by Chris Cheatham, Associate

Binding arbitration is often touted as an economical alternative dispute resolution process for the construction industry.  It is debatable whether arbitration is less costly than litigation, and if you are not careful with the terms of your arbitration clause, you can unintentionally make the process less than binding; resulting in more costs and expanded appellate review of the arbitration ruling.

One of the “selling” points of arbitration has been the finality associated with an arbitration ruling.  The finality is the result of the very limited grounds of review for a court to overturn or reverse the arbitration ruling.  Those grounds or standards for a reviewing court can apply to an arbitration ruling are called vacatur standards.  Congress and many states have enacted statutes which specifically identify and limit the vacatur standards for a court to overturn or reverse an arbitration ruling.  There is no doubt that these statutes, for better or for worse, provide for a more restricted judicial review of the “correctness” of an arbitration ruling, in contrast to an appellate court’s review of a trial court’s ruling.

Perhaps knowingly, or in some instances unknowingly, parties include terms in their contract’s arbitration clause which, if enforced, would expand an appellate court’s grounds for reviewing an arbitration ruling beyond the statutory vacatur standards.  For example, does your arbitration clause allow for the review of arbitration rulings for “errors of law or fact”? If it does, your contract’s arbitration clause, if enforced, would allow a more expansive review of an arbitration ruling than if the ruling were reviewed under most statutory vacatur standards.  With the expansion of a court’s review standards, the finality of an arbitration ruling is lessened.

The question for this article is how do the courts look at arbitration clauses expanding their scope of review and authority beyond the statutory vacatur standards to “correct” an arbitration ruling? The answer is that it depends on which court reviews your arbitration clause and ruling.

The Federal Arbitration Act Review Standards

The Federal Arbitration Act (“FAA”) applies to any arbitration agreement involving interstate commerce or maritime transactions.  Generally, this means that for those construction projects involving interstate purchase or shipment of goods, materials or equipment or other interstate activities, where an arbitration clause has been included in the project contracts, the FAA will likely apply to the arbitration process.  The FAA provides that arbitration decisions “shall be valid, irrevocable, and enforceable” unless, on appeal, a court finds one of the following grounds exist for vacating the decision:

1.    The arbitration award was procured by corruption, fraud, or undue means;

2.    There was evident partiality or corruption by the arbitrators;

3.    The arbitrators were guilty of misconduct in refusing to postpone the hearing, or in refusing to hear evidence pertinent and material to the controversy; or the arbitrators were guilty of any other misbehavior by which the rights of any party have been prejudiced; or

4.    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.

9 U.S.C. § 10 (2000).  The effect of these FAA vacatur standards is a very limited judicial review of arbitration decisions.  Recognizing the limited basis for appeal, it is not uncommon that parties to a contract with an arbitration clause incorporate broader standards of judicial review for arbitration decisions.  In other instances, a party may not recognize it is signing onto expanded grounds for appellate review of arbitration decisions.  Presently, the issue whether contractual vacatur standards beyond the standards of the FAA are enforceable will depend on the jurisdiction in which the appeal of the arbitration decision is undertaken.  The U.S. Supreme Court has yet to rule on the issue.

The Federal Ninth Circuit: FAA Standards Apply

The federal Ninth Circuit (federal courts in Alaska, California, Idaho, Arizona, Guam, Montana, Hawaii, Nevada, Oregon and Washington) has refused to enforce arbitration agreements allowing for review of arbitration rulings beyond the FAA vacatur standards.  In Kyocera Corp. v. Prudential-Bache Trade Services, 341 F.3d 987, 1000 (9th Cir. 2003), three parties – Kyocera Corporation (“Kyocera”), Prudential-Bache Trade Corporation (“Prudential”) and LaPine Technology Corporation (“LaPine”) – had a contract that by the contract’s arbitration clause, expanded judicial review of arbitration decisions beyond the FAA standard.  By their contract, an arbitration decision could be vacated on appeal if the findings of fact were not supported by evidence or for erroneous conclusions of law.  After a contract dispute arose, the three parties arbitrated and LaPine and Prudential were awarded $243 million in damages from Kyocera.  On appeal, a federal district court applied the FAA statutory standards of review, not the broader contract standard, to the arbitration ruling and denied Kyocera’s motion to vacate the damages award.  Kyocera then appealed to the U.S. Court of Appeals for the Ninth Circuit, arguing that the district court erred in not applying the broader contractual standards of review.

The Ninth Circuit appellate court held that the district court properly applied the FAA standards of review.  The court explained that through the FAA, Congress enumerated limited grounds on which a federal court may vacate, modify or correct an arbitration decision.  This enumeration was part of Congress’ power to determine the standards by which federal courts render decisions.  In the mind of the court, since Congress had specified the exclusive standards for federal courts reviewing an arbitration ruling, private parties could not contractually impose their own standards on the courts.

The Federal Fourth Circuit: Parties May Contract for Vacatur Standards

In contrast to the Ninth Circuit, the federal Fourth Circuit (federal courts in Maryland, Virginia, West Virginia, North Carolina and South Carolina) has permitted parties to contract for their own arbitration review standards.  For example, in Syncor Int’l Co. v. McLeland, a dispute arose regarding a noncompete agreement between a pharmaceutical company, Syncor International Corporation (“Syncor”) and its former employee, David McLeland (“McLeland”).  No. 96-2261, 1997 WL 452245 (4th Cir. August 11, 1997).  The parties’ contract included an arbitration agreement expanding the FAA vacatur standards, by allowing for review of “errors of law or reasoning.” In an arbitration between the two, the arbitrator ruled that the employee, McLeland, had violated the non-compete agreement.  On appeal, the federal district court refused to apply the arbitration agreement’s broader vacatur standards and, instead, upheld the arbitrator’s decision based on the FAA standards of review.

In an unpublished ruling, the Fourth Circuit appellate court did not agree and held that the lower district court should have reviewed the arbitration decision based on the contractually specified vacatur standards.  In so ruling, the Fourth Circuit Court relied on a Fifth Circuit Court’s interpretation of the FAA: “Because these parties contractually agreed to expand judicial review, their contractual provision supplements the FAA’s default standard of review and allows for de novo review of issues of law embodied in the arbitration award. . . . The FAA does not prohibit parties who voluntarily agree to arbitration from providing contractually for more expansive judicial review of the award.” Id. (quoting Gateway Techs., Inc. v. MCI Telecomm. Corp., 64 F.3d 993, 997 (5th Cir. 1995)).

Virginia State Courts: VUAA Standards Apply

Many states, including Virginia, have enacted Uniform Arbitration Acts, similar to the FAA, to govern the arbitration of disputes not involving interstate commerce.  In Virginia, the Act is called the Virginia Uniform Arbitration Act (“VUAA”).  The VUAA establishes five grounds for vacating an arbitration ruling, the four statutory FAA standards and one additional standard: that being where there was no arbitration agreement, the issue was not adversely determined, and the party did not participate in the arbitration hearing without raising the objection.  Va. Code Ann. § 8.01- 581.010.

The Virginia Supreme Court has held that Virginia state courts must strictly and only apply the VUAA’s five grounds for vacatur when reviewing arbitration decisions.  Signal Corp. v. Keane Fed. Sys., Inc., 574 S.E.2d 253, 256 (Va. 2003).  In Signal Corp., Signal Corporation (“Signal”), a contractor responsible for a highway project, terminated Keane Federal Systems, Inc. (“Keane”), a subcontractor for the project.  Keane claimed that Signal wrongfully terminated its subcontract and instituted arbitration proceedings against the contractor.  An arbitration panel awarded damages to Keane.  The state circuit court denied Signal’s motion to vacate the award.

On appeal to the Virginia Supreme Court, Signal argued that the arbitrators exhibited a “manifest disregard of the law” because the arbitrators found that Signal engaged in statutory conspiracy without finding that Signal engaged in concerted action, a prerequisite of conspiracy.  The Virginia Supreme Court refused to vacate the award “because to do so would require that this Court add words to Code § 8.01-581.010, which enumerates the bases on which a court shall vacate an arbitration award.” Since the VUAA did not explicitly allow courts to vacate judicial awards for a “manifest disregard of the law,” the Virginia Supreme Court rejected Signal’s contention and affirmed the judgment of the circuit court upholding the arbitration ruling.

California State Courts: Supreme Court to Decide Soon

California has also adopted the Uniform Arbitration Act to govern the arbitration process in the form and under the terms of the California Arbitration Act (“CAA”).  The CAA’s vacatur standards are essentially identical to the VUAA’s vacatur standards, but the CAA includes one additional standard of review: where an arbitrator making the award either: (a) failed to disclose within the time required for disclosure a ground for disqualification of which the arbitrator was then aware; or (b) was subject to disqualification upon grounds specified elsewhere in the code but failed upon receipt of timely demand to disqualify himself or herself as required by that provision.  Cal. Civ. Proc. § 1286.2(a).

The California Supreme Court is currently reviewing the California Court of Appeals’ decision in Cable Connection, Inc. v. DIRECTV, Inc. to determine whether parties can contractually deviate from the CAA’s judicial review standards.  49 Cal. Rptr. 3d 187 (Cal. Ct. App. Sept. 22, 2006).  In DIRECTV, Inc., DIRECTV dealers (“Dealers”) formed a class action against DIRECTV, alleging the company reduced commissions and assessed chargebacks which violated the Dealers’ contracts.  The Dealers and DIRECTV had provided in the arbitration agreement of their contracts that: (1) California substantive law would apply; and (2) arbitration awards could be vacated for “errors of law or reasoning.” Based on their contracts, the Dealers filed a demand for class arbitration.  Since the arbitration terms of the contracts were silent as to whether class arbitration was permitted, the arbitrators initially determined that California substantive law permitted class arbitration.  DIRECTV sought to vacate the arbitration decision, claiming that the arbitrators: (1) exceeded their authority; (2) refused to admit material evidence; and (3) made errors of law, as was disallowed in the arbitration agreement.  The trial court vacated the award because the arbitrators exceeded their powers “by rewriting the parties’ agreements to allow for class wide arbitration” and for failing to admit evidence.  The Dealers subsequently appealed the trial court’s decision.

The California Court of Appeals rejected the contractual arbitration review standards, relying on the Ninth Circuit’s rationale as to FAA vacatur standards: “Just as the FAA does not compel federal courts to enforce attempts to contractually expand their limited power to review arbitral decisions, it also does not compel California courts to enforce attempts to contractually expand their power to review arbitral decisions conferred by the California Arbitration Act.” The court concluded that the trial court was not authorized to review the validity of the arbitrators’ reasoning for errors of fact or law.  Currently, the Supreme Court of California has granted cert to an appeal of the DIRECTV, Inc. case to determine whether parties can contractually alter the scope of judicial review in their arbitration agreements.  An update of this important pending case will be provided in a future issue.

Conclusion

How a court will interpret the vacatur standards incorporated in the arbitration clause of your contract depends on the jurisdiction that will hear the appeal of an adverse arbitration decision.  If you wish to avoid protracted litigation over appeals of an arbitration ruling, you should carefully review the proposed arbitration clause to assure that review of any arbitration ruling will be limited to the FAA or state vacatur standards.  If you want broader standards of review of arbitration rulings, then put those standards in your arbitration clause, recognizing that enforcement of the broader standards will still be dependent on the court hearing the appeal.


The information or opinion provided in this article is the author's own and not necessarily that of Watt, Tieder, Hoffar & Fitzgerald, LLP. The author is solely responsible for the information and opinion that he or she has provided. The information contained herein does not replace seeking specific legal counsel to directly address individual client needs.

Watt, Tieder, Hoffar & Fitzgerald is one of the largest construction law firms in the world, with a practice that encompasses all aspects of construction contracting, claims and disputes resolution, and transactional legal services. WTHF principally represents large general contractors, design firms, and sureties throughout the country and internationally.