First Department Rejects Errors in Contract Interpretation as a Basis for Vacating An Arbitration Award

• Posted on: Nov 4 2019

Previously, this Blog has written about the difficulties a party encounters when trying to vacate an arbitral award. (E.g., here , here and here.) Indeed, courts are very reluctant to disturb the decision of an arbitrator. The cases show that the courts limit vacatur of an arbitral award to a very narrow set of statutory and judicially created reasons. As shown in Matter of Nexia Health Tech., Inc. v. Miratech, Inc., 2019 N.Y. Slip Op. 07701 (1st Dept. Oct. 24, 2019) (here), interpretative errors of law and fact are insufficient to overturn an arbitral award.

Arbitration and the Policy That Favors It

Arbitration is an alternative form of dispute resolution where the parties voluntarily agree that a neutral, private person will resolve any legal disputes between them, instead of a judge or jury in a court of law. In recent years, arbitration has increased in popularity and is part of most business and commercial contracts and employment agreements.

This increase in popularity reflects the federal and state policy that arbitration is a favored means of resolving disputes. See, e.g., Moses H. Cone Mem’l Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 24 (1983) (stating that the FAA evinces a “liberal federal policy favoring arbitration”); Epic Sys. Corp. v. Lewis, 138 S. Ct. 1612, 1621 (2018); Harris v. Shearson Hayden Stone, Inc., 82 A.D. 2d 87, 91-93 (1st Dept.), aff’d, 56 N.Y.2d 627 (1981) (“[T]his State favors and encourages arbitration as a means of conserving the time and resources of the courts and the contracting parties. . . .”).

In 1925, Congress enacted the United States Arbitration Act, now known as the Federal Arbitration Act (“FAA”), for the express purpose of making “valid and enforceable written provisions or agreements for arbitration of disputes arising out of contracts, maritime transactions, or commerce among the States or Territories or with foreign nations.” Its primary purpose is to ensure that “private agreements to arbitrate are enforced according to their terms.” Volt Info. Scis., Inc. v. Board of Trustees of Leland Stanford Junior Univ., 489 U.S. 468, 479 (1989).

Whether enforcing an agreement to arbitrate or construing an arbitration clause, courts and arbitrators must “give effect to the contractual rights and expectations of the parties.” Volt, 489 U.S. at 479. “[A]s with any other contract, the parties’ intentions control.” Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, Inc., 473 U.S. 614, 626 (1985). This is because an arbitrator derives his/her powers from the parties’ agreement to forgo the legal process and submit their disputes to private dispute resolution. See AT&T Techs., Inc. v. Communications Workers, 475 U.S. 643, 648-649 (1986).

Underscoring the consensual nature of private dispute resolution, parties are “generally free to structure their arbitration agreements as they see fit.” AT&T Techs., 475 U.S. at 648-649. And, they may specify with whom they choose to arbitrate their disputes. E.g., Moses H. Cone, 460 U.S. at 20. It therefore falls to courts and arbitrators to give effect to contractual limitations, and when doing so, courts and arbitrators must not lose sight of the purpose of the exercise: to give effect to the intent of the parties. Volt, 489 U.S. at 479.

Judicial Review of Arbitral Awards

The Court’s role in reviewing an arbitration award is limited. An arbitration award will be confirmed even when the award does not conform to a court’s sense of justice so long as the arbitrator “offer[s] even a barely colorable justification for the outcome reached.” Wien & Malkin LLP v. Helmsley-Spear, Inc., 6 N.Y.3d 471, 479-80 (2006) (internal quotations omitted); Matter of Daesang Corp. v. NutraSweet, 167 A.D.3d 1, 15 (1st Dept. 2018), lv. denied, 32 N.Y.3d 915 (2019). Thus, an arbitral award will not be subject to vacatur for ordinary errors, even if an arbitrator’s legal and procedural rulings might reasonably be criticized on the merits. Id. As the United States Supreme Court observed: “The potential for . . . mistakes [by the arbitrator] is the price for agreeing to arbitration.” Oxford Health Plans LLC v. Sutter, 569 U.S. 564, 572-573 (2013). See also Wilkins v. Allen, 169 N.Y. 494, 497 (1902) (noting that “however disappointing [an award] may be,” parties that have bargained for arbitration “must abide by it”).

Under Section 10(a) of the FAA, a court will vacate an arbitral award for the following reasons: (1) the award was procured by corruption, fraud, or undue means; (2) there was evident partiality or corruption in 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 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(a)(1)-(4). [Ed. Note: This Blog discussed the grounds for vacatur under New York law here.]

Apart from Section 10(a) of the FAA, courts have vacated arbitral awards when an arbitrator manifestly disregards the law. Duferco Intl. Steel Trading v. T. Klaveness Shipping A/S, 333 F.3d 383, 388 (2d Cir. 2003); Goldman v. Architectural Iron Co., 306 F.3d 1214, 1216 (2d Cir. 2002) (citing DiRussa v. Dean Witter Reynolds Inc., 121 F.3d 818, 821 (2d Cir 1997)). See also Matter of Daesang, 167 A.D.3d at 15-16 (citing Wein, 6 N.Y.3d at 480-81). Importantly, the doctrine does not apply to the facts. Wein, 6 N.Y.3d at 483.

Application of the doctrine is limited. Matter of Arbitration No. AAA13-161-0511-85 Under Grain Arbitration Rules, 867 F.2d 130, 133 (2d Cir. 1989). It is a doctrine of last resort. Duferco, 333 F.3d at 389. It requires more than a simple error in law or a failure by the arbitrators to understand or apply it; and, it is more than an erroneous interpretation of the law. Id. The doctrine is “limited to the rare occurrences of apparent egregious impropriety on the part of the arbitrators.” Daesang, 167 A.D.3d 1, 15-16.

To modify or vacate an award on the ground of manifest disregard of the law, a court must find both that (1) the arbitrators knew of a governing legal principle yet refused to apply it or ignored it altogether, and (2) the law ignored by the arbitrators was well defined, explicit, and clearly applicable to the case. Wallace v. Buttar, 378 F3d 182, 189 (2d Cir. 2004) (quoting Banco de Seguros del Estado v. Mutual Mar. Off., Inc., 344 F.3d 255, 263 (2d Cir 2003)). See also Wien, 6 N.Y.3d at 480-81 (footnotes omitted).

The petitioner bears a heavy burden when invoking the doctrine. As one district court observed, the manifest disregard standard is so difficult to satisfy that it “will be of little solace to those parties who, having willingly chosen to submit to inarticulated arbitration, are mystified by the result; for a party seeking vacatur on the basis of manifest disregard of the law ‘must clear a high hurdle.’” Goldman Sachs Ex’ion & Clearing, L.P. v. Official Unsecured Creditors’ Comm. of Bayou Grp., 758 F. Supp. 2d 222, 225 (S.D.N.Y. 2010).

Matter of Nexia Health Technologies, Inc. v. Miratech, Inc.

[Ed. Note: the background discussion comes from the parties’ memoranda and the Court’s description of the facts.]

Matter of Nexia arose in the context of information technology services that were performed by defendant Miratech, Inc. (“Miratech”), for plaintiff, Nexia Health Technologies, Inc. (“Nexia”).

The dispute has its origins in 2012, when Nexia decided to upgrade its software platform, which had been in commercial use for approximately ten years. Nexia wanted to develop a next generation version of the software platform, Version 10 (“V10”), that would use modern development languages and incorporate more advanced software tools and architecture than the version then-in use. By May 2015, Nexia had partially developed V10, but needed external assistance to complete the upgrade for commercial release. Miratech contacted Nexia to offer its services in completing the new version of the software platform (“V10 Project”).

Thereafter, in June 2015, the parties executed a Letter of Intent (“LOI”). The LOI defined the initial contractual relationship between Nexia and Miratech, the work to be performed in connection with the upgrade to V10 and informed the later negotiations and formation of the Master Services Agreement (“MSA”) between the parties.

On January 1, 2016, the parties executed the MSA. The MSA contained certain limitations on liability. In Section 13.1, the parties agreed that neither would be liable for indirect damage (including negligence), loss or damage of data, loss of potential clients, lost profits, business fields or any other damages of the kind. In Section 13.2, the parties agreed that “total liability under a SOW/PO [i.e., Statements of Work/Purchase Orders] (including the sum of damages and loss reimbursements of a Party under the SOW) [would] not exceed 10% of amounts paid by [Nexia] to Miratech during the 12 month period ending with the date of a Claim of other Party.” Thus, under this section, “[t]he total liability under an Agreement (including the sum of damages and loss reimbursements of a Party under the Agreement) [would] not exceed (1) USD $1 million or (2) 10% of the amounts paid by [Nexia] to Miratech under the Agreement during the 12 month period ending with the date of the Claim of the other Party, whichever of the two amounts is lower.”

Pursuant to the parties’ agreement, Miratech was to perform its services in three phases. Nexia paid Miratech the agreed-on fee for Phase 0 of the V10 Project, as well as the fee for completing Phase 1 of the project. In total, Nexia paid Miratech more than $1.6 million (Cdn) to develop the V10 software.

Nexia claimed that it never received a product that met the contractual specifications in the MSA or had any commercial value. According to Nexia, as of April 30, 2016, the agreed upon deadline for completing Phase 2 of the V10 Project, Miratech had failed to deliver a compliant and stable version of V10 that could be delivered to Nexia’s clients for further testing. As a result, said Nexia, one of its primary clients cancelled its contract with the company. Because of Miratech’s alleged failure to timely deliver a marketable product, Nexia terminated the MSA on June 1, 2016.

Miratech commenced an arbitration for payment of the amounts due in connection with the work performed in completing Phase 2 and Phase 3 of the V10 Project. Nexia counterclaimed, alleging that, among other things, Miratech breached the MSA. The arbitrator found in favor of Meritech.

The arbitrator held that Miratech was entitled to be paid for all the time reflected in the invoices it submitted to Nexia in connection with Phase 2 of the V10 Project. The arbitrator also held that Miratech was to be compensated for Phase 3 of the V10 Project although there was no meeting of the minds as to the pricing of the work performed during Phase 3 as Nexia had been unjustly enriched by Miratech’s work during that phase. Consequently, the arbitrator awarded Miratech $1,183,633.60 (Cdn) for the work performed during Phase 2 of the V10 Project and $321,428.57 for the work performed during Phase 3 of the project. The arbitrator also awarded Miratech $410,549.24 (Cdn) in interest.

At issue in Matter of Nexia was whether the arbitrator manifestly disregarded the law in failing to apply the limitations of liability clause of the MSA (i.e., Section 13.2) to the damages awarded for Phase 2 of the V10 Project. Slip Op. at *1. The Supreme Court held that the arbitrator did not manifestly disregard the limitations of liability clause. In doing so, the court denied Nexia’s petition to vacate the award and granted Meritech’s cross motion to confirm the award.

The Court’s Decision

The Appellate Division, First Department, affirmed. The Court found that the arbitrator “gave a colorable justification for the outcome reached.” Slip Op. at *2. “In reaching his conclusion,” observed the Court, “the arbitrator did not contradict an express term of the contract, rather, he interpreted it.” Id.

The arbitrator found that a correct reading of the clause “assumes that invoices and amounts due must have been paid and the clause limits liability upon payment in the ordinary course.” Since no invoices were paid for Phase 2, the arbitrator reasoned that the limitation of liability clause did not limit the damages awarded to respondent for work performed under Phase 2.

Id.

“Even if the arbitrator’s interpretation was erroneous,” noted the Court, “it [did] not equate to manifest disregard of the law.” Id. “Vacatur on the basis of manifest disregard of a contract is appropriate [only] . . . where the arbitral award contradicts an express and unambiguous term of the contract.” Id. (quoting Wien at 6 N.Y.3d at 485).

Moreover, the Court held that vacatur was not appropriate under 9 USC § 10(a)(4) of the FAA (i.e., the arbitrator exceeded his authority) because the arbitrator “had the power to interpret the contract and decide the issues based on the parties’ submissions.”  Id.

Takeaway

The First Department’s analysis and opinion, though short, underscores the difficulties a party faces trying to vacate an arbitration award on any of the enumerated grounds under the FAA and the manifest disregard of the law doctrine – difficulties that this Blog has noted in its previous posts.

In light of the difficulties one encounters trying to vacate an arbitral award, parties agreeing to arbitrate their disputes should do so with their eyes wide open.  Arbitration can be a very effective forum for the resolution of disputes. It is a less formal and less costly alternative to resolve disputes.  But, as Matter of Nexia shows, parties should expect to live with the outcome of their arbitration, even if the outcome seems unjust or erroneous, or both.

Tagged with: ADR, Alternative Dispute Resolution, Arbitration, FAA, Federal Arbitration Act, Manifest Disregard of The Law, Vacatur