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Clashing with a private arbitration panel, a New York state court recently vacated a $25 million punitive damages arbitration award-for the second time-roiling some in the national arbitration community. The state intermediate appellate court ruled that the award was in “manifest disregard of the law” that limits punitive damages to at most a high single-digit multiplier of the compensatory damages award, which was $1.1 million. While many courts have long said they have the right to set aside an “irrational” award, no other state court has set a punitive damages award aside for being inconsistent with constitutional due process guideposts laid out by the U.S. Supreme Court. Critics of the New York decisions fear they portend a dangerous trend that threatens the heart of the arbitration process-finality. “It’s virtually unheard of for a court to interfere in this private process,” said administrative law specialist Richard Reuben, a professor at the University of Missouri-Columbia School of Law. “If this decision were allowed to stand, became the prevailing view, it would undermine one of the primary virtues of arbitration: finality.” Not everyone agrees. While Ron Raider, a complex commercial litigator at Atlanta’s Kilpatrick Stockton, notes that it is “surprising and a rarity for a court to intervene,” he said that the facts cry out for intervention. “The 25-1 disparity between punitive and compensatory damages sticks out like a sore thumb and makes it easy without changing the law for the court to intervene. I wouldn’t necessarily see it as a major trend because these circumstances are so glaring and punitive damages are rarely an element of commercial arbitrations.” The tug of war between the court and the arbitrators either represents a wrongful intrusion by the court into the arbitration process, or a court’s legitimate exercise of discretion to vacate an award that violates substantive or constitutional law, lawyers involved in the case claimed. The high courts in Connecticut and Alabama-when confronting the identical issue the New York court faced-took different paths in concluding they had the power to vacate the excessive punitive damages arbitration awards before them. Nevertheless, neither court chose to intervene. A tortured path The origins of the court conflict began two years ago, when a National Association of Securities Dealers arbitration panel, after 54 days of trial, found that the defendant, a brokerage firm, had conducted a “horrible campaign of deception, defamation and persecution” against its employee, Stephen Sawtelle, a broker. In September 2003, the panel awarded nearly $1.1 million in actual damages and $25 million in punitive damages. Though the compensatory damages award is no longer in dispute, the size of the punitive award in relation to it is at the core of the controversy. The defendant appealed the panel’s award to the New York Supreme Court, a trial court, which affirmed the award. But New York’s intermediate-level Appellate Division, 1st Department, vacated the $25 million award for being “arbitrary,” and “in manifest disregard of the law.” S awtelle v. Waddell & Reed Inc., No. 115056/01 (N.Y. App. Div.). The appeals court relied on two U.S. Supreme Court cases, BMW of North America v. Gore, 517 U.S. 559 (1996), and State Farm Mut. Ins. Co. v. Campbell, 538 U.S. 408 (2003), in finding that the due process clause of the U.S. Constitution sets rough limits on the ratio between punitive and actual damages. The trial court then sent the case back to the panel to determine punitive damages again. And once again, the arbitration panel set punitive damages at $25 million. This time the trial court judge, Supreme Court Justice Michael D. Stallman of Manhattan, not only vacated the punitive damages award, but ordered that a new arbitration panel hear the case on remand. He said that the first panel had thumbed its nose at the appeals court by resurrecting the award. Sawtelle challenged the setting aside of the award and the court’s right to dismiss the original arbitration panel. Last month, the appeals court affirmed Stallman’s rulings. Sawtelle’s lawyer, Jeffrey Liddle of New York’s Liddle & Robinson, declined to comment. But in court filings, he said that the due process clause doesn’t apply to arbitration. Not so, said the defendant’s attorney, Seth Schwartz of Skadden, Arps, Slate, Meagher & Flom. “When you agree to arbitrate, you do not forgo the right to have substantive law apply,” Schwartz said. “[Under State Farm], because compensatory damages were substantial and there was no physical harm and no showing of repeated misconduct of a similar variety, a punitive award equal to the compensatory award is the appropriate limit.” Atlanta attorney Raider agrees. “Regardless of the forum in which parties decide to resolve a dispute,” Raider said, “you’re expecting due process and commercial laws and rules to apply.” National landscape The Federal Arbitration Act, which governs Sawtelle, severely limits a court’s authority to vacate an arbitration award. “Manifest disregard of the law”-the appeals court’s rationale for overturning the award in Sawtelle-is a nonstatutory ground that New York and a few other state courts recognize. The National Conference of Commissioners of Uniform State Laws rejected the addition of that standard, as well as a standard that is “violative of public policy,” when it last revised the Uniform Arbitration Act in 2000. Stephen Hayford, a professor of business law at Indiana University’s Kelley School of Business, was in the thick of those discussions. “The [ Sawtelle] dilemma is one of the outfalls when judges stick their noses into matters that the parties have contractually committed themselves to resolve through private arbitration,” said Hayford, who has been an arbitrator for 30 years. “At the end of the day, the outcomes are meant to be insulated from judicial scrutiny. It’s an alternative, not a precursor to litigation.” A state action-rather than a merely private arbitration between parties-would have to be involved for the Gore and State Farm guideposts to be mandatory in arbitration, said University of Kansas School of Law Professor Christopher Drahozal, a commercial arbitration specialist. He said further that most courts have found no state action in arbitration. “That would seem to suggest that federal constitutional due process constraints on punitive damage awards shouldn’t apply to arbitrations.” Only Alabama has found that a lower court’s review of an arbitration constituted a state action, and therefore that Gore applied. Nevertheless, the court chose to accept the challenged arbiters’ ratio and did not resort to a Gore analysis. Birmingham News Co. v. Horn, 901 So. 2d 27 (2004). When the Connecticut Supreme Court considered the issue this year, it found there was no state action in arbitration, and therefore Gore did not apply. The court also noted that Connecticut did not have a clearly defined public policy against excessive punitive damages awards. While refusing to vacate a $5 million punitive damages award, although no compensatory damages had been awarded, the court maintained that it had the right to review a grossly excessive award. MedValUSA Health Programs Inc. v. Memberworks Inc. 872 A.2d 423 (2005). The underlying claim in Sawtelle is a violation of the Connecticut Unfair Trade Practices Act. The arbitration was held in New York because it is the nearest office of the National Association of Security Dealers, the governing body that facilitated the arbitration. In Sawtelle, the New York appeals court sidestepped the state-action issue. It said that while there is ample authority that “private arbitration does not implicate due process concerns,” that is “besides the point . . . [because State Farm and Gore] also provides a guide for determining whether such an award is irrational,” and therefore in “manifest disregard of the law.”

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