August 21, 2020 Articles

Arbitrators Must Disclose Ownership Interest

Arbitrator disclosure of an economic interest does not suffice as constructive notice of an ownership interest for parties to make an informed decision for waiver.

By Jeanine Telfer

The Ninth Circuit vacated an arbitrator’s award, finding that a distributor did not waive its evident partiality claim, and held that arbitrators must disclose an ownership interest in arbitration organizations. See Monster Energy Co. v. City Beverages, 940 F.3d 1130 (9th Cir. 2019), cert. denied (U.S. June 29, 2020) (No. 19-1333). 

The fact that there are two sophisticated, large companies involved is critical to how the series of events unfolded. One party is City Beverages, LLC, d/b/a Olympic Eagle Distributing (Olympic), which is an Anheuser-Busch distributor. The other party to this suit is Monster Energy Co. Monster and Olympic entered into a 20-year exclusive agreement in 2006 in which Olympic agreed to promote and sell Monster energy drinks. The agreement provided that Monster could terminate the relationship without cause as long as Monster paid a severance fee. Monster terminated the agreement in 2014 and offered to pay the $2.5 million severance fee as provided in the terms of the agreement. However, Olympic instead invoked Washington State’s Franchise Investment Protection Act (FIPA), which prohibits termination of a franchise contract absent good cause. See Wash. Rev. Code § 19.100.180(2)(j). As a result, Monster compelled arbitration under the terms of the agreement that specified JAMS Orange County (JAMS) as the arbitrator. JAMS provided a list of seven arbitrators and the parties agreed on one. The parties entered into arbitration and the arbitrator issued an interim award finding that Olympic was not entitled to protection under FIPA and awarded Monster attorney fees. When Monster filed a petition to confirm the award, Olympic filed to have the award vacated because it later discovered the arbitrator was a co-owner of JAMS, which was not disclosed prior to arbitration. Olympic requested, subpoenaed, and ultimately filed a motion to compel information from JAMS regarding the arbitrator’s financial interest in JAMS and JAMS’ relationship with Monster. Despite JAMS’ refusal to comply, the district court confirmed the award. The Ninth Circuit found arbitrators must disclose their ownership interest in any arbitration organization they are affiliated with in connection with the proposed arbitration and any nontrivial business dealings with the parties to the arbitration.

Arbitrator Has a Duty to Disclose Potential Conflicts

It is well established that arbitrators must “disclose to the parties any dealings that might create an impression of possible bias.” See Commonwealth Coatings Corp. v. Cont’l Cas. Co., 393 U.S. 145, 149 (1968). In the instant case, the arbitrator submitted a disclosure statement indicating that he has served as an arbitrator for Monster within the last five years, that he has an economic interest in the overall financial success of JAMS, and that he arbitrated a separate dispute between Monster and a distributor that resulted in an award against Monster of almost $400,000. The arbitrator failed to disclose he was a co-owner of JAMS. On its face, it does appear that the arbitrator made great efforts to create an appearance of neutrality by disclosing an example case in which he ruled against Monster. However, it appears he knew of the potential conflict that he failed to disclose given the degree to which he failed to comply with the multiple requests for information regarding his financial interest in JAMS and JAMS’ relationship with Monster.

Impact of Arbitrator’s Ownership Interest and Nontrivial Business Dealings

The Ninth Circuit entered into a twofold inquiry: “(1) whether the Arbitrator’s ownership interest in JAMS was sufficiently substantial, and (2) whether JAMS and Monster were engaged in nontrivial business dealings.” Over the course of five years, JAMS administered 97 arbitrations for Monster, which clearly constitutes a significant source of business for JAMS. Given the amount of business JAMS does with Monster, even an employee without an ownership interest, provided JAMS is a fairly small entity, could still have a substantial economic interest in ensuring Monster continues to provide prospective employment—particularly in light of how many arbitrations JAMS has done in the past five years. However, in the instant case, as a co-owner, the arbitrator receives a part of the proceeds for every arbitration in which JAMS is employed. Consequently, this arbitrator’s ownership interest, given the relationship between JAMS and Monster, is actually quite substantial and nontrivial. The fact that the arbitrator avoided all instances of disclosing this information is also indicative, from an ethical standpoint, that even the arbitrator knew the significance of this information in ensuring a well-informed waiver.

As a result, the Ninth Circuit established that recusal or disqualification is not required when economic conflicts exist for arbitrators; instead, there must be “disclosure prior to conducting an arbitration concerning (1) the arbitrator’s ownership interest, if any, in the entity under whose auspices the arbitration is conducted, and (2) whether the entity under whose auspices the arbitration is conducted and one or more of the parties were previously engaged in nontrivial business dealings.”

“Repeat Player” Bias

This litigation involved two sophisticated parties; however, the factors established could be of great significance instead to unsophisticated parties or those who are not in the position to renegotiate the terms of an agreement prior to signing. This will ensure that parties can make their own informed decisions about whether a particular arbitrator is likely to be neutral. It does put the onus on arbitrators to disclose their ownership interests in their arbitration organization. If the entity that chose the arbitration organization is not a “repeat player,” thus constantly in arbitration, then preserving the neutrality of the process is not as significant of an issue.

But, when a “repeat player” is involved, this permits the other party to make an informed decision regarding waiver. Accordingly, this decision creates more significant protections for parties who are forced to use arbitrators due to a form contract, such as unsophisticated parties and parties who are subject to one-sided, perhaps unfair, agreements, without the privilege or ability to negotiate better agreements. Examples include agreements required to acquire employment, agreements that are already included in the purchase a product, or agreements made to obtain a necessary service. In these instances, the agreements are not open for negotiation, and if the facts were the same as in the instant case, there would be a reasonable impression of bias. But there does still remain the issue of what happens when a party objects to the person with an ownership interest. An arbitrator with only an economic interest can be substituted, but the “repeat player” bias still remains.

The Ninth Circuit found in this case that the ownership interest does give a reasonable impression of bias. Nevertheless, the arbitrator’s award was consistent with the original agreement reached between the parties. As mentioned, these are two sophisticated parties. The agreement provided that it can be terminated without cause as long as Monster paid a severance fee. Olympic knew this and yet still signed the form agreement that dictated JAMS as the arbitrator. Olympic is in a position where it could have negotiated a better agreement. There is nothing provided by Olympic to suggest the agreement was invalid. As a matter of a fact, the district court found it was valid, and Olympic did not appeal that decision. There is nothing to suggest an arbitrator with no economic interest would have issued a different award.

The nature of the form agreement used by Monster and the number of agreements arbitrated made it easily evident at a minimum that there could be a “repeat player” bias. Yet, Olympic not only signed the agreement but went through with the arbitration instead of engaging in more thorough due diligence regarding the relationship between JAMS and Monster prior to agreeing to an arbitrator. As noted by the dissent, Olympic could have easily researched online, through a record search, how many arbitrations JAMS conducted with Monster as a party. The very nature of having any private arbitration firm dictated by the terms of an agreement at the forefront rises to a clear showing of an inherent bias to keep the client. Olympic was in a position to know prior to signing the agreement that JAMS conducted a significant number of arbitrations for Monster. The district court held that Olympic to validly agreed to the terms of the contract, which Olympic did not appeal. Olympic was clearly satisfied to go through with the arbitrator chosen when the disclosure showed no history of siding only with Monster. It was only after losing at arbitration that Olympic did further investigation, requested additional information, and moved to vacate the award.

The Reward: Attempting Another Bite at the Apple

While the Ninth Circuit’s decision could be potentially instrumental in leveling the playing field for parties who are forced to sign a form contract, it unfortunately gives more sophisticated parties another bite at the apple when the arbitration does not go their way, by moving to vacate if an ownership interest is not disclosed. Most owner neutrals of organizations will likely update their disclosures to avoid seeing awards vacated as a result of this decision. Nevertheless, in the instant case, the agreement was legitimate. Olympic clearly agreed to Monster terminating without cause and then decided when it came to fruition that it was not going to abide by the agreement and would use FIPA as a defense. This response to the termination of the agreement raises the question of whether Olympic entered into the agreement in full faith, knowing it would go this route instead of negotiating an agreement from the outset that would be fair to both parties. The decision rewards Olympic and attacks an award that otherwise seems valid. While, yes, the lack of disclosure of an ownership interest does not constitute a constructive waiver, when weighed with the facts of the case, it does not rise to a reasonable impression of bias here.

In the short term, the factors as established in this decision will more likely result in sophisticated parties more extensively litigating to vacate arbitrator awards when dissatisfied with the result. It has already started. An example of this came in a decision issued in July 2020 when Aqua Dynamic Systems, Inc., moved to vacate an arbitration award that was in favor of Levi Strauss & Co. because two JAMS panelists did not disclose their shareholder interest in JAMS. See Levi Strauss & Co. v. Aqua Dynamics Sys., Inc., No. 15-cv-04718-WHO (N.D. Cal. July 20, 2020). Aqua’s argument failed, however—ultimately and ironically because it was Aqua that forced the parties into arbitration and it was Aqua that choose JAMS. Nevertheless, this goes to show the impact of how this decision will be used adversely from its intent. The gates have already opened to allowing a sophisticated party to try to vacate an award issued by an arbitrator it chose, simply because that party was dissatisfied with the results. Surely, there are more in the pipeline making their way up.

Jeanine Telfer is an attorney with the U.S. Postal Service and is based in Long Beach, California.


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