Irrationality, Manifest Disregard of The Law and The Contractual Obligation to Arbitrate Disputes

• Posted on: Jul 27 2020

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. Rent-A-Ctr., W, Inc. v. Jackson, 561 U.S. 63, 67 (2010) (noting that “arbitration is a matter of contract”). In business and commercial transactions, arbitration is the preferred means of resolving disputes. It is encouraged and recognized as the public policy of the State of New York. Matter of Smith Barney Shearson v. Sacharow, 91 N.Y.2d 39, 49 (1997) (citations and quotation marks omitted). Id. Consequently, courts will interfere as little as possible with the agreement of consenting parties to submit their disputes to arbitration. Id. at 49-50. (citations omitted).

Since arbitration is a “creature of contract” (Louis Dreyfus Negoce S.A. v. Blystad Shipping & Trading Inc., 252 F.3d 218, 224 (2d Cir. 2001)), only signatories to a contract containing an arbitration agreement can be compelled to arbitrate. TBA Global, LLC v. Fidus Partners, LLC, 132 A.D.3d 195, 202 (1st Dept. 2015). Consequently, “a party cannot be required to submit to arbitration any dispute which he has not agreed so to submit.” AT&T Techs., Inc. v. Communications Workers of Am., 475 U.S. 643, 648 (1986) (quoting Steelworkers v. Warrior & Gulf Nav. Co., 363 U.S. 574, 582 (1960)). For this reason, “a party will not be compelled to arbitrate and, thereby, to surrender the right to resort to the courts, absent evidence which affirmatively establishes that the parties expressly agreed to arbitrate their disputes. The agreement must be clear, explicit and unequivocal and must not depend upon implication or subtlety.” Waldron v. Goddess, 61 N.Y.2d 181, 183-84 (1984).

If there is a binding agreement to arbitrate and the parties have arbitrated their dispute, any award issued by the arbitrator can be confirmed or vacated by a court of competent jurisdiction. 

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 Federal Arbitration Act, 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). 

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 Execution & Clearing, L.P. v. Official Unsecured Creditors’ Comm. of Bayou Grp., 758 F. Supp. 2d 222, 225 (S.D.N.Y. 2010).

The grounds for modification or vacatur under CPLR § 7511 are limited.  These include: (1) “corruption, fraud, or misconduct in procuring the award”; (2) partiality of the arbitrator; (3) the arbitrator exceeded his power or imperfectly executed it; and (4) failure to follow the procedures of Article 75 of the CPLR. CPLR § 7511(b)(1)(i)-(iv).  Only when the record demonstrates one of the foregoing will a New York court vacate or modify an award under the CPLR. Matter of New York City Tr. Auth. v. Transport Workers Union of Am., Local 100, AFL-CIO, 6 N.Y.3d 332, 336 (2005).

[Ed. Note: This Blog discussed the grounds for vacatur under New York law here and here.]

Relevant to today’s article is CPLR § 7511 (b) (1) (iii) – vacatur on the basis that the arbitrator exceeded his/her power or so imperfectly executed it. Under that section, vacatur is appropriate “only where the [] award violates a strong public policy, is irrational or clearly exceeds a specifically enumerated limitation on the arbitrator’s power.” Matter of New York City Tr. Auth., at 336; accord Matter of Falzone v. New York Cent. Mut. Fire Ins. Co., 15 N.Y.3d 530, 534 (2010). “Even where an arbitrator has made an error of law or fact, courts generally may not disturb the arbitrator’s decision.” Falzone, 15 N.Y.3d at 534. A court must “give deference to the decision of the arbitrator … even if the arbitrator misapplied the substantive law in the area of the contract.” New York City Tr. Auth., 6 N.Y.3d at 336 (internal quotation marks and citations omitted); accord Falzone, 15 N.Y.3d at 534. “‘That reasonable minds might disagree over what the proper penalty should have been does not provide a basis for vacating the arbitral award or refashioning the penalty.’” Matter of Shenendehowa Cent. Sch. Dist. Bd. of Educ. v. Civil Serv. Empls. Assn., Inc., Local 1000, AFSCME, AFL-CIO, Local 864, 20 N.Y.3d 1026, 1028 (2013), quoting City School Dist. of the City of N.Y. v. McGraham, 17 N.Y.3d 917, 920 (2011).

In today’s article, we examine three cases in which the foregoing issues were considered. Kothari v. Brink’s U.S., 2020 N.Y. Slip Op. 32378(U) (Sup. Ct., N.Y. County July 17, 2020) (here); Dora’s Naturals, Inc. v. Guayaki Sustainable Rainforest Prods., Inc., 2020 N.Y. Slip Op. 32379(U) (Sup. Ct., N.Y. County July 20, 2020) (here); and Vitra, Inc. v. Ninety-Five Madison Co., L.P., 2020 N.Y. Slip Op. 32389(U) (Sup. Ct., N.Y. County July 21, 2020) (here).

Kothari v. Brink’s U.S. 

Kothari involved a dispute over the failure to pay for goods previously delivered and the consequent refusal to deliver a new order of goods until such payment was made. More specifically, Plaintiffs brought suit to recover damages due to defendants’ failure to ship cut and polished diamonds from Mumbai. Defendants claimed that they withheld the shipment because there was an outstanding balance owed to them. Defendants declined to complete delivery until the debt was satisfied. Defendants maintained that the shipments were governed by a contract with a nonparty.

Defendants contended that any disputes about the shipments had to be resolved in mandatory arbitration under the governing contract. 

Plaintiffs opposed the motion, maintaining that although they were an intended beneficiary of the contract containing the arbitration clause, they were not a party to it and could not be compelled to arbitrate. Plaintiffs contended that they were a consignee rather than a shipper and, therefore, were not a party to the subject shipping contract. Plaintiffs insisted that the unsigned, undated, contract could not compel arbitration. 

The Court agreed with Defendants.

First, the Court found that Defendants had presented “specific and direct evidence that Mr. Kothari [Plaintiffs’ managing member] signed the terms and conditions [of the subject contract] (which indisputably contain[ed] an arbitration clause) without specific denials of that evidence.” Slip Op. at *3.

Second, the Court found that even if the affidavit evidence was not dispositive, Plaintiffs’ argument was contradicted by its own allegations. Id. In this regard, the Court observed that “plaintiffs [were] suing based on the very contract they claim they never signed.… Plaintiffs cannot have it both ways; they cannot simultaneously seek recovery based on a breach of contract and then claim they are not bound by the provisions of the contract that they don’t like.” Id. 

Accordingly, the Court granted Defendants’ motion to compel arbitration. Id. at *4.

Dora’s Naturals, Inc. v. Guayaki Sustainable Rainforest Prods., Inc.

Dora’s Naturals involved a 20-year distribution agreement between Dora’s Naturals, Inc. (“Dora’s”), a distributor of food products, and Guayaki Sustainable Rainforest Products, Inc. (“Guayaki”), a manufacturer of organic beverages (“Distribution Agreement”). Under the Distribution Agreement, Dora’s was appointed the exclusive authorized distributor of all Guayaki products in the New York metropolitan area (with limited specified exceptions). 

In 2018, Guayaki terminated the Distribution Agreement, without stating any reasons for the termination, but stating that Dora’s was not entitled to payment from Guayaki because the contract precluded recovery for consequential damages, including lost profits. 

The termination of the Distribution Agreement gave rise to the arbitration, at which the primary issue was Dora’s entitlement to damages. As noted by the arbitrators, and not disputed in the court proceeding, Guayaki breached the Distribution Agreement by terminating the Agreement before its expiration without grounds. After an eight-day evidentiary hearing and extensive briefing, the arbitrators awarded Dora’s damages for lost profits in the amount of $4,998,000 (“Final Award”). In support of this holding, the arbitrators reasoned that “whether analyzed under the case law relating to general damages or the case law relating to consequential damages, on the facts presented [at the arbitration], lost profits are recoverable.”

The arbitrators further held that “any lost profits from a breach would be the ‘natural and probable consequence of the breach,’ as required for general damages.” In the alternative, the arbitrators held that the lost profits claimed by Dora’s would be recoverable if viewed as consequential damages rather than general damages. 

In seeking to modify the Final Award to vacate the award of damages, Guayaki argued that the arbitrators’ holdings on damages were based on “manifest disregard of the law.”

The Court denied the motion to vacate the Final Award, holding that, “under either standard [i.e., arbitrator irrationality or manifest disregard of the law], grounds do not exist for the vacatur of the damages awarded by the arbitrators.” Slip Op. at *4. The Court said that “[i]n concluding that Dora’s was entitled to an award of lost profits, the arbitrators carefully considered, and rejected, Guayaki’s argument that the lost profits were consequential damages, recovery for which was barred by the terms of the Distribution Agreement.” Id. 

The Court explained that the arbitrators did not disregard the law; instead, they followed it. Id. at *5 (citing Biotronik A.G. v. Conor Medsystems Ireland, Ltd., 22 N.Y.3d 799 (2014)). The Court found that “the arbitrators considered the terms of the Distribution Agreement and the nature of the relationship between Dora’s and Guayaki, as reflected in that Agreement” and “concluded that ‘the arrangement between Dora’s and Guayaki mirror[ed] in many ways the relationship between the manufacturer and distributor in Biotronik.’” Slip Op. at *5. The Court also found that the arbitrators’ reasoning comported with Biotronik, noting that, “‘as in Biotronik, the arrangement between Dora’s and Guayaki was not simply one between the seller and a buyer who was in the business of reselling’; that the Distribution Agreement clearly contemplated that Dora’s would resell Guayaki’s product; and that “‘any lost profits from a breach would be the natural and probable consequence of the breach, as required for general damages.’” Id., quoting Final Award, at 14 (internal quotation marks and citation omitted).

[Ed. Note: In Biotronik, the Court of Appeals explained that “[l]ost profits may be either general or consequential damages, depending on whether the non-breaching party bargained for such profits and they are ‘the direct and immediate fruits of the contract.’ Otherwise, where the damages reflect a ‘loss of profits on collateral business arrangements,’ they are only recoverable when ‘(1) it is demonstrated with certainty that the damages have been caused by the breach, (2) the extent of the loss is capable of proof with reasonable certainty, and (3) it is established that the damages were fairly within the contemplation of the parties.’” Biotronik, 22 N.Y.3d at 805-806 (internal citations omitted).] 

The Court further found that the arbitrators comported with the law by finding, “in the alternative, that if viewed as consequential damages, the lost profits claimed by Dora’s would be recoverable.” Id. at *6.  The Court explained that the arbitrators properly based their finding on the language of the Distribution Agreement. Id. Section 13 (C) of the Distribution Agreement, on which Guayaki relied, provided that: “Notwithstanding any other provisions of this Agreement, in no event shall either Party be liable to the other for incidental, special or consequential damages, or punitive damages.” Section 13 (C) appeared in the Indemnification Section of the Distribution Agreement. Id. By contrast, noted the Court, the Termination Section of the Agreement also contained a general provision on damages. Id. That section (Section 10 (A)) provided that: “A decision by either party to terminate this Agreement pursuant to this paragraph will not affect either party’s right to seek damages against the other for a breach of the terms of this Agreement.… Nothing contained herein shall be deemed to limit either Party’s right to obtain damages or equitable relief if either Party shall breach its obligations under this Agreement. All remedies shall be cumulative and are intended to be, and shall be non-exclusive.” Id. The arbitrators concluded that Section 10 (A) was dispositive “‘because the limitation on damages [was] nestled in the provisions relating to indemnification and because there is contrary and similarly phrased language relating to damages in Section Ten of the Distribution Agreement relating to termination the language in the specific provision relating to termination, which expressly provide[d] for no limitation on rights to damages, governs.’” Id., quoting Final Award, at 18 (internal quotation marks omitted). 

The Court concluded that regardless of whether the arbitrators were correct in their application of the caselaw or assessment of the evidence, “[t]he arbitrators unquestionably considered the applicable law and rendered a well-reasoned opinion that [did] not manifestly disregard the law.” Id. at *7. Additionally, the Court held that the Final Award was not “irrational”. Id.

Vitra, Inc. v. Ninety-Five Madison Co., L.P.

Vitra, Inc. (“Vitra”) manufactures and sells furniture in showrooms and retail stores throughout the United States. Ninety-Five Madison Co., L.P. (“Ninety-Five Madison”) owns property in New York City (“Premises”). On June 18, 2016, the parties entered a lease (“Lease”) pursuant to which Ninety-Five Madison leased to Vitra certain space at the Premises for use as a retail store and showroom. The parties agreed that Ninety-Five Madison would undertake certain construction work before Vitra occupied the Premises.

Vitra alleged that Ninety-Five Madison failed to perform its construction work by the agreed-upon date and, as a result, Vitra commenced an action. On December 7, 2017, the parties entered into a Settlement Agreement of the action, which was so ordered by the court. Pursuant to the Settlement Agreement, all disputes arising out of or relating to the interpretation and enforcement of the Settlement Agreement would be decided through arbitration under the auspices of JAMS.

The arbitrator rendered a series of awards, which Ninety-Five Madison moved to vacate: (1) the Third Interim Award dated March 10, 2019 (“Third Interim Award”) and the subsequent Order on Respondent’s Motion for Reconsideration of Third Interim Award dated September 18, 2019 (the “September 2019 Order”); and (2) the Arbitrator’s Order on Claimant’s Application for Directions to Respondent dated August 29, 2019 (“August 2019 Order”) and the Arbitrator’s Second Partial Final Award dated January 7, 2020 (“Second Partial Award”). Vitra cross-moved to confirm: (1) the Third Interim Award and for an order directing the Clerk of the Court to enter a money judgment in Vitra’s favor and against Ninety-Five Madison in the sum of $596,291.90, plus interest, as provided for in the Third Interim Award; and (2) the Second Partial Award and for an order directing the Clerk of the Court to enter a money judgment in favor of Vitra and against Ninety-Five Madison in the sum of $525,000.00, plus interest as provided for in the Second Partial Award.

The Court confirmed the awards. 

The Court held that the Third Interim Award and the September 2019 Order were “rationally based.” Slip Op. at *6. The Court found that the “Arbitrator adequately supported his conclusions, citing the language of the Lease and Settlement Agreement and the supplemental affidavit” of the person who negotiated the Lease on behalf of Vitra. Id. In confirming the award, the Court noted that “Ninety-Five Madison failed to provide its own affidavit from the individual who negotiated the lease on Ninety-Five Madison’s behalf.” Id. at *5.

The Court held that “the Arbitrator did not exceed his authority in issuing the Second Partial Final Award.” Id. at *8. The Court noted that prior to the issuance of the Second Partial Final Award, “the parties disagreed about the filing of an online permit application on the Department of Buildings (“DOB”) website for a sidewalk shed.” Id. at *9. Vitra maintained that Ninety-Five Madison was required to file this application in order for Vitra to proceed with its renovations. After Ninety-Five Madison failed to file the application, Vitra applied to the Arbitrator to require Ninety-Five Madison to file the application by a date certain or face monetary sanctions. In response, the Arbitrator issued the August 2019 Order, directing Ninety-Five Madison to file the application by September 3, 2019 or face a monetary sanction of $25,000 per day. Ninety-Five Madison did not file the application until September 24, 2019, twenty-one days after the deadline. Pursuant to the August 2019 Order, Vitra moved for a monetary award against Ninety-Five Madison for the delay and Ninety-Five Madison filed its own motion to reconsider the August 2019 Order. On January 7, 2020, the Arbitrator issued the Second Partial Final Award, granting Vitra’s application for monetary sanctions of $525,000 and denied Ninety-Five Madison’s application to reconsider the August 2019 Order.

The Court held that “the Arbitrator’s proffered reasons for the decision to award monetary sanctions ha[d] a sound basis.” Id. at *9. The Court explained that the “Arbitrator considered all the arguments presented by Ninety-Five Madison as to why sanctions should be denied” and “thoroughly explained his decision” to award monetary sanctions. Id. Accordingly, the Court found “the Second Partial Final Award and the August 2019 Order [to be] reasonable and rational.” Id. 

Takeaway

The cases discussed in today’s article illustrate three points about arbitration. First, it is a “creature of contract” and the decision whether an agreement to arbitrate exists will be governed by the rules of contract interpretation. Second, courts accord deferential treatment to the decisions made by arbitrators. Finally, the grounds under which vacatur or modification is permitted under CPLR § 7511 are narrow and difficult to overcome.