On August 9th, 2022, a federal court in Virginia confirmed an arbitration award and held that a general choice of law provision does not displace the Federal Arbitration Act (FAA) and require the application of state arbitration law. Vogel v. Gracias Juan, LLC, 1:21-CV-1355, 2022 WL 3213537 (E.D. Va. Aug. 9, 2022)
Plaintiffs Glenn Vogel and Doug Lee entered into a Membership Interest Purchase Agreement (MIPA) with Nathan Hibler and defendant Gracias Juan, LLC (hereinafter “Gracias”) to purchase a 91 percent interest in Espire Services, LLC (Espire). A dispute arose under the agreement. RSM US LLP (RSM), an independent accounting firm, arbitrated the dispute and issued an award in favor of Vogel and Lee.
On November 10, 2021, Vogel and Lee filed suit in the Circuit Court of Fairfax County, Virginia, seeking to confirm the arbitration award. Gracias removed the action to federal court on the basis of diversity jurisdiction and moved to vacate the award.
The parties’ agreement contained a choice of law provision stating that the MIPA “shall be governed by and construed in accordance with the internal laws of the Commonwealth of Virginia without giving effect to any choice or conflict of law provision or rule.” Based on this, Vogel and Lee argued that the Virginia Uniform Arbitration Act governed the MIPA. Gracias argued that the FAA applied.
Before deciding whether to confirm or vacate the award, the court addressed what law to apply. The court determined that "[a] general choice of law provision, as the MIPA contained, is insufficient to displace the FAA[.]” The court reasoned that “while the general choice-of-law provision invokes [state] substantive law for issues of contract interpretation,” a general choice of law provision “is irrelevant to the decision whether the FAA applies.” Rota-McLarty v. Santander Consumer USA, Inc., 700 F.3d 690, 697 n.7 (4th Cir. 2012)
The court then noted that, under the FAA, a party moving to vacate an arbitration award faces a “heavy burden.” The court emphasized that "review of an arbitration award is limited to determining whether the arbitrators did the job they were told to do—not whether they did it well, or correctly, or reasonably, but simply whether they did it.”
In the motion to vacate, Gracias contended RSM committed two errors. First, Gracias argued that the MIPA's arbitration provisions limit the arbitrator's review solely to figures presented in the post-closing statement and that RSM exceeded its powers by reviewing updated estimates of Espire's net working capital on the closing date. The court rejected this argument, because review of the MIPA provision at issue confirmed that the arbitrator acted well within the scope of its authority. “Nowhere in the MIPA did the parties agree that the arbitrator was required to ignore updated estimates of Espire's finances not known at the time of the initial Post-Closing Statement.” The MIPA explicitly authorized RSM to “determine the Net Working Capital” of Espire at the time the sale closed, which is precisely what RSM did in its detailed award.
Gracias’ also contended that RSM manifestly disregarded the law by misapplying generally accepted accounting principles (GAAP). Gracias argued that RSM should have, but did not, determine that the $6,000,000 loan taken by Espire to finance Vogel and Lee’s purchase of Espire qualified as a current asset of Espire as of the closing date. The court rejected this argument as well.
The court noted that case law in the Fourth Circuit requires vacatur of an award that reflects a “manifest disregard of the law and was not drawn from the essence of the governing arbitration agreement.” See Patten v. Signator Ins. Agency, Inc., 441 F.3d 230, 234 (4th Cir. 2006). However, in the Patten case, the court said that “[a]n arbitration award fails to draw its essence from the agreement only when the result is not rationally inferable from the contract” and that the party challenging the arbitration award bears the heavy burden of showing that a manifest disregard of the law took place.
Here, the court concluded that "[n]othing in the Seller's motion to vacate suggests that RSM manifestly disregarded the law in concluding that the loan proceeds should be excluded from Espire’s Net Working Capital." The court held that Gracias’ argument that RSM incorrectly interpreted GAAP principles was insufficient to show that RSM had manifestly disregarded the law. The fact that RSM was an independent accounting firm selected by both parties furthered indicated to the court that RSM was in the best position to apply GAAP principles to accurately evaluate the LLC's finances and resolve the parties’ accounting dispute.
The court concluded that Gracias was really seeking de novo review of the arbitrator's award but held that such review would frustrate the core purpose of arbitration and was impermissible.