Arbitration is supposed to be easier and faster than litigation. But the ongoing battle between Mattel Inc. and Hall Street Associates proves it has the potential to be anything but. What should have been a relatively simple landlord-tenant dispute resolved after a weeklong hearing by an arbitrator has taken three tangled trips through the federal court system over the course of nearly eight years, finally landing on the Supreme Court’s October 2007 docket.

In Hall Street Associates v. Mattel the Supreme Court will decide a relatively bland legal issue–whether the terms of the Federal Arbitration Act (FAA) preclude companies from agreeing to expanded grounds for judicial review of an arbitration award outside of the four narrow bases for such review the FAA sets forth. The 9th Circuit had ruled that FAA did preclude such agreements. As the Supreme Court determines that issue and finally puts Hall Street and Mattel’s battle to rest, the future of arbitration as a viable way to resolve important commercial disputes hangs in the balance.

“If the Supreme Court upholds the 9th Circuit, parties will think twice about whether they can accept the liability of arbitrating disputes with only the narrow standard of review under the FAA,” says Evan Tager, co-chair of the appellate and Supreme Court practice at Mayer Brown, who wrote an amicus brief on behalf of an association of wireless telephone carriers. “Not too many courts have seriously examined the pros and cons of this.”

Freedom of Contract
The case began in February 2000 when real estate firm Hall Street sued Mattel, alleging the toymaker had breached the terms of its lease by contaminating groundwater on the Beaverton, Ore., property it rented from Hall Street starting in 1981. The lease said Mattel would indemnify Hall Street for any damages Mattel caused by violating environmental laws.

The parties agreed to arbitrate the dispute, specifying in their arbitration agreement that the arbitrator would provide a written decision detailing his or her factual findings and legal conclusions. According to the parties’ contract, the district court would be able to review that decision for any “substantial errors of evidence or law.” In January 2002 an arbitrator issued a judgment for Mattel, finding that although the company did violate an Oregon environmental statute, the alleged contamination fell under an exception in the lease’s language.

After a series of appeals from both parties, four opinions by the Oregon District Court, another visit to arbitration and two trips to the 9th Circuit Court of Appeals, the 9th Circuit finally concluded that the portion of the arbitration award that provided for de novo judicial review was unenforceable under the FAA. It ordered the district court to reinstate the original award for Mattel.

The 9th Circuit based its ruling on an interpretation of the FAA statute that provides four narrow procedural grounds for which a court may review and overturn an arbitration award: where the award was obtained by fraud or corruption; where the arbitrators were corrupt; where the arbitrators engaged in misconduct that prejudiced the rights of either party; or where the arbitrators exceeded their powers. It held that those four standards are the only reasons for which a court may disturb the finality of an arbitration award–no matter what the parties’ agreement says.

“Although the arbitrator’s assessment of the merits of the case contains possible errors of law, those errors are not a sufficient basis for a federal court to overrule an arbitration award,” the court wrote.

Efficiency Versus Accuracy
Five other circuit courts–the 1st, 3rd, 4th, 5th and 6th–have allowed parties to commercial arbitration to contractually agree to any level of judicial review they see fit, reasoning that the FAA’s review provisions merely set the default standard of review in the absence of explicit contractual provisions. These courts have ruled that the FAA doesn’t prevent parties from specifying broader grounds for which to seek judicial review.

In the 7th Circuit case Baravati v. Josephthal, Lyon & Ross Inc., Judge Richard Posner wrote, “Short of authorizing trial by battle or ordeal, or more doubtfully, by a panel of three monkeys, parties can stipulate to whatever procedures they want to govern the arbitration of their disputes.”

The conflicting standards highlight a central question about what motivates parties to arbitrate disputes in the first place. All courts that have considered the issue agree that encouraging parties to arbitrate disputes rather than go straight to court is an important policy goal underlying the FAA. Some courts have reasoned that the best form of encouragement is enforcing the parties’ arbitration contracts as written, thereby ensuring that arbitration yields a fair result that surprises neither party.

Other courts–such as the 9th and 10th Circuits–have put greater emphasis on limiting judicial review, reasoning that a chief advantage of arbitration is resolving disputes without the costly and time-consuming involvement of the courts.

But many argue that if the Supreme Court adopts the 9th Circuit’s reasoning, it will achieve an unwanted result: fewer sophisticated parties will be willing to consider arbitration at all, and thus even more cases will end up on federal court dockets.

Elizabeth Gaudio, senior executive counsel for the National Federation of Independent Businesses’ Legal Foundation, a court advocate for small businesses, points out that small businesses consider language allowing judicial review for serious legal error a standard feature of their arbitration agreements.

“Many of our members are being advised by their counsel not to enter into any arbitration agreements until this is resolved,” she says. “The inability to contract for expanded judicial review is deterring parties from using arbitration.”

High Stakes
But given the policy arguments on both sides of the case, it’s difficult to predict how the Supreme Court will approach the issue.

“We know the Supreme Court will be solicitous of arbitration,” says Thomas Boeder, a partner at Perkins Coie in Seattle, “but what that will lead them to conclude about the right to appeal is hard to predict. There’s a good argument that awards should be appealable, and there’s also a good argument these disputes should stay out of court.”

Even with the current disagreement among the circuits, companies can at least agree to choice-of-law provisions that place them in a circuit that allows judicial review of arbitration awards. But even that small protection will disappear if the Supreme Court upholds the 9th Circuit’s narrow reading of the FAA. And the stakes for the future of arbitration are clearly high.

“If you need to assume you’ll have no ability to appeal no matter how far off the target the award is, arbitration will be very risky,” Boeder says. “Inability to appeal would be a major defect in arbitration as a mechanism to resolve large disputes.”