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May 24, 2016 Articles

Can Parties to an Arbitration Agreement Contract for Expanded Judicial Review?

By Linda L. Morkan

By now, everyone is familiar with the benefits arbitration offers as an alternative to traditional litigation. Contracting parties can acknowledge the possibility of a future dispute and negotiate how that dispute will be resolved in private arbitration. They can choose an arbitrator, which is especially important in specialized trades where expertise is essential to understanding the parties’ agreement. They can choose a time frame, because we all know how court cases can drag on. And they can choose the scope of the remedy, perhaps removing the option for class actions or the recovery of punitive damages, for example.

But in 2008, the U.S. Supreme Court held that the Federal Arbitration Act (FAA) does not allow contracting parties to choose how arbitration awards will be reviewed, once such rewards are submitted to a trial court for confirmation or vacatur. Hall St. Assocs. v. Mattel, Inc., 552 U.S. 576, 590 (2008). In so interpreting federal law, however, the Supreme Court also indicated that state arbitration laws may differ from the FAA, and state law might allow contracting parties to agree to a broader grant of review. The intervening years have seen states lining up on either side of the issue, creating a great divide in state/federal arbitration law. Massachusetts is the latest to join the majority position, following the U.S. Supreme Court’s lead. Katz, Nannis & Solomon, P.C. v. Levine, 473 Mass. 784, 46 N.E.3d 541 (2016). There are vocal outliers, though, and these courts insist that they are the ones defending the underlying philosophy that arbitration is a formal dispute resolution tool controlled by the parties who agreed to it. It is not a fight that will be resolved any time soon.

The U.S. Supreme Court Strictly Construes the FAA in Hall Street
The FAA was passed by Congress in 1924 and was intended to counteract judicial hostility to the recognition of private arbitration. Section 2 of the FAA establishes that agreements to arbitrate contract disputes shall be “valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.” It was thought that the FAA would offer parties a simplified process to enforce written arbitration agreements. But thousands of federal judicial decisions can attest to the fact that the process has been anything but simple.

One of the issues that arose was whether contracting parties could provide for the grounds on which a court would later review an arbitration award, in a quasi-appeal process. One of the main benefits of the federal and state arbitration acts was that they permitted judicial recognition of an arbitration decision, transforming what was essentially a private dispute resolution into a fully enforceable judgment with all the force of law. Ostensibly intending a mostly hands-off judicial review, FAA sections 10 and 11 outline that an arbitrator’s ruling will be reversed only in the most limited of circumstances. It was generally accepted that errors of fact or law would not provide a sufficient basis to have an award vacated. Error correction was traded for the benefit of speedy and final enforcement of an arbitration award.

As is the way of the world, however, contracting parties wanted more control over their arbitrations. They began to contract with each other for more expansive review—say, for example, by allowing a court to vacate an award based on an arbitrator’s legal errors. (Remember, many arbitrations are presided over by someone experienced in the subject matter of the dispute but likely not experienced in legal concepts.) At first, many federal courts allowed this contractual expansion because it seemed to be in keeping with the principle that private parties are able to contract as they please. Even the Supreme Court appeared to endorse this approach, stating once that arbitration is “a matter of consent, not coercion, and parties are generally free to structure their arbitration agreements as they see fit. Just as they may limit the issues which they will arbitrate . . . so too may they specify by contract the rules under which the arbitration will be conducted.” Volt Info. Scis., Inc. v. Bd. of Trs., 489 U.S. 468, 479 (1989). Not everyone agreed, however, and some circuit courts endorsed a strict reading of the FAA, which they said did not permit broad judicial review. As time passed, a troublesome split developed among the federal circuits.

The Supreme Court intervened. Somewhat surprisingly, considering the language in Volt, the Court resolved the circuit split in favor of the strict constructionists. Hall St., 552 U.S. at 590. In Hall Street, the parties had entered into a lease with an arbitration clause that allowed the district court to vacate, modify, or correct the arbitrator’s award if either (1) it was not supported by substantial evidence or (2) its conclusions of law were clearly erroneous. The FAA does not authorize either of these as grounds for vacating an arbitration award. After an award in its favor was vacated, Mattel argued that the district court had erred in failing to strictly interpret the FAA. The Supreme Court agreed. A 6–3 ruling written by Justice Souter held that the statutory grounds for vacating or modifying an arbitration award are exclusive and cannot be supplemented by contract.

But the Hall Street Court was not done yet. Introducing a decided twist, the Court noted that, while the FAA had to be read strictly, the federal act was “not the only way into court for parties wanting review of arbitration awards: they may contemplate enforcement under state statutory or common law . . . where judicial review of different scope is arguable.” Hall St., 552 U.S. at 590. In other words, the Court sent an open invitation to everyone to test state arbitration laws if they were looking for a broader scope of judicial review. And with these words was created a federal/state law dichotomy of epic proportion, as states began to take up the question of whether their own laws also mandated as narrow a judicial review of arbitration awards as did the FAA.

The Hall Street Followers
The Supreme Court’s invitation in Hall Street is interesting because the FAA and almost all state arbitration acts share common ancestry. Indeed, in some cases, the state and federal laws are virtual twins. One would therefore not expect to find authority for broad judicial review in one place and not in the other.

The granddaddy of all arbitration acts is the 1920 New York arbitration statute. It ultimately gave rise to both the FAA and the Uniform Arbitration Act (UAA), which 37 states have adopted. Other states (such as Texas) voluntarily chose to follow the FAA where it was not contrary to state law. Still other states (such as Massachusetts) were early adopters, recognizing arbitration awards long before the passage of the UAA (but still modeling their state laws after the same 1920 New York law). Thus, there is considerable overlap between state and federal law when it comes to arbitration procedure. This similarity provides fertile ground for adoption of the Hall Street strict construction approach.

Most recently, the Supreme Judicial Court of Massachusetts weighed in, ruling that the Massachusetts Arbitration Act (MAA), like the FAA, limits the grounds on which a trial court can vacate an award. Katz, Nannis & Solomon, P.C., 473 Mass. at 789–90. In a unanimous decision, Katz held that section 12 of the MAA explicitly lays out the sole grounds on which a court can vacate an arbitration award: when “it was procured by corruption, fraud or other undue means,” or “the arbitrators exceeded their powers.” Id. Otherwise, despite what the parties might have privately agreed, the MAA directs that the court “shall confirm” the award. Quoting Hall Street, the Katz court held that the statutory language “carries no hint of flexibility.” Id. at 791. One must admit that “no hint of flexibility” is the very definition of a rigid approach.

Katz might be the most recent opinion adopting the reasoning of Hall Street, but the Massachusetts court is just another in a steady stream of state appellate courts that have aligned themselves with the Supreme Court’s legal analysis. See generally HL 1, LLC v. Riverwalk, LLC, 15 A.3d 725, 727, 736 (Me. 2011); Pugh’s Lawn Landscape Co. v. Jaycon Dev. Corp., 320 S.W.3d 252, 260 (Tenn. 2010); Brookfield Country Club, Inc. v. St. James-Brookfield, LLC, 287 Ga. 408, 413, 696 S.E.2d 663 (2010); John T. Jones Constr. Co. v. City of Grand Forks, 665 N.W.2d 698, 704 (N.D. 2003). Other states reached the same conclusion as Hall Street independently and earlier. See, e.g., Brucker v. McKinlay Transp., 454 Mich. 8, 9, 557 N.W.2d 536 (1997); Schnurmacher Holding, Inc. v. Noriega, 542 So. 2d 1327 (Fla. 1989); Konicki v. Oak Brook Racquet Club, Inc., 110 Ill. App. 3d 217, 441 N.E.2d 1333 (1982). Because of the similarities between the FAA and the UAA, these courts hardly have to explain their reasons for adopting a strict constructionist approach; they just have to cite Hall Street. The majority position is certainly the path of least resistance.

The Hall Street Naysayers
On the veritable heels of the release of Hall Street, one state adopted a diametrically opposed position, taking the Supreme Court up on its not-so-subtle invitation to test-drive state arbitration laws for a more contract-friendly milieu. In Cable Connection, Inc. v. DIRECTV Inc., 44 Cal. 4th 1334, 190 P.3d 586 (2008), the California Supreme Court held that the California Arbitration Act (CAA) permitted expanded judicial review of the arbitrator’s legal errors where the parties had contracted for the right to seek such review. Despite the fact that the FAA and CAA contained nearly identical language, the California Supreme Court rejected Hall Street’s strict analysis and held that the CAA allowed expanded judicial review by contract. Id. at 1354–64. In reaching this result, the California Supreme Court relied on state-specific factors, such as preexisting case law permitting parties to contract for specific judicial review and the legislative history of the CAA. Id. While the default position under the CAA is for a limited judicial review of awards, and parties who do not express a preference will receive that limited review, those parties who do choose to contract for broader review are entitled to exactly that. Id. at 1358.

Two years after the California Supreme Court rejected the Hall Street approach, the Supreme Court of Alabama followed suit, citing the California decision favorably. See Raymond James Fin. Servs. v. Honea, 55 So. 3d 1161, 1168 n.4 (Ala. 2010). The Alabama Supreme Court relied on its own overriding common law that “courts must rigorously enforce contracts” to give effect to the contractual rights and expectations of the parties. Id. at 1169.

And even more recently, the Texas Supreme Court unanimously and stridently echoed this position, harkening back to the very roots of the alternative dispute resolution movement:

[I]f there is one thing which more than another public policy requires it is that men of full age and competent understanding shall have the utmost liberty of contracting, and that their contracts then entered into freely and voluntarily shall be held sacred and shall be enforced by Courts of justice.

Nafta Traders, Inc. v. Quinn, 339 S.W.3d 84, 95–96 (Tex.), cert. denied, 132 S. Ct. 455 (2011) (internal quotations omitted).

When a court begins a ruling remarking on the “sacred” right of contract, it is fair to assume that it is not going to adopt a rigid test whose hallmark is a refusal to enforce parties’ contracts.

Now, as was the case with the CAA, the Texas Arbitration Act (TAA) is also virtually indistinguishable from the FAA. Nevertheless, the Nafta Traders court disagreed with Hall Street’s rigid analysis and held that the authority of an arbitrator to resolve a dispute was grounded wholly in the agreement of the parties to submit their dispute to arbitration, so that any restriction on what kinds of decision the arbitrator was permitted to make had to likewise be within the power of the parties to determine. Id. at 92–93.

The Nafta Traders court made no attempt to hide its disapproval of the Hall Street approach, repeatedly citing other U.S. Supreme Court precedent that for years had extolled the virtue of respecting the rights of contracting parties to determine the scope and structure of their private dispute resolution process. Holding that it was required to be faithful to the text of the TAA, the Nafta Traders court concluded that the TAA was no impediment to an agreement that allows for judicial review of an arbitration award for reversible error. Id. at 97.

Finally, two other states—Connecticut and New Jersey—are also routinely cited as being in the minority position. Connecticut, however, articulated its support for contractual expansion of judicial review before the U.S. Supreme Court’s issuance of Hall Street. HH East Parcel, LLC v. Handy & Harman, Inc., 287 Conn. 189, 947 A.2d 916 (2008). It remains to be seen whether Connecticut will continue to adhere to its broad stance once its supreme court has had the opportunity to address the U.S. Supreme Court’s Hall Street rationale and with the benefit of the positions taken by the majority of its sister states. As for New Jersey, its legislature enacted a statute specifically authorizing parties to expand the scope of judicial review, closing the door on the question in that state. N.J. Stat. Ann. § 2A:23B-4(c).

We are far from tabulating the final state count of “yea-sayers” and “naysayers” to the Hall Street approach. But it is fair to say that the majority of state courts of last resort are now willing to adopt the Supreme Court’s FAA analysis wholesale and apply it to their own state arbitration acts, despite the well-articulated flaws in that analysis. It is important then, for contracting parties (and the lawyers who represent them) to be aware of (1) whether their state has yet weighed in on the ongoing dispute (and on which side); and, if not (2) whether their state’s arbitration act possesses a history that would support a claim that the parties have the right to insist that an arbitration award be error-free in whatever manner their agreement demands. Otherwise, arbitration becomes a decidedly less attractive dispute resolution option.

Keywords: litigation, woman advocate, arbitration, judicial review, Federal Arbitration Act, FAA, MAA, CAA, TAA, UAA, Uniform Arbitration Act, 1920 New York arbitration statute, arbitration clauses, alternative dispute resolution

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