Charles F. Forer, Charles F. Forer Alternative Resolution Services

ADR

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

Bob did not make the mistake this time. The arbitrator’s legal error undermined Bob’s client’s case by relying on a legally flawed interpretation of the parol evidence rule.

As Bob explained to his client, however, “I will file a vacatur petition and get the court to overturn this flawed arbitration award. I already have worked my usual magic. When I drafted the arbitration agreement last year, I made sure we could seek relief from an arbitrator’s legal errors.”

How did Bob work his magic? By insisting on the following provision in the arbitration agreement: “This contract is to be construed in accordance with the internal substantive laws of the commonwealth of Puerto Rico.”

This reference to Puerto Rican law was not a stretch. The other side was based in Puerto Rico and the parties had many meetings in Puerto Rico. By inserting this clause, Bob thought he was taking advantage of Puerto Rican arbitration law, which specifically provides for a searching judicial review of an arbitration award. At least that’s what Bob intended.

In the face of this choice-of-law clause, Bob knew a court could not wash its hands of an error-filled arbitration award.

In response to Bob’s vacatur petition, the other side did something that Bob thought was weird. It did not lock horns on the legal issue of whether the arbitrator got it right on the parol evidence rule. Instead, it said the court should apply the more limited standard of judicial review, set forth in the Federal Arbitration Act (FAA), and confirm the arbitration award even if it was riddled with legal errors.

The court agreed with Bob’s adversary and paid no attention to Bob’s “magic.” Denying Bob’s vacatur petition, the court’s brief order said that Bob’s client “asserts the award should not be confirmed due to legal errors; but under the FAA, mere legal error is not a ground for vacating an arbitration award.”

But wait a second. Bob’s choice-of-law provision said Puerto Rican law applied; and Puerto Rican law indisputably provides for expanded judicial review of an arbitration award. What more do you need? How could the court refuse to tackle Bob’s legal arguments founded on substantive Puerto Rican law regarding the parol evidence rule? The answer: Bob did not draft the arbitration clause properly.

To understand Bob’s error, let’s go back to basics. The FAA applies only to a “contract evidencing a transaction involving interstate commerce.” That was the case with Bob’s client. The underlying contract involved the sale of goods manufactured in Puerto Rico and delivered to Bob’s client in Pennsylvania.

Further, according to the U.S. Supreme Court, the FAA bars courts from honoring parties’ agreements to have courts review an arbitration decision for legal error where the FAA applies. However, the Supreme Court has instructed that “parties are generally free to structure their arbitration agreements as they see fit,” and “just as they may limit by contract the issues which they will arbitrate, so too may they specify by contract the rules under which that arbitration will be conducted,” see Volt Information Sciences v. Board of Trustees, 489 U.S. 468, 479 (1989).

This means contracting parties can do what Bob here sought to do—dispense with the application of the FAA in favor of state arbitration law. As the Supreme Court stated in Hall Street Associates v. Mattel, 552 U.S. 576, 590 (2008), “the FAA is not the only way into court for parties wanting review of arbitration awards: they may contemplate enforcement under state statutory or common law, for example, where judicial review of different scope is arguable.”

Bob messed up, however, by failing to follow the Supreme Court’s instructions; Bob failed as a contract drafter to displace properly the application of the FAA.

As the U.S. Court of Appeals for the First Circuit held earlier this month, the parties must “explicitly” agree to have a state law or statute displace the FAA. A general choice-of-law provision does not do the trick. “The mere inclusion of a generic choice-of-law clause within the arbitration agreement is not sufficient to require the application of state law concerning the scope of review, since there is a strong federal policy requiring limited review … A generic choice-of-law clause, standing alone, is insufficient to support a finding that contracting parties intended to opt out of the FAA’s default regime for vacatur of arbitral awards,” as in Dialysis Access Center v. RMS Lifeline, No. 17-2014, 2019 U.S. App. LEXIS 22999, at *10 (1st Cir. Aug. 1, 2019) (citation omitted). A court will allow the displacement of FAA law in favor of state law “only if the parties have so agreed explicitly.”

What should Bob have done? To avoid application of the FAA (and thereby to expand the court’s review of the arbitration award as intended), he should have explicitly stated that the Puerto Rico Arbitration Act applied. For instance: “This contract is to be construed in accordance with the internal substantive laws of the co mmonwealth of Puerto Rico. The Puerto Rico Arbitration Act shall displace the Federal Arbitration Act and shall govern any arbitration proceeding arising in whole or in part out of or relating in any way to this contract.”

How many of us will ever deal with Puerto Rican law? Isn’t this just an interesting—but irrelevant—legal discussion? The answer: if you want to protect your clients in drafting arbitration agreements, pay attention; you otherwise will join Bob in the “I intended but failed to do it properly” department.

Puerto Rico is not the only jurisdiction that allows for expanded judicial review of arbitration awards. The arbitration statutes of several jurisdictions also provide for expanded review. In New Jersey, for instance, parties by contract may expand the scope of judicial review of an arbitration award, see N.J.S.A. 2A:23B-4(c) (“Nothing in this act shall preclude the parties from expanding the scope of judicial review of an award by expressly providing for such expansion in a record.”); see, e.g., Curran v. Curran, 453 N.J. Super. 315, 322 (App. Div. 2018) (“the parties may voluntarily elect to expand judicial review of an arbitration award by providing for such expansion in their contract”).

The takeaway? If you want a state arbitration statute or common law to trump the FAA, do not rely on a general choice-of-law provision that mumbles that a state’s law shall govern enforcement of the contract. Instead, explicitly state that the parties intend to enforce their agreement under a specified jurisdiction’s law instead of under the FAA. Otherwise, at least where the FAA applies (because the contract involves interstate commerce), a court will stick it to you the same way the court stuck it to Bob—presuming that the parties intended for the FAA to govern their arbitration.

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