator. More arbitrators decrease the chance that the award misinterprets or misconstrues the law to your detriment.

Assess carefully whether to file a motion to vacate. Possible sanctions for a failed motion could be substantial. You should consider whether the slight chance for vacatur is worth the heavy price you could pay in sanctions.

1 441 F.3d 905 (11th Cir. 2006).
2 539 U.S. 444 (2003).
3 In the absence of both a contractual procedure and governing rules for selecting an arbitrator, a court will appoint an arbitrator. 9 U.S.C. 5.
4 AAA Commercial Arbitration Rule ll.
5 Id.
6 Id.
7 See State Bar of Texas Alternative Dispute Resolution Handbook (2003), Kay and Frank Elliott, eds., Chapter 4, "Arbitration," by R. Doak Bishop and Craig S. Miles, 4.13 at 82-83.
8 9 U.S.C. 10.
9 Brabham v. A.G. Edwards & Sons, Inc., 376 F.3d 377, 381-82 (5th Cir. 2004).
10 E. Associated Coal Corp. v. United Mine Workers of Am . , 531 U.S. 57, 62 (2000).
11 See Lifecare Int'l, Inc. v CD Medical, Inc., 68 F.3d 429, 435 (11th Cir. 1995).
12 Brabham, 376 F.3d at 381-82.
13 Id.
14 Id. at 382. Reflecting the rigor of this standard, the Eleventh Circuit has vacated only one award since recognizing it in 1997. Harbert, 441 F.3d at 910 .
15 W.R. Grace & Co. v. Local Union 759, Int'l Union of United Rubber Workers, 461 U.S. 757, 766 (1983).
16 E. Associated, 531 U.S. at 62 (quoting W.R. Grace, 461 U.S. at 766) .
17 See Lifecare, 68 F.3d at 435 .
18 441 F.3d at 909.
19 Id.
20 Id.
21 Id. at 911-12 .
22 Id . at 912.
23 Id. at 911-12.
24 Id. at 913.
25 Id.
26 Id.
27 Id. at 913-14.
28 Id. at 914.
29 See id.
30 Id.
31 Both district and appellate courts have issued sanctions for frivolous motions to vacate and appeals of orders on those motions, but they have done so rarely over the years. See, e.g., Cuna Mut. Ins. Soc. v. Office and Professional Employees Int'l Union, 443 F.3d 556, 560-61 (7th Cir. 2006) (upholding Rule 11 sanctions for groundless motion to vacate); Flexible Mfg. Sys. Pty. Ltd. v. Super Prods. Corp., 86 F.3d 96, 101 (7th Cir. 1996) (issuing sanctions for "frivolous" appeal of denial of motion to vacate under Federal Rule of Appellate Procedure 38). No appellate court until the Harbert decision, however, has encouraged sanctions for unsucessful motions to vacate
32 Fed. R. Civ. P. 11(c).

Michael W. Youtt and Jeremiah J. Anderson practice in the litigation Department of King & Spalding's Houston office.

Please email the authors at myoutt@kslaw.com or jjanderson@kslaw.com with questions about this article.