When the arbitration agreement states that each party shall bear its own legal fees, do the arbitrators have authority to award legal fees as a sanction for bad faith conduct in the arbitration? In a recent case in New York, two federal judges said yes, and two said no.
But the two votes in favor formed the majority on a three-judge panel of the Second Circuit Court of Appeals, and so that prominent Court has now held, apparently for the first time, that arbitrators do not exceed their powers by awarding fees as a sanction for bad faith conduct in the proceedings when the contract states that each party shall pay its own legal fees. Reliastar Life Ins. Co. v. EMC National Life Co., 2009 U.S. Dist. LEXIS 7647 (2d Cir. April 9, 2009).
For the panel majority, it was self-evident that arbitrators have “inherent authority” to award fees as sanctions if the parties have conferred broad authority on the arbitrators to resolve disputes. Rejecting the position that the specific contract language negated this authority, the majority construed that language as merely a declaration that the “American Rule” on attorneys’ fees would apply. The American Rule of course provides that ordinarily each party shall bear its own fees, with certain exceptions including, notably, fee-shifting as a sanction for bad faith conduct during the proceedings. The parties’ declaration that each would bear its own fees, taken to mean “the American Rule applies,” meant, to the panel majority, that the bad faith exception also applies unless the parties excluded it in specific terms.
For the dissenting judge on the Second Circuit, and the federal district judge whose decision was reversed, the issue was as simple and the answer as clear as the words in the agreement. The parties had made a clear decision to bear their own legal costs without exception, and the interpolation of the “American Rule,” including its exceptions, into those unambiguous words was a contradiction of the parties’ intent as expressed in the contract.
Which side has the better argument? The panel majority’s approach to contract interpretation seems flawed. It is certainly true, as the majority states, that providing arbitrators with power to sanction bad faith conduct by awarding legal fees and costs fee-shifting will promote efficient arbitrations. But the majority seems to engage in creative contract interpretation to make its own conception of good arbitration procedure to match the intent of the parties as reflected what they wrote in the agreement. According to the majority, the contract’s declaration that each party shall bear the legal fees of its own counsel is to be construed as an adoption of the “American Rule” on attorneys’ fees. But there is no objective evidence in the words of the contract that the drafters and signers of the contract were even familiar with the American Rule. Further, if simple language that “each party shall bear its own legal costs” is construed as an adoption of the American Rule, then the words mean, among other things, that each party shall bear its own legal costs unless the claims in the arbitration arise under a statute that provides for recovery of such costs by the prevailing party. That would seem to be a fundamental departure from what the parties said. The majority did not deal with that conundrum, as it was concerned only with an exception for sanctions in case of bad faith procedural conduct.
Further, the Court’s construction depends on the assumption that parties of Amercian nationality are aware of the American Rule on attorneys’ fees. But if the same language appears in a contract between parties at least one of whom is not American, the slender justification for this assumption falls away.
The majority proceeds from the premise that arbitral authority to award fees as a sanction is an “inherent power” of arbitrators resulting from the parties’ conferral of power to resolve disputes without making specific limitations on their remedial powers.
But calling the conferral of power to award sanctions “inherent” seems transparently to be a device to interpolate a judicial view of sound arbitral procedure into the terms of a private contract. In fact, what the parties stated in this contract was that the arbitrators should (i) consider customary and standard practices in the life or health reinsurance business, and (ii) apply New York law and the Federal Arbitration Act.
On this point, the dissenting judge seems to have it right when she writes: “Inherent authority is authority which is not conferred; inherent authority is possessed regardless of the intentions of those who have power to confer authority….[T]he notion of authority inhering in an arbitral panel, whose authority is derived from the agreement of the parties before it, is problematic.”
Much more can and should be said about this provocative and important decision. I offer the foregoing as an introduction to the issues raised, and hope to have more to say in the coming days.