Courts Strive To Define The Powers Of An Arbitrator

Robert B. Davidson

A neutral based in New York, Robert B. Davidson, Esq. is the Executive Director of JAMS' Arbitration Practice. He may be reached at


Nearly 40 years ago, the Supreme Court broadened an arbitrator's jurisdiction to decide at least some challenges to the existence of the underlying contract. Since the decision in Prima Paint (Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 18 L.Ed.2d 1270 (1967), the courts have continued to wrestle with the contours of an arbitrator's power.

Prima Paint declared that agreements to arbitrate were severable from the contracts in which they were imbedded. This permitted arbitrators to arbitrate disputes that involved threshold issues concerning the validity or effectiveness of the underlying contract without ousting themselves of jurisdiction. Thus, in Prima Paint, the issue of whether or not one of the arbitrating parties who signed the contract was induced by fraud to do so was held to be an arbitrable issue, notwithstanding the fact that if the proponent prevailed on that claim, the contact which contained the arbitration clause would be a nullity.

Since Prima Paint, many (but not all) courts have made a distinction between "voidable" contracts (including, for example, contracts induced by fraud), and "void" contracts (including, for example, contracts on which a signature of one of the parties has been forged). "Voidable" contracts are arbitrable unless the party who wishes to avoid arbitration can show that the arbitration clause itself was induced by fraud. "Void" contracts are not arbitrable until, at least, a court first determines whether the contract is valid. Arbitrators, say the cases, seem to have the power to decide issues relating to contract validity in the "voidable" situations, but not if the contract is alleged to be "void."

One of the most interesting cases in this area is out of the Third Circuit. In Sandvik AB v. Advent International Plc et al., 220 F.3d 99 (3d Cir. 2000), Advent International ("AI") (the buyer) argued that its agent that executed the acquisition agreements with the seller was not authorized to do so. The seller sued AI in Delaware District Court, notwithstanding the fact that the contract that the agent signed called for the arbitration of any disputes before the Netherlands Arbitration Institute (the "NAI"). The NAI Rules expressly authorize arbitrators to decide threshold matters of arbitrability, including whether or not a contract that contains an arbitration clause is invalid or void.1 AI moved to arbitrate all disputes under the agreement, including whether or not its agent had been authorized to execute the contracts. The seller, on the other hand, contended that AI had no right to invoke the arbitration clause without first acknowledging the validity of the underlying contract (i.e. conceding one of the ultimate issues, that of its agent's authority). Otherwise, argued Sandvik, the contract was void and there was no arbitration clause upon which AI could rely. In Sandvik, the Third Circuit agreed with the seller, holding that AI - even though it was the party seeking to arbitrate - could not rely upon the arbitration clause without a prior determination of the validity of the underlying contract. The Third Circuit remanded the case to the district court for a trial on the issue of whether or not the agent was authorized to execute the agreement. In its opinion, the Third Circuit declined to follow the reasoning of the Ninth Circuit in a similar case, Teledyne, Inc. v. Kone Corp., 892 F.2d 1404 (9<^>th Cir. 1990), calling the Ninth Circuit's reasoning in that case "facile". Although the issue was briefed and argued, the Sandvik court did not discuss the NAI Rules and the impact of those Rules upon the issue of arbitrability.

Building upon the Sandvik case, the Third Circuit, in a case decided in June of 2003, determined that an arbitrating party in an international case that protested the arbitrator's authority to decide a threshold issue (and, thus, preserved its right) was entitled to a trial in the district court - post arbitration - as to whether or not the agreement that it executed was, in fact, "void". In the case of China Minmetals Materials Import & Export Co. v. Chi Mei Corporation, 334 F.3d 274 (3d Cir. 2003), Chi Mei argued before the arbitrator that its signature on the underlying agreement was a forgery. Chi Mei objected to the arbitration going forward, but participated in the arbitration nevertheless. The arbitrator ultimately determined that Chi Mei, contrary to its contention that its signature on the contract was a forgery, did not demonstrate that it had not executed the contract. In the alternative, the arbitrator found that Chi Mei was bound to the agreement even if it did not execute the contract. When Minmetals moved in the district court to recognize and enforce the award under the New York Convention, Chi Mei opposed the motion arguing that it was entitled to a trial in the district court as to whether or not it had executed the contract. The district court agreed, and Minmetals appealed to the Third Circuit. The Third Circuit affirmed, permitting Chi Mei a jury trial in the district court on the sole issue of whether or not its signature on the underlying contract was a forgery.

Many practitioners view this decision as one fraught with mischief. Any arbitrating party with a threshold defense, such as an agent's lack of authority to sign or the like, might now feel free to participate in an arbitration (after preserving its right to complain about the award) and then get a second bite at the apple if the arbitration is determined against it. The countermeasure to this would be an immediate application to a court of appropriate jurisdiction by the party against whom the defense is asserted. That application would seek to litigate the threshold issue before the arbitration continued. This procedure would add a layer of cumbersomeness, expense and uncertainty that the Supreme Court might not have envisioned when it decided Prima Paint.

These issues regarding arbitrability have become a hot topic in arbitration circles. Three recent cases out of the U.S. Supreme Court have dealt with these thorny issues. The first, Howsam v. Dean Witter Reynolds, Inc., 537 U.S. 79 (2002) involved the issue of whether or not a dispute was time-barred under the NASD Arbitration Rules. Despite the existence of an arbitration clause in the underlying contract, Dean Witter filed a lawsuit in the district court asking the court to declare the dispute ineligible for arbitration because it was time-barred. The district court, however, dismissed the action stating that the NASD arbitrators should interpret and apply the NASD rule. The Supreme Court, after a Tenth Circuit reversal, agreed with the lower court and held that the NASD arbitrator should apply the time limit rule to the underlying dispute. In so deciding, the Supreme Court opined: "Parties to an arbitration contract would normally expect a forum-based decisionmaker to decide forum-specific procedural gateway matters, and any temptation here to place special anti-arbitration weight on the word 'eligible' in [the NASD Rule] is counterbalanced by the NASD rule that 'arbitrators shall be empowered to interpret and determine the applicability' of all Code provisions." The Supreme Court found that the applicability of the NASD time limit rule was a matter presumptively for an arbitrator and not a judge. That rule, said the Supreme Court, closely resembled the gateway questions that the Supreme Court had found not to be "questions of arbitrability" (similar to issues like waiver or delay). It is particularly interesting in Howsam that the Supreme Court had no problem in citing the institutional rules to which the parties had agreed in justifying its decision that an arbitrator should decide a particular issue, while the Third Circuit in Sandvik failed even to discuss the fact that the institutional rules that the parties had selected provided that an arbitrator should decide the issue presented in that case.

In April of 2003, the Supreme Court decided Pacificare Health Systems v. Book, 123 S.Ct. 1531 (2003). There, physicians sued a healthcare provider claiming that the provider habitually and unlawfully failed to reimburse them for healthcare-related services that they had provided. The case was brought under RICO, ERISA and various other statutory and common law grounds. The healthcare provider's standard agreement with the physicians provided for arbitration and also stated that the arbitrators were prohibited from awarding punitive damages. When the healthcare provider moved to arbitrate the dispute, the physicians responded that they could not obtain meaningful relief in arbitration for their claims under the RICO statue when a provision in the arbitration clause precluded the arbitrator from granting punitive damages.

The Supreme Court agreed with the healthcare provider and sent the case to arbitration. After opining that treble damages in RICO and antitrust actions were not necessarily punitive (i.e. they could be remedial), the Supreme Court left it to the arbitrator "in the first instance" to decide the case. The Supreme Court said that it would be "mere speculation" that an arbitrator might interpret the agreement in a manner that might deny the benefits of the RICO statute to the doctors. Whether or not the language of the arbitration clause precluded RICO relief was, as a first matter, for an arbitrator to decide.

The last case in this trilogy is one that is generating significant interest among the arbitration community. In Green Tree Financial Corp. v. Bazzle, 123 S.Ct. 2402, 156 L.Ed.2d 414 (2003), a sharply divided Supreme Court decided that it was up to an arbitrator and not a court to determine whether or not a particular arbitration clause empowered the arbitrator to resolve a case as a class action. The finance company (Green Tree) had argued that an arbitration clause between it and a single borrower could not, under any circumstances, be read to authorize a class action. The South Carolina Supreme Court disagreed and held that the clause did permit the arbitrator to determine the merits in the context of a class action. Four of the Justices of the U.S. Supreme Court vacated the South Carolina judgment and explained that it was not for the South Carolina Supreme Court to determine what the arbitration clause meant, but it was for the arbitrator to make that determination. In so holding, the four-member plurality said: "The question here does not fall into the limited circumstances where courts assume that the parties intended courts, not arbitrators, to decide a particular arbitration-related matter, as it concerns neither the arbitration clause's validity nor its applicability to the underlying dispute. The relevant question here is what kind of arbitration proceeding the parties agreed to, which does not concern the state statute or judicial procedures [citations omitted] but rather contract interpretation and arbitration procedures. Arbitrators are well-situated to answer that question.

What can we glean from these recent cases? It appears that arbitrators may decide gateway issues concerning whether conditions precedent to arbitration have been fulfilled or whether defenses such as latches, waiver or the like, should preclude a claim. They can also decide if an arbitration clause permits a particular dispute to be brought as a class action. When the issue relates, however, to a determinative threshold event, such as declaring a contract "void" (whatever that may mean in a specific context), then the tendency is to leave that issue for the courts even in the face of the parties' agreement that their dispute shall be resolved in accordance with arbitration rules that provide for such issues to be determined by arbitrators.

The debate continues so stay tuned for future decisions that will continue to define the powers of arbitrators.1 NAI Article 9(4) and 9(5) provide:

A plea that the arbitral tribunal lacks jurisdiction shall be decided by the arbitral tribunal.

An arbitration agreement shall be considered and decided upon as a separate agreement. The arbitral tribunal shall have the power to decide on the validity of the contract of which the arbitration agreement forms part or to which the arbitration agreement is related.