For many decades, the reinsurance marketplace has adopted arbitration as the preferred mode of dispute resolution. The expressed goals of arbitration are familiar — timely and efficient resolution of disputes by a panel of experts familiar with the intricacies of the business. One way that the Federal Arbitration Act (FAA) facilitates those goals is by promoting finality. The grounds for vacating an award pursuant to the FAA are highly limited and difficult to sustain. See 9 U.S.C. § 10(a).

Despite those obstacles, over the last several years it has become commonplace for losing parties to reinsurance arbitrations to challenge the award in court. Thus, even after a lengthy arbitration, the parties now often engage in months, or even years, of appellate litigation before learning whether an award will stand.

Because it is extremely difficult to challenge an arbitration award on the merits, many losing parties have based their efforts to overturn an arbitration award on alleged nondisclosures by arbitrators during the arbitrator appointment process. Among the limited grounds for vacating an award contained in the FAA is that an arbitrator displayed “evident partiality” in making the award. As interpreted by the courts over the years, the standard for proving actual partiality is appropriately onerous — akin to a finding of fraud or corruption by the arbitrators. Accordingly, cases where arbitrators were found to be actually biased have been extremely rare.

Going back to the United States Supreme Court's opinion in Commonwealth Coatings Corp. v. Continental Casualty Co., 393 U.S. 145, 89 S. Ct. 337 (1968), however, courts have been more willing to vacate an award under the “evident partiality” standard based on nondisclosures of an arbitrator's personal monetary interest in the dispute — or with a party — from which partiality might be inferred. Indeed, reinsurance practitioners are eagerly awaiting the Second Circuit Court of Appeals forthcoming decision in Scandinavian Reinsurance Co. v. St. Paul Fire & Marine Insurance Co., 732 F. Supp. 2d 293 (S.D.N.Y. 2010). The opinion in that case should help further define the boundaries of required disclosures by arbitrators regarding their involvement in other potentially related arbitrations.

A recent decision by the Texas Appellate Court provides a new twist in this ongoing saga. Although the case was decided under the applicable Texas arbitration statute, the relevant provisions of that statute are identical to the FAA.

The Karlseng v. Cooke Decision

In Karlseng, et al v. Cooke, No. 05-09-01002, Tex. App. LEXIS 4868 (Tex. App. June 28, 2011), the Court of Appeals of Texas, Fifth District (Dallas) unanimously vacated a substantial arbitration award based on nondisclosures regarding the arbitrator's social and personal relationships with the counsel for the prevailing party. The case involved a (non-reinsurance) partnership dispute that was arbitrated before a single neutral arbitrator pursuant to the JAMS arbitration procedures. After a lengthy arbitration, the arbitrator ruled in favor of the plaintiff, Cooke, and awarded $22 million in damages, including more than $6.0 million in attorneys' fees. Karlseng moved to vacate based on alleged nondisclosure of the arbitrator's relationship with the lead counsel for the plaintiff.

A remarkable aspect of the case is the extensive discovery that took place as part of the vacatur proceedings in the reviewing trial court, including document discovery of all emails and other communications that took place over a 15-year period concerning the arbitrator's communications with Cooke's counsel. That documentary discovery was supplemented by depositions and hearing testimony of the arbitrator, the lawyer, and their spouses regarding the intimate details of every social or business interaction over that time frame, including the text of thank you notes, dinner invitations, and so forth. Following that discovery, the trial court rejected Karlseng's challenge and confirmed the award. On appeal, however, the Court of Appeals unanimously reversed, ordering the vacatur of the award.

The opinion recites in laborious detail the history of the interactions between the arbitrator and lawyer from the time the lawyer was a law clerk in 1994 through their dealings after the arbitration award was issued. The gist of the record is that the lawyer and arbitrator, and their wives, pursued a regular — but not particularly close or active — social and professional relationship over an extended time frame. This involved periodic calls regarding business and legal issues, mutual invitations to speak at conferences and similar marketing events, expensive dinners at country clubs, gifts baskets provided at Christmas, and tickets to a Dallas Mavericks game. Although the opinion presents these facts devoid of characterization, the record portrays a mutually beneficial relationship in which the lawyer became well known to a successful local arbitrator, whereas the arbitrator potentially stood to benefit from arbitration appointments from a prominent local firm.

Clearly there is nothing inappropriate regarding such relationships within a local legal community, which are commonplace. The Court of Appeals, however, was understandably troubled by the complete nondisclosure of those relationships when the arbitrator was appointed. Applying precedent of the Texas Supreme Court, the relevant test espoused by the court was whether the arbitrator failed to “disclose facts that might, to an objective observer, create a reasonable impression of the arbitrator's partiality.” The Court concluded that the opposing party was entitled to know and to consider the relationship between the arbitrator and counsel at the time the arbitrator was appointed.

Several facts appear to have weighed heavily in the court's assessment. First, even though the arbitrator and lawyer knew each other well, when the lawyer first appeared in the case, the lawyer and arbitrator introduced themselves to each other as if they had never met. Second, although the two temporarily ceased their socializing during the pendency of the case, very shortly after the award was issued, the arbitrator invited the lawyer and his wife and another couple to a lavish dinner at a Dallas restaurant. Finally, although the arbitrator testified that he had forgotten about much of the history of his social interaction with the lawyer over the years, when the lawyer appeared in the case, the arbitrator admitted that he made no effort to undertake any due diligence to review or remind himself regarding the extent of that relationship. The Court emphasized that an arbitrator possesses a duty of inquiry and due diligence when it comes to disclosures.

Practical Lessons From the Opinion

Observers may differ regarding whether the nondisclosures at issue warranted the vacatur of the underlying award. The salient practical point from this opinion, however, is that companies engaged in arbitration can take steps to avoid such a debate altogether. Although no lawyer enjoys losing a hard-fought case on the merits, certainly an even worse experience for any corporate or outside counsel would be to expend the company's valuable time, resources, and energy in a lengthy arbitration, only to ultimately have a successful award vacated based on procedural concerns that were wholly preventable.

Many clients and counsel view the issue of arbitrator disclosures as a matter purely for the arbitrators. The Karlseng decision provides a cautionary tale against such an approach. Companies would do well to appreciate that many arbitrators are effectively solo practitioners who have entered that vocation on a part-time basis in the latter stages of their careers. They often understandably lack organized or detailed records of their prior business engagements. It also should not be assumed that arbitrators can remember their myriad professional and social engagements over the years — even more recent ones.

For that reason, instead of simply relying on the arbitrator's records and recall, when addressing the issue of arbitrator disclosures, parties can protect themselves by taking an active role in the process. A relevant step that could be added to companies' pre-dispute checklists would be to have the client and law firm involved review their records (or at least circulate an email among the relevant group) to uncover all prior, arguably material, professional or social dealings with the arbitrator. The findings can then be put on the record. Equally, rather than assuming that an arbitrator will actively review his or her records before completing a disclosure form, clients could specifically request that this be done and obtain confirmation when the process is complete. Had the lawyer in the Karlseng case prompted such simple preventative measures at the outset of the case, he would not have put his client at risk of having a successful award challenged at the close of an already expensive arbitration.

These steps may be more than what is actually required by the current state of the law under the FAA. The point is, however, that litigants should assume that their opponents will use any grounds available — however meritless — to challenge an adverse arbitration ruling. Accordingly, companies would be well served by implementing small preventative steps that could help avoid months or years of expensive and disruptive post-arbitration court proceedings. If successful in that endeavor, not only will companies save themselves resources and aggravation, but they will capture more of the benefits that arbitration offers as a dispute resolution mechanism.