The EPC Contract
The dispute between LPP and CEM arose from the construction of the Hobbs Generating Station (Hobbs), a 604-megawatt natural gas-fired electric generation facility located in Lea County, near Hobbs, New Mexico. CEM and its joint venture partner identified the site for Hobbs in 2005. Centennial was then CEM's sole member, and it formed CEM for the sole purpose of constructing Hobbs. Centennial also once owned a substantial interest in LPP, which was created for the sole purpose of owning and operating Hobbs. In fall 2006, Centennial sold its interest in LPP to a private equity company. As part of that transaction, CEM and LPP entered into the contract that would become the focus of their arbitration, the Engineering, Procurement and Construction Agreement (EPC Contract).
Under the EPC Contract, LPP hired CEM to perform engineering, procurement, construction, testing, and commissioning services for Hobbs. The target price for the project (which was not guaranteed) was $272 million, and CEM agreed to complete its work and have Hobbs operating by June 1, 2008. It is uncontested that the final project was over cost (at approximately $400 million) and several weeks late. Nonetheless, Hobbs has been complete and fully operational since 2009.
The Arbitration Demand and Award
In December 2009, pursuant to a provision in the EPC Contract, LPP demanded arbitration against CEM before the American Arbitration Association. In the demand, LPP underscores that the EPC Contract contains a provision limiting CEM's liability to LPP absent gross negligence (Limited Liability Provision). Demand ¶ 11. The Limited Liability Provision states, in pertinent part:
Except for . . . liability arising out of the fraud, gross negligence, willful conduct of [CEM] . . . [CEM]'s aggregate liability to [LPP] arising from th[e] [EPC Contract] and [its services] shall in no event exceed twenty-two million, forty-three thousand, three hundred two dollars ($22,043,302), and [LPP] releases [CEM] from any liability and damages in excess of such amount.
EPC Contract § 12.7. But, in the arbitration demand, LPP claims that "CEM's multiple, recurrent, chronic and pervasive failures to properly perform" under the EPC Contract "are in breach of CEM's contractual obligations, and are grossly negligent or willful misconduct, such that the limitations of liability under the EPC Contract does not apply." Demand ¶ 12 (emphasis added). Enumerating some of the allegedly abhorrent conduct, LPP claims that CEM failed to prepare and implement a viable project plan, failed to properly manage subcontractors, grossly mismanaged the construction schedule, and used equipment and systems that failed to meet specifications. Demand ¶ 13. LPP claims that CEM's "grossly negligent mismanagement" resulted in the increase in project construction costs and in the project missing its target completion date. Demand ¶¶ 14–15.
Of note, LPP's prayer for relief requests, in separately lettered clauses, that the arbitrator find that CEM breached the EPC Contract and that the breaches were grossly negligent. The prayer also includes the typical "catch-all" relief language. It reads:
LPP requests that the arbitrator: (a) determine that CEM is in breach of its contractual obligations under the EPC Contract; (b) find that CEM's breaches are a result of CEM's grossly negligent mismanagement of its duties and role as EPC Contractor, or are a result of willful misconduct, such that the limitation of liability under the EPC Contract does not apply; (c) award LPP compensatory damages for its injuries, including not less than [$77 million] in excess construction costs, and not less than [$68 million] in delay and excess operational costs; (d) award LPP damages equal to the increased operating costs required by [a] failed water treatment system, and the additional capital and construction costs that will be required to replace it; and (e) grant such other, further additional relief as just will require.
Demand ¶¶ 14–15. CEM moved to dismiss the arbitration demand, arguing that, absent gross negligence, the damages sought by LPP were foreclosed by certain provisions in the EPC Contract limiting CEM's liability (including the Limited Liability Provision) and that the demand did not allege sufficient facts to establish that CEM acted with gross negligence. Motion at 9–15. In its opposition brief, LPP argued that, taking the demand allegations as true, its "claims are sufficient to fit within a cognizable legal theory of gross negligence." Opposition at 10. As discussed below, the Colorado Energy decision relied on this language to CEM's detriment. Yet LPP also stated in its opposition brief that CEM's motion "must fail, because the allegations in the [d]emand . . . properly state claims of breach of contract and gross negligence." Opposition at 3 (emphasis added).
In May 2010, the initial arbitrator in the matter, who unfortunately passed away while the arbitration was pending, denied CEM's motion to dismiss, and, in doing so, he made the following statement, which the Colorado Energy court later deemed significant: "The allegations in LPP's demand . . . state a claim for gross negligence which, if proven, could form the basis for the recovery of causally related damages notwithstanding the limitations on liability and damages in the EPC [C]ontract." (Order of May 10, 2011, ¶ 1 (emphasis added).
A new arbitrator presided over a 10-day evidentiary hearing, which included 14 witnesses, and issued the arbitration award. This arbitrator concluded that, while CEM "was guilty of poor planning, bad management and stubborn adherence to poor practices" in performing its duties under the EPC Contract, that conduct did not rise to the level of gross negligence or willful conduct. Award at 11–12. Therefore, he refused to award many of the damages that LPP requested. Nevertheless, the arbitrator said that LPP raised the alternative theory that, "even if it fail[ed] to prove gross negligence by [CEM]," it is entitled to recover ordinary breach of contract damages under the EPC Contract. Award at 12. Thus, the arbitrator awarded LPP $22,043,302, finding that CEM breached the agreement by failing to provide adequate services and that the resultant damages were well above the cap in the Limited Liability Provision. Award at 14–16.
The Proceedings in the New York Supreme Court and Its Appellative Division
CEM struck first, filing a petition in the New York Supreme Court, asking the court to, among other things, modify the portion of the award granting LPP $22,043,302 on a stand-alone breach of contract claim. In its petition and motion in support, CEM argued that the arbitrator violated section 11(b) of the Federal Arbitration Act (FAA), 9 U.S.C. § 11(b), by awarding damages on a matter not submitted to him. Section 11(b) provides that arbitration awards may be modified where "the arbitrators have awarded upon a matter not submitted to them," and section 10(a)(4), 9 U.S.C. § 10(a)(4), which is more commonly cited as a basis to alter awards, provides that awards may be vacated where "arbitrators exceeded their powers." More specifically, CEM argued that "LPP submitted its claim for arbitration solely on the theory that CEM had breached the EPC [Contract] by performing its work on Hobbs in a grossly negligent fashion"; the initial arbitrator's decision on CEM's motion to dismiss "found that LPP's claim was arbitrable, but only if [LPP] could prove gross negligence"; "[n]o stand-alone breach of contract claim remained in the case" after the decision; and "the parties never mutually agreed that such a claim be submitted to arbitration." Petition at 36–38; see also Motion in Support at 7–8.
In opposition, LPP argued that it maintained at every stage of the arbitration that it was proceeding on a breach of contract theory in addition to gross negligence. In particular, LPP noted that its arbitration demand "specifically alleged that CEM had breached its obligations under the [EPC] [C]ontract, and that [CEM's] conduct related to the breaches constituted gross negligence." Opposition to Petition ¶ 3. LPP also noted that, in its pre- and post-trial briefs and at the arbitration hearing, it "specifically asserted that CEM had breached the EPC [Contract] and was liable for at least $22 million—the amount specified in the contractual limitation of liability—and further argued that because CEM's conduct constituted gross negligence, the limitation of liability did not apply, and CEM would be liable for all damages proven." Opposition to Petition ¶¶ 8–9.
In April 2013, Judge Charles Ramos agreed with CEM and, among other things, vacated the $22,043,302 award to LPP. The Appellate Division unanimously affirmed the trial court's decision in February 2014. The main part of the court's analysis is contained in one paragraph of its brief opinion:
Under the [FAA], which the parties invoke, an arbitration award may be vacated where the arbitrators exceeded their powers. Accordingly, where arbitrators rule on issues not presented to them by the parties, they have exceeded their authority and the award must be vacated. The arbitration demand, the prehearing motion practice and [the initial arbitrator]'s decision make it clear that gross negligence was the only claim by LPP that was presented to [the subsequent arbitrator] for a hearing. Therefore, [the arbitrator] exceeded his authority by finding that CEM breached the EPC [Contract] and awarding damages for cost overruns.
Colorado Energy, 981 N.Y.S.2d at 46 (citations omitted). In support of its view that LPP only advanced gross negligence, the court quoted the language from LPP's opposition to CEM's motion to dismiss, which only describes gross negligence as LPP's "cognizable legal theory." The court also emphasized the language from the initial arbitrator's decision on that motion to dismiss, noting that the allegations in the arbitration demand "state a claim for gross negligence" that "could form the basis for the recovery of causally related damages" as opposed to a basis to recover such damages. Colorado Energy, 981 N.Y.S.2d at 46 & n.1. As noted above, LPP sought leave to further appeal the Appellate Division's decision, but it was denied. In re Colorado Energy Mgmt., LLC, 13 N.E.3d 662 (N.Y. 2014).
Is the Colorado Energy Decision Correct?
The Colorado Energy decision conspicuously lacks any discussion about the standard the court applied in deciding whether the arbitrator exceeded his authority. In New York (and elsewhere), it is well established that a party moving to vacate an award bears a "very high" burden. D.H. Blair & Co. v. Gottdiener, 462 F.3d 95, 110 (2d Cir. 2006). Thus, New York courts are directed to accord "the narrowest of reading" to section 10(a)(4) of the FAA when deciding whether or not to vacate an award, and they are "similarly limited" when deciding whether or not to modify an award under section 11(b). Seed Holdings, Inc. v. Jiffy Int'l AS, 5 F. Supp. 3d 565, 588 (S.D.N.Y. 2014). In both instances, the court's inquiry focuses on whether the arbitrators had the power based on the parties' submissions to reach an issue. TA Assocs., L.P. v. Gandy, No. 654360/2013 (N.Y. Sup. Ct. June 9, 2014). Said differently, the principal question is whether the arbitration award "draws its essence" from the parties' submission. ReliaStar Life Ins. Co. of N.Y. v. EMC Nat'l Life Co., 564 F.3d 81, 85 (2d Cir. 2009). "Courts have found arbitrators exceeded their authority where arbitrators went beyond alternative reasoning not presented by the parties and instead awarded relief not requested by the parties." Gandy, No. 654360/2013 (internal quotation marks and brackets omitted).
The trial court in Colorado Energy and the Appellate Division perhaps did not apply a properly deferential standard in deciding to vacate the arbitration award at issue. While it is apparent that LPP focused on establishing gross negligence in the arbitration in order to avoid the monetary damages cap in the Limited Liability Provision, as shown above, its demand and some later filings do seem to indicate, although not remarkably clearly, that LPP was asserting an ancillary breach of contract claim. The arbitrator, who had a firsthand account of the arbitration proceedings, certainly believed that LPP sought damages based on an ordinary breach of contract theory. The Colorado Energy trial court and the Appellate Division arguably did not offer sufficient grounds to depart from the judgment of the arbitrator, particularly in light of the deference accorded to arbitrators under New York law.
Avoiding the Result in Colorado Energy
Parties may consider these actions to avoid suffering the same fortune as LPP:
• The arbitration demand should clearly set forth each legal theory on which the claimant seeks damages, and consider presenting those theories in separate counts of the demand.
• Dispositive motion papers should, where appropriate, mention each legal theory that the claimant is submitting to the arbitrator.
• The claimant should ensure at any preliminary hearing in the arbitration that the arbitrator understands what legal theories the claimant is submitting.
• Any prehearing or posthearing brief should clearly describe each legal theory on which the claimant seeks damages.
• The claimant should clearly submit in writing, whether by an amended demand or otherwise, any additional legal theories advanced during the arbitration.
If these steps are followed, a dispute about the issues submitted to the arbitrator is less likely.
Keywords: litigation, ADR, arbitration, vacatur, legal theory, submit, submission, arbitral award