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Arbitrator Disclosure Requirements and Enforceability of Awards

10/22/2010

This article reprint appears courtesy of the New York Law Journal.

Related Attorneys: Steven C. Schwartz and David Wax

One of the bedrock assumptions underlying arbitration law is that parties who choose arbitration implicitly agree to forgo some of the procedural niceties of litigation. In effect, they trade some of the protections of the formal judicial process for the speed, cost savings and decision by industry experts potentially available in arbitration. This trade-off is made enforceable by the Federal Arbitration Act (FAA), which (among other things) sharply restricts the circumstances under which courts may vacate arbitration awards.

Ironically, however, courts sometimes seek to hold arbitrators to standards stricter than those applicable to judges. A recent example is the February decision by Judge Shira Scheindlin in Scandinavian Reinsurance Co. Ltd. v. St. Paul Fire & Marine Insurance Co.¹ In Scandinavian Re, Judge Scheindlin vacated an arbitration award on the basis of the "evident partiality" of two arbitrators who neglected to make disclosures concerning their service in a different arbitration. Notably, the matters that Judge Scheindlin held should have been disclosed did not relate to relationships between the arbitrators and the parties. As a result, those matters were not obvious indicators of bias.

The Scandinavian Re decision has proved controversial in arbitration circles. One New York Law Journal commentator has argued for an expansive reading of the decision, suggesting that "[b]y interpreting 'evident partiality' to go beyond a specific relationship to a party to reach knowledge concerning a witness and issues in a parallel, undisclosed proceeding, Scandinavian Re may prove to be an important step in holding arbitrators to a higher standard of impartiality."²

This article will take the opposite view, arguing that Scandinavian Re stretches the "evident partiality" standard far beyond its intended limits. As discussed below, if Scandinavian Re is upheld by the U.S. Court of Appeals for the Second Circuit, several critical advantages of arbitration may be lost.

'Evident Partiality'

The critical issue in Scandinavian Re was the extent to which an arbitrator's failure to make disclosures to the parties can support vacating an eventual arbitration award. The issue implicates §10(a)(2) of the FAA,³which allows a court to vacate an award "where there was evident partiality or corruption in the arbitrators…."

In developing tests of "evident partiality," courts have been mindful of the nature of arbitration. As the Second Circuit has observed, "parties agree to arbitrate precisely because they prefer a tribunal with expertise regarding the particular subject matter of their dispute."⁴ This desire for expertise is significant because "[f]amiliarity with a discipline often comes at the expense of complete impartiality."⁵

Accordingly, the Second Circuit's test of "evident partiality" is less rigorous than the "appearance of bias" standard that would apply to judges, but more rigorous than a "proof of actual bias" standard.⁶ Instead, the Second Circuit holds that "'evident partiality'…will be found where a reasonable person would have to conclude that an arbitrator was partial to one party to the arbitration."⁷

The connection between "evident partiality" and arbitrator disclosure requirements goes at least as far back as the Supreme Court's 1968 decision in Commonwealth Coatings Corp. v. Continental Cas. Co.⁸ In Commonwealth Coatings, the Court vacated an arbitration award where the neutral arbitrator had failed to disclose a business relationship with one of the parties to the arbitration. In a concurrence that has been given greater weight than the plurality opinion, Justice Byron White explained that:

it is enough for present purposes to hold, as the Court does, that where the arbitrator has a substantial interest in a firm which has done more than trivial business with a party, that fact must be disclosed. If arbitrators err on the side of disclosure, as they should, it will not be difficult for courts to identify those undisclosed relationships which are too insubstantial to warrant vacating an award.⁹

The Second Circuit has followed Justice White's approach. For example, in a 2007 case, it held that "[a]n arbitrator who knows of a material relationship with a party and fails to disclose it meets Morelite's 'evident partiality' standard: A reasonable person would have to conclude that an arbitrator who failed to disclose under such circumstances was partial to one side."¹⁰ Further, citing Justice White, the Second Circuit also held that:

where an arbitrator has reason to believe that a nontrivial conflict of interest might exist, he must (1) investigate the conflict (which may reveal information that must be disclosed under Commonwealth Coatings) or (2) disclose his reasons for believing there might be a conflict and his intention not to investigate.¹¹

In short, cases in the Second Circuit require arbitrators to disclose material relationships with the parties to an arbitration, and in some circumstances to investigate whether such conflicts exist.

'Scandinavian Re' Decision

In Scandinavian Re, the issue was whether the award rendered in one arbitration should be vacated because two of the three arbitrators had failed to disclose their service in a second arbitration. Although neither of the parties in the first arbitration was involved in the second, the losing party argued that this non-disclosure justified vacatur because: (1) the winning party in the first arbitration was tangentially related to a party in the second; (2) there was a witness who testified in one arbitration and whose videotaped deposition was shown in the second; and (3) the arbitrations concerned similar disputes under similar reinsurance contracts.

Although the facts are complex, some explanation may be helpful. The first arbitration was between St. Paul Fire & Marine Insurance Co. and two of its affiliates (collectively, St. Paul)¹² and Scandinavian Reinsurance Company Limited (Scandinavian Re). The dispute related to a reinsurance agreement under which Scandinavian Re had reinsured St. Paul, and centered on Scandinavian Re's bid to rescind that contract. The second arbitration was between Platinum Underwriters Bermuda, Ltd. (Platinum) and PMA Capital Insurance Company (PMA). That dispute related to another reinsurance contract, under which Platinum had reinsured PMA. The second arbitration focused on the interpretation of specific provisions of the contract.

The parties disagreed as to the extent to which the two arbitrations were related. Perhaps the critical connection between the two, however, was that Platinum's parent company had purchased renewal rights and related assets from St. Paul when that company stopped writing reinsurance business in 2002. In other words, Platinum had been formed to continue certain reinsurance business that had originated with St. Paul.¹³

The Scandinavian Re arbitration began before the Platinum arbitration. Indeed, at the time of the organizational meeting—at which arbitrators typically make disclosures—the second arbitration had not yet been commenced. Nevertheless, the Platinum arbitration proceeded at a faster pace than the Scandinavian Re arbitration, and the hearing in the Platinum arbitration took place first. Accordingly, by the time of the hearing in the Scandinavian Re arbitration, the two arbitrators clearly could have disclosed their involvement in the Platinum arbitration. For reasons that remain unclear, they did not.

This non-disclosure came to light after the arbitration panel in the Scandinavian Re arbitration had rendered an award in favor of St. Paul. Scandinavian Re learned of the Platinum arbitration when a federal court in Pennsylvania vacated the award.¹⁴ Claiming that the arbitrators' failure to disclose their involvement in the second arbitration justified a finding of "evident partiality" under §10 of the FAA, Scandinavian Re moved to vacate the award against it.

Scandinavian Re's motion tested the boundaries of "evident partiality." Prior cases had held that an arbitrator's failure to disclose material relationships with a party to the arbitration could justify vacating the award. Here, however, the non-disclosure related not to a relationship between the arbitrators and a party, but rather to their service in an arbitration involving different parties.

Judge Scheindlin held that this distinction was insignificant. She explained that:

A reasonable person concludes that an arbitrator is partial to one side because the undisclosed relationship is material, not because the material relationship is with a party. In other words, the significance of the relationship is the decisive factor, not which people the relationship involves.¹⁵

Further, Judge Scheindlin found that the arbitrators' service in the Platinum arbitration was material because its similarities to the Scandinavian Re arbitration might allow the arbitrators to make use of "ex parte information" they learned in the Platinum arbitration. As Judge Scheindlin put it:

By participating in both the Scandinavian Re Arbitration and the Platinum Bda Arbitration, Dassenko and Gentile placed themselves in a position where they could receive ex parte information about the kind of reinsurance business at issue in the Scandinavian Re Arbitration, be influenced by recent credibility determinations they made as a result of Hedges's testimony in the Platinum Bda Arbitration, and influence each other's thinking on issues relevant to the Scandinavian Re Arbitration.¹⁶

Was the Decision Justified?

There seems little question that the Scandinavian Re decision, if upheld, would expand the scope of "evident partiality" under §10 of the FAA. Indeed, the Law Journal commentary cited above lauds the decision as "an important step in holding arbitrators to a higher standard of impartiality."¹⁷ However, for several reasons, imposing such a "higher standard" is arguably inconsistent with both the FAA and with the fundamental goals of arbitration. Three of these reasons are discussed below.

The Decision Is Inconsistent With the FAA. First, Judge Scheindlin's expansion of the "evident partiality" standard for vacating arbitration awards is arguably inconsistent with the FAA. The obvious purpose of the "evident partiality" standard is to allow courts to vacate an award where an arbitrator may be biased for or against one side or the other. Yet the risk that arbitrators might be influenced by "ex parte information" cannot be equated with the kind of bias the statute addresses.

The difference can be illustrated with two Second Circuit cases. In Applied Industrial Materials Corp. v. Ovalar Makine Ticaret Ve Sanayi, A.S.,¹⁸ an arbitration award was vacated because the neutral arbitrator failed to disclose a business relationship between his company and one of the parties. The court explained that, "[a] reasonable person would have to conclude that an arbitrator who failed to disclose under such circumstances was partial to one side."¹⁹

Why would a reasonable person have to conclude that the non-disclosing arbitrator was partial? The obvious answer is that an arbitrator who fails to disclose his relationship with a party may be seeking to hide the relationship. And one reason why an arbitrator might seek to hide his relationship with a party is to conceal his bias in favor of that party. In other words, the non-disclosure may itself be an indication of bias.

This logic becomes even clearer in light of the Second Circuit's decision in Lucent Technologies Inc. v. Tatung Co.²⁰ There, a disclosure form submitted by an arbitrator to the AAA revealed his relationship with one of the parties, but the AAA failed to provide the disclosure form to the other party. The Second Circuit held that the disclosure to the AAA was enough to preclude any finding of bias, even though the other party had not had the ability to object. The court explained that:

The concern, noted in Commonwealth Coatings, that nondisclosure might create an appearance of bias or even be evidence of bias is simply not present in this case. There is no basis to argue that Leuning and Lucent intended to hide their relationship from Tatung.²¹

This rationale, however, does not apply where the non-disclosure relates to a matter other than the arbitrator's relationship with a party. Take the example of the Scandinavian Re arbitration, in which two arbitrators failed to disclose their service in the second arbitration. Judge Scheindlin may have been correct that the arbitrators' service in two arbitrations created a risk that they would be influenced by ex parte information. But it does not follow that they were biased in favor of one side or the other. Indeed, without more, it seems impossible to infer from the mere non-disclosure which side might have benefited from any ex parte information.

In short, Judge Scheindlin vacated the arbitration without clear evidence of "evident partiality."

The Decision Would Hold Arbitrators to Higher Standards Than Judges. A second problem with the Scandinavian Re decision is that it would hold arbitrators to standards that are more demanding than those applicable to judges.

In fact, judges are not disqualified even where they have the kind of ex parte information at issue in Scandinavian Re. Under the federal recusal statute, a judge must disqualify himself where "he has…personal knowledge of disputed evidentiary facts concerning the proceeding."²² But "personal knowledge" does not include knowledge gained in another proceeding. As the Supreme Court has observed, "[i]t has long been regarded as normal and proper for a judge to sit in the same case upon its remand, and to sit in successive trials involving the same defendant."²³

Moreover, the standards applicable to arbitrators are less rigorous than those applicable to judges.²⁴ Thus, if a judge would not be disqualified based on ex parte information gained in another judicial proceeding, an arbitrator should not automatically be deemed biased because of information gained in another arbitration.

The Decision Would Undermine the Goals of Arbitration. Finally, the Scandinavian Re decision threatens to undermine some of the chief goals of arbitration.

For example, Judge Scheindlin's suspicion of ex parte information is inconsistent with the parties' agreement to submit their disputes to arbitrators with reinsurance expertise. Indeed, expert arbitrators are expected to draw on their ex parte understanding of their fields. This implies a different set of expectations than would apply to a judge. As Judge Richard Posner explained nearly 30 years ago:

There is a tradeoff between impartiality and expertise. The expert adjudicator is more likely than a judge or juror not only to be precommitted to a particular substantive position but to know or have heard of the parties (or if the parties are organizations, their key people).²⁵

The Scandinavian Re decision may also undermine the certainty and speed of arbitrations. By expanding the types of non-disclosures that may justify vacating awards, the decision makes it far more likely that a losing party will succeed in challenging an award. The inevitable result will be awards that are less likely to be final, and disputes that take far more time and money to resolve.

In short, the Scandinavian Re decision is flawed. While holding arbitrators to higher standards sounds like a noble goal, the result would be unlikely to improve the arbitration process.

Steven C. Schwartz is a partner in the New York office of Locke Lord Bissell & Liddell and is the author of Reinsurance Law: An Analytic Approach, published by Law Journal Press. David Wax, an associate at the firm, provided research for this article.

Endnotes:

1. 2010 WL 653481 (S.D.N.Y. 2010).
2. Kim J. Landsman, "Holding Arbitrators to Higher Standards of Impartiality," New York Law Journal, May 21, 2010.
3. 9 U.S.C. §10(a)(2).
4. Morelite Construction Corp. v. New York City District Council Carpenters Benefit Funds, 748 F.2d 79, 83 (2d Cir. 1984).
5. Id.
6. Id. at 83-84.
7. Id. at 84.
8. 393 U.S. 145 (1968).
9. 393 U.S. at 151-52.
10. Applied Industrial Materials Corp. v. Ovalar Makine Ticaret Ve Sanayi, A.S., 492 F.3d 132, 137 (2d Cir. 2007).
11. Id., 492 F.3d at 138.
12. There were actually three St. Paul entities involved, but the court discussed them collectively.
13. Scandinavian Re, 2010 WL at 4-5.
14. See PMA Capital Ins. Co. v. Platinum Underwriters Bermuda, Ltd., 659 F. Supp. 2d 631 (E.D. Pa. 2009).
15. Scandinavian Re, 2010 WL at 8.
16. Id.
17. Kim J. Landsman, "Holding Arbitrators to Higher Standards of Impartiality," New York Law Journal, May 21, 2010
18. 492 F.3d 132, 137 (2d Cir. 2007).
19. Id.
20. 379 F.3d 24 (2d Cir. 2004).
21. 379 F.3d at 29.
22. 28 U.S.C. §454 (b)(1).
23. Liteky v. United States, 510 U.S. 540, 551 (1994).
24. Morelite, 748 F.2d at 83.
25. Merit Ins. Co. v. Leatherby Ins. Co., 714 F.2d 673 (7th Cir. 1983).