As the retreat from long-running and expensive court proceedings has become more like a stampede, courts have become increasingly favorably disposed to facilitating out-of-court resolutions of disputes. This has generally led, among other things, to enlarging the powers of arbitrators, with many decisions holding that they can grant forms of relief that courts cannot. However, a recent New York court decision in Grynberg v. BP Exploration Operating, has taken a significant turn in the opposite direction.

In Grynberg, the Appellate Division, First Department, by way of a short slip opinion [92 AD 3d 547 (Feb. 21, 2012)], affirmed a holding by Supreme Court Justice Jane Solomon (No. 116840, slip op. 33401(U), Sup. Ct. N.Y. Co., Dec. 8, 2010), that arbitrators do not have the power to award sanctions under New York law. The holding is particularly surprising because both the relevant facts as set forth below,1 as well as the law, seem to clearly point the other way.

Factual Summary

The arbitration arose out of a 1996 dispute concerning rights to an oil field in the Caspian Sea near the Republic of Kazakhstan which the parties settled in two settlement agreements containing identical arbitration clauses that named Stephen Hochman as the sole arbitrator. The settlement agreements required respondents to account for and pay to claimants a portion of the profits respondents earned when they sold their interests in the Kazakhstan oil venture at a price that Grynberg alleged was too low.2

During the 10-year period over which the arbitrator decided 13 separate disputes, individual claimant Jack Grynberg began four lawsuits, all without success, and “made numerous applications to Hochman which were perceived as burdensome, diversionary and delaying.”

On Feb. 9, 2010, Hochman issued a 30-page final Decision and Award in which he made 13 separate sub-awards. In sub-award 11, titled “Respondents’ Motion for Sanctions,” he cited ReliaStar Life Ins. of New York v. EMC National Life, 564 F.3d 81 (2d Cir., 2009), as authority to impose a sanction against Grynberg in the amount of $3 million, payable to respondents, based on ReliaStar’s holding that “sanctions may be awarded against a party guilty of bad faith conduct in the course of an arbitration under the Federal Arbitration Act (FAA).”

Even without ReliaStar, the arbitrator’s authority to grant such relief would have seemed perfectly clear since the scope of his authority was governed by the arbitration agreements and Rule 45 of the American Arbitration Association Rules, as in effect in 1999, which provided that “the arbitrator may grant any remedy or relief that [he] deems just and equitable and within the scope of the agreement of the parties.…” Moreover, the settlement agreements contained a broad arbitration clause that covered all disputes “arising out of, in relation to or in any way connected with this Agreement.”

This also provided that “the arbitration shall be regulated by the procedures of the New York Arbitration Act [CPLR Article 75]…” and that the rights and obligations of the parties shall be construed in accordance with the terms of the settlement agreements “and the substantive law of the State of New York (excluding choice of law rules).” Moreover, the arbitrator had the discretionary power to award costs and attorney fees since the parties agreed to expand his power to grant remedies pursuant to AAA Rule 45, notwithstanding the provisions of CPLR §7513, which prohibit arbitrators from awarding attorney fees “unless otherwise provided in the agreement to arbitrate.”

The arbitrator explained that the $3 million was being awarded “as sanctions, not as an award of attorney’s fees,” was “based solely on the documents and facts in the record and not on the basis of disputable evidence” and that he deemed the sanction “just and equitable under the circumstances.”

While confirming 12 of the 13 sub-awards, Solomon vacated the imposition of sanctions under sub-award 11, doing so, however, on grounds different from those cited by the Appellate Division in its short order of affirmance. Nothing in either decision suggested: (1) that the settlement agreements or the arbitration agreements contained a prohibition against the award of attorney fees, sanctions or punitive damages; (2) that the facts as found by the arbitrator were insufficient to meet the standards pursuant to which a court could award sanctions; or (3) that the amount of the sanction even approached the amount of attorney fees that the arbitrator could have awarded in view of the numerous “burdensome, diversionary and delaying” claims that the arbitrator apparently determined were made by Grynberg in bad faith over 10 years of arbitrated disputes.

Based on the facts and applicable law, it is respectfully submitted that both courts erred in holding that the arbitrator did not have the power to award sanctions. However, since the Appellate Division’s affirmance avoided adopting either of the two reasons on which Solomon based her vacatur of the sanctions award, the erroneous reasons given in support of both decisions will be discussed separately.

Solomon’s Two Reasons

Solomon’s first reason for vacating the sanction award was that the FAA did not apply because the arbitration agreement provided that “the arbitration shall be regulated by the procedures of the New York Arbitration Act” and failed to also provide for the possible applicability of the FAA.

Solomon acknowledged that the Second Circuit held in ReliaStar that, in matters governed by the FAA, “‘[w]here an arbitration clause is broad, arbitrators have the discretion to order such remedies as they deem appropriate’ and ‘consistent with this principle, we here clarify that a broad arbitration clause…confers inherent authority on arbitrators to sanction a party that participates in the arbitration in bad faith…’ (ReliaStar, 564 F.3d at 86).” She nevertheless held that ReliaStar was not applicable despite the comparable broad arbitration clause in the present case because it lacked language similar to the following underlined provision found in the ReliaStar arbitration agreement:

Any arbitration instituted pursuant to this Article shall be held in New York, New York…, and the laws of the State of New York and to the extent applicable, the Federal Arbitration Act shall govern the interpretation and application of this Agreement. (Emphasis added.)

However, both the U.S. Supreme Court and the New York Court of Appeals have consistently held that the FAA applies in cases involving interstate commerce without the need to expressly so provide. Accordingly, Solomon’s reasoning that additional language like the above is a prerequisite to the applicability of the FAA in cases where the agreement is governed by the New York Arbitration Act is not consistent with New York law, and if it were, it would be preempted by the FAA.

In support of her holding that the FAA does not apply in this case, Solomon cited Volt Info. Sciences v. Board of Trustees, 489 U.S. 468 (1989), in which the Supreme Court merely held that a California law which permitted a court to stay arbitration pending resolution of a related litigation involving third parties not bound by the parties’ arbitration agreement did not conflict with the FAA’s policy favoring arbitration. Volt is distinguishable from this case because the California arbitration law did not limit the authority of arbitrators to award the same remedies that a court could award, but merely delayed the start of the arbitration without limiting the authority of the arbitrator to decide all matters in dispute.

As the Supreme Court noted in the landmark case of Mastrobuono v. Shearson Lehman Hutton, 514 U.S. 52, (1995), “the California rules [in Volt] were ‘manifestly designed to encourage resort to the arbitral process…’ and they ‘generally foster[ed] the federal policy favoring arbitration.’” (514 U.S. 52, 57 (1995)), making it clear that a state arbitration rule that prohibits arbitrators from awarding a remedy that a court has the power to award would not be consistent with the federal policy favoring arbitration.

Solomon’s second reason for vacating the sanction award was that New York law bars arbitrators from awarding sanctions. In support of that ruling Solomon noted in a footnote that, although “Federal courts have the inherent right to sanction…, New York courts may only sanction under 22 NYCRR Part 130 [Part 130 of the Rules of the Chief Administrative Judge of the Courts]….” However, the possibility that New York courts may not have the same inherent right to sanction as federal courts has no bearing on the inherent power of arbitrators to award sanctions where they have the authority to grant any remedy or relief that they deem just and equitable. Rule 22 NYCRR Part 130, applicable only to court proceedings, can neither add to nor subtract from the power of arbitrators to award sanctions against a party who engages in frivolous or bad faith conduct, especially where the parties have agreed to the AAA Rules that authorize arbitrators to “grant any remedy or relief that the arbitrator deems just and equitable.”

Solomon did not claim that anything in the parties’ agreements prohibited the arbitrator from awarding sanctions. Nor did she explain why incorporating the AAA Rules in the parties’ arbitration agreement, which gave the arbitrator the discretionary power to award attorney fees, something a court could not do, did not also grant the arbitrator the discretionary power to award sanctions, which is consistent with what a court could do.

First Department’s Reason

In its slip opinion, the First Department affirmed the lower court’s decision to vacate the sanctions award in the following single paragraph, without further discussion or authority:

The arbitrator’s imposition of the $3 million award in sanctions against Jack Grynberg (Award 11) was punitive in nature, regardless of the label attached. Accordingly, the award violated public policy and was properly vacated. (see Garrity v. Lyle Stuart, 40 NY2d 354, 356 [1976]; Matter of MKC Dev. v. Weiss, 203 AD2d 573, 574 [1994]).

The First Department erred first by applying a New York non-statutory standard of review, i.e., “violative of a strong public policy,” although it should have applied the FAA’s only non-statutory standard, which is the “manifest disregard” standard. In Wien & Malkin v. Helmsley-Spear, 12 A.D.3d 65 (1st Dept. 2004), the First Department initially reviewed the arbitration award under the more liberal New York standard rather than the stricter FAA “manifest disregard” standard, erroneously believing that interstate commerce was not affected by the issue in dispute. After the New York Court of Appeals denied leave to appeal, the U.S. Supreme Court granted certiorari and remanded the case to the Appellate Division with instructions to decide the vacatur issue based on the FAA’s manifest disregard standard.

The First Department also erred by failing to recognize that neither of the two cases it cited, Garrity or MKC, supports its decision. In Garrity, the New York Court of Appeals held in a 4-3 decision that “an arbitrator has no power to award punitive damages, even if agreed upon by the parties.” (40 N.Y.2d at 356) That case involved a claim by an author against his publisher for its “malicious” withholding of royalties due the author for the purpose of coercing the author to withdraw a separate pending lawsuit against the publisher. Despite the broad arbitration clause in the publishing agreement, the majority opinion characterized punitive damages as “a social exemplary ‘remedy,’ not a private compensatory remedy” (id. at 358) and overturned the decisions of both lower courts that upheld the arbitration panel’s punitive damage award. The dissent argued that since the arbitration agreement contained a broad arbitration clause and concerned no third-party interests, there was “no question involving public policy of such magnitude as to call for judicial intrusion” [citations omitted]. (Id. at 363)

MKC, the only other authority cited by the First Department in support of its holding that New York public policy prohibits arbitrators from awarding sanctions, relied on Garrity and held that, because the arbitration agreement did not authorize the arbitrators to award attorney fees, the arbitrators could not justify awarding them instead as a sanction to punish the respondents for their behavior during the arbitration. However, in Grynberg, the arbitrator had the authority to award attorney fees.

In Mastrobuono, supra, the U.S. Supreme Court made it clear that decisions of the lower federal courts applying New York law that relied on Garrity to overturn an NASD arbitration panel’s punitive damage award should be reversed as “being inconsistent with the central purpose of the FAA, which is to ensure ‘that private agreements to arbitrate are enforced according to their terms.’” [quoting Volt] (Id. at 53) In doing so, it laid out the law with respect to the power of arbitrators to award punitive damages in its footnote 7 as follows:

Were we to confine our analysis to the plain language of the arbitration clause, we would have little trouble concluding that a contract clause which bound the parties to “settle” “all disputes” through arbitration conducted according to the rules that allow any form of “just and equitable” “remedy or relief” was sufficiently broad to encompass the award of punitive damages. Inasmuch as agreements to arbitrate are “generously construed”…, it would seem sensible to interpret the “all disputes” and “any remedy or relief” phrases to indicate, at a minimum, an intention to resolve through arbitration any dispute that would otherwise be settled in a court, and allow the chosen dispute resolvers to award the same varieties and forms of damages or relief as a court would be empowered to award. (Emphasis added.)

Conclusion

Even if the sanctions award against Grynberg were deemed to be solely punitive and thus akin to punitive damages, Mastrobuono makes it clear that the FAA preempts Garrity unless the parties had evidenced an intention to exclude punitive damages as one of the remedies that the arbitrator had the power to award.

Norman Solovay, a former litigator, is founder of Mediation-Plus-More, a mediation organization. He is president of the Global Collaborative Law Council and the author of “The Internet and Dispute Resolution: Untangling the Web,” published by ALM.

Endnotes:

1. The record on appeal was filed under seal leaving Solomon’s opinion as the only publicly available source for these facts.

2. This and additional details of Grynberg’s claims are summarized in the opinion of the U.S. District Court for the District of Columbia that can be found at www.gpo.gov/fdsys/pkg/USCOURTS-dcd-1_08-cv-00301. The Nov. 12, 2008, Memorandum Opinion is available as a pdf file.