A recent US Second Circuit Court of Appeals decision re-affirmed some well-settled principles about the appealability of district court orders dealing with arbitration. The Court held that an order of the district court refusing to enjoin a pending arbitration was not appealable while the arbitration was in progress. (Accenture, Inc. v. Spreng, 2011 U.S. App. LEXIS 10933 (2d Cir. May 27, 2011)). But what seems more interesting about the case, for the practicing arbitrator, is the arbitral procedural order that led to this costly spasm of collateral litigation.

Accenture was named a Respondent in a breach of contract arbitration by the former owner of a company Accenture had purchased – the owner having been given an employment contract that Accenture later terminated. The case was on an accelerated timetable, commenced in June 2010 and scheduled for merits hearings beginning October 19, 2010. In mid-September, Claimant received documents from Accenture, responsive to discovery requests, that led Claimant to seek permission to add a claim for fraudulent inducement of the contract. But Claimant made his request to amend only one week before the first hearing date, and the arbitrator denied leave to amend.

Claimant responded by filing with the AAA a “without prejudice” withdrawal of the pending arbitration, and a new arbitration demand encompassing the original contract claim and the new fraud claim. Accenture asked the arbitrator in the first case to determine that the withdrawal of claim was “with prejudice,” but was informed by the AAA that the arbitrator was functus officio. That decision launched Accenture’s litigation initiative, seeking to enjoin the second arbitration in favor of the first.

The case report does not indicate whether the second arbitration progressed during the litigation. But whereas the district court decided the motion to enjoin on December 23, 2010 and the Second Circuit agreed to hear and decide the case on an accelerated timetable (while denying a stay of the arbitration pending appeal), it seems fair to assume that arbitration #2 was on hold, whether by stipulation or voluntary decision of the arbitrator or indulgence of the AAA, until the litigation ran its course.

Looking back on this history today, and considering that seven months were lost to litigation that resolved no aspect of the pending dispute, it seems fair to ask whether the arbitrator might have made a more prudent decision. Claimant’s willingness to start anew in order to arbitrate the fraud and contract claims in one proceeding should have been anticipated. If the arbitrator was not aware that the AAA would permit “without prejudice” withdrawal and recommencement in the circumstances, it would seem that sound case management by the AAA and the arbitrator should have led to the arbitrator being so informed. Further, Accenture’s responses, before the AAA and the courts, were also foreseeable.

An order granting leave to amend obviously would have required postponement of then-imminent hearings and a new round of discovery and pre-hearing submissions. But if Claimant deserved to suffer some procedural adverse consequence for having (apparently) been dilatory in proposing the new fraud claim — notably allowing nearly four weeks to elapse after obtaining the critical new documents, a period that ended only a week before the hearing date — perhaps the better approach, consistent with the objectives to optimize decision costs and streamline proceedings, would have been to grant leave to amend, to require completion of pre-hearing activity on the fraud claim on a timetable that placed burdens on the parties commensurate with their respective responsibility for the late emergence of the new claim, and to reschedule the merits hearings perhaps 60 or 90 days forward.

It might be counter-argued that in a civil litigation in the same posture, most judges would deny leave to amend a pleading one week before the trial date. But to approve of the arbitrator’s decision on this basis overlooks two fundamental differences between arbitration and civil litigation. First, litigation consumes scarce public resources (judges, clerks, courtrooms, etc.), and rules and judicial doctrines concerning amendments, withdrawal of proceedings, etc. reflect to a significant extent concerns about the systemic, public costs of ill-timed strategic corrections by the parties. An arbitrator hired by the parties and being well-paid for her time has far less reason to consider her own inconvenience resulting from a belated proposed schedule change. Second, judicial rules for pleadings, discovery, pre-trial orders, etc. are relatively inflexible due to the sheer volume of cases the courts must process. The arbitrator’s discretion to short-circuit formalities of pleadings and to truncate pre-hearing proceedings is, within the confines of due process, one of the principal strengths of arbitral procedure.

Much of the foregoing will seem obvious to the experienced arbitrator. But the ranks of arbitrators include, often by choice of the parties, many retired judges and senior status lawyers arriving from careers focused in other disciplines without particular exposure to the arbitral process. Arbitral institutions that welcome, as they should, such newly-minted arbitrators to their rosters, bear a large responsibility for their exposure to shared norms and best practices in the arbitrator community.

Last week the US Second Circuit Court of Appeals wrote what should be the final chapter in one of the largest international arbitrations to emerge from the US financial crisis of 2007-2008.

The case was an “international” arbitration only in the sense that Claimant was a Swiss company while Respondent was a US affiliate of a Swiss investment bank. The arbitration took place in New York under the arbitration rules of the Financial Institutions Regulatory Authority (FINRA), and resulted in an award issued by a three-member tribunal, without reasons as is customary in FINRA arbitrations, in favor of Claimant for more than $400 million of investment losses. After two years of post-award litigation focused on the bank’s claims of inadequate disclosure by the non-lawyer arbitrator, the judgment confirming the award has been upheld and the matter presumably has reached a conclusion. (STMicroelectronics, N.V. v. Credit Suisse Securities (USA) LLC, 2011 U.S. App. LEXIS 11116 (2d Cir. June 2, 2011)).

My topic for discussion is the Second Circuit’s rejection of the bank’s claim of misconduct by the arbitrator in regard to his disclosures during the appointment process. But for financial crisis aficionados I offer this brief recap of the essential facts: The bank, having assured the customer that it would abide the latter’s instructions to invest its funds only in federally-guaranteed securities, mainly pools of student loans, instead put the client’s funds in risky derivatives bearing no federal guarantees, and the bank consistently mis-identified the investments in the e-mail confirmations so that the client would think its instructions were being heeded. When the scheme was uncovered, the customer was left with worthless, unmarketable securities. Two of the bank’s investment managers were eventually prosecuted for securities fraud, convicted, and sentenced to jail terms.

The bank’s challenge to the non-lawyer arbitrator — a retired finance professional acting frequently as an expert witness and consultant in customer-bank disputes —  claimed the arbitrator made misleading and inadequate disclosures that concealed the fact that he was engaged mainly by customers and therefore was pre-disposed toward the customer position on issues germane to the dispute.  The Second Circuit, in agreement with the District Court, held that the bank had failed even to establish its factual premise that the arbitrator worked predominantly for customers — and so the Court had no occasion to reach what it said were difficult and unresolved issues of whether the type of predisposition alleged, when concealed by non-disclosure, could support the vacatur of an award on grounds of “misconduct” by the arbitrator resulting in “prejudice” to the party. (FAA Section 10(a)(3)).

What I find to be an especially curious element of the Court’s analysis of the bank’s position is its observation (with a decided note of criticism) that the bank had failed even to request use of the discovery methods under the Federal Rules of Civil Procedure to secure details about the challenged arbitrator’s expert witness engagements. The Court stated that while it had shown reluctance in several cases to allow discovery to be used to mount challenges to awards based on arbitrator bias, it had not entirely foreclosed this type of use of court-annexed evidence-gathering.

But if, as the Court seems to suggest, this would have been a suitable occasion for discovery in aid of a post-award inquisition on an arbitrator, what are the criteria, inferable from this case, against which such requests will be measured in the future?

The first element would appear to be that the applicant for discovery has a substantial non-speculative concern about the arbitrator based upon concrete (but insufficient) evidence already in its possession. Here the bank had the formal written disclosure that said the arbitrator had had prior expert engagements on “both sides” of bank customer disputes. But the bank’s investigation, triggered by an offhand remark by the arbitrator during the hearings, revealed that he had apparently testified mainly for customers. 

Second, it would appear that the discovery applicant should have at least a credible legal position that, if the facts turn out to be as the applicant alleges, vacatur of the award under the FAA would be appropriate. In STMicro v. Credit Suisse, the bank’s position was that if indeed the arbitrator had been an expert/consultant mainly for customers against banks, but had not so indicated in the written disclosures, this would constitute misconduct prejudicial to the bank warranting vacatur. Neither the parties’ briefs nor the Court’s own research uncovered case law pointing in either direction on this issue.  

Third, the applicant should have a plausible position that the alleged arbitrator misconduct had a material impact on the outcome. This is technically part of the second element above (i.e. “prejudice”). But it deserves to be stated and considered separately from whether the alleged conduct was in fact misconduct at all.  In ST Micro v. Credit Suisse, the arbitral tribunal had issued an unreasoned award giving money damages in excess of $400 million; the award did not even indicate which of several causes of action (fraud, contract, negligence, fiduciary duty, etc.) had been sustained. In such circumstances, it cannot be excluded that the challenged arbitrator was a particularly effective advocate of the customer’s position in the deliberations of the Tribunal. Applicants for post-award discovery on arbitrator conduct may face a higher burden where there is a reasoned, unanimous award – suggesting that any misconduct or bias of one arbitrator, who was not the presiding arbitrator, was inconsequential.  A similarly higher burden may be imposed even when the unanimous award is unreasoned but is made by a tribunal that includes party-appointed arbitrators.  If the challenged arbitrator is the other party’s appointee, but the challenging party’s appointee subscribes to the award, the court may doubt that the applicant has a prima facie case of prejudice. In the Second Circuit case under discussion, all three arbitrators had been appointed by FINRA based on the parties’ rankings of a list of candidates.

Fourth, the court must consider that the discovery request is made in a proceeding that likely started with a petition to confirm the award – and was met, in response, with a cross-motion to vacate. Confirmation proceedings are supposed to be streamlined and expedited, according to the Supreme Court. And the grounds for vacatur are to be narrowly construed. Such discovery requests must be viewed in the context of federal arbitration policy as reflected in FAA jurisprudence.

To answer tentatively the question posed in the title of this post, the Second Circuit in STMicro v. Credit Suisse can scarcely be said to have opened the floodgates for discovery designed to mount an award challenge based on arbitrator bias or misconduct. But parties seeking such discovery will surely find STMicro v Credit Suisse in their research. And so it is useful to consider, as this post has attempted, precisely what are or should be the factors guiding judicial discretion in addressing such discovery requests.

(This is a condensed Arbitration Commentaries version, without citations, of what may become a longer and more formal article on joinder of new parties in an ongoing international arbitration. The source material for this Commentary consists of the various reports of the UNCITRAL Working Group and the notes of the UNCITRAL Secretariat, which may be found on the UNCITRAL website.)

The joinder of persons as new parties to an ongoing international arbitration, before an arbitral tribunal already appointed by the original parties or confirmed by an appointing authority, has presented difficulties that have not yet yielded to a unifying transnational practice principle.

The problems unique to joinder are not exclusively those associated with arbitration involving non-signatories to the arbitration agreement. Those challenges are present even if the non-signatory is named in the original Request for Arbitration.  The unique problems arise from the conceptual difficulty of requiring New Party C to arbitrate before a tribunal that has been selected only by Original Parties A and B.

UNCITRAL Rule 17(5), an entirely new provision in the 2010 UNCITRAL Rules,  is the product of several years of debate in the UNCITRAL Working Group that was charged with giving birth to the 2010 Rules. The 1976 version of the Rules had no provision on joinder, so the adoption of any measure was an important new development.  As first introduced as a proposal in 2006, the text would have read:

The arbitral tribunal may, on the application of any party, allow one or more third persons to be joined in the arbitration as a party and, provided such a third person and the applicant party have consented, make an award in respect of all parties involved in the arbitration.

But some questioned whether this was a new development at all. After all, the 1976 Rules did not expressly forbid joinder. If the new party and the existing parties consented, joinder could and presumably did occur.

The challenge was to have a rule that would permit a third person to be joined, and for the joined person to be regarded as having consented that its rights and duties should determined by the award of an arbitral tribunal that it had no role in selecting.

To meet this goal, new text of the proposed Rule emerged:

The arbitral tribunal may, at the request of any party, allow one or more third persons to be joined in the arbitration as a party provided such person is a party to the arbitration agreement, unless the arbitral tribunal finds, after giving all parties, including the person or persons to be joined, the opportunity to be heard, that joinder should not be permitted because of prejudice to any of those parties.  The arbitral tribunal may make a single award or several awards in respect of all parties so involved in the arbitration

Proponents of this text urged the view that if the newly-joined person were already a party to the arbitration agreement, that person could be said to have consented in advance to the prospect of being joined to an arbitration already pending between other parties to the same agreement, before a tribunal chosen by or for those original parties, provided of course that the arbitration to which the third person was being joined was pursuant to that agreement.

Opponents of this text argued that an award against the joined person would be vulnerable to challenge under Article V(1)(d) of the New York Convention as having been made according to procedures that varied from the agreement of the parties. They sought to re-insert the requirement that all parties should consent to the joinder at the time of joinder.

But the proposed reinsertion of such specific consent language was rejected. Consent, said the proponents of 17(5) as adopted, was adequately addressed by the requirement that the joined person be a party to the arbitration agreement.

After nearly four years of gestation, including comments elicited from major arbitral institutions, the proponents prevailed and this major new development in international arbitration procedure came into force in the 2010 UNCITRAL Rules.

To my knowledge no court has yet been required to decide whether an award against a party joined under Rule 17(5) violates the New York Convention. But the case for such a violation would seem to be unpersuasive. The Convention does not elevate equality of the parties in selection of the Tribunal to the status of an independent principle. That principle is enshrined to an extent in virtually all modern arbitration rules and laws, but is sometimes qualified due to the need to serve other important interests.

For example, the ICC Rules do not provide for strict equality of all original parties in selecting a tribunal in all cases. If a Claimant names four Respondents in the Request for Arbitration, and there will be three arbitrators, the Claimant is expected to nominate one arbitrator and the Respondents are to nominate one arbitrator jointly. The four Respondents are only treated equally with Claimant if they fail to make a joint nomination, whereupon the ICC Court will appoint the entire tribunal. (ICC Rule 10).

Of course, joinder under UNCITRAL Rule 17(5) might not save the award against the joined party from vacatur in the courts at a seat of arbitration whose arbitration law does enshrine a principle of strict party equality in choosing the tribunal. But that is not the case in UNCITRAL Model Law countries, where vacatur standards are co-extensive with grounds for refusal of enforcement under the Convention. Nor is it the case under the US Federal Arbitration Act.

Where issues of consent are most likely to arise in joinder practice under Rule 17(5) is in the realm of non-signatories to the arbitration agreement. The drafters of Rule 17(5) obviously selected the phrase “party to the arbitration agreement” with considerable deliberation. Perhaps a person that is required to arbitrate because a signatory signed the contract as her agent is a “party.” But what about a person against whom the arbitration clause may be enforced under the doctrine of arbitral equitable estoppel? Whether that person is a 17(5) “party” to the arbitration agreement probably depends on the view under law applicable to determine who is required to arbitrate under the agreement. No guide to a drafters’ interpretation of “party to the agreement” is to be found in the UNCITRAL drafting history (travaux préparatoires). So joinder practice will still be marked by some variation depending upon the applicable arbitrability law.

That said, Rule 17(5) is a major accomplishment. It may become the transnational standard to which major arbitral institutions gravitate as they review and update their rules on joinder.  Such a rules review at the ICC is in progress (although this writer has not involvement or knowledge of the position the revised ICC Rules will take). An important advance in the efficiency of arbitral proceedings should be the result if Rule 17(5) is widely emulated, and this should be seen as wan improvement that does not give serious offense to the consensual basis for arbitration.

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With best regards.

Today I briefly note two recent arbitrability decisions of US federal district courts, one in Los Angeles and one in Connecticut.

In Los Angeles, the Court granted a motion to compel arbitration filed by an affiliate of Roche Pharmaceuticals, and stayed the action pending completion of an ongoing arbitration in Zurich, but did not dismiss the case entirely. The Court evidently found that plaintiff’s single cause of action for a declaratory judgment of patent invalidity was outside the scope of the agreement to arbitrate, but that whether the parties’ patent license agreement required patent validity to be determined by the country that issued the patent was a question of contract interpretation falling within the scope of the license agreement’s arbitration provision, and was therefore to be resolved in the Zurich arbitration before any further proceedings on the invalidity claim in the California federal court.  No more can be discerned of the parties’ arguments before the Court, as nearly the entire record was placed under seal upon the application of Roche’s counsel. (One Lambda, Inc. v. Roche Molecular Systems, Inc., 2011 U.S. Dist. LEXIS 54627 (C.D. Cal. May 19, 2011)).   

Meanwhile, in Connecticut, there has been a useful decision helping to define the limits of the “offensive” use of equitable estoppel by non-signatories to compel signatories the arbitrate disputes with them.  At the heart of the dispute was the arbitration clause in a consumer’s wireless service agreement with AT&T – reminiscent of the Supreme Court’s recent decision in AT&T Mobility v. Concepcion.  But here the party seeking to enforce the arbitration clause — to avoid a class action litigation challenging alleged unfair debt collection practices — was an independent collection company that contracted with AT&T, unbeknownst to it wireless services customer, to collect delinquent accounts.  The debt collector argued that agency principles justified enforcement of the arbitration agreement by the non-signatory, but this was defeated by AT&T’s contract with the debt collector that expressly declared the latter to be an independent contractor, not an agent. The debt collector argued in the alternative that AT&T’s customer was estopped to deny it the right to enforce the arbitration agreement in view of its involvement in the relationship between AT&T and the customer, but this was rejected by the Court because that involvement was unknown to the consumer and therefore this was not a circumstance where it would be unfair for the consumer, as a signatory to the arbitration agreement, to take the position that it did not expect to arbitrate disputes with a non-signatory. (Lucy v. Bay Area Credit SVC LLC, 2011 U.S. Dist. LEXIS 55088 (D. Conn. May 23, 2011)).   

In a not infrequent scenario in international commercial arbitration, the Claimant seeks to be paid for services rendered or goods delivered or intellectual property licensed to the Respondent, and the Respondent offers a series of defenses and counterclaims that, according to Claimant, are merely contrivances designed to obscure the fact that Respondent is in financial distress and so it cannot or rather would prefer not to pay the obligation. If the Claimant then asks the Tribunal to grant an interim measure in the form of security to satisfy an eventual award of money damages, the first line of opposition will often be that the neither the applicable rules of arbitration nor the applicable arbitration law in the jurisdiction provide in terms for the granting of such relief by the arbitral tribunal.

The absence of specific provision for security in some institutional rules governing international arbitration (e.g. the AAA International Arbitration Rules, in contrast to, e.g. the 2010 UNCITRAL Arbitration Rules and 2006 amendments of the UNCITRAL Model Law) is rarely the only reason for the frequent denial of such relief. But arbitrators may justifiably consider that the absence of specific mention of security for the amount in dispute as a species of provisional measure, in some arbitration rules, and only fairly recent addition of such specific mention in the UNCITRAL Rules and in the Model Law, is reflective of the reasons often mentioned in arbitral awards and in commentaries why such relief should often be denied – e.g., that the relief may impose undue hardship, that granting the relief may imply a pre-judgment of the merits, and that financial distress of a commercial counterparty (unless the product of misconduct to conceal or dissipate assets) is a business risk that parties either do or do not address by specific provisions in their contracts.

And yet arbitral attitudes toward pre-award security in a particular case cannot help but be influenced by judicial attitudes toward such arbitral relief in the courts at the seat of the arbitration. And in that regard, attention should be given to the decision last week by a well-respected US district judge in New York, one of that court’s most frequent authors of decisions about arbitration, in On Time Staffing, LLC v. National Union Fire Ins. Co., 2011 U.S. Dist. LEXIS 50689 (S.D.N.Y. May 12, 2011). In On Time Staffing, the Court refused to vacate an arbitration panel’s interim award ordering security for a portion of the amount in dispute. The outcome, the rationale stated in the decision, and the Court’s reminder that a similar decision was made by the US Second Circuit Court of Appeals eight years ago, may well encourage parties arbitrating in New York to seek such relief more often, and may well lead to such requests more frequently being granted.

In On Time Staffing, Claimant was the provider of workers compensation insurance to Respondent.  When Respondent allegedly was in default in payment of premiums, Claimant commenced arbitration and made its request for pre-hearing security in the demand for arbitration.  The Court’s decision reports that Respondent cited a provision of the insurance agreement that entitled the insurer to “additional collateral” if the insured disputed payment obligations without providing written particulars.  But the Court, refusing to vacate the panel’s order for security as exceeding the powers of the arbitrators (Federal Arbitration Act Section 10(a)(4)), cited only the broad powers the contract’s arbitration clause conferred. The Court did not rest its decision on the insurer’s right to enforce a specific contract right to security.

A broad arbitration clause, the court stated, confers on arbitrator “the discretion to order remedies they determine appropriate.”  (Quoting from the US Second Circuit Court of Appeals decision in Banco de Seguros del Estado v. Mutual Marine Office, Inc., 344 F.3d 255, 262 (2d Cir. 2003), in which the Court upheld an arbitration panel’s award of pre-hearing security even though the arbitration agreement did not expressly authorize the panel to issue such an award). 

While the reluctance of arbitrators to grant pre-award security for the amount in dispute does not arise mainly from a concern that they lack sufficient power, and so the Court’s holding that the arbitrators did not exceed their powers is not itself  a particularly significant development, the Court’s attitude clearly was in favor of the view that security for the award is in proper circumstances appropriate to ensure that the arbitration will not be a meaningless exercise. Said the Court: “The Panel, in the absence of language in the arbitration agreement expressly to the contrary, possesses the inherent authority to preserve the integrity of the arbitration process to which the parties have agreed by, if warranted, requiring the posting of pre-hearing security. . . . Otherwise, an arbitration panel with a well-founded concern that a party was financially unable to satisfy an eventual award would have no recourse to protect itself against the risk that its significant expenditures of time and effort would be for naught.”

It is notable that the Court’s rationale focuses on protection not of the Claimant’s economic interest in realizing proceeds of an eventual award of money damages, but rather on the arbitration process agreed upon by the parties. The Court refers to the right of the arbitral tribunal to “protect itself.”   This approach reflects a view an agreement of the parties to arbitrate, perhaps especially when the clause states that the decision of the arbitral panel will be “final and binding,” commits the parties to a dispute resolution process that includes eventual compliance with the arbitral tribunal’s decision.  This is not to say that the agreement implies a waiver of the rights of limited judicial review provided by the Federal Arbitration Act and the New York Convention. But it does imply that non-compliance with an award, without moving to vacate the award or opposing its enforcement on grounds permitted by the Convention, is a breach of the agreement to arbitrate. And it would follow from that premise that the costs incurred by an award winner to obtain enforcement by reducing the award to judgment and having execution on the judgment, should be recoverable as money damages for breach of the arbitration agreement.

The view that compliance with the award by the loser is a part of the contractually agreed process is considerably different than what may be said to be the prevailing view: that the arbitral process agreed upon culminates in an award that constitutes an entitlement to use the judicial process to obtain a judgment according to the terms of the award and to have execution on the judgment using the laws and means the state provides for this purpose.  If arbitrators agree with this emergent view that the agreement to arbitrate generally includes an agreement to implement the results of the arbitration in a voluntary or at least self-executing way, they may, other things being equal, be more favorably inclined toward requests for pre-award security.