Online Exclusive: Supreme Court Decision Narrows Courts’ Ability to Overturn Arbitration Agreements.

Cardiologist Zev Lagstein developed heart disease, severe migraines and other neurological problems in 2001. Several physicians examined him and concluded the health issues permanently disabled him from practicing medicine. Following the diagnosis, Lagstein submitted a disability insurance claim to Lloyd’s of London. His policy with Lloyd’s was supposed to pay $15,000 per month for up to 60 months of disability.

By 2002, Lagstein had not received any benefits or even a decision on his claim. He was forced to go back to work, against his doctors’ advice. After another year, Lloyd’s still had not made a decision about the claim. He filed suit in the Federal District Court for the District of Nevada for breach of contract, among other things. Lloyd’s compelled arbitration, based on the binding terms of Lagstein’s insurance policy.

A three-member arbitration panel started hearings in July 2006, approximately four and a half years after Lagstein filed his original claim. After the hearings, the arbitrators agreed that Lloyd’s had violated its contract. The majority ruled that Lloyd’s owed Lagstein the full value of his policy, $900,000, and
$1.5 million for emotional distress. The majority also concluded punitive damages were warranted but decided to determine that amount at a separate hearing.

The dissenter only wanted to award Lagstein $11,000 under his policy and no emotional distress or punitive damages. But that November, the majority awarded Lagstein an additional
$4 million in punitive damages.

Displeased with the expensive ruling, Lloyd’s filed a motion to vacate the award in Nevada District Court. The company argued the timing of the punitive award put it outside the panel’s jurisdiction. Lloyd’s also found out about a decade-old ethics controversy involving two of the arbitrators and claimed the controversy–along with the fact that the arbitrators did not disclose it–was evidence of their partiality.

The district court vacated the arbitration awards, saying they were excessive and in manifest disregard of the law. It also agreed the punitive award exceeded the panel’s jurisdiction.

Lagstein appealed, and a 9th Circuit panel reinstated the award on June 10. In Lagstein v. Certain Underwriters at Lloyd’s, Judge William Canby, Jr., wrote that the court system cannot overrule an arbitration decision simply because judges disagree with the result. To warrant judicial intervention, an arbitration panel must have engaged in flagrant misconduct.

“[I]t must be clear from the record that the arbitrators recognized the applicable law and then ignored it,” Canby wrote.

Lagstein should remind in-house counsel to enter arbitration without any expectation of court review–in almost any situation.

“Basically, a court will not review whether an arbitrator got it right or wrong,” says Russell Glazer, a Troy Gould partner. “[This] makes sense, because the whole point of arbitration is trying to build your own dispute resolution mechanism.”

Tough Sell

Lagstein is based on solid precedent, experts say. Courts are generally quite reluctant to review arbitration decisions, and the 9th Circuit went to great lengths to make that clear, says Douglas Hallett, a Los Angeles area civil litigator. Canby wrote that the court should ignore arbitrators’ errors, as long as they were relatively small and unintentional, when deciding whether to vacate arbitration.

“If the arbitration panel makes some mistakes along the way,” Hallett says, “as long as there was some rational basis for the decision, [courts] are going to overlook those mistakes.”

The circuit did find errors in the arbitrators’ reasoning, but Lagstein emphasizes misconduct must be explicit to warrant review. Vague claims of excessiveness, small mistakes and a difference of opinion are not enough, according to the court.

“[I]t was error for the district court to vacate the arbitration awards simply because it found the total size either shocking or unsupported by the record,” Canby wrote.

Hallett says the decision’s strong language sets up strict, blunt criteria for overturning arbitration decisions: corruption, fraud, partiality and blatant misconduct.

“Unless you can get into those rubrics,” he says, “you’re not going to get out of an arbitration decision.”

For example, the court said an arbitration award doesn’t need to be rational in light of the facts of a case. Rationality only matters with respect to the contract that grants arbitrators their authority.

“It’s not looking at the merits and saying, ‘How did they ever reach this conclusion? This is shocking to the conscience,’” says Doug Scullion, a Gordon & Rees partner. “It’s that the award isn’t consistent with the powers enumerated in the arbitration contract.”

Just Like Trial

Both the district and circuit courts’ dismissals of Lloyd’s partiality challenge underscores the need for parties to do their due diligence for arbitration as if they were in court, Scullion says.

Not only was the cited controversy involving the two arbitrators old, it didn’t involve the litigating parties at all. Lloyd’s didn’t investigate the arbitrators until after they made their ruling, and information about the controversy was easily accessible online.

“Publicly available information is unlikely to provide a basis for a later challenge, especially if … it has nothing to do with the parties to the arbitration,” Scullion says.

Counsel should check arbitrators’ backgrounds for conflicts and brief them on relevant law before hearings start. If possible, Glazer also suggests that parties discuss specific goals for the process, such as what qualifications they want arbitrators to have or what issues they want arbitrators to examine.

In many cases, experts say arbitration is still expensive and time-consuming–just like trial–only without appeals. Deciding whether to arbitrate is not necessarily a simple choice. It’s best to figure out what you want from arbitration before deciding to do it, Glazer says.

“Arbitration is not like an on or off switch,” Glazer says. “It requires thought up front. Not just, ‘Is it a good idea in our transaction,’ but ‘What do we want it to look like?’”