Swimming Against the Tide? “Evident Partiality” of a Party-Appointed Arbitrator in the Second Circuit

Summary of Lloyd’s
In Lloyd’s, Alex Campos, a party-appointed arbitrator, failed to disclose several contacts with ICA, his appointer. Perhaps the most serious was that Campos had been the president and chief executive officer of a human resources firm at the same time that Ricardo Rios, a director of ICA, was the chief financial officer of that firm. Rios was also a witness in the arbitration hearing.

The parties’ contract required that the arbitrators “be active or retired disinterested executive officers” from certain insurance companies and permitted party discussion with its party-appointed arbitrator before discovery. The proceeding was ad hoc.

The Second Circuit acknowledged the value of arbitrator disclosure and transparency and that, in failing to disclose his contacts, Campos had violated his ethical duties:

Mainstream arbitral guidelines such as ARIAS and the American Arbitration Association require comprehensive disclosure. . . . It would appear that Alex Campos violated these ethical codes; and future parties may well be wary of his participation on panels. However, it is well-established that such ethical violations do not compel vacatur of an otherwise valid arbitration award. . . . An arbitrator’s “failure to make a full disclosure may sully his reputation for candor but does not demonstrate evident partiality.” Sphere Drake Ins. v. All American Life Ins., 307 F.3d 617, 622-23 (7th Cir. 2002).

The court held that an undisclosed relationship between a party and its party-appointed arbitrator constitutes evident partiality if the undisclosed relationship clearly and convincingly (1) violates the arbitration agreement (here if it violated the contractual requirement of disinterestedness) or (2) prejudicially affected the award. The Second Circuit remanded the case for findings under these standards. In effect, after Lloyd’s, barring a violation of the parties’ contract, a motion to vacate an award based on a party-appointed arbitrator’s failure to disclose may require actual proof that the nondisclosure skewed the award in favor of the arbitrator’s appointer.

To put this holding in context, it is useful to review the precedent that informed the court’s thinking.

Supreme Court Precedent on Evident Partiality
Fifty years ago, the U.S. Supreme Court addressed “evident partiality” in Commonwealth Coatings Corp. v. Continental Casualty Co., 393 U.S. 145 (1968). An obviously aghast Justice Black, writing for a plurality of four justices, vacated an award where the third “supposedly neutral” member of an arbitration panel failed to disclose that one of his regular customers was one of the arbitration parties and that the party’s patronage of the arbitrator’s business was “repeated and significant” and “even went so far as to include the rendering of services on the very projects involved in this lawsuit.” Justice Black found that the provisions of the FAA regarding evident partiality and vacation of an award procured by “corruption, fraud, or undue means” showed a “desire of Congress to provide not merely for any arbitration but for an impartial one.” He went on to note that arbitrators should be held to an even higher standard than judges:

It is true that arbitrators cannot sever all their ties with the business world, since they are not expected to get all their income from their work deciding cases, but we should, if anything, be even more scrupulous to safeguard the impartiality of arbitrators than judges, since the former have completely free rein to decide the law as well as the facts and are not subject to appellate review. We can perceive no way in which the effectiveness of the arbitration process will be hampered by the simple requirement that arbitrators disclose to the parties any dealings that might create an impression of possible bias.

In an oft-cited concurring opinion, Justice White claimed to join Justice Black’s opinion with merely some “additional remarks” that a number of courts, including the Second Circuit, have essentially found irreconcilable with Justice Black’s viewpoint. Justice White stated that

[t]he Court does not decide today that arbitrators are to be held to the standards of judicial decorum of Article III judges, or indeed of any judges. It is often because they are men of affairs, not apart from but of the marketplace, that they are effective in their adjudicatory function. . . . [A]rbitrators are not automatically disqualified by a business relationship with the parties before them if both parties are informed of the relationship in advance, or if they are unaware of the facts but the relationship is trivial. . . .

Justice White declared that arbitrators “cannot be expected to provide the parties with [their] complete and unexpurgated business biography. But it is enough for present purposes to hold, as the Court does, that where the arbitrator has a substantial interest in a firm which has done more than trivial business with a party, that fact must be disclosed.”

Courts over the intervening decades have struggled to reconcile these opinions—often noting, as the Second Circuit has done, that the Commonwealth opinions were unclear or even irreconcilable—and have struggled to come up with a proper nondisclosure standard.

Morelite: The Second Circuit’s “Have to Conclude” Standard
In Morelite Construction Corp. v. New York City District Council Carpenters Benefit Funds, 748 F.2d 79, 83–84 (2d Cir. 1984), the Second Circuit vacated the award of a single arbitrator whose father was a senior executive for one of the parties because of the “inevitable” father-son loyalty, noting that

standards for disqualification of arbitrators have been held to be less stringent than those of federal judges . . . [f]or to disqualify any arbitrator who had professional dealings with one of the parties (to say nothing of a social acquaintanceship) would make it impossible, in some circumstances, to find a qualified arbitrator at all. Mindful of the trade-off between expertise and impartiality, and cognizant of the voluntary nature of submitting to arbitration, we read Section 10(b) as requiring a showing of something more than the mere “appearance of bias” to vacate an arbitration award. To do otherwise would be to render this efficient means of dispute resolution ineffective in many commercial settings.

“Familiarity with a discipline often comes at the expense of complete impartiality [and] . . . specific areas tend to breed tightly knit professional communities,” the Morelite court flatly stated.

Nevertheless, the court acknowledged that it had a responsibility to “maintain the integrity of the federal courts’ role in affirming or vacating awards,” and in this regard, the court noted that although an “appearance of bias” standard was too low, proving “actual bias” was too difficult. Accordingly, the Second Circuit held that evident partiality within the meaning of 9 U.S.C. § 10, based on an undisclosed relationship, will be found

where a reasonable person would have to conclude that an arbitrator was partial to one party to the arbitration. In assessing a given relationship, the courts must remain cognizant of peculiar commercial practices and factual variances. Thus, the small size and population of an industry might require a relaxation of judicial scrutiny, while a totally unnecessary relationship between arbitrator and party may heighten it.

Back to Lloyd’s
In Lloyd’s, the Second Circuit systematically laid out its understanding of the current state of the law in the circuit and identified the following principles.

Neutral arbitrators. The Lloyd’s court reaffirmed the Morelite “would have to conclude” standard and stated that the Second Circuit requires something more than the mere appearance of bias to vacate an arbitration award.

The court emphasized that it is the materiality of the undisclosed information, not the nondisclosure itself, that is important. It declared that the Supreme Court’s opinion in Commonwealth “established” that an arbitrator’s failure to disclose a material relationship with one of the parties can constitute “evident partiality” requiring vacatur of the award but does not establish a per se rule that requires an award to be vacated whenever an undisclosed relationship is discovered.

Even with respect to neutral arbitrators, the court said, “we have not been quick to set aside the results of an arbitration because of an arbitrator’s alleged failure to disclose information.” The court stated that it had concluded in several instances that the evident partiality standard was not satisfied because the complaining party should have known or could have learned of the relationship just as easily before the arbitration as after  the party lost the case, as well as in situations where the undisclosed relationship was “too insubstantial to warrant vacating the award.”

In “broader strokes,” the court affirmed that the FAA does not proscribe all personal or business relationships between arbitrators and the parties.

The court also said it would not vacate an award when the party opposing the award “identifies no direct connection between the arbitrator and the outcome of the arbitration.”

The court cited with approval the value of specialized arbitrators and opined that “[j]udicial tolerance of relationships between arbitrators and party representatives reflects competing goals in partiality decisions.” It noted that the best informed and most capable potential arbitrators may be repeat players with deep industry connections who will understand the trade’s norms of doing business and the consequences of proposed lines of decision, particularly where the parties regularly seek out such arbitrators.

Party-appointed arbitrators. Having outlined the standards for neutral arbitrators, the Lloyd’s court went on to discuss, and distinguish, the standards applicable to party-appointed arbitrators.

The court began by declaring that “the principles and circumstances that counsel tolerance of certain undisclosed relationships between arbitrator and litigant are even more indulgent of party-appointed arbitrators, who are expected to serve as de facto advocates,” citing with approval Sphere Drake Insurance Ltd. v. All American Life Insurance Co., 307 F.3d 617 (7th Cir. 2002). The court also quoted a 1962 case for the proposition that “[t]here has grown a common acceptance of the fact that the party-designated arbitrators are not and cannot be ‘neutral,’ at least in the sense that a third arbitrator or judge is.” Astoria Med. Grp. v. Health Ins. Plan of Greater N.Y., 227 N.Y.S. 2d 401, 404 (1962).

The court emphasized that arbitration is a creature of contract and that courts must hold parties to their bargain. The court stated that parties are free to choose for themselves to what lengths they will go in quest of impartiality, including the various degrees of partiality the court believed are part of the party-appointment procedure.

The court also approvingly cited several cases from other circuits holding that the disclosure requirements for neutral arbitrators do not extend to party-appointed arbitrators.

Although the court declined to “catalogue all material” undisclosed relationships that may “bear upon the service of a party-appointed arbitrator,” it did describe two circumstances under which such a relationship would be material: (1) the undisclosed relationship violated the arbitration agreement and (2) the party-appointed arbitrator’s partiality had a prejudicial effect on the award. With respect to the latter, however, the court cautioned that the alleged prejudicial effect needed to be clear:

In the absence of a clear showing that an undisclosed relationship (or the non-disclosure itself) influenced the arbitral proceedings or infected an otherwise-valid award, that award should not be set aside even if a reasonable person (or court) could speculate or infer bias.

Practice Points
Lloyd’s was decided in the context of the reinsurance industry and the specific qualifications the arbitrators were required to have. Although litigants no doubt will seek to distinguish Lloyd’s on this ground, the court did not so limit its holding, and counsel should assume it applies to all industries.

The Second Circuit’s general view that it is commonly expected that party-appointed arbitrators lack neutrality—and even have trouble playing a neutral role—has provoked the most controversy, and to this extent, the court would appear to be swimming against the tide. As commentators have noted, the “leading [domestic and international] arbitral rules, both in their latest versions and their earlier versions within the last 10 years or so, reflect the general practice that all arbitrators are expected to be neutral.” John Fellas, “Evident Partiality and the Party-Appointed Arbitrator,” N.Y. L.J.,June 27, 2018. For example, the commercial rules of both the American Arbitration Association (AAA) and JAMS in essence create a presumption that the arbitrators will be impartial or neutral and independent unless the parties explicitly agree that they will not be neutral (AAA Commercial Rule 18; JAMS Rule 7). The rules of the International Institute for Conflict Prevention & Resolution (CPR) flatly require that arbitrators serving on a CPR-administered or non-administered panel be “neutral and impartial.” (Rule 7.1 (non-administered and administered rules)). In short, the prevailing contractual standards set forth in the provider rules presume or require neutrality.

In broader strokes, industry expertise in no way means that an arbitrator is incapable of conducting a neutral and balanced assessment of the case, and the ability to do this is generally expected of today’s arbitrators, party-appointed or otherwise. Nonetheless, as Mr. Fellas advises—and consistent with the Second Circuit’s emphasis on the importance of the parties’ bargain—it may be advisable for parties drafting arbitration clauses to consider providing specifically, where that is their intent, that all arbitrators are to be “impartial and independent” and for chairs to confirm this. In addition, contractually requiring the disclosure of all “material” or other relationships relevant to the parties may be advisable.

Even if the parties’ contract does explicitly permit partiality, however, the question remains whether the Second Circuit has inappropriately watered down the role of the FAA and the courts in supervising arbitration awards with its relaxed nondisclosure standard. Whether or not the Second Circuit struck the right balance will be debated for some time. In the end, given the lack of recent Supreme Court guidance and decisions such as Lloyd’s, it is absolutely critical for parties to address arbitrator qualification, disclosure, and impartiality requirements in their contract ex ante to ensure that they get the arbitration panel—and the efficient process free of one common source of post-arbitration litigation—that they want.

Conna A. Weiner is a mediator, arbitrator, and special master for JAMS in Boston, Massachusetts.

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