Under the Camel’s Nose: Will “Manifest Disregard of the Law” Survive Hall Street?

By Scott Leonard

On March 25, 2008, the U.S. Supreme Court held that parties may not privately contract for expanded court review of arbitration awards beyond the limited grounds provided in Sections 10 and 11 of the Federal Arbitration Act (“FAA”). See, Hall Street Associates, L.L.C. v. Mattel, Inc. 128 S.Ct. 1396 (2008).

The Court’s decision resolves a split among the federal circuit courts of appeal on the issue of whether a party may contract to expand the grounds for review of an arbitral award.

The decision, however, may indirectly threaten the doctrine of “manifest disregard of the law” as a viable common law challenge to arbitral awards. It remains to be seen whether this popular method of attacking arbitral awards survives the decision.

Although the decision does not resolve this question directly, it will have a broad impact on the practice.

Background

This case involved a landlord-tenant lease dispute. Hall Street, the landlord, initially sued Mattel seeking, among other things, indemnity for the costs of environmental clean up and damages to the property while (and before) Mattel occupied the premises.

The lease included an indemnity provision requiring the tenant to follow all applicable environmental regulations and cover the costs “resulting from the failure of the tenant or its predecessor lessees to follow environmental laws while using the premises.” State law apparently required testing of the water and the tests showed high amounts of manufacturing waste in the property’s well water.

Mattel signed a consent order with the Oregon Department of Environmental Quality providing for cleanup of the site and gave notice of intent to terminate the lease. Hall Street then sued Mattel for indemnity and to prevent termination of the lease.

The Arbitration

In a very unusual arbitration procedure, the parties first litigated the lease termination matter and later, with district court approval and supervision, submitted the indemnity issues to arbitration.

During the litigation, the parties executed an agreement which purported to instruct the district court to “vacate, modify or correct any award: (i) where the arbitrator’s findings of facts are not supported by substantial evidence, or (ii) where the arbitrator’s conclusions of law are erroneous.”

Mattel won the arbitration. The arbitrator found that no indemnification was due because the lease obligation to follow all applicable environmental laws did not require compliance with the testing requirements of an Oregon state water quality law. The arbitrator found the water quality law dealt with human health and not environmental contamination.

Hall Street moved to vacate the award on legal error, notably not “manifest disregard” of the law. The district court agreed with Hall Street, finding legal error in the arbitrator’s failing to treat the Oregon water quality act as an applicable environmental law under the terms of the lease. The case was remanded for further arbitration and, predictably, Hall Street prevailed.

On appeal, the 9th Circuit reversed, holding the FAA does not authorize the kind of expansive judicial review the parties agreed to. The court noted “[…] the terms of the arbitration agreement controlling the mode of judicial review are unenforceable and severable.”

The federal circuits split on the issue. Like the Ninth, the Tenth Circuit held that parties may not contract for expanded judicial review beyond the narrow grounds provided in the FAA.

In contrast, the First, Third, Fourth, Fifth and Sixth Circuits decided the opposite. These courts reasoned that the central purpose of the FAA is to ensure that private agreements to arbitrate are enforced according to their terms. Under this rationale, the terms of the FAA are “mere threshold provision[ s] open to expansion by agreement.”

Discussion

The critical issue is determining the applicable standards of review to vacate an award.

An arbitration award may be vacated under the FAA when the award was “procured by corruption, fraud, or undue means; (2) where there was “evident partiality” or corruption in the arbitrators; (3) or the arbitrators were guilty of misconduct for refusing to postpone the hearing upon sufficient cause shown; or refusing to hear evidence pertinent and material to the controversy; or of any other misbehavior by which the rights of any party have been prejudiced; (4) where 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.”

In this case, Hall Street argued that the above FAA provisions are not exclusive for two reasons.

First, Hall Street argued the Supreme Court’s decision in Wilko v. Swan, 346 U.S. 427 (1953) recognized “manifest disregard of the law” as an independent basis for vacating an award distinct from statutory grounds. The “camel’s nose,” the Court noted, was Hall Street’s argument that if judges can expand the statute, so may contracting parties.

The Court rejected this argument, finding it “too much for Wilko to bear.” Although the FAA permits parties to tailor important aspects of arbitration by contract (selecting arbitrators and determining their qualifications, which issues are arbitrable and choice of law) the Court noted that it had taken the Wilko language “without embellishment.”

The Court, without overruling its prior decision, denied that Wilko created “manifest disregard of the law” as a supplemental basis for overturning an arbitrator’s decision. Second, Hall Street also raised contract arguments favoring the policy of party-autonomy in arbitration. In particular, Hall Street argued that the agreement to review for legal error ought to prevail because “arbitration is a creature of contract” and the “FAA is motivated, first and foremost, by a congressional desire to enforce agreements into which parties have entered.”

The Court rejected this argument too, relying on the “old rule” of ejusdem generis. This rule applies “when a statute sets out a series of specific items ending with a general term, that general term is confined to covering subjects comparable to the specifics it follows.”

In this case, the Court applied the principle and held the parties may not expand judicial review to “any legal error” as the FAA only includes grounds for specific outrageous conduct. As the Court noted, “fraud and mistake of law are not cut from the same cloth.”

In the final act, the Supreme Court remanded the matter for further proceedings to determine if the agreement to arbitrate may be viewed as an exercise of the District Court’s case management authority under FRCP 16.

Conclusion

The Court’s ruling forces the Wilko Camel’s nose into the open. The common law basis for vacating arbitral awards where there is a “manifest disregard of the law” is now under a cloud. At best, the doctrine is threatened, and, at worst, may no longer be viable.

In either case, this important decision has broad and immediate implications on the practice.

Unfortunately, the Court has not made negotiating the fallout easy. Rather dryly, the Court simply noted the uncertainty to be expected following its decision. It discussed concerns raised by Hall Street and its amici that “parties will flee from arbitration if expanded review is not open to them,” while Mattel’s amici “foresees flight from the courts” if expanded review is allowed.

The Court concluded: “[w]e do not know who, if anyone is right, and so cannot say whether the exclusivity reading of the statute is more of a threat to the popularity of arbitrators or to the courts. But whatever the consequences of our holding, the statutory text gives us no business to expand the statutory grounds.”

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