The National Law Journal
Overturning an arbitral award on appeal is notoriously difficult because the standards of review under the Federal Arbitration Act (FAA) and analogous statutes are extremely narrow. Understanding those standards and how they have been applied may give you at least a fighting chance to prevail.
Arbitration is a creature of contract between parties who have willingly agreed to resolve their disputes outside the courts. It is encouraged by the legal system as a fast, cheap and informal alternative to litigation. See, e.g., Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth Inc., 473 U.S. 614, 625, 628 (1985). Reviewing courts therefore accord great deference to arbitral decisions to preserve these benefits of arbitration.
The 'grudgingly narrow' review under the FAA
FAA § 10(a) provides four limited bases, which have been described as "grudgingly narrow" (Eljer Mfg. Inc. v. Kowin Dev. Corp., 14 F.3d 1250, 1253 (7th Cir. 1994)) for vacating an arbitral award: (1) the award was procured by corruption, fraud or undue means; (2) there was evident partiality or corruption by the arbitrators; (3) there was arbitral misconduct, such as refusal to hear material evidence; or (4) the arbitrators exceeded their powers, or so imperfectly executed their powers that they failed to render a mutual, final and definite award.
The fourth statutory ground, arbitrators exceeding their powers, is the one most frequently used as a basis for vacatur. While its application has been inconsistent, this standard is based on the fundamental principle that the FAA ensures enforcement of the terms of the parties' agreement to arbitrate. See, e.g., Mastrobuono v. Shearson Lehman Hutton Inc., 514 U.S. 52, 57 (1995); Volt Info. Sciences Inc. v. Board of Trustees, 489 U.S. 468, 476, 478-79 (1989). Courts have vacated arbitral awards under the "exceeded powers" standard where the arbitrators' decision addressed issues not submitted to arbitration (Roadway Package Sys. Inc. v. Kayser, 257 F.3d 287, 300-01 (3d Cir. 2001)), involved parties or transactions outside the scope of the arbitration clause (Eljer , 14 F.3d at 1256-57) or awarded remedies barred by the agreement (Coast Trading Co. Inc. v. Pacific Molasses Co., 681 F.2d 1195, 1198 (9th Cir. 1982)).
Manifest Disregard Standard. There are also nonstatutory grounds for vacatur, all of which involve some review, albeit extremely narrow, of the merits. Chief among these is review of arbitral awards for "manifest disregard of the law." This standard derives from dicta in Wilko v. Swan (346 U.S. 427 (1953), overruled on other grounds) and in Rodriguez de Quijas v. Shearson/American Express Inc . (490 U.S. 477 (1989)), and was endorsed by the Supreme Court in First Options of Chicago Inc. v. Kaplan, 514 U.S. 938, 942 (1995) ("parties [are] bound by [an] arbitrator's decision not in 'manifest disregard' of the law").
The standard is not without its critics. Judge Richard A. Posner has taken the position that manifest-disregard review should be jettisoned because it either duplicates the "exceeded powers" standard or "is meant to smuggle review for clear error in by the back door." Baravati v. Josephthal, Lyon & Ross Inc., 28 F.3d 704, 706 (7th Cir. 1994). Nevertheless, the federal circuits have adopted the manifest-disregard standard, as have most of the states.
Although the precise formulations of this standard vary, manifest-disregard review is extremely narrow. Arbitral awards cannot be overturned merely because the arbitrators misunderstood or misapplied the law. Typically, courts hold that the governing law must be clearly established and that the arbitrators must be aware of the law, but nonetheless choose to disregard it. E.g., Montes v. Shearson Lehman Bros. Inc., 128 F.3d 1456, 1461 (11th Cir. 1997); Westerbeke Corp. v. Daihatsu Motor Co. Ltd., 304 F.3d 200 (2d Cir. 2002). Not surprisingly, motions to vacate based on this standard are rarely successful. The 2d U.S. Circuit Court of Appeals recently surveyed the 48 cases since 1960 in which it considered manifest-disregard claims, and noted that arbitral awards were vacated in only four of those cases, and three of those had other possible bases for vacatur. Duferco Int'l Steel Trading v. T. Klaveness Shipping A/S, 333 F.3d 383, 389 (2d Cir. 2003).
When circuit courts have found manifest disregard, the record and the arbitrators' decision appear to have left them little choice. The 11th Circuit, for example, vacated an arbitral award where counsel for the prevailing party had "flagrantly and blatantly" urged the arbitration panel to disregard applicable law under the Fair Labor Standards Act, and the record provided no basis "to refute the suggestion that the law was disregarded." Montes, 128 F.3d at 1461-62. Likewise, where there was "overwhelming evidence" of age discrimination and the applicable law had been explained to the arbitrators, the 2d Circuit concluded that the arbitrators must have manifestly "ignored the law or the evidence or both." Halligan v. Piper Jaffray Inc., 148 F.3d 197, 204 (2d Cir. 1998).
A finding of manifest disregard, however, may not be enough. In Hardy v. Walsh Manning Securities LLC, 341 F.3d 126, 133 (2d Cir. 2003), the court found that an arbitration panel manifestly disregarded the law by holding a corporate employee liable under the doctrine of respondeat superior. But the court decided to remand to the panel to clarify whether it really intended to hold the employee liable under that doctrine. Id. at 134.
Claims that an award exceeded the arbitrators' powers and manifestly disregarded the law may overlap, and courts often blur the distinctions between the doctrines. The 6th Circuit recently upheld the vacatur of a damages award to nonparties to the contract, stating that it both exceeded the arbitrators' authority and manifestly disregarded the law by asserting jurisdiction over a nonparty. Nationwide Mut. Ins. Co. v. Home Ins. Co., 330 F.3d 843, 847 (6th Cir. 2003). See also Duferco, 333 F.3d at 389 (overlap of manifest disregard and exceeding powers standards).
Given the extremely narrow review under manifest disregard, appellate counsel should scrutinize the record to determine if the award can be challenged as exceeding the arbitrators' powers. This ground for vacatur is based on a foundational principle of arbitration law, that the FAA is intended to ensure enforcement of the terms of the parties' agreement, and therefore does not face quite the same daunting review as do manifest disregard claims.
Public Policy . In certain circumstances, an award may also be challenged on the ground that it violates public policy. Under this basis for vacatur, which originated in the specialized context of labor arbitration, an award may be vacated if it violates a well-defined and dominant public policy that can be found in laws or legal precedents. See Eastern Associated Coal Corp. v. United Mine Workers of America, Dist. 17, 531 U.S. 57, 63 (2000). While often invoked in the employment context, public policy has occasionally been the basis for challenging awards in commercial arbitrations. See, e.g., Seymour v. Blue Cross/Blue Shield, 988 F.2d 1020 (10th Cir. 1993) (public policy basis for challenging awards in contract cases that violate state law); Schoonmaker v. Cummings & Lockwood of Conn. P.C., 252 Conn. 416, 426-36 (2000) (requiring de novo review of claim that award violates established public policy).
Public policy has been used, with other grounds, to challenge arbitral punitive damages awards. See, e.g., Fahnestock & Co. Inc. v. Waltman, 935 F.2d 512 (2d Cir. 1991) (vacating punitive damages award as exceeding arbitrators' powers and violating New York public policy barring punitive damages in arbitrations); Sawtelle v. Waddell & Reed Inc., 754 N.Y.S.2d 264, 271 (N.Y. App. Div. 2003) (reducing award because it disregarded the law barring excessive punitive damages).
Can parties change judicial review of awards?
Contractually Altering Judicial Review. Given the uncertainties and risks of arbitration, it may be tempting for counsel to specify in the arbitration contract itself the standards of review of an arbitral award. Whether parties can contractually alter the standards of review is one of the most hotly disputed topics in arbitration law today. The 2d Circuit recently held that parties cannot contractually restrict judicial review of arbitral awards: "The manifest disregard standard together with [FAA] § 10(a) represent a floor for judicial review of arbitration awards below which parties cannot require courts to go, no matter how clear the parties' intentions." Hoeft v. MVL Group Inc., 343 F.3d 57, 64 (2d Cir. 2003). But see Bowen v. Amoco Pipeline Co., 254 F.3d 925, 931 (10th Cir. 2001) (parties may contractually eliminate all judicial review).
The circuits are split as to whether parties may contractually expand the scope of judicial review of arbitral awards to allow, for example, review of awards for legal error or lack of substantial supporting evidence. See, e.g., Roadway Package Sys. Inc. v. Kayser, 257 F.3d 287 (3d Cir. 2001) (parties can expand judicial review); Bowen, 254 F.3d at 931-37 (10th Cir.) (parties cannot expand judicial review). The two schools of thought rely on competing principles.
The courts allowing expansion of review emphasize that the FAA is designed to enforce the terms of the parties' agreement to arbitrate. Courts barring such expanded review emphasize that the efficiencies of arbitration would be lost if parties could require review of arbitral awards on the merits, and that private parties cannot dictate how federal courts should conduct judicial review. The 9th Circuit's jurisprudence has been particularly interesting, reversing its 1997 decision permitting contractual expansion in an en banc decision in 2003. Kyocera Corp. v. Prudential-Bache Trade Services Inc., 341 F.3d 987 (9th Cir. 2003), cert. dismissed, 124 S. Ct. 980 (2004).
Given the risks and uncertainties in appealing arbitral awards, counsel should closely examine the applicable standards of review and consider contractually altering them when it is possible to do so.