Albert Bates Jr., left, and R. Zachary Torres-Fowler, right, of Pepper Hamilton.

On June 7, the U.S. Court of Appeals for the Second Circuit, in the case of Certain Underwriting Members of Lloyds of London v. Insurance Company of the Americas, No. 17-1137-cv (2d Cir. June 7, 2018), overturned the lower court’s decision to vacate an arbitrator’s award and remanded the case for further proceedings. While this case arose in the unique context of a reinsurance arbitration using nonneutral party-appointed arbitrators, the opinion contains broad language that could have lasting negative ramifications on the arbitration community, as it risks causing confusion over the role of party-appointed arbitrators.

The appellant, Insurance Company of the Americas (ICA), insures workers’ compensation claims in the construction industry. The appellee, Certain Underwriting Members of Lloyds of London (the underwriters), provided ICA with second and third layer reinsurance under a series of treaties, each of which contained an arbitration clause requiring disputes to be resolved through arbitration using a three-arbitrator panel. The panel was composed of two party-appointed arbitrators and a third arbitrator, selected by the two party-appointed arbitrators, who served as the panel’s chair. However, in this case, the party-appointed arbitrators were not intended to be “neutral” arbitrators. Instead, as the court noted, the parties’ arbitration agreement permitted the parties to engage in ex parte communications with their party-appointed arbitrator during discovery.

During the course of the relationship, a dispute arose concerning the coverage of multiple claims valued in excess of $12.5 million by ICA against the underwriters. After the underwriters declined the claim, the parties proceeded to arbitration, where ICA was awarded net damages of $1.5 million. The underwriters subsequently filed a motion in the Southern District of New York to vacate the arbitration award on several grounds, including evident partiality on the part of the arbitrator appointed by ICA, manifest disregard of the law, and prejudicial misconduct. ICA cross-moved to confirm the award.

The lower court granted the underwriters’ motion to vacate the award and denied ICA’s motion to confirm on the basis that the arbitrator appointed by ICA failed to disclose various relationships he maintained with ICA representatives and that those relationships were found to be “significant enough to demonstrate evident partiality.” ICA appealed the lower court’s decision, arguing that the arbitration award was not void for evident partiality under the Federal Arbitration Act, even if ICA’s party-appointed arbitrator failed to disclose close relationships with former and current directors of ICA.

On appeal, the Second Circuit announced a new standard to assess “evident partiality” on the part of an arbitrator appointed by a party. The court held that a party seeking to vacate an award “must sustain a higher burden to prove evident partiality on the part of an arbitrator who is appointed by a party and who is expected to espouse the view or perspective of the appointing party.” As a result, according to the court, “an undisclosed relationship between a party and its party-appointed arbitrator constitutes evident partiality, such that vacatur of the award is appropriate if: the relationship violates the contractual requirement of disinterestedness … or it prejudicially affects the award.” Accordingly, the Second Circuit vacated the lower court’s decision and remanded for further proceedings consistent with its opinion.

The Second Circuit’s opinion should logically be limited to cases where the party-appointed arbitrator is not intended to be “neutral.” However, an animating and problematic feature of the decision is the court’s apparent assumption that all party-appointed arbitrators are fundamentally distinct from the arbitrator-chairs because, unlike the arbitrator-chairs, party-appointed arbitrators are not presumed neutral. Specifically, the Second Circuit repeatedly returned to the concept that party-appointed arbitrators should not be considered neutral umpires, but rather “are expected to serve as de facto advocates” and therefore, should be subject to a different standard for “evident partiality.” To those active in the U.S. arbitration community, the overly simplistic assertion, albeit in dicta, that arbitrators appointed by a party are de facto advocates, flies in the face of the American Bar Association/American Arbitration Association Code of Ethics for Arbitrators in Commercial Arbitration (2004) (ABA/AAA Code) as well as other institutional arbitration rules and general arbitration practices.

Canon IX of the ABA/AAA Code establishes the presumption that party-appointed arbitrators are neutral, but recognizes that there are certain types of tripartite arbitration where the parties understand and expect that the two arbitrators appointed by the parties may be predisposed towards the appointing party. This limited circumstance, when a party-appointed arbitrator is not subject to the default presumption of neutrality, is governed by Canon X of the ABA/AAA Code, titled “Exemptions for Arbitrators Appointed by One Party Who Are Not Subject to the Rules of Neutrality.” Unfortunately, the Second Circuit’s opinion appears to gloss over the distinction between neutral and non-neutral party-appointed arbitrators.

Canon IX’s presumption that all three arbitrators are neutral, and are expected to observe the same standards as the third arbitrator, has been the default presumption among U.S. practitioners and arbitrators since the ABA/AAA Code was adopted in 2004. Consequently, if read broadly, the Second Circuit’s statement, in dicta, that “expecting of party-appointed arbitrators the same level of institutional impartiality applicable to neutrals would impair the process of self-governing dispute resolution,” would be at odds with the ABA/AAA Code and contrary to the rules of leading arbitral institutions, such as the American Arbitration Association (Commercial Rule 18; Construction Rule 20), CPR Institute (Administered Rule 7), JAMS (Comprehensive Rules 7), and the ICC (Article 11.1 of the Rules). Indeed, although the Second Circuit highlighted that some of its sister circuits followed similar distinctions between party-appointed arbitrators and chairs, most of the cited cases were outdated and do not reflect the current ABA/AAA Code, institutional rules governing the majority of arbitrations conducted in the United States, or current practices and expectations in the commercial arbitration community at large.

Unfortunately, the Second Circuit’s opinion may create further confusion. The facts presented involved a non-neutral party-appointed arbitrator who failed to make appropriate disclosures regarding his relationship with the party that appointed him. The holding that a party seeking to vacate an award “must sustain a higher burden to prove evident partiality on the part of an arbitrator who is appointed by a party and who is expected to espouse the view or perspective of the appointing party” is also clearly directed to non-neutral party-appointed arbitrators.

However, the vast majority of business-to-business disputes do not involve partisan arbitrators.  In the absence of an express agreement of the parties that the party-appointed arbitrators are nonneutral, each arbitrator is expected to be neutral, impartial, and independent. Consequently, some of the court’s dicta suggesting that so-called “wing” arbitrators will not be held to the same disclosure or other standards as the chair is problematic. The ABA/AAA Code, and the rules of leading arbitral institutions, presume that all party-appointed arbitrators are intended to be neutral, and are expected to observe the same standards as the third arbitrator, unless the agreement to arbitrate provides otherwise. The court’s failure to expressly distinguish between the differing duties of a party-selected neutral arbitrator and a party-appointed nonneutral arbitrator may create confusion where none should exist.

Albert Bates Jr. is a partner in the construction practice group of Pepper Hamilton, resident in the Pittsburgh office. He leads the group’s international construction arbitration team. 

R. Zachary Torres-Fowler is an associate in the construction law practice group of Pepper Hamilton, resident in the Philadelphia office. Torres-Fowler joined the firm’s construction law practice group in 2017.