July 27, 2016 Practice Points

Second Circuit Reaffirms Manifest Disregard of Law as a Valid Ground for Vacature

By Edward Lozowicki

The Second Circuit recently reaffirmed its position that manifest disregard of law or the arbitration agreement is a valid ground for vacating an arbitration award. Sutherland Global Services v. Adam Technologies, 2016 WL 494155 (2d Cir. 2016). Its decision highlights a split among the circuits.  

In 2008, the U.S. Supreme Court held that §10(a) of the Federal Arbitration Act (FAA) provides the “exclusive grounds” for vacating arbitration awards. Hall St. Assocs. LLC v. Mattel, Inc., 552 U.S. 576 (2008). Since then, the circuits have split on whether manifest disregard of the law survives as a separate ground for vacature. The Fifth, Eighth, and Eleventh Circuits have held that manifest disregard is no longer a valid ground, while the Second, Fourth, and Ninth Circuits have held that it is valid as a “judicial gloss” on the grounds stated in FAA §§10(a)(3) and (4). The Third Circuit has not yet ruled on this issue.  

In Sutherland, the Second Circuit read Hall Street to hold that the grounds for vacature in section 10 of the FAA are “generally exclusive,” but stated that “as ‘judicial gloss on the specific grounds for vacature of arbitration awards’ in the FAA, an arbitrator’s “‘manifest disregard’ of the law or of the terms of the arbitration agreement remains a valid ground for vacating arbitration awards.” Id. Manifest disregard of the arbitration agreement as a ground for vacature appears consistent with FAA §10(a)(4) which allows vacature if the arbitrator exceeds his or her powers.  

In Sutherland, the appellant argued that the arbitration panel had exceeded its powers and manifestly disregarded the parties’ contract and New York law because: (1) a material contract document had not been executed by the parties, and (2) the panel based the award on work performed by appellant’s affiliate contrary to the terms of the contract. The Sutherland court rejected these arguments. It said that the primary inquiry under §10(a)(4) is whether the arbitrator’s award draws its essence from the parties’ agreement and provides even a “barely colorable” justification for the arbitrator’s interpretation of it. It held that the arbitrators had interpreted the contract so as to rebut the appellant’s contentions, and that the court would not scrutinize the panel’s contractual interpretation or its factual findings.  

The appellant also argued that the arbitrators committed legal error because they ignored a contract provision that limited liability. The court disagreed stating that manifest disregard of the law applies only in those exceedingly rare instances where there is some egregious impropriety on the part of the arbitrator. The court elaborated: “It is not enough … to show that the panel committed an error—or even a serious error … It is only when [an] arbitrator strays from the interpretation and application of the agreement and effectively ‘dispenses his own brand of industrial justice’ that his decision may be unenforceable.” Id. Since the court found no manifest disregard of either the law or the arbitration agreement, it affirmed the district court’s confirmation of the award. 

A similar conclusion was reached by the Fourth Circuit several years ago. Wachovia Securities, LLC v. Brand, 671 F.3rd 472 (2012). In Wachovia, the losing party argued that the arbitrators had manifestly disregarded a state statute by refusing to hold an evidentiary hearing on the victor’s claim for attorney’s fees. The losing party argued that the arbitrators violated Section 10(a)(3) which provides for vacature “where the arbitrators were guilty of . . . misbehavior by which the rights of any party have been prejudiced.” In rejecting this argument, the court applied a two-part test: (1) whether the applicable legal principle is clearly defined and not subject to reasonable debate; and (2) whether the arbitrator refused to heed that principle. It ruled that the test was not satisfied because the meaning of the statute was not clearly defined and was subject to debate. It further reasoned that: “Whether manifest disregard is a ‘judicial gloss’ or an independent ground for vacature, it is not an invitation to review the merits of the underlying arbitration ...” Id. at 483. The denial of the appellant’s motion to vacate was affirmed.  

Sutherland and Wachovia provide guidance for arbitrators drafting arbitration awards. Since an award must draw its essence from the underlying agreement, the award should set forth the arbitrator’s interpretation of the agreement and any governing law. Further, the award should not include statements that suggest a controlling principle of law is being flouted.  

Keywords: alternative dispute resolution, adr, litigation, manifest disregard, rare, egregious, own brand of industrial justice

Edward Lozowicki is with Lozowicki ADR in Palo Alto, California.

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