Supreme Court building. February 7, 2007. Credit: Diego M. Radzinschi/LEGAL TIMES.

Congress enacted the Federal Arbitration Act (FAA) in 1925 to ensure the validity and enforcement of arbitration agreements, thereby encouraging resolution of disputes outside of the court system. Under the FAA, “arbitration is a matter of contract, and courts must enforce arbitration contracts according to their terms.” Rent-A-Center, West v. Jackson, 561 U.S. 63, 67 (2010). The Supreme Court has recognized that the FAA reflects a Congressional intent to enact “a national policy favoring arbitration.” Southland Corp. v. Keating, 465 U.S. 1, 10 (1984). New York law is in accord. As the New York Court of Appeals has stated: “the announced policy of [New York] favors and encourages arbitration as a means of conserving the time and resources of the courts and the contracting parties.” Nationwide Gen. Ins. Co. v. Inv’rs Ins. Co. of Am., 37 N.Y.2d 91, 95 (1975).

Appellate courts in the federal system and New York recently issued a string of significant decisions re-affirming their pro-arbitration stance in Henry Schein, Daesang and Spell. Henry Schein v. Archer & White Sales, No. 17-1272 (Jan. 8, 2019); Daesang v. NutraSweet Co., 85 N.Y.S.3d 6 (1st Dep’t 2018); NRT New York v. Spell, 88 N.Y.S.3d 34 (1st Dep’t 2018). In particular, the Henry Schein case, which was decided by the U.S. Supreme Court in January, reaffirmed the high court’s deference to the “front-end” of the arbitration process, by ruling that courts must enforce contracts that delegate to an arbitrator the question whether a dispute is arbitrable in the first place—even if it is claimed that the argument for arbitration is “wholly groundless.” Henry Schein, No. 17-1272 at 1. Mirroring Henry Schein, the Appellate Division, First Department, recently decided Daesang and Spell, both of which reversed trial court rulings vacating arbitration awards because the trial courts inappropriately waded into the merits of the arbitrator’s rulings. These decisions signaled the Appellate Division’s deference to the “back-end” of the arbitration process.

‘Henry Schein’

Henry Schein arose from a complaint filed by Archer & White Sales, a small dental equipment distributor, against Henry Schein, LLC, the successor-in-interest to a dental equipment manufacturer, alleging violations of federal and state antitrust law. Henry Schein invoked the dispute resolution provision in the parties’ distribution contract and sought to compel arbitration of the dispute. Archer objected, claiming that the dispute was not subject to arbitration, because the dispute resolution carved out actions seeking injunctive relief, and the complaint sought an injunction. Relying on Fifth Circuit precedent, the district court held that where a party’s argument for arbitration is “wholly groundless,” it has authority to resolve the threshold question of arbitrability, notwithstanding that the agreement expressly incorporated AAA rules that empower arbitrators to resolve arbitrability questions. The district court ruled that Henry Schein’s argument in favor of arbitration was wholly groundless and declined to compel arbitration. The Fifth Circuit affirmed.

The Supreme Court unanimously reversed and ruled that the “wholly groundless” exception is inconsistent with the FAA and Supreme Court precedent. The court relied on §2 of the FAA, which provides that an arbitration provision “shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.” 9 U.S.C. §2. Under this provision, the parties may ask the court to enforce not only that an agreement that an arbitrator decide “the merits of a particular dispute but also ‘gateway’ questions of ‘arbitrability,’ such as whether the parties have agreed to arbitrate or whether their agreement covers a particular controversy.” Henry Schein at No. 17-1272 at 4.

In so ruling, the court cited to longstanding precedent holding that a court may not rule on the merits of an underlying claim assigned by contract to an arbitrator, even if the court believes the claim to be “frivolous.” Id. at 5. The court ruled this principle “applies with equal force to the threshold issue of arbitrability.” Id. Notably, the court declined to rule on whether the contract at issue actually did delegate the arbitrability question to the arbitrator, and instead remanded the question to the Fifth Circuit. The court noted that to delegate such threshold arbitrability questions to an arbitrator, the parties’ agreement must contain “clear and unmistakable evidence” that they did so. Id. at 6.

‘Daesang’ and ‘Spell’

On Sept. 27, 2018, the Appellate Division, First Department, issued a highly-anticipated decision in Daesang, reversing the trial court’s vacatur of an arbitration award, and re-affirming that “judicial review of arbitration awards is extremely limited.” 85 N.Y.S.3d at 15.

The case arose from an arbitration over whether NutraSweet, the world’s largest producer of an artificial sweetener, could cease making payments under an asset purchase agreement it had entered into with Daesang, a Korean food corporation. The New York arbitral tribunal dismissed all of NutraSweet’s counterclaims and defenses, which were based on rescission and breach of contract, and awarded approximately $100 million damages to Daesang. Nutrasweet then moved to vacate the award, arguing that the tribunal manifestly disregarded the law, imperfectly executed its powers, and violated public policy in dismissing its counterclaims and defenses. The trial court agreed, and remanded the case back to the tribunal.

The First Department, however, unanimously reversed, ruling that the “[t]he order vacating the award … cannot be justified under the ‘emphatic federal policy in favor of arbitral dispute resolution’ embodied in the FAA.” Id. at 4. The court ruled that Nutrasweet’s argument that the tribunal incorrectly dismissed its claims for equitable rescission did “not meet the high standard required to establish manifest disregard of the law,” because Nutrasweet failed to demonstrate that “the arbitrator[s] knew of the relevant principle, appreciated that this principle controlled the outcome of the disputed issue, and nonetheless willfully flouted the governing law by refusing to apply it.” Id. at 18. Next, the court reversed the trial court’s ruling that the tribunal’s dismissal of Nutrasweet’s breach of contract counterclaim as waived constituted an “egregious dereliction of duty” sufficient to support vacatur, reasoning that “a court is not empowered by the FAA to review the arbitrator’s procedural findings, any more than it is empowered to review the arbitrator’s determinations of law or fact.” Id. at 20, 22. Finally, the court rejected Nutrasweet’s argument that enforcement of the arbitration award would be contrary to public policy, because a public policy defense only applies where “enforcement might violate our most basic notions of morality and justice,” which was not the case as to the award. Id. at 25.

Less than two months later, on Nov. 19, 2018, the First Department, issued NRT New York v. Spell, another decision reversing the trial court’s vacatur of an arbitration award and emphasizing the extremely narrow review applied to arbitration awards, this time under New York law.

Spell involved an arbitration between Citihabitats, an apartment broker, and Suzy Spell, regarding a brokerage contract for Spell’s apartment in Manhattan. Under the contract, Citihabitats could recover a sales commission if Spell sold the apartment to a tenant “within 6 months after expiration of the lease term or extension thereof.” Spell, 88 N.Y.S.3d at 35. Citihabitats procured tenants, who rented the apartment until the written lease expired a year later. They continued to live there on a month-by-month basis for approximately another year, before purchasing the apartment. The arbitrator ruled that Citihabitats was not entitled to a sales commission since the apartment was sold more than 6 months after the written lease expired. The trial court vacated the award, finding that the arbitrator’s determination was “wholly irrational,” because the month-to-month lease operated as an “extension” under the parties’ contract.

The First Department unanimously reversed. The court reasoned that “CPLR 7511 provides just four grounds” for vacatur, and the ground relied on by the trial court—where an arbitrator “exceeded his power”—occurs only where “the arbitrator’s award violates a strong public policy, is irrational or clearly exceeds a specifically enumerated limitation on the arbitrator’s power.” Id. at 35-36. The court noted that courts must defer to arbitration awards “even if the arbitrator misapplied the substantive law in the area of the contract.” Id. at 36. Because the arbitrator’s interpretation of the contract was “neither wholly irrational nor contrary to any strong public policy,” the court directed that the award be confirmed. Id.

Implications

The Supreme Court’s decision in Henry Schein, and the First Department’s decisions in Daesang and Spell, reaffirm that those courts will strictly enforce arbitration agreements on the front-end of the arbitration process, and afford a high degree of deference to the arbitrator’s award at the back-end of the process. If parties desire to take advantage of the rule in Henry Schein and delegate threshold arbitrability questions to an arbitrator, they should be sure to make that intent clear in the arbitration provision itself. And if parties do agree to refer disputes to arbitration, as Daesang and Spell demonstrate, they should be mindful that judicial review of the outcome of the arbitration is likely to be extremely limited.

Gregg Weiner is partner and litigation and enforcement practice group co-chair at Ropes & Gray. Christian Reigstad and Dielai Yang are associates at the firm.