Arbitration agreements are quickly becoming a staple of commercial contracts as contracting parties hope to avoid litigation in the event of a dispute. Broadly, these agreements can be divided into two categories: (1) arbitration agreements between consumers and corporate sellers of goods or services; and (2) arbitration agreements between sophisticated corporate actors.
This discussion will focus on the latter sort of arbitration agreements. In this context, two or more corporate entities with roughly equal bargaining power negotiate an arbitration agreement with a specific scope ex ante. Arbitration agreements, like other contracts, are interpreted in accordance with their terms and the intentions of the parties.1 Since arbitration agreements are creatures of contracts, the parties have considerable freedom to design an agreement that suits their collective needs.
There are many aspects of the arbitration agreement that are subject to change according to the negotiation and final agreement of the parties. This article, however, will focus on one of the differences, specifically – the availability of appeal, appellate procedure, and standards of review that apply in different forums.
Most large contracts between corporate actors will deal in interstate commerce and will therefore fall under the purview of the Federal Arbitration Act (“FAA”).2 Federal courts, including the United States Supreme Court, have been very aggressive in enforcing the FAA. They often invalidate state laws that stand in the way of Congress’ expressed intent to compel courts to enforce arbitration agreements according to their terms.3
I. The Narrow Grounds for Appeal under the FAA and Common Law
The FAA carves out a very narrow set of means to vacate an arbitration award. These grounds come from reading two provisions of the FAA together. First, Section 9 provides that once an arbitrator has issued an award pursuant to an arbitration agreement between two parties, either party, within one year of the award, may submit an application for an order confirming the award to the court specified by the agreement.4 If no court is specified, the application must be made to the Federal District Court in and for the district in which the award was made.5 Section 9 further provides: “[T]he court must grant such an order unless the award is vacated, modified, or corrected as prescribed in sections 10 and 11 of this title.”6
As is clear from the text of the FAA, Section 9 is not permissive. Any court of competent jurisdiction that receives a timely application must issue an order enforcing the arbitration award. The provisions of Section 11 require correcting the arbitration award to conform with the clear intentions of the arbitrator. As such, they do not reach the substantive merits of the dispute. Only the grounds specified in Section 10 may serve to vacate the award on the merits.7 Therefore, it is especially important to read the text of Section 10. In its entirety, it provides:
(a) In any of the following cases the United States court in and for the district wherein the award was made may make an order vacating the award upon the application of any party to the arbitration: (1) where the award was procured by corruption, fraud, or undue means; (2) where there was evident partiality or corruption in the arbitrators, or either of them; (3) where the arbitrators were guilty of misconduct in refusing to postpone the hearing, upon sufficient cause shown, or in refusing to hear evidence pertinent and material to the controversy; or of any other misbehavior by which the rights of any party have been prejudiced; or (4) where the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made.8
The most vital takeaway from this Section is that any party seeking to invalidate an arbitration award faces an uphill battle. Indeed, courts have held that Section 10 requires a reviewing court to show an extraordinary level of deference to the arbitration award.9
To prevail, the moving party must plead and prove one of several extreme claims: (1) that fraud or corruption tainted the procurement of the award; (2) that one or more of the arbitrators (who are selected according to a process in which the parties mutually agree) was clearly partial; (3) that the arbitrator(s) engaged in procedural misconduct that caused actual prejudice to a party; or (4) that the arbitrator(s) exceeded their powers under the agreement outright. Notably, Section 9 does not mention any grounds for vacating the award for even the most erroneous findings of fact or conclusions of law.
Two somewhat controversial grounds to vacate arbitration awards have been developed at common law. However, they, like the statutory provisions of Section 10, are rarely satisfied.
The first exception occurs when the arbitration agreement is “completely irrational.” This means, essentially, that the award fails to interpret the arbitration agreement in accordance with its text and the intentions of the parties.10 It does not allow one party to move to vacate the award simply because it disagrees with the arbitrator’s interpretation of a given term; the exception is much narrower. So long as the arbitrator was “even arguably” applying the contract, the award will not be vacated under this exception.11 This is a very deferential standard.
The second exception applies when an arbitrator shows “manifest disregard for the law.” The deference accorded to the arbitration award under this exception is even stronger than the name might suggest. Such manifest disregard does not entail merely an erroneous interpretation or application of the law. Rather, the party seeking to vacate the award must show that the arbitrator was “fully aware of the existence of a clearly defined governing legal principle, but refused to apply it, in effect, ignoring it.”12
The Eighth Circuit demonstrated the difficulty of prevailing under this exception when it offered an example of an arbitrator who “stated the law, acknowledged that he was rendering a decision contrary to law, and said that he was doing so because he thought the law unfair . . . .”13 An arbitrator’s mere silence, even in committing the clearest and most fundamental errors of law, will not satisfy the standard.14
This requirement that the arbitrator, like a cartoon villain, state on the record both that he was breaking the law and why he broke the law is more than a little out of touch with reality. Even the most incompetent or ill-meaning arbitrators could avoid review simply by remaining silent. Add to this extraordinarily high bar the fact that arbitrators are not required to elaborate on their reasoning supporting the award, so an arbitrator’s failure to clearly identify the applicable law or to explain how the law applies does not demonstrate disregard for the law.15
II. How to Get Around Them
While it might seem that you’re essentially out of luck if a binding arbitration award is entered against you, there are some tools that allow for more searching appellate reviews of arbitration awards. However, they all must be bargained for ex ante and stated explicitly in the arbitration agreement.
A. Pursuing an Appeal in State Court
The first way to avoid these incredibly narrow grounds for appeal is to provide in the arbitration agreement that the award shall be entered in a state court rather than a federal court. Section 9 allows the parties to specify in their agreement that the award be entered in any court; there is no requirement that this be a federal district court. However, it is important to note that if the parties fail to specify a state court in which to enter the award, the award may only be entered in the United States District Court in and for the District in which the award was made.16 The natural upshot of this is that the parties cannot avoid federal court without specifically providing for entry of the arbitration award in a state court, since the default rule offers them relief exclusively in federal court.
Section 10 only governs the actions of federal courts. This insight, again, comes from reading Sections 9 and 10 together. While Section 9 says that “the court must grant such an order unless the award is vacated, modified, or corrected as prescribed in sections 10 and 11 of this title,” the limitations of Section 10 only apply to United States (or federal) courts.17
The Supreme Court has stated, on this basis, that states within their own judicial systems may expand the scope of appellate review by either statute or common law.18 Various states have followed this decision and allowed parties to seek more sophisticated appellate review in state court, even when their agreements are governed by the FAA.19
However, states do not have uniform standards for appeal, and some states have standards for vacating an arbitration award that are even more restrictive than those provided for by Section 10 of the FAA.20 In Katz, the court interpreted the Massachusetts Arbitration Act – a piece of legislation that is even more restrictive than the FAA. It does not contain the evident partiality or arbitrator’s misconduct grounds for vacating an arbitration award that are found under the FAA. Instead, it “strictly binds” the court to enforce the award unless the award was procured through fraud or the arbitrator exceeded her power. The court held that the parties could not seek expanded appellate review through the courts of either Massachusetts or the United States.21
Therefore, there is at least one state in which seeking an appeal in state court puts a party seeking to vacate an arbitration award in an even worse position than under the FAA. Parties should therefore take care to review the applicable state arbitration laws before agreeing to the entry of an award in state court. However, even these well-researched provisions pose the risk of foreclosure on appellate remedies, as the Supreme Court has repeatedly stricken down any state law provisions it deemed adverse to the provisions of the FAA in the past.22
B. The Holy Grail: Appellate Arbitration
The ideal arrangement for parties seeking to include a riskless appellate relief provision comes from the American Arbitration Association (“AAA”) itself. In 2013, it promulgated optional appellate rules that allow parties to stipulate to optional or mandatory review of their arbitration award by a specific roster of appellate arbitrators.
The rules allow for an appeal to be filed within thirty days of the entry an arbitration award and prevent the operation of judicial enforcement mechanisms, like those contained in Section 9 of the FAA, until the appeal is resolved. Filing or withdrawing an appeal of the arbitration award tolls the one-year statute of limitations placed on arbitration awards by the FAA. The rules employ a reversible fee-shifting system to prevent frivolous appeals and stipulate that all parties who participate in the appeal shall be deemed to have consented to an entry of the resulting award in federal or state court.
The rules greatly enhance the appellate rights available to the parties. For instance, Rule A-10 states that appeals may be grounded in errors of law that are material or prejudicial and in determinations of fact that are clearly erroneous.23 However, the arbitrators are not able to order a new arbitration process for the parties. While this is not as holistic as appellate reviews normally appear, it places the appealing party in a much better position than under Section 9 of the FAA. It also seems to mirror the standards of review for fact and law in appellate settings, allowing for deference to initial decisions while also supplying mechanisms for error correction. In similar fashion to the court system, parties are prevented from raising new issues of fact or law on appeal.24
III. What to Keep in Mind
Contracting ex ante for private appellate review of arbitration awards allows parties to partake in the best of both worlds. Parties can avoid the risk and uncertainty of expanded (or contracted) judicial review in state courts while taking advantage of a clearly-defined system for the correction of errors in law or fact interpretation. Parties are also able to enjoy the relative speed and cost-savings enabled by arbitration because entirely new proceedings cannot be imposed by the appellate body.
The only drawback to expanding appellate review through state law or private appellate procedures is that it requires the parties to anticipate these problems and negotiate procedural mechanisms that will govern them ex ante. Although this task can be onerous and the solutions developed may never end up in use, parties that eventually encounter conflicts will find the exercise well worth the time and effort.
First Options of Chicago, Inc., v. Kaplan, 514 U.S. 938, 947 (1995). ↩
See Southland Corp. v. Keating, 465 U.S. 852, 853 (1984). ↩
See, e.g., AT&T Mobility LLC v. Concepcion, 563 U.S. 333, 333 (2011) (overruling California’s Discover Bank rule that expanded the grounds for invalidating arbitration agreements under the unconscionability doctrine). ↩
9 U.S.C. § 9. ↩
Id. (emphasis added). ↩
Hall St. Assocs., L.L.C. v. Mattel, Inc., 552 U.S. 576, 578 (2008). ↩
9 U.S.C. § 10. ↩
Stark v. Sandberg, Phoenix & von Gontard, P.C., 381 F.3d 793, 798 (8th Cir. 2004). ↩
See id. ↩
Id. at 802; Ballantuono v. ICAP Securities USA, LLC, 557 Fed. Appx. 168, 174 (3d Cir. 2014); Duferco Int’l Steel Trading v. T. Klaveness Shipping A/S, 333 F.3d 383, 389 (2d Cir. 2003) (emphasis added). ↩
Lincoln Nat’l Life Ins. Co. v. Payne, 374 F.3d 672, 675 (8th Cir. 2004). ↩
See Stroh Container Co. v. Delphi Indus., Inc., 783 F.2d 743, 750 (8th Cir. 1986). ↩
See Horton, Inc. v. NSK Corp., Inc., 544 F. Supp. 2d 817, 824 (D. Minn. 2008). ↩
9 U.S.C. § 9. ↩
See 9 U.S.C. § 10 (“In any of the following cases the United States court in and for the district wherein the award was made may make an order vacating the award . . . .”) (emphasis added). ↩
See Hall Street, 552 U.S. at 590. ↩
See, e.g., Raymond James Financial Services, Inc. v. Honea, 55 So. 3d 1161, 1170 (Ala. 2010) (enforcing a contract provision that allowed de novo review of the arbitration award in an Alabama trial court); see also Cable Connection, Inc. v. DIRECTV, Inc., 44 Cal. 4th 1134, 1352-53 (Cal. 2008) (allowing for expanded judicial review of arbitration awards under the California Arbitration Act). ↩
See Katz, Nannis & Solomon, P.C. v. Levine, 473 Mass. 784, 789-90 (2016). ↩
Id. at 793. ↩
See, e.g., Concepcion, 563 U.S. at 333. ↩
American Arbitration Association, Optional Appellate Arbitration Rules (effective Nov. 1, 2013), https://www.adr.org/sites/default/files/AAA%20ICDR%20Optional%20Appellate%20Arbitration%20Rules.pdf. ↩
See id. ↩