Carefully Draft Your Arbitration Clause—You Just Might Get What It Says

When drafting an alternative dispute resolution provision for a commercial contract, lawyers can start with sample standard clauses that an administering organization such as the American Arbitration Association (AAA) and others provide. They also can use clause-drafting tools such as AAA’s free ClauseBuilder. Sometimes, though, lawyers decide to create their own dispute resolution clause either out of whole cloth or by tweaking the standard language. When that new, bespoke clause is applied to an actual dispute, however, one party might argue that the clause doesn’t mean what it says or should be read differently from its plain meaning. Whether there was a true misunderstanding between the contracting parties or merely legal drafting gone awry, courts usually hold the parties to the plain language they agreed to in the arbitration provision. This article reviews some court decisions in which the courts applied arbitration clauses as written with regard to arbitrator appointment and reasoned awards.

At the start of 2020, the Fifth Circuit Court of Appeals denied vacatur of a $62.9 million arbitration award, finding that the arbitration panel—consisting of nine arbitrators—was “fairly constituted.” Soaring Wind Energy, L.L.C. v. Catic USA Inc., 946 F.3d 742, 747 (5th Cir. 2020). Accordingly, the appellate court affirmed the district court’s confirmation of the award in favor of the plaintiffs-appellees.

A bit of background is helpful for this case. Most of the Soaring Wind parties were members of Soaring Wind Energy, LLC. The limited liability company (LLC) agreement that created Soaring Wing LLC contained a dispute resolution clause providing that “any controversy, dispute, or claim arising under or related to [the Agreement] . . . shall be submitted to binding arbitration” if negotiations failed. The clause further provided:

Within 15 days after receipt of [an arbitration] demand, each other Disputing Member receiving notice of the Dispute shall name an Arbitrator. . . . The Arbitrators so selected shall within 15 days after their designation select an additional Arbitrator. . . . In the event that there are more than two Disputing Members to the Dispute, then unless otherwise agreed by the Disputing Members, the Arbitrators selected by the Disputing Members shall cause the appointment of either one or two Arbitrators as necessary to constitute an odd number of total Arbitrators hearing the Dispute.

Soaring Wing Energy, L.L.C. v. Catic USA Inc., 333 F. Supp. 3d 642, 649 (N.D. Tex. 2018).

Thereafter, a dispute arose among certain parties to the LLC agreement. Tang Energy Group, one of the Soaring Wind LLC members, filed an arbitration against Catic USA, Inc., an individual (Paul Thompson), and other non-signatory, non-U.S. entities affiliated with Catic, claiming the respondents had breached the LLC agreement. Four other Soaring Wind LCC members joined Tang as claimants in the arbitration, and the now-five claimants named five different arbitrators pursuant to the dispute resolution clause. Catic and Thompson named their own two arbitrators. The seven party-selected arbitrators then collectively selected two additional arbitrators, for a total panel of nine arbitrators.

While the arbitration was pending, Catic and Thompson sued in federal court, arguing that the panel of nine was improperly constituted. They contended the panel instead should consist of only three arbitrators—one selected by each side and the third chosen by the party-selected arbitrators. The district court dismissed those claims for lack of subject matter jurisdiction under the Federal Arbitration Act (FAA), and the Fifth Circuit affirmed. AVIC Int’l USA, Inc. v. Tang Energy Grp., Ltd., Civil Action No. 14-CV-2815-K, 2015 WL 477316, at *4–5 (N.D. Tex. Feb. 5, 2015), aff’d, 614 F. App’x 218 (5th Cir. 2015).

The panel (of nine) ultimately found Catic liable to the claimants for $62.9 million. Catic sought to vacate the award, and the claimants sought to confirm it. Soaring Wind Energy, 946 F.3d at 749. In seeking vacatur, Catic argued (again) that the panel was improperly constituted because the arbitration claimants selected five arbitrators while respondents selected only two. Catic claimed that this selection process was contrary to the language of the contract and violated the due process and public policy requirements of the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York Convention) by being fundamentally unfair. Id. at 755.

The appellate court disagreed. First, it noted that the FAA requires that “[i]f in the agreement provision be made for a method of naming or appointing an arbitrator or arbitrators or an umpire, such method shall be followed. . . .” Id. (citing FAA, 9 U.S.C.A. § 5). Failure to follow the clause’s specified process could lead to vacatur. But here, “[t]here was no such departure” from the contractual arbitrator selection process. Id. While the case had only two sides, claimants and respondents, it involved seven members of the Soaring Wind LLC, each of which was a “Disputing Member” under the dispute resolution clause. And the clause specifically allowed for each disputing member to name an arbitrator. The court noted that, in its 2015 decision, it had stated Catic was “asking us to rewrite their agreement’s arbitration provision.” Id. (quoting AVIC International, 614 F. App’x at 219). Because the LLC agreement’s arbitrator selection provisions expressly focused on the number of disputing parties, not the number of sides, the court concluded that “the Agreement’s written procedure was followed.” Id.

The court also disposed of Catic’s argument that the court should disregard the LLC agreement’s plain language out of fairness: “It is not the court’s role to rewrite the contract between sophisticated market participants, allocating the risk of an agreement after the fact, to suit the court’s sense of equity or fairness.” Id. at 756 (citation omitted). Moreover, the fact that Catic’s expectations regarding the dispute resolution process may have been frustrated “does not render the Agreement absurd or unfair.” Id.

Finally, the Fifth Circuit found that the award did not violate due process by having the two sides appoint an uneven number of arbitrators, so the award could be enforced against Catic’s Chinese affiliates under the New York Convention. The court held:

The Agreement was not a contract of adhesion but a bespoke deal made between extremely sophisticated parties. The Agreement did not inherently favor one party or another; it just so happened that Catic USA was outnumbered. The agreed-upon selection process was followed to the letter: Catic USA and Thompson selected the arbitrators and received the process they were due.

Id.

For these, and other, reasons, the court affirmed the district court’s judgment confirming the arbitration award.

In another case in Texas, a state appellate court reversed confirmation of an arbitration award because the arbitrator was not appointed in accordance with the arbitration agreement. PlainsCapital Bank v. Gonzalez, et al., 598 S.W.3d 427 (Tex. App. 2020). In PlainsCapital Bank, the parties’ arbitration clause provided that the AAA rules “will govern the selection of the arbitrator and the arbitration process.” Id. at 430. When the parties could not agree on an arbitrator, one side asked the court to appoint the arbitrator, which the court did. Under the AAA’s rules, however, the AAA (and not the court) should have appointed the arbitrator. The appellate court began its analysis by noting, “[A]rbitrators must be selected pursuant to the method specified in the parties’ agreement. An arbitrator selected contrary to the method in the parties’ agreement lacks jurisdiction over the dispute.” Id. (citing Americo Life, Inc. v. Myer, 440 S.W.3d 18, 21 (Tex. 2014)). Because the arbitrator was improperly appointed by the court, instead of the AAA in accordance with the clause’s adoption of the AAA rules, he had no jurisdiction over the case. Therefore, the arbitrator exceeded his authority in rendering the award, and the award was vacated. Id. at 431.

Another arbitration clause provision that has led to challenges and, sometimes, vacatur is a requirement that the arbitrator issue a reasoned award. Absent party agreement on the form of award, “the arbitrator may issue an award that does nothing more than ‘announce[] the result.’” Smarter Tools, Inc. v. Chongqing SENCI Imp. & Exp. Trade Co., Ltd., No. 18-cv-2714 (AJN), 2019 WL 1349527, at *3 (S.D.N.Y. Mar. 26, 2019) (citation omitted). Some parties may want to know the arbitrator’s reasoning for the award, however, so they may agree in their arbitration clause that the arbitrator must issue a reasoned award. But what makes an award sufficiently “reasoned” to comply with such a clause? Where a clause requires a reasoned award, if an arbitrator’s award is not deemed “reasoned” enough, then it is subject to vacatur.

Case law provides some guidance as to how much “reasoning” is necessary for an award to be considered a reasoned award. The Second Circuit Court of Appeals has stated that a reasoned award “requires something more than a line or two of unexplained conclusions, but something less than full findings of fact and conclusions of law on each issue raised before the panel.” Leeward Const. Co., Ltd. v. Am. Univ. of Antigua-College of Med., 826 F.3d 634, 640 (2d Cir. 2016). The Leeward court further noted, “A reasoned award sets forth the basic reasoning of the arbitral panel on the central issue or issues raised before it [but it] need not delve into every argument made by the parties.” Id.

In 2019, applying this standard, the district court in Smarter Tools found that an arbitrator exceeded his authority by not issuing the reasoned award the arbitration clause required. Smarter Tools, 2019 WL 1349527, at *4. Specifically, the court found the award was not reasoned because the arbitrator summarily dismissed the respondent’s counterclaims without noting a basis for that decision. The court concluded that, while “the arbitrator was not obliged to discuss each piece of evidence presented by [respondent], he must at least provide some rationale for the rejection of [respondent’s] overall argument for [claimant’s] liability.” Id. at *3. Instead of vacating the award, however, the court remanded the case to the arbitrator to clarify his findings. Id. at *5.

A Texas appellate court similarly remanded a case to an arbitrator because the award, required to be reasoned by the parties’ post-contracting agreement, failed to address a key defense. Stage Stores, Inc. v. Gunnerson, 477 S.W.3d 848, 859 (Tex. App. 2015). The court concluded that “a reasoned award is ‘an award that is provided with or marked by the detailed listing or mention of expressions or statements offered as a justification of . . . the decision of the Panel’ or arbitrator.” Id. (citation omitted, emphasis in original). But see Rain CII Carbon, LLC v. ConocoPhillips Co., 674 F.3d 469 (5th Cir. 2012) (“We decline to narrowly interpret what constitutes a reasoned award to overturn an otherwise apparently seamless proceeding. The parties received precisely what they bargained for—a speedy, fair resolution of a discrete controversy by an impartial panel of arbitrators skilled in the relevant areas of the law.” (quoting Cat Charter, LLC v. Schurtenberger, 646 F.3d 836, 846 (11th Cir. 2011))).

The ultimate lesson to be learned from these cases is that if contracting parties specify something in their commercial contract’s arbitration clause—whether relating to arbitrator appointment, the form of the award, or another aspect of the arbitration—they should understand that courts are likely to apply the plain language of those clause provisions. Particularly before drafting a one-off, tailored arbitration agreement, lawyers should consider the various types of potential disputes that could arise from the agreement and how any resulting arbitrations could play out, to ensure that the arbitration they ultimately get is the arbitration they expected.