LJL 33rd Street Assocs., LLC v. Pitcairn Props. Inc., No. 11-5425-cv & No. 12-1382-cv (2d Cir. July 31, 2013) [click for opinion]

LJL 33rd Street Associates, LLC, and Pitcairn Properties Inc., jointly owned a high-rise luxury residential building in New York City pursuant to an Operating Agreement that gave LJL the option to purchase Pitcairn's interest if then-CEO Salah A. Mekkawy ceased to be employed by Pitcairn.  The Agreement specified that the Purchase Price to be paid by LJL would be derived from the Stated Value.  The Stated Value would be determined by agreement of the parties.  But if they were unable to agree within ten days, either party could submit the dispute for determination by Expedited Arbitration, "whereupon the arbitrator shall select an independent, third party MA1 appraiser who shall determine the Stated Value."  The arbitration clause provided that disputes will be resolved by "the Expedited Arbitration procedures of the American Arbitration Association" with certain modifications, and specified that "[i]n rendering such decision and award, the arbitrators shall not add to, subtract from or otherwise modify the provisions of the Agreement and may only determine the issue or question presented as their award."

After a takeover of the board of Pitcairn's parent company, the new board voted to fire Mekkawy.  Pitcairn did not ask LJL whether it would exercise its purchase option if Mekkawy were terminated, but had previously met with one of LJL's principals, who had told Pitcairn that LJL did not like or want to deal with Mekkawy.  After Mekkawy's termination, LJL exercised its purchase option. When the parties could not agree on the value of the property, LJL filed an arbitration demand asking for determination of both the Stated Value and the Purchase Price.  Pitcairn objected, arguing that the agreement provided for arbitration of only the Stated Value, not the Purchase Price. 

The arbitrator selected an appraiser to determine the property's value.  During the arbitration hearing, the parties introduced testimony and appraisal reports and cross-examined each other's witnesses.  The arbitrator sustained LJL's objections, on hearsay and other grounds, to four of Pitcairn's exhibits.  The arbitrator entered an award determining the Stated Value as $56.5 million, based on the appraiser's appraisal, but declined to determine the Purchase Price. 

LJL petitioned a New York state court to confirm the arbitrator's determination of Stated Value but to vacate his refusal to determine the Purchase Price.  LJL argued that Pitcairn had forfeited objection to arbitrating the Purchase Price under a provision of New York's arbitration law, New York Civil Practice Law and Rule § 7503(c), because it had not moved for a stay of arbitration within 20 days of LJL's demand.  Pitcairn removed the case to federal court and cross-petitioned to vacate the award based on the arbitrator's exclusion of evidence, which it argued violated the Federal Arbitration Act ("FAA"), 9 USC § 10(a)(3).  The district court ruled in favor of Pitcairn on both issues.

On appeal, the Second Circuit Court of Appeals affirmed in part and vacated in part. The court held that Pitcairn had not waived its objection to arbitrating the Purchase Price.  New York CPLR § 7503(c) does not apply, the court held, to objections (like Pitcairn's) that are based on the limited nature of the arbitration agreement.  The law applies only to objections on grounds that "valid agreement was not made or has not been complied with" and to objections based on time limitations.

The court also held that the arbitrator properly refused to determine the Purchase Price.  The court rejected LJL's argument that an issue arising out of an arbitrated issue is itself arbitrable when it is inextricably interwoven with the merits of the arbitrated matter.  The court found that such a rule has no application to a case like this one where the two issues were "unquestionably analytically distinct" and where the arbitration clause expressly confined the scope of arbitration to certain issues and specifically instructed the arbitrators not to expand the scope to other issues. 

But the court held that the arbitrator's decision to exclude Pitcairn's hearsay exhibits did not constitute fundamental unfairness so as to amount to "misconduct" under 9 U.S.C. § 10(a)(3).  The court disagreed with the lower court's assertion that an arbitrator's unreasonable exclusion of pertinent evidence could justify vacating an award.  But even if it could, this was not an instance of fundamental unfairness.  Arbitrators are not bound by the rules of evidence; they may admit hearsay or exclude it, especially when the evidence in question could be presented without relying on hearsay and where presenting hearsay would be unfairly prejudicial to the adversary.  Pitcairn could have avoided hearsay evidence by simply calling as witnesses the makers of the exhibits, which would have provided LJL the opportunity to cross-examine them.  Furthermore, since the exhibits presented expert valuations of the property, and since such valuations are derived from complex factors, LJL would have been severely prejudiced if the exhibits were presented to the appraiser without first offering LJL the opportunity to test their probative value through cross-examination.  The court therefore concluded that the arbitrator was within the bounds of his "substantial discretion" in excluding the hearsay exhibits.

The court also found legally insufficient Pitcairn's claims that LJL breached its fiduciary duties and the covenant of good faith and fair dealing by failing to disclose LJL's intention to exercise its purchase option and refusing to sell the property to a third party.  The purchase option was LJL's contractual right and there was no evidence of misrepresentation or bad-faith conduct.