An arbitration decision cannot be overturned merely because the arbitrator commits legal error. Thus, the losing party may be blindsided by a large and erroneous award, yet have little recourse. For example, a court may confirm an arbitration award that exceeds the statutory limit for noneconomic losses. Or a court may confirm an arbitration award in an insurance bad faith action that vastly exceeds the policy value, even if the award is “shocking or unsupported by the record.”
With advance planning, this potential disadvantage has now become easier to avoid. In November 2013, the American Arbitration Association issued new Optional Appellate Arbitration Rules. The AAA joined JAMS and the International Institute for Conflict Prevention & Resolution (CPR) in providing standardized procedures for a more searching review than a court would provide in determining whether to vacate an arbitration award. The AAA’s new rules underscore the benefits of considering and agreeing to the manner in which an arbitration decision may be reviewed before each party knows whether it will support the decision or seek to overturn it.
Under the new AAA appellate rules, a party may appeal on the grounds that the underlying award is based upon either an error of law that is material and prejudicial or a determination of fact that is clearly erroneous. The appeal is decided by a panel of three appellate arbitrators, unless the parties agree to use a single arbitrator. Oral argument is at the discretion of the panel. The panel can adopt the underlying award or substitute its own award, but it may not order a new hearing or send the case back to the original arbitrator for further action.
Filing an appeal incurs an administrative fee of $6,000, in addition to the fees and costs of the appeal tribunal itself. The AAA appellate rules expect that the appeal can be completed in about three months after notice is filed, but several of the intermediate deadlines may be extended. While still untested, this arbitration appellate process provides an extra layer of protection for the outlier decision that otherwise would become final.
Parties should consider incorporating the AAA appellate rules when forming arbitration agreements. They should also consider the differences between federal and state law when drafting arbitration agreements, especially as it relates to the type of judicial review the resulting arbitration decision will receive. Although grounds for vacating an award are nominally similar under both the FAA and CAA, the scope of review a court applies can depend on the governing statute. Under the FAA, an arbitrator exceeds assigned powers if the award is completely irrational or exhibits a manifest disregard for the law, and the law disregarded is well-defined, explicit and clearly applicable. (Kyocera Corp. v. Prudential-Bache Trade Servs. Inc.) Under the CAA, the merits of the controversy are not subject to judicial review, so courts will not review the validity of the arbitrator’s reasoning or the sufficiency of the evidence supporting an award even if the arbitrator manifestly disregards the law. (Moncharch v. Heily & Blase)
Thus, an arbitration award can meet a different fate depending on the review. A court applying the FAA vacated an arbitration award enforcing a covenant not to compete because the covenant was clearly invalid under California law. (Comedy Club, Inc. v. Improv West Assocs.) Another court applying the FAA vacated an arbitration award because the great weight of the evidence showed age discrimination, contrary to the arbitrator’s finding. (Halligan v. Piper Jaffray Inc.) If evaluated under the CAA, the awards would likely have been confirmed because the reviewing court would have been precluded from assessing the merits of each case.
Whether the FAA or CAA governs can determine whether the court enforces the parties’ agreement for the court itself to perform a more searching form of judicial review. The FAA does not permit parties to expand scope of judicial review by their agreement. (Hall Street Assocs., L.L.C. v. Mattel Inc.) But the CAA allows parties to agree that arbitrators shall not have power to commit errors of law, and that an award may be vacated for such an error on appeal to a court with jurisdiction. The parties can agree which procedural rules (FAA or CAA) control the award confirmation, but if they fail to agree, a federal court will likely apply the FAA and a state court the CAA.
In Cable Connection, Inc. v. DIRECTV Inc., the California Supreme Court applied the CAA and enforced the parties’ agreement that the arbitrators lacked the power to commit legal error. The Court determined the arbitrators misapplied the AAA arbitration rules, as well as California law governing the availability of classwide arbitration, and remanded to the arbitration panel for reconsideration. If governed by the FAA, the court likely would have rejected the parties’ attempt to change the court’s standard of review and confirmed the award because, although the arbitrators may have misapplied the law, they did not exhibit a manifest disregard for the law.
The bottom line is that when drafting a pre-suit arbitration agreement or agreeing to arbitrate a dispute after it is filed, parties should consider incorporating the new AAA Optional Appellate Arbitration Rules (or the JAMS, CPR or other privately administered rules). Alternatively, or in combination, the parties could agree that the CAA will apply and that arbitrators do not have the power to make errors of law, and thus permit judicial review of the underlying arbitration decision for legal error. Or the parties could expressly agree to FAA procedural rules, and rely on the federal manifest disregard standard as a final backstop against an unreasonable decision.
Eric Boorstin is an associate at Horvitz & Levy; he can be reached at [email protected]. Jeremy Rosen is an appellate specialist and a partner at the firm; he can be reached at [email protected].
