Under the Federal Arbitration Act (FAA), 9 U.S.C. 10(a), there are several bases on which a court may vacate an arbitration award, whether domestic or international. These grounds generally concern misconduct on the part of arbitrators and include, in §10(a) (4), “where the arbitrators exceeded their powers.”

In 1953, in Wilko v. Swan, 346 U.S. 427, 436 (1953), the Supreme Court of the United States stated:

In unrestricted submissions, such as the present margin agreements envisage, the interpretation of the law by the arbitrators in contrast to manifest disregard are not subject, in the federal courts, to judicial review for error in interpretation.

Succeeding generations of losing parties in arbitration have relied on Wilko's “manifest disregard” phrase in efforts to vacate arbitration awards. Although “manifest disregard” is not included in the FAA as one of the grounds for vacating an award, various circuit courts of appeal began to recognize manifest disregard of the law by the arbitrators as a ground for vacating awards.

In Hall Street Associates v. Mattel, 552 U.S. 576 (2008), the Supreme Court cast doubt on the validity of manifest disregard as a separate basis for vacating an award, where, in commenting on the Wilko dictum, the court said, “'manifest disregard' can be read as merely referring to the §10 grounds collectively, rather than adding to them, … or as shorthand for the §10 subsections authorizing vacatur when arbitrators were 'guilty of misconduct' or 'exceeded their powers.'”

Thereafter, some circuits declared manifest disregard dead. See, e.g., Medicine Shoppe Int'l v Turner Invs., 614 F. 3d. 485, 489 (8th Cir. 2010). But the Second Circuit is among the courts that have kept the notion alive by treating it as a separate, nonstatutory basis for challenging arbitration awards, although it appears to have rarely, if ever, been asserted as the sole ground. One result has been aspersions that have been cast on New York as a venue for international arbitrations based on the perception that arbitration awards are less inviolate than they are in other world centers of arbitration.

The facts have not supported that perception. A study in August 2012 by a committee of the New York City Bar made the point that there were actually few cases in New York in which manifest disregard was found to be the basis for vacating an award, and that there had been, at that time, no international award rendered in New York that had “ever been set aside in the Second Circuit on the ground of manifest disregard.” Report, p. 2, (emphasis in original).

That statement can no longer be made. A recent decision in the Southern District of New York relied on manifest disregard as a separate basis for refusing to enforce an international arbitration award. Another recent case in the Southern District has also indicated that manifest disregard can be relied on in connection with an international award, though finding it inapplicable under the facts of the case before it.

In a recent case, SDNY Civil Action No. 18-CV-7620-KNF, decided on March 22, 2019, Magistrate Judge Kevin Nathaniel Fox, sitting by consent of the parties in place of the district court judge, pursuant to 28 U.S.C. §636(c) and Fed. R. Civ. P. 73 vacated an amended arbitration award rendered under the Commercial Rules of the American Arbitration Association (AAA Rules). Manifest disregard was one of the grounds on which the court relied—the first time, to the knowledge of the authors, that the doctrine has been used in a court in the Second Circuit to vacate an international arbitration award.

In the arbitration, the tribunal issued an award granting the award creditors $39.2 million in damages, including prejudgment interest. In response to an application by the losing parties, the arbitrators amended their award on the basis that they were correcting a computational error—something tribunals are permitted to do under Rule 50 of the AAA Rules. The tribunal then reduced the award by $2,177,482.

The award creditors moved to vacate the amended award, contending that the arbitrators did not actually correct a computational error, but impermissibly changed their award by altering the legal standard for determining prejudgment interest from what they had previously used. The court ruled that, in doing so, the tribunal exceeded its powers, in violation of FAA §10(a)(4), and did so in manifest disregard of the law. The court found that the tribunal, when it modified its award in violation of the AAA Rules, did so knowingly since it acknowledged, in a portion of its order modifying the award dealing with a separate argument made by the award creditors regarding the calculation of prejudgment interest, that accepting the argument, even if meritorious, would “'constitute a mistake of law'” as to which “'we have no jurisdiction.'” Opinion, p. 16. The court concluded that the tribunal “decided to ignore” the “well-defined, explicit and clearly applicable law prohibiting the arbitration panel from exercising jurisdiction over an issue of law …” Opinion, p. 17.

The court added: “Moreover, the arbitration panel not only exceeded its powers when it changed course in the amended final award by subtracting distribution payments from the principal amount only and not from the sum of the principal amount and the interest amount, as it had done in the final award, it also exhibited manifest disregard of the law prohibiting the arbitration panel from acting as it did.”

The court applied the elements of manifest disregard of the law as set forth in Schwartz v. Merrill Lynch & Co., 665 F. 3d 444, 452 (2d Cir. 2011), under which the movant must show that (1) the governing law alleged to have been ignored by the arbitrators was “well defined, explicit, and clearly applicable” and (2) “the arbitrator knew about the existence of a clearly governing legal principle but decided to ignore it or pay no attention to it.”

The court, in ruling that these standards had been met, relied on the tribunal's own statements as reflecting both its awareness of the legal principle that legal conclusions in an award may not be altered after an award and on what the court regarded as its decision to ignore the principle. Thus, the court found two bases for vacating the amended award, both the statutory one of exceeding its powers in issuing its damages award in violation of the AAA rule and the extra-statutory one of “exhibit[ing] manifest disregard of the law prohibiting [it] from acting as it did” by committing its transgression knowingly. Opinion, p. 16.

The second decision, Smarter Tools v. Chongqing SENCI, 2019 U.S. Dist. 50633, decided a week later, on March, 26, 2019, saw yet another effort to drag in manifest disregard as a basis for vacating an international arbitral award. In this case, SENCI was awarded $2.4 million for goods (generators) received and not paid for by Smarter Tools, whose counterclaims were dismissed by the arbitrator. Smarter Tools thereafter petitioned a court in the Southern District of New York for an order setting aside the award that had been made in favor of SENCI by a sole arbitrator sitting in New York City under the rules of the International Centre for Dispute Resolution of the American Arbitration Association.

Smarter Tools presented two arguments in support of its petition. First, it asserted that the arbitrator had exceeded his authority under §10(a) (4) of the FAA by failing to issue a reasoned award and providing no reasons for his conclusion that Smarter's counterclaims were not supported. Second, it argued that the arbitrator manifestly disregarded the law by failing to apply the United Nations Convention on Contracts for the International Sale of Goods (CISG).

The district court held that the award had not met the standard for a reasoned award because it contained no explanation for the rejection of Smarter Tool's claims. The court found insufficient the only reason given by the arbitrator for his finding—his negative determination concerning the credibility of the testimony of Smarter's expert witness on its counterclaim for damages for loss of future profits and loss of goodwill.

The district court ruled that the arbitrator had exceeded his authority by failing to issue a reasoned award and remanded it to the arbitrator for clarification of his findings. The court gave careful consideration to the manifest disregard contention but rejected its applicability. The court made the statement that “manifest disregard of the law or of the parties' relevant agreement” was a basis under which “an arbitrator award may be vacated under Section 10(a) [of the FAA].” Opinion, p. 5. But, quoting from descriptions in Second Circuit decisions of manifest disregard as “a doctrine of last resort [whose] use is limited only to those exceedingly rare instances where some egregious impropriety on the part of the arbitrators is apparent,” the court found no indication in the record that the arbitrator had reached his results other than through consideration of the CISG, which both sides conceded was applicable. Opinion, p. 8. The court went on to say: “Indeed, [Smarter's] own formulation of its argument reveals that, although couched in terms of manifest disregard for the law, the argument is better classified as an objection to the way the law was applied.” Id. In concluding that the arbitrator did not act in manifest disregard of the law, the court commented: “It is not this Court's place to review the arbitrator's evidentiary determination nor to second guess his application of relevant law.” Id., p. 9.

The manifest disregard doctrine has primarily been regarded as another way of looking at the conduct of arbitral tribunals that can also be regarded as exceeding their powers in violation of §10(a)(4) of the FAA. In Smarter Tools, the district court followed a path frequently followed by courts, expressing reluctance to rely on the manifest disregard doctrine when setting aside an award and placing a heavy burden of proof on the petitioner to establish some “egregious impropriety” on the part of the tribunal. In the other case, however, manifest disregard was given a more leading role. The case is unusual in that does not concern what might be said to involve an egregiously improper ruling by a tribunal, involving as it did the application of accounting principles rather than more palpable improprieties. Nevertheless, the district court applied the manifest disregard doctrine on top of the statutory provision on exceeding of powers because it evidently found that the tribunal deliberately decided not to apply an applicable legal principle that it admitted was applicable.

Although the two decisions have accorded new respect to manifest disregard as an independent ground for vacatur in international cases, they do not lend support to those who contend that arbitral awards in New York are more susceptible to being set aside than are awards in other countries that are frequent hosts to international arbitration.

For example, under §69 of the English Arbitration Act of 1996, courts may vacate an arbitral award for any legal error caused by the arbitrator's misapprehension or misapplication of the applicable law—a standard much broader than manifest disregard. Although §69 may be waived, §68 of the same act may not be, and it offers numerous grounds on which awards can be overturned for “serious irregularity affecting the tribunal, the proceedings or the award,” including “uncertainty or ambiguity as to the effect of the award” and “failure to comply with the requirements as to the form of the award.”

France has a reputation of giving great deference to arbitration awards. There, too, however, as the New York City Bar report notes (pp. 27-29), awards have been vacated on grounds that, at bottom, appear to be the result of a court's believing that the arbitrators made a serious error. In one case, for example, the Cour de Cassation, France's highest civil court, held, concerning a domestic award, that it should be vacated because it was issued with no reference to equity, whereas the arbitration agreement provided for the arbitrators to decide ex aequo et bono. Civ. 1, 1er fevrier 2012, Pourvoi N. 11-11084.

The reality is that there will occasionally be arbitral awards that are so egregious that they deserve to be annulled. It appears that even countries that are considered to be arbitration-friendly have some safety valve mechanism to deal with such situations. Although they are not called “manifest disregard,” they achieve the same purpose, and, accordingly, it is inappropriate for others to attack U.S. courts on the basis of the manifest disregard safety valve that remains accessible in some of the federal circuits.

Lawrence W. Newman is senior counsel and David Zaslowsky is a partner in the New York office of Baker McKenzie. They can be reached at [email protected] and [email protected], respectively. Natalia Mori of the firm's Lima office assisted in the preparation of this article.