ADR

Increasingly, attention has been drawn by courts and commentators to arbitrators’ authority and the scope of awards they may issue. For example, the two most recent articles in The Legal in this column have focused on whether and when an arbitrator might award post-judgment interest that differed from the statutory rate. (See Charles F. Forer’s “Difference Between Post-Judgment, Post-Award Interest,” published July 9; and my article “Are There Limits to an Arbitrator’s Award of Interest,” published June 18.)

Similarly, the U.S. Supreme Court recently upheld an arbitrator’s authority to decide whether to allow class action arbitration proceedings. In that case, Oxford Health Plans LLC v. Sutter, No. 12-135, June 10, 2013, the agreement contained broad contractual language precluding litigation and requiring arbitration of any dispute arising under the contract. In both a footnote and a concurring opinion, however, the Supreme Court specifically noted that this holding might be limited as the parties had consented to the arbitrator deciding in the first instance whether the contract authorized class arbitration.

The above matters focused on the authority of the arbitrator to render particular decisions based upon either specific language in the arbitration agreement or the expressed understanding of the parties.

Are there times, however, when the arbitrator may fashion an award not based upon authority specifically conferred by the arbitration agreement or the consent of the parties, but because that award would essentially reflect the essence of the contract and a proper solution to the issues raised by the controversy?

Such a situation was faced recently by the U.S. Court of Appeals for the Fifth Circuit in Timegate Studios v. Southpeak Interactive LLC, 713 F. 3d. 797 (April 9, 2013).

The court’s opinion recites that Timegate and Gamecock Media Group had entered into an agreement to develop and publish a video game called Section 8. Essentially, Timegate was to create the game and Gamecock was to fund, manufacture and market it. In addition, although Timegate retained exclusive ownership of the game, Gamecock had a worldwide license of eight years to the original game as well as five years to any sequels or platform translations; Gamecock was specifically prohibited from preparing derivative works or otherwise exploiting Section 8 except in accordance with the contract.

After only two months, the agreement fell apart and Timegate sued Gamecock seeking damages for breach of the publishing agreement. Gamecock countered that it was Timegate that had breached the contract and engaged in fraud. The parties proceeded to arbitration in accordance with the provisions of their agreement.

The Fifth Circuit reported that the arbitrator found in favor of Gamecock as “Timegate had actively engaged in a litany of fraudulent misrepresentations and contractual breaches.”

Most significantly, in considering how Gamecock might be compensated for its damages, the arbitrator found that the “monetary award of damages for losses to date failed to fully compensate Gamecock for all of Timegate’s fraud and contractual breaches.” In particular, Timegate’s other product developments and breaches effectively “deprived Gamecock of the opportunity to exploit the potential opportunities offered by other iterations, distribution channels and sequels of Section 8.”

Accordingly, in addition to an award of $7.35 million, the effect of the arbitrator’s award was to “realign major elements of the parties’ future relationship as established by their original agreement.” The parties’ distinct roles as developer and publisher were effectively dissolved so that Gamecock would have a perpetual license in the intellectual property of the game, and each party could develop related products without any obligation to report or pay royalties to the other.

Upon appeal, the district court, while acknowledging that a finding of fraud would permit an arbitrator to fashion an award that conflicts with contractual provisions, noted that such an award must be rationally inferable from the parties’ central purpose in drafting the agreement. It held that the conversion of what was a temporary licensing agreement into a permanent contract under which each of the parties could develop competing products exceeded the arbitrator’s authority and was “inconsistent with the fundamental purpose of the contract”; in the court’s opinion, the arbitrator’s modification neither preserved the intent nor was consistent with the essence of the contract. Accordingly, it vacated the arbitrator’s award.

The Fifth Circuit reversed the district court. It pointed out that courts must be very deferential to the arbitrator’s award, even if they disagree with it, and, “In deciding whether the arbitrator exceeded its authority, we resolve all doubts in favor of arbitration.” The court stated that it would sustain the arbitration award as long as the arbitrator’s decision draws its essence from the contract and “if it is rationally inferable from the letter or the purpose of the underlying agreement.” Moreover, “an arbitrator has not exceeded his powers unless he has utterly contorted the evident purpose and intent of the parties — the ‘essence’ of the contract.”

In fact, the court emphasized that “the arbitrator’s selection of a particular remedy is given even more deference than his reading of the underlying contract.”

Based on these considerations, the appellate court recognized that the agreement contemplated a collaborative effort between parties with distinct expertise, in which they were to work jointly to create, market and popularize the video game. However, the original agreement did not contemplate a perpetual relationship.

Nonetheless, the arbitrator found that Timegate had breached the agreement in so many ways and the relationship had become so contentious that future collaborative relationship was no longer possible. Accordingly, the court concluded that “the perpetual license granted to Gamecock represents an attempt by the arbitrator to restore to Timegate and Gamecock the fundamental goal of the agreement: mutual access to financial benefits derived from their joint creation and distribution of Section 8.”

“As the arbitrator recognized, the parties were unable to work together in a cooperative effort to profit from this venture because of Timegate’s numerous breaches,” so a monetary award could only recompense losses to date. The success or profitability of future developments, however, “was so speculative that the arbitrator rationally could have concluded that a monetary award was not an appropriate remedy for those breaches.” The only way to give Gamecock the opportunity to benefit from the future development of variations of Section 8 was to cut Gamecock loose from Timegate and allow it to independently pursue game marketing efforts. To do this, the arbitrator granted the perpetual license to Gamecock, a remedy that also left Gamecock free to develop and promote Section 8 variations on its own.

Finally, the appellate court rejected Timegate’s argument that the perpetual license remedy could not further the essence of the agreement because it conflicted with specific provisions in the agreement governing the retention and limitation of intellectual property rights. The court pointed out that the agreement was “extremely particularized” with hundreds of individual provisions governing every foreseeable aspect of the parties’ relationship. The multiple, irreversible breaches by Timegate, therefore, must inevitably result in the realigning of some of the original contract’s provisions. Otherwise stated, “If the ‘essence’ of such a complex contract rested on every provision in the contract, an arbitrator could not possibly fashion a remedy.”

The message for any party contemplating submission of a dispute to arbitration should be clear. Arbitrators, it would appear, may fashion remedies beyond the simple awarding of money damages, if necessary to reflect the “essence” and intent of the parties.

If so, care should be taken in specifically describing the authority of the arbitrator and what limitations, if any, should be in place. For example, at the beginning of this article, reference was made to whether an arbitrator may impose a post-judgment interest rate. Other issues may include whether the arbitrator may award attorney fees, impose penalties for vexatious conduct, provide preliminary relief, issue orders to protect against the dissipation of assets, or even, as in the case discussed herein, revise the contractual relationships of the parties to provide appropriate relief for an injured party.

The rules of some ADR providers often provide some guidance in this regard, but are not always sufficiently clear to allow a precise understanding of the arbitrator’s authority. Recognizing the possibility that such authority may not be sufficiently delineated, therefore, it would be good to carefully consider those provisions of the arbitration agreement that discuss the scope of the arbitrator’s authority; attention should be given to whether language should be included that grants the arbitrator authority beyond the simple rendering of a monetary award or, conversely, whether such language should specifically delimit areas in which the arbitrator may be involved.

Failure to note this issue may result in the arbitrator taking unexpected action that completely realigns the relationships of the parties, an outcome that one may assume Timegate, the original plaintiff in the case described above, certainly did not contemplate.

Abraham J. Gafni is a mediator/arbitrator with ADR Options and a professor at Villanova University School of Law.