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March 07, 2016 Articles

Third Circuit Rules No Second Bite at the Arbitration Apple

By Sarah Espinosa

On September 29, 2015, the U.S. Court of Appeals for the Third Circuit issued a precedential decision concerning whether and when a party to arbitration waives its right to challenge the arbitration award. The Third Circuit joined a number of other circuits, and cited as persuasive authority holdings from the Second, Eighth, and Ninth Circuits, in adopting a constructive knowledge standard in the assessment of motions to vacate an arbitration award as a result of an arbitrator's failure to disclose. Essentially, a party to an arbitration should not wait to investigate or allege arbitrator malfeasance until after a decision is issued, because if such knowledge could have been discovered prior, with reasonable care and diligence, the party will waive its ability to subsequently challenge the award.

Goldman Sachs v. Athena
In Goldman, Sachs & Co. v. Athena Venture Partners, LP, 803 F.3d 144 (3d Cir. 2015), the parties engaged in a nine-day arbitration hearing before a panel of three arbitrators under the auspices of the Financial Industry Regulatory Authority (FINRA). During the course of the hearing, one of the panel members disclosed that there were allegations pending against him in New Jersey. The allegations concerned the arbitrator's alleged unauthorized practice of law. In making this disclosure, the arbitrator described the incident in question as involving "my representation of a family frien[d] in a local municipal court." Id. at 146 n.4 (alteration in original). When the arbitration award was issued in favor of Goldman Sachs, the arbitrator in question did not sign the award. Under the applicable arbitration agreement, the signature of the other two arbitrators constituted a binding award.

After receiving the award, Athena conducted a background investigation of the arbitrator in question and discovered that, not only was the initial disclosure grossly misleading, the arbitrator also failed to disclose various other allegations, including alleged misconduct before the Michigan State Bar and alleged fraud in issuing checks despite possessing insufficient funds. Athena filed a motion to vacate the award, alleging the arbitrator's failure to disclose was a violation of the arbitration agreement and FINRA rules. The district court granted vacatur, citing the Federal Arbitration Act, 9 U.S.C. § 10(a)(3) and (4), and holding "that FINRA failed to provide the parties with three qualified arbitrators." Goldman Sachs, 803 F.3d at 147. Goldman Sachs appealed the ruling, arguing in part that Athena waived its right to challenge the award.

Third Circuit Adopts the Constructive Knowledge Standard
In overturning the district court and holding that Athena waived its right to challenge the arbitration award, the Third Circuit adopted the constructive knowledge standard. The court defined constructive knowledge as: "[k]nowledge that one using reasonable care or diligence should have, and therefore that is attributed by law to a given person." Goldman Sachs, 803 F.3d at 148 (citing JCI Commc'ns Inc. v. Int'l Bhd. of Elec. Workers, Local 103, 324 F.3d 42, 52 (1st Cir. 2003)). The court held:

The rationale for applying constructive knowledge in the arbitration context makes good sense. It both encourages parties to conduct adequate due diligence prior to issuance of the award and promotes the arbitration goals of efficiency and finality. Therefore, we conclude that if a party could have reasonably discovered that any type of malfeasance, ranging from conflicts-of-interest to non-disclosures such as those at issue here, was afoot during the hearings, it should be precluded from challenging the subsequent award on those grounds.

Goldman Sachs, 803 F.3d at 149. The court further expounded: "A party should not be permitted to game the system" or take "a second bite of the apple" by waiting to investigate an issue that it could have discovered prior to issuance of the award. The Third Circuit holding offers this clear guidance: "This is all to say, under the constructive knowledge standard, a party may not conduct a background investigation on an arbitrator after the award with the sole motivation to seek vacatur. If it were any other way, arbitrations would cease to have finality and result in endless hearings within hearings." Id. at 149–50.

Favoring the Finality of the Arbitration Award
The Third Circuit's holding in this matter emphasizes the goals of efficiency and finality in arbitration. As such, parties are well served to investigate and raise any arbitrator nondisclosures or conflicts it may or should have discovered prior to the award, or risk waiving its right to subsequently challenge the award on this basis.

Keywords: litigation, ADR, alternative dispute resolution, arbitration, waiver, arbitrator nondisclosure, constructive knowledge

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