United States: Defining The Limits Of Arbitral Authority - When Arbitration Awards Rewrite Commercial Contracts Instead Of Interpreting Them

Robert Kaler is a Partner in Holland & Knight's Boston office

"We have become an arbitration nation," said the U.S. Court of Appeals for the Ninth Circuit earlier this year, "an increasing number of private disputes are resolved not by court, but by arbitrators."1 In the area of complex commercial contracts, arbitration clauses are often inserted based on the assumption that they will more efficiently resolve contractual disputes consistent with the contract's provisions. At times, however, arbitrators issue awards that impose their own view of a "just" remedy at the expense of the painstakingly negotiated provisions in the parties' contracts, effectively rewriting those contracts, and imposing obligations on the parties that they did not, and never would have, voluntarily assumed. When this happens, the limited scope of judicial review of arbitration awards can be discouraging to aggrieved parties, but discouragement need not deter them from seeking judicial review.

When arbitration awards resolving contract claims are not based on the actual provisions of the relevant contracts, but rather on an individual arbitrator's personal sense of "justice" and "public policy," they can be successfully challenged, and vacated by the courts.2 As the U.S. Supreme Court has explained, "the task of an arbitrator is to interpret and enforce a contract, not to make public policy," and where it does the latter, "an arbitration decision may be vacated under §10(a)(4) of the FAA [Federal Arbitration Act3] on the ground that the arbitrator 'exceeded [his or her] powers.'"4 In other words, interpretation of the parties' contract by the arbitrator is acceptable; interpolation and rewriting of it is not.5 The question is where are the Courts supposed to draw that line, and at what point do arbitration awards cross the line.

The U.S. District Court in Massachusetts recently addressed some of these issues in granting a motion to partially vacate an arbitration award filed by the owner of a 1,200 mile fiber optic telecom network in Axia NetMedia Corporation, et al. v. Mass. Tech. Park Corp., No. 17-cv-10582, 2019 U.S. Dist. LEXIS 88549 (D. Mass. May 28, 2019). In that case, the relevant arbitration award purported to remedy an alleged breach of and "failure of consideration" for the owner's underlying network operator agreement with the plaintiff's subsidiary by rewriting that agreement so as to materially change its financial requirements, requiring the owner to accept the rewritten operator agreement if the subsidiary chose to "assume" it in bankruptcy,6 which it did, and simultaneously voiding the plaintiff's guaranty of its subsidiary's obligations to the owner under the operator agreement, which itself required the guaranty.

The owner moved to vacate the portion of the award voiding the guaranty from the parent company on grounds that it exceeded the arbitrator's authority by completely ignoring some of the key provisions in the parties' contracts, and irrationally rewriting others. The owner also argued that the award's voiding of the guaranty, combined with its forcing of the owner to accept the re-written operator agreement with the bankrupt subsidiary, would place it in a fundamentally different position going forward than it had bargained for by forcing it to contract with "a shell entity that is in bankruptcy on a major public network that has four more years to go on the contract and no guaranty from the parent," id. at *19; something to which the owner did not agree and would never have agreed voluntarily.

In granting the owner's motion, and vacating the award with respect to its voiding of the guaranty, the Court held that "the arbitrator exceeded his powers under the FAA by prospectively voiding the Guaranty [of the parent company] while re-writing the terms of the NOA [the operating agreement between the bankrupt subsidiary and the owner], and requiring the owner to accept it, because "the parties never intended to bestow this power upon the arbitrator." Id. at *17-18. The Court also held that in this part of the award, the arbitrator "fundamentally altered the relationship between the parties to adhere to his own concept of fairness," id. at *18, and "constructed an arrangement that ... [the owner] would never have agreed to ex ante," id., noting that the necessity of the guaranty had been "reflected in the original contractual arrangement." Id. The Court also held that in simultaneously rewriting the operator agreement and voiding the guaranty, the arbitrator had "disregarded" relevant contract sections, including language in the guaranty providing that changes to the underlying operator agreement would not affect the validity of the guaranty, and language in the rewritten operator agreement requiring the guaranty. Id. at *19-20.

In so ruling, the Court relied on the U.S. Supreme Court's holding in Stolt-Nielsen S.A. v. AnimalFeeds Int'l Corp., 559 U.S. 662, 671 (2010), that "the arbitrator ... is not free to ignore or abandon the plain language of the [parties' agreement]...," and that "[a]n arbitrator exceeds his powers ... when he reforms material terms of a contract so that the agreement conforms with his own sense of equity or justice." The Court also cited other cases applying this rule that had reached the same result, including PMA Capital Ins. Co. v. Platinum Underwriters Bermuda, Ltd., 400 Fed.Appx. 654, 656 (3d Cir. 2010), where the appellate court held that "t]he arbitrators in this case, by ... rewriting material terms of the contract they purported to implement, went beyond the scope of their authority."

In addition to holding that "the arbitrator exceeded his authority here,"7 the Court also addressed an important procedural issue relating to challenges to arbitration awards, which is whether language in an arbitration agreement stating that any resulting arbitration award will "final, binding and non-appealable" precludes the federal courts from reviewing such an award, and if appropriate vacating or modifying it, under the Federal Arbitration Act (FAA). In finding that such language did not preclude FAA review in this case, the Court noted that a number of federal courts across the country have held that while such language precludes general re-adjudication of the merits of an arbitration, it cannot override the statutory review provided for under the FAA, and that the sophisticated parties in this case could be presumed to have been aware of these precedents and must therefore have intended that result in their contracts.

In enacting the judicial review sections of the FAA, Congress provided a check on the authority of arbitrators in order to ensure that it remains within the limits of the parties' agreements, and their intentions. As the courts increasingly define the limits of arbitrators' authority in the context of individual cases, they are providing that check, while still granting the required deference to arbitration decisions that fairly interpret and draw their essence from the parties' contracts. It can be a complicated task, however, and parties seeking judicial review and vacatur of arbitration awards continue to bear a significant burden of proof. Simply arguing that the arbitrator exceeded his or her authority, or "rewrote" the contract, for example, does not make it so.

In another recent case, for example, Photographic Illustrators Corp. v. OSRAM Sylvania, Inc., 366 F. Supp. 3d 160 (D. Mass. 2019), the U.S. District Court for Massachusetts declined to vacate an arbitration award on either of those grounds after finding that, despite the moving party's argument to the contrary, the arbitrator "did not ignore the plain terms" of the parties' contract, in fact adjusted his award to adhere to those terms, and "did not ignore what the Agreement 'specifically and expressly provided.'" Id. at 168-169. Although the moving party had claimed, for example, that "the arbitrator exceeded his authority" in awarding certain large amounts of attorneys' fees and costs to the opposing party, which had prevailed only on its contract claim and not on its overlapping copyright claim, the Court concluded that "[h]e did not," in the process pointing out ways in which the arbitrator had been careful not to ignore, go beyond, or rewrite the contract, which the Court recognized would not have been permissible.8

These and other recent cases illustrate that reasoned judicial review of arbitration awards, and the authority of arbitrators to issue them, is both feasible and practical, and bearing in mind Justice Frankfurter's admonition about the dangers of unchecked authority in any context,9 it is a review process that parties should not hesitate to exercise – particularly where Congress has expressly provided for it.

Footnotes

1. Aspic Eng'g & Constr. Co. v. ECC Centcom Constructors LLC, 913 F.3d 1162, 1169 (9th Cir. 2019).

2. Id. at 1169 ("Although courts play a limited role in reviewing arbitral awards, our duty remains an important one. When an arbitrator disregards the plain text of a contract without legal justification simply to reach a result that he believes is just, we must intervene. ...We therefore affirm the district court's vacatur of the Award.").

3. Federal Arbitration Act, 9 U.S.C. § 10(a)(4) ("In any of the following cases the United States court in and for the district wherein the award was made may make an order vacating the award upon the application of any party to the arbitration – ... (4) where the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made.")(emphasis added).

4. Stolt-Nielsen S.A. v. AnimalFeeds Int'l Corp., 559 U.S. 662, 671-72 (2010).

5. See, e.g., El Mundo Broadcasting v. United Steelworkers Of America, 116 F.3d 7, 10 (1st Cir., 1997)("In sum, the arbitrator, under the guise of finding the "imitation of Actions" provision to be unenforceable, ignored the plain terms of the contract agreed to by the parties and supplanted their agreement with a personal undefined standard of timeliness."); Steward Family Hospital v. Mass. Nurses Assn., 2018 U.S. Dist. LEXIS 198353, *20 (D. Mass. 2018)("By going further and reducing the discipline imposed by the Hospital to what he believed was more appropriate, the arbitrator was prescribing his own brand of industrial justice in violation of the plain terms of the contract....The arbitrator's award is vacated.")

6. In bankruptcy, the debtor, if it can satisfy certain requirements, is entitled to "assume" (i.e. undertake to perform) or "reject" (decline to perform) its contracts as part of its plan of reorganization.

7. Axia Netmedia Corp., 2019 U.S. Dist. LEXIS 88549 at *20.

8. Photographic Illustrators Corp., 366 F. Supp. 3d at 168 ("he [the arbitrator] did not state, for example, that the Agreement permitted PIC to recover for work spent exclusively prosecuting its copyright counterclaim or that Sylvania owed whatever fees and costs PIC agreed to pay its attorneys under its contingency arrangement, however unreasonable. In fact, the arbitrator reduced the consultant and expert witness fees to account for the work they did solely on the copyright counterclaim...")

9. See Youngstown Sheet & Tube Co. v. Sawyer, 343 U.S. 579, 594 (1952) (Frankfurter, concurring)("The accretion of dangerous power does not come in a day. It does come, however slowly, from the generative force of unchecked disregard of the restrictions that fence in even the most disinterested assertion of authority.")

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