ADR

Editor's note: This article describes a hypothetical situation.

Another loss at an arbitration hearing for Bob. Within a few days, Bob figured out what happened: the loss was due to a partial and biased arbitrator who had concealed her connections to Bob's adversary. In seeking to vacate the “tainted” award, all Bob had to do was rely on the plain language of the Federal Arbitration Act. Bob confidently assured his client that this one would be easy. Not surprisingly—at least for folks who know Bob—it was not “easy.” To make matters worse, Bob had laid his own trap from the start.

Here is what happened. Representing one of the two partners in a complex business matter, Bob inserted an arbitration clause into the partnership agreement. Although he customarily did not like three-arbitrator panels, Bob concluded that this time was different. If Bob's client and Alfred, the other partner, ever got into a dispute, it would be messy and complicated. Plus, there would be a lot of money at stake. Bob figured a three-arbitrator panel would avoid the risk of an off-the-deep-end award from a sole arbitrator. Bob also thought a three-arbitrator panel would bring more expertise and understanding to a complex dispute.

Bob did not want three neutral arbitrators. He instead wanted two party-appointed arbitrators and a third neutral arbitrator. Why? To create an “insurance policy”: the party-appointed arbitrators would insure that the panel carefully considered all the issues; and three arbitrators—rather than just one—would insure that the final award was not an outlier or “crazy” (Bob's phrase). To avoid “excessive bias”—again, Bob's phrase—the arbitration provision stated that all three arbitrators had to “disinterested.”

In the arbitration that Bob lost, Alfred's party-picked arbitrator (other arbitrator) failed to disclose, to Bob and to the other arbitrators, her following connections with Alfred:

• The other arbitrator was the president of a human resources firm that had extensive dealings with Alfred.

• The other arbitrator's human resources firm and Alfred have offices in the same office suite.

• A former director of a corporation in which Alfred was the sole shareholder was CFO of a firm that provided consulting services to the other arbitrator.

• A few months after the initial case management conference in the arbitration proceeding that Bob lost, but before the hearing started, the other arbitrator hired the former CEO of one of Alfred's companies to be the CEO of the other arbitrator's human resources firm. This former CEO testified in the arbitration hearing.

“Enough said.” That is how Bob concluded the facts section of his motion—actually, the “undisputed racts” section—in which he sought to vacate the arbitration award in favor of Alfred and against his client.

The court flatly denied Bob's motion to vacate the “tainted” arbitration award in a one-page pithy order. Did the court get it right?

Let's go back to some basic principles, which might be dizzying:

• Under Section 10(a)(2) of the FAA, a court may vacate an arbitration award “where there was evident partiality or corruption in the arbitrators, or either of them.”

• Proving “evident partiality” is not easy; the party challenging an award based on evident partiality must clear a high hurdle.

• A challenging party has an even higher burden in seeking to demonstrate “evident partiality” of a party-appointed arbitrator, who is supposed to be an advocate for his or her appointing party.

• An arbitrator's nondisclosure of a material relationship with a party sometimes can constitute “evident partiality.” At least if the relationship is “substantial.”

• An indirect or tangential relationship between an arbitrator and a party does not constitute “evident partiality.”

We know the failure to disclose “substantial” relationships—whatever they are—can be grounds for vacatur. Um, except not all the time. So how do we determine when vacatur is warranted? Or, put another way, why didn't Bob prevail when he sought vacatur?

In Certain Underwriting Members of Lloyds of London v. Florida, 892 F.3d 501 (2d Cir. 2018), the court faced these bewildering issues. There, a party sought vacatur of an adverse arbitration award because the other side's selected arbitrator failed to disclose several connections and relationships with his appointing party.

The court did not provide simple rules or easy-to-apply tests. For instance, distinguishing between ethical standards governing arbitrators and the principles governing vacatur, the court noted that an arbitrator's ethical lapse is not a ground for vacatur: “An arbitrator's failure to make a full disclosure may sully his reputation for candor but does not demonstrate evident partiality.”

Thankfully, the court gave two bits of guidance in determining whether a party-appointed arbitrator has engaged in “evident-partiality.”

First, vacatur would be warranted if the party-appointed arbitrator's partiality “had a prejudicial effect on the award.” This less-than-clear standard means the arbitrator's partiality must have influenced the arbitral proceeding or infected the arbitration award. Not surprisingly, determining whether there was “a prejudicial effect” can require the reviewing court to hold an evidentiary hearing. Unfortunately, Bob's vacatur papers did not seek an evidentiary hearing. Nor did Bob assert that the other arbitrator's partiality had a prejudicial effect on the award.

Second, because “arbitration is a creature of contract,” parties are free to structure their arbitration agreements, including specifying the rules that will govern their arbitration proceeding. In Certain Underwriting Members of Lloyds of London, the arbitration agreement said only that the party-appointed arbitrators would be “disinterested”: “In this case, the qualification in the contract is 'disinterested,' which would be breached if the party-appointed arbitrator had a personal or financial stake in the outcome of the arbitration.” Likewise, the only arbitrator-qualification in the Bob-drafted arbitration agreement was a “disinterested” requirement. As in Certain Underwriting Members of Lloyds of London, Bob's vacatur motion did not claim, let alone present clear and convincing evidence, that the attacked arbitrator had a personal or financial stake in the outcome of the arbitration.

At the time of drafting the arbitration agreement, the aggrieved party in Certain Underwriting Members of Lloyds of London and Bob each could have specified other, and more rigorous, standards for the appointed arbitrators. They could, for instance, have said that the arbitrators cannot have any direct or indirect financial, business or personal interest (with the parties; or in the outcome of the arbitration proceeding. For instance:

The arbitrators shall not have any direct or indirect present or former business or professional relationship with either party (or either party's counsel) of such nature that the arbitrator's independence with respect to that party could reasonably be questioned.

To prevent such relationships and contacts from being buried, the arbitration agreement could have insisted that the parties furnish each other and the proposed arbitrators, before appointment, with some or all the following information:

• The name of each officer, director, shareholder, trustee, parent corporation, subsidiary corporation, affiliated corporation, member, partner and joint venturer of each party;

• The name of each material witness and expert witness; and

• The name of each attorney and law firm that represents each party.

The arbitration agreement also could have required the proposed arbitrators to disclose some or all of the following to the parties:

• If he or she is or was related by blood or marriage to any party or the attorneys or witnesses for any party (and “party” could be broadly defined);

• If he or she is or was an officer, director or shareholder, partner, surety, guarantor, creditor, debtor, member, employer, employee or trustee of any party;

• If he or she has or had any social or business contacts or relationships with, or in any way represented or been affiliated with, any party;

• If he or she ever has been adverse to any party or to the witnesses or attorneys of any party, or has ever asserted any claims against or defended any claims brought by any party or the witnesses or attor­neys of any party; or

• If he or she has any financial interest in the controversy or otherwise has any interest in the controversy that could in any way be affected by the outcome of the proceeding.

A party may be tempted to withhold facts that suggest that a prospective arbitrator—party-appointed or not—has a possible conflict of interest. Or a party may not feel it is “worth the effort” to investigate potential conflicts. But, here again, the arbitration agreement can let the parties know that a nondisclosure or an improper investigation of possible conflicts would breach the rules—the contract—governing their arbitration proceeding:

Each party warrants, represents and covenants that, after reasonable investigation, it has disclosed to all other parties [name of prospective arbitrator]'s current, past or possible future representations or consulting relationships with, or pecuniary interest in, [name of party and names of party's affiliates, partners, and officers] and [name of party's attorney and law firm]; and (b) has no knowledge of any actual or potential conflicts of interest that could reasonably be perceived as affecting the impartiality of [name of prospective arbitrator].

Let's go back to Bob. In drafting the arbitration agreement, he did not take the steps to make sure that the parties would flag conflict issues at the start—and then consent (or not) to any possible conflicts. Nor did he specify adequately the rules governing the arbitration proceeding. Maybe Bob's improper contract drafting got him into his present mess. You think?

Charles F. Forer independently provides arbitration, mediation and all other neutral services. He is a co-chair of the Philadelphia Bar Association's alternative dispute resolution committee and a former chair of the fee disputes committee. He is a frequent lecturer and writer on the use of ADR in a variety of settings. Contact him at 610-999-5764 and c[email protected].