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“Evident partiality or corruption in the arbitrators” is one of the statutory grounds for vacatur of an arbitration award made in the United States, as provided on Section 10(a)(2) of the Federal Arbitration Act. I take brief note here of a decision this week in the Ninth Circuit US Court of Appeals that usefully reiterates aspects of the meaning of those terms. (Lagstein v. Certain Underwriters at Lloyd’s, 2010 U.S. App. LEXIS 11836 (9th Cir. June 10, 2010)).

In this case, the Lloyd’s underwriters, after receiving a large award against them from a tribunal composed of retired Nevada state court judges, hired investigators to comb through archives in quest of embarrassing facts that the arbitrators had not disclosed. The detectives managed to find that one of the ex-judge arbitrators had been mired on an ethics controversy as a trial judge a decade earlier, and that a second arbitrator, then a judge of the Nevada Supreme Court, had sided with his colleague in appeals relating to the ethics matter.

Of course these matters had nothing at all to do with the parties to the arbitration. To show evident partiality, the Court held, a party challengin an award “must establish specific facts indicating actual bias toward or against a party,” or show that the arbitrator failed to disclose information that “creates a reasonable impression of bias.” The Court also rejected the notion that there was “evident corruption.” Having not previously decided the meaning of this term, the Court held the allegations of corruption mustat least relate to the case or the parties, and not merely some prior instance of improper conduct.

The US Second Circuit Court of Appeals last week added an instructive new chapter to the ongoing tug-of-war, in Congress and the courts, over the use of arbitration clauses by consumer products companies avoid liability to consumers. (Hines v. Overstock.com, Inc., 2010 U.S. App. LEXIS 11265 (2d Cir. June 3, 2010)).

Overstock.com is a well-known internet discount home furnishings merchant.  Plaintiffs alleged that Overstock had sold them a vacuum cleaner, as new, which was in fact “refurbished,” and that when they returned the item they were charged a $30 restocking fee even though Overstock had given assurances they could return the item for a full refund. They brought suit in US District Court in New York, seeking to proceed on behalf of a class. Overstock petitioned under Section 4 of the Federal Arbitration Act to compel the named plaintiffs to arbitrate under AAA Rules in Salt Lake City, Utah, as provided in an arbitration clause in Overstock’s Terms and Conditions of Use for its website.

Overstock’s website included its “Terms and Conditions of Use,” according to the evidence accepted by the District Court, only on a link to be found if the consumer scrolled down to the bottom of a web page that was not necessary to read in full to effectuate an online purchase. In addition, only by scrolling to the end of the Terms and Conditions would the consumer see the notice advising that by using the Overstock.com website, the consumer was deemed to have agreed to arbitrate all disputes concerning the use of the site.

The District Court granted summary judgment denying Overstock’s petiition to compel arbitration, and here the  Second Circuit affirmed. Overstock cited the language in FAA Section 4 directing the district courts to proceed to try the issue of whether an agreement to arbitrate was made, when that matter is put in issue, as it was here. But Plaintiffs argued, and the Second Circuit agreed, that no trial on the issue of the making of the agreement to arbitrate is required, and summary judgment denying the motion is proper, unless the moving party shows at least prima facie the existence of such an agreement. Here, the Court held, there was insufficient evidence of even constructive knowledge of the agreement to arbitrate, where there was nothing directing the consumer to find, much less to read the arbitration clause, and nothing requiring the consumer specifically to express agreement with the arbitration clause or, for that matter, the terms and conditions more generally.

A revised and updated version of the International Bar Association Rules for the Taking of Evidence in International Arbitration (“Revised Rules”) is moving rapidly toward formal adoption by the IBA. The draft was published for comment several weeks ago and the comment period ended June 1.

This is the first of perhaps several commentaries on particular aspects of the Revised Rules. 

An important new feature of the Revised Rules concerns the contents of the written reports of party-appointed experts. Under the Revised Rules, the Expert Report must contain “a statement of his or her independence from the Parties, their legal advisers and the Arbitral Tribunal.” Further, if the Expert Report has been translated, it shall contain “a statement as to the language in which it was originally prepared, and the language in which the Party-Appointed Expert anticipates giving testimony at the Evidentiary Hearing.”

The phrasing here concerning independence seems carefully calculated to encourage but not require that the party-appointed Expert should actually be “independent” in the same sense that an arbitrator must be. It also appears intended to encourage but not require fairly extensive disclosure by the Expert of his or her prior business or personal relationships with the parties, their counsel, and members of the Arbitral Tribunal.

It remains up to the parties and their counsel who select their experts to bear whatever credibility risks might be associated with a conclusory or qualified statement of independence, or with a less than fulsome disclosure of past relationships with the appointing party and its counsel. 

The new requirement on translation may help to expose the role of counsel in the preparation of the Expert Report, especially where, as is often the case in investor-State arbitrations, English-speaking investor counsel may have to rely heavily on experts in legal and economic aspects of a State whose official language is not English and whose professional ranks are not generally bi-lingual. 

These new aspects of the rule on Expert Reports highlight for arbitrators some options to streamline proceedings. For example, a Tribunal might inform the parties that it elects not to allow Document Requests for documents concerning the Expert’s relationships with the appointing party and its counsel. In conjunction with taking that position, the tribunal might announce that it will place considerable weight on the Expert’s declaration of independence when it comes time to decide whether the conclusions drawn by the Expert are entirely objective. Cross-examination for bias will tend to be more limited if document production on this subject is off limits.

But the Tribunal can make clear to the parties, at the preliminary hearing or terms of reference stage, that with this limitation on effective cross-examination for expert bias comes a corresponding duty of full disclosure, the absence of which may lead to adverse inferences about the Expert’s objectivity.

It may be that large law firms will continue to use as experts large economics consulting firms to whom they have turned for help on many prior occasions. Compliance by such firms with the new statement of independence requirement is likely to reveal in many cases that the consulting firm has had prior engagements for opposing counsel as well. Such firms thrive because their opinions are respected for objectivity notwithstanding that they may have worked in the past for the same law firm in its representation of other clients.

Thus it remains to be seen whether a new standard of independence for party-appointed experts will emerge, by which the expert is expected to have the same degree of independence as an arbitrator. But the required statements concerning independence and translation, if heeded by the parties and used effectively by the tribunal, can prevent the issue of possible expert bias from becoming a time-consuming sideshow in an already difficult case.

It is important here to take note of the path not taken in these relatively modest steps concerning the independence of party-appointed experts. In September 2007, the Chartered Instutute of Arbitrators (“CIArb”) had issued a “Protocol for the Use of Party-Appointed Expert Witnesses in International Arbitration,” prepared by its Practices and Standards Committee.

The CIArb Protocol urged what some might argue to be a laudable but unrealistic model for party-engaged expertise: that the role of the party-appointed expert should be to assist the Tribunal, by objective analysis, rather than to advocate the position of the party that appointed her. In line with that mission, the CIArb Protocol requires that the Expert Report include a Declaration, in the specific language of Article 8 of the Protocol, and most notably:

“(a) I understand that my duty in giving evidence in this arbitration is to assist the arbitral tribunal decide the issues in respect of which expert evidence is adduced. I have complied with, and will continue to comply with, that duty.

(b) I confirm that this is my own, impartial, objective, unbiased opinion which has not been influenced by the pressures of the dispute resolution process or by any party to the arbitration.”

It merits note that in mandating such a declaration, the CIArb Protocol went further in regulating the expert’s conduct than did the 2005 UK Civil Justice Council’s Protocol for the Instruction of Experts to Give Evidence in Civil Claims (“CJC Protocol”). Article 4 of the CJC Protocol (maintained in the October 2009 updating) declares that experts have a “duty to help the court” that “overrides any obligation to the person instructing or paying them.” And the same Article exhorts experts to “provide opinions which are independent, regardless of the pressures of litigation.” But the CJC Protocol did not propose specific declarations concerning independence as required or even recommended contents of the expert’s written report.

Here I cannot resist a “war story” that is instructive. Some 20 years ago, as counsel to a US company in an ICC arbitration against its Italian supplier, there was a serious question whether the choice of law clause called for, in the circumstances, application of Italian law or the law of New York. I submitted expert opinions on each potentially applicable body of law. The New York law expert, a retired judge of the state’s highest court, recived and edited drafts of his opinion that had been prepared by counsel. The Italian law expert, a professor in Milan, refused to even meet with me to discuss the case, on the basis that he did not wish for his objectivity to be impaired by the advocacy I would presumably introduce into our discussions. This message was conveyed on the day I arrived in Milan for our scheduled meeting. Instead, I enjoyed a sunny late winter day on the ski slopes in Courmayeur. The professor’s opinion was a model of clarity and elegance — in its original Italian and in translation — and it significantly advanced my client’s case.

One can imagine that lawyers with common law training and experience within the IBA Rules working group expressed concern about the constraints on counsel-expert interaction that could arise from imposing such a declaration requirement on party-appointed experts. The IBA Rule strikes a balance by injecting independence as a laudable objective for party-appointed experts, but without legislating independence criteria that would require advocates from different legal cultures to conform their conduct to a uniform transnational standard.

It is essential to the integrity of the arbitral process that arbitrators make complete disclosure, at every stage of the proceedings, of relationships that might reasonably call into question their impartiality or independence in the eyes of the parties. A related principle, less discussed and less articulated in rules and law, is that a party that becomes aware, during the proceedings, of a possibly compromising relationship that an arbitrator has not disclosed, should determine promptly whether the relationship is one that should prevent the arbitrator from continuing to serve, and should raise the issue promptly or be foreclosed from doing so later on.

A recent decision from the US Second Circuit Court of Appeals addresses the disconcerting problem of the party that remains silent, until the award is issued, about a potential conflict of interest of one of the arbitrators that is known to that party but has not been disclosed by the arbitrator.  In this case, the potential for a conflict of interest had been known from the time the underlying contract had been signed, because that contract had made the person eventually named as arbitrator eligible to be appointed to certify the quality of the adverse party’s products. The Court held that a challenge to the award based on the arbitrator’s alleged partiality must fail, where the complaining party had knowledge of the potential conflict of interest at the time the arbitrator was chosen, and thus had sufficient information to investigate the arbitrator’s relationship with the adverse party before or during the arbitration. (Schwartzman v Harlap, 2010 U.S. App. LEXIS 10057 (2d Cir. May 18, 2010)).

The obligations of counsel in the Schwartzman case were relatively clear, because the potential conflict was known from the time of the contract. But when counsel becomes aware, mid-arbitration, of a possibly compromising relationship of the arbitrator, and the existence of a conflict or even a duty of the arbitrator to disclose is not clear absent further investigation, there will rarely be clear ethical and legal rules to guide the decision. If the significance of the relationship cannot be assessed without more investigation, in many legal systems the right to challenge the arbitrator’s impartiality cannot be deemed waived where waiver requires a fully-informed decision. But if the party knows or has reason to know that the information is not necessarily known to the arbitrator — such as an attorney-client relationship in a distant overseas office of her firm — then unless rules or laws require action or penalize inaction by counsel, there will be a natural temptation to have the best of both worlds for the client by awaiting the arbitrator’s award and then making a challenge if it is not satisfactory.  

Courts and arbitral institutions should develop rules that advance a simple and uncontroversial goal: to have the least amount of repetition of proceedings resulting from arbitrators’ voluntary or required resignations or succesful challenges to awards. That goal is best served by penalizing a party for its failure to explore fully a potential conflict of interest at the time the circumstances came to its attention. In theory, this could result in preventing succesful challenges to awards that may indeed have been influenced by a predisposition of the arbitrator toward the winning side. But in a system that values efficiency and transparency, the party who becomes aware of the potential for this outcome and uses it as a form of hedging deserve little sympathy and it seems entirely just to prevent the party from challenging the award and partiality grounds.

Recently the US Third Circuit Court of Appeals, sitting en banc on its own motion, held that when a motion to compel arbitration is opposed to the extent that the arbitration clause bars class actions, the District Court must resolve the challenge to the class action prohibition, and not refer that issue to the arbitrator. (Puleo v. Chase Bank USA, 2010 U.S. App. LEXIS 9497 (3d Cir. May 10, 2010)).

The Third Circuit en banc majority opinion starts from the premise that a “question of arbitrability” is presented whenever one party challenges in whole or in part the validity of the arbitration agreement.

I question this broad an approach. Certainly if a party contends that the agreement to arbitrate is a contract of adhesion and should not be enforced, there is a question of arbitrability. If that party’s position is sustained, the dispute is resolved in court.

But how does the principle articulated by the Third Circuit apply when, as in Puleo, the named parties do not contest that their claims must be arbitrated, but insist that those portions of the arbitration clause that prevent them from arbitrating in a representative capacity are unconscionable? Is this a question of “arbitrability” as the courts have defined that phrase? When the consequence of deciding the validity challenge favorably is to enlarge the scope of arbitration, not to remove disputes or parties from arbitration, is that an “arbitrability” decision?

The Third Circuit majority says “yes.” The Court maintains that the issue is one of the alleged partial invalidity of the arbitration agreement. The majority addresses the issue from several directions. First, they point out that the FAA only permits a court to compel arbitration in accordance with the terms of the parties’ agreement. Thus, the Court reasons, if there is a dispute over what those terms are, the Court must resolve it before making its order to compel arbitration. On this view, a challenge to the validity of any portion of the arbitration agreement, when raised in conjunction with a motion to compel, must be regarded as a question of arbitrability for the court to decide (absent a clear and unmistakable agreement of the parties to have the arbitrator decide it).

Thus, the Court holds, the District Court here could not have entered an order to compel arbitration without first resolving Plaintiffs’ unconscionability challenge to the class action waiver.

Next, the Third Circuit expresses the view that deciding whether the arbitration may proceed as a class action “calls into question the very authority of the arbitrator to preside over the dispute, and, by extension, the validity of the Agreement itself.”

This articulation is imprecise. When the Claimant questions not the duty to arbitrate but only the clause’s limitation on arbitrable claims to those claims that are personal to the Claimant, the arbitrator’s “authority to preside” is not at issue. The question is does the arbitrator have authority to preside over dozens or hundreds of consolidated disputes that are substantially identical, and as to which the putative individual claimants have not opted in, nor assigned their claims to the nominal Claimant, nor otherwise indicated a desire to have their rights arbitrally determined.

It is this array of “who” questions — with whom have Defendants agreed to arbitrate in this case, and which Claimants have agreed to arbitrate their claims in this case, that makes the issue of whether the class action waiver is unconscionable a question of arbitrability. Indeed, in the Supreme Court’s recent decision in the Stolt-Nielsen case, the “who are the parties to the agreement” question is identified as the marker that makes the issue of class action arbitration a question of arbitrability on which no deference is due to an arbitrator’s decision.

Four of the ten judges of the Third Circuit, joining in a dissent, held the view that no question of arbitrability was presented, and that the question of whether the class action waiver was unconscionable was suitable for the arbitrator to decide as a question of arbitral procedure. The dissenters’ state that their conception of arbitrability is that of the Supreme Court in Howsam v Dean Witter — i.e. either a dispute over the validity of the arbitration agreement, or a dispute of whether a particular claim or dispute is within the scope of what the parties agreed to arbitrate. The dissenters find that the class action waiver unconscionability issue does not fall into either category.

But the position that this is not a “scope of arbitrable issues” arbitrability question is, in my view, flawed. Whether the parties’ agreement provides for arbitration over the alleged unfair treatment by the bank of a credit card holder other than the named claimant seems to me to be just as much a scope issue as whether the sgreement provides for arbitration of the named claimant’s unfair treatment claim. In my view a matter of procedure is a matter concerning how the arbitrator organizes proceeding leading to the final adjudication of the claimant’s claim. If the arbitrator were permitted to decide whether she may also adjudicate claims belonging to absent claimants for whom the nominal claimant wishes to be a proxy, she would not be deciding only the procedure for getting to a result on the claimant’s claim.

The politically-charged access to justice considerations associated with disputes over class arbitration appear to have been as divisive within the Third Circuit as they were on the Supreme Court in Stolt-Nielsen. Regrettably, these considerations threaten to interfere with precise analysis. Within the framework of federal jurisprudence on the allocation of decisions between courts and arbitrators, the unconscionability issue in Puleo v Chase seems to have been clearly one for the court. Taking that view should not brand its proponents as opponents of arbitral class actions merely because, in this case, the District Court held that the class action waiver was not unconscionable. Indeed a growing body of federal appellate jurisprudence has sustained district court decisions finding such waivers in comsumer contracts to be unconscionable under applicable state law. District courts in the Third Circuit, such as the one in Puleo v Chase, have been inhibited from so ruling by a much-criticized Third Circuit decision in 2007 (Gay v CreditInform, 511 F.3d 369) that suggested in dicta that Pennsylvania unconscionability law as applied to class action waivers is pre-empted by the Federal Arbitration Act. But the Third Circuit in a subsequent case held that New Jersey law as applied to class action waivers is not pre-empted by the FAA (Homa v. American Express, 558 F.3d 225).

Last week the Supreme Court accepted certiorari in a case from the Ninth Circuit, in which the Court affirmed a District Court decision finding an arbitral class action waiver unconscionable under California law. (AT&T Mobility v. Concepcion). The Supreme Court has agreed to consoider whether the FAA pre-empts California law because the unconscionability principles applied are specific to arbitration clauses and not applicable to contracts generally. (Discussion of that issue will be the sunject of a future Commentary).