The Supreme Court likely will be called upon to resolve the emerging circuit split on this issue, but until it does so, lawyers drafting arbitration agreements or participating in arbitration disputes must account for the split in their advice to their clients.

Parties that agree to submit their disputes to arbitration generally seek a quick and efficient alternative to litigation. Arbitration, however, has not always delivered on its promise, as it has been transformed increasingly into a process more akin to litigation in terms of cost and delay. One of the driving forces behind this phenomenon is the potential that an arbitration award may be vacated for “manifest injustice,” which some arbitrators regard as a reason to conduct arbitrations in a manner that resembles procedures in the civil justice system, including an expansive “search for the truth” through discovery and substantial motion practice to decide the contours of the final hearing.

The Supreme Court of the United States recently tried to return some degree of efficiency to arbitration by eliminating the power of judges under the Federal Arbitration Act (FAA) to vacate arbitral awards on grounds not set forth in the FAA. As illustrated in a recent U.S. Court of Appeals for the Fifth Circuit opinion, a circuit split has emerged on the issue of whether “manifest disregard of the law” constitutes a permissible basis for vacatur under the FAA. This circuit split will have to be resolved by the Supreme Court, but in the meantime it creates important issues for parties drafting arbitration agreements and those arbitrating under them.

The Federal Arbitration Act and Vacatur of Arbitral Awards

Three sections of the FAA control the power of courts to review arbitral awards. First, assuming the arbitration agreement allows for it, courts have an obligation to confirm arbitral awards unless they vacate, modify or correct them as permitted by the FAA. Second, courts can vacate arbitral awards if one or more of the following are true:

  • The award was procured by corruption, fraud or undue means.
  • There was evident partiality or corruption in an arbitrator.
  • An arbitrator was guilty of misconduct in refusing to postpone the hearing upon sufficient cause shown, or in refusing to hear evidence pertinent and material to the controversy, or was guilty of any other misbehavior by which a party’s rights have been prejudiced.
  • An arbitrator exceeds his or her powers, or so imperfectly executes them that a mutual, final and definite award upon the subject matter submitted was not made.

Finally, courts can modify or correct awards if material mistakes are evident in a calculation or description of something to which the award refers; an arbitrator awards on a matter not submitted to him or her, unless the matter does not affect the merits of the decision on the matter submitted; or the award is imperfect in matter of form not affecting the merits of the controversy.

The Supreme Court recently determined that the FAA does not authorize courts to review arbitral awards more expansively than this, relying on Hall St. Assocs., L.L.C. v. Mattel, Inc. (“We hold that the statutory grounds are exclusive.”) Oddly, the Hall Street dispute began when litigants in the District of Oregon entered an arbitration agreement to resolve an indemnification issue arising out of the lawsuit. As part of the contract, the parties agreed that the district court could confirm, vacate, modify or correct the arbitral award, and that the court must vacate, modify or correct the award if the arbitrator’s factual findings were not supported by substantial evidence or the legal conclusions were erroneous. The Supreme Court held that the parties could not—by agreement—expand the scope of review authorized by the FAA. The Supreme Court was careful to limit its holding to FAA review. (“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.”)

The Current Circuit Split on “Manifest Disregard of the Law”

On March 5, 2009, in Citigroup Global Markets Inc. v. Bacon, the Fifth Circuit held that the grounds for vacatur of arbitral awards did not include “manifest disregard of the law” by the arbitrator. Although it had (like all the circuits) previously permitted courts to set aside arbitral awards for manifest disregard of the law, the Fifth Circuit held that that rule did not survive Hall Street: “Hall Street unequivocally held that the statutory grounds are the exclusive means for vacatur under the FAA. Our case law defines manifest disregard of the law as a nonstatutory ground for vacatur. Thus, to the extent that manifest disregard of the law constitutes a nonstatutory ground for vacatur, it is no longer a basis for vacating awards under the FAA.”

The First Circuit has stated it understands Hall Street to mean “that manifest disregard of the law is not a valid ground for vacating or modifying an arbitral award in cases brought under” the FAA, but did not have occasion to hold so because the case before it had not been brought under the FAA. Ramos-Santiago v. United Parcel Serv. (1st Cir. 2008). The Fifth Circuit appears to be the first circuit to hold that Hall Street insulates arbitral awards from searching review for legal errors.

Other circuits, however, have interpreted Hall Street to preserve courts’ ability to review arbitral awards for legal errors. Focusing on the Supreme Court’s speculation in Hall Street that “‘manifest disregard’ may have been shorthand for § 10(a)(3) or § 10(a)(4)” of the FAA, the Second Circuit held that its review for manifest disregard—which it believed to be narrow—was the equivalent of a review for “arbitrators [who] have thereby ‘exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made.’” Stolt-Nielsen SA v. AnimalFeeds Int’l Corp. (2d Cir. 2008) (quoting 9 U.S.C. § 10(a)(4)). Less than two weeks later, the Sixth Circuit explained its view that Hall Street only curtailed private attempts to expand FAA review but did not overrule judicial doctrines—such as manifest disregard of the law—developed under the FAA. Coffee Beanery, Ltd. v. WW, L.L.C. (6th Cir. 2008). Most recently, the Ninth Circuit has held: “[T]he manifest disregard ground for vacatur is shorthand for a statutory ground under the FAA, specifically 9 U.S.C. § 10(a)(4), which states that the court may vacate where the arbitrators exceeded their powers.” Comedy Club, Inc. v. Improv W. Assocs., (9th Cir. 2009).

The Effects of the Circuit Split on Drafters and Practitioners

The Supreme Court likely will be called upon to resolve this emerging split. Until it does so, however, lawyers drafting arbitration agreements as well as those participating in arbitration disputes must account for the split in their advice to their clients.

Drafting Arbitration Agreements

The central holding of Hall Street was that parties to an arbitration agreement cannot directly adjust the FAA’s standard of review. The Supreme Court was equally clear, however, that the FAA allows the parties great latitude to determine—by contract—any procedural limitations on the arbitration itself. Parties wishing to ensure an efficient arbitration can agree, for example, to curtailed (or no) discovery, limited (or no) pre-hearing briefing and a short deadline for entry of a final award. Parties were able to control their arbitration costs in this manner before Hall Street, and they should continue to do so.

Even with the circuit split unresolved, parties may even be able to limit courts’ ability to review their arbitral awards for manifest disregard of the law under the FAA. As a statutory matter, the court empowered to vacate an award is the one “in and for the district wherein the award was made.” Accordingly, where the parties set the seat of their arbitration may increase the likelihood of a final decision subject to limited appellate review. An award made in New York can currently be reviewed for manifest disregard of the law, but an award made in New Orleans cannot. The choice of where to arbitrate can result in a more efficient (and cost-effective) appeal. Parties may be able to avoid the issue entirely by setting their arbitration outside the United States and under a legal regime that more readily accepts limited review of arbitral awards, such as that of the United Kingdom.

Practice Under Existing Arbitration Agreements

Practitioners must know whether the award they seek will be subject to judicial review for manifest disregard of the law. If it will be, then practitioners must arbitrate the dispute with an eye toward creating the record necessary to challenge the award on “appeal.” Thus, these arbitrations likely will involve more briefing and more discovery, as the parties will want to create the most robust record possible. Tribunals in these arbitrations want to minimize the risk of vacatur, so they are likely to accede to parties’ demands for more process. Unsurprisingly, the costs of this style of arbitration rival those involved in complex civil litigation. Such costs, however, can be avoided in a proceeding insulated from manifest disregard review.

Conclusion

Arbitration is supposed to provide an efficient, cost-effective manner of resolving disputes. Over time, arbitration has lost some of its advantage over civil litigation as it has become more like its competitor. The Supreme Court’s resolution of whether “manifest disregard of the law” is a ground on which arbitral awards can be vacated under the FAA will help determine whether arbitration will regain some of its lost identity. Even under the current circuit split, however, parties can seat the arbitration in a circuit or non-U.S. jurisdiction that favors limited review, and structure their arbitration agreement to control arbitration costs.