The U.S. Third Circuit Court of Appeals has issued an important reaffirmation of certain core principles in the American jurisprudence of the New York Convention. In a “non-precedential” opinion that will nevertheless be very persuasive in future cases, the Court:
1. Declared, consistent with prior case law in other federal courts, that Convention Article V(1)(e)’s reference to “a competent authority of the country… under the law of which the award was made” refers “‘exclusively to procedural and not substantive law, and more precisely, to the regimen or scheme of arbitral procedural law under which the arbitration was conducted.'” Here, the Court held, the arbitration award was made in Singapore under Singapore arbitration procedural law, and so the order of a Philippine court that might have been construed as setting aside the award furnished no basis for a U. S. court to refuse enforcement.
2. The “public policy” defense to enforcement under Convention Article V(2)(b) extends only to “‘violat[ions] [of] the forum state’s most basic notions of morality and justice.'”
Here, the Court found, not only was there no violation of public policy by the District Cour proceeding with enforcement while set aside proceedings were pending in Singapore, but such action was fully consistent with the policy objectives underlying U.S. accession to the Convention.
Steel Corp. of the Philippines v. Int’l Steel Services, 2009 U. S. App. LEXIS 25404 (3d Cir. Nov. 19, 2009).

Does Chapter Two of the Federal Arbitration Act confer federal subject matter jurisdiction, in a federal district court at the seat of the arbitration, over a motion to vacate a Convention award?

A senior federal district judge in Chicago has raised this issue, sua sponte, in an action to vacate a Convention award that was brought to the federal court from an Illinois state court by a Notice of Removal. In a published order, the Court expressed doubt that federal subject matter jurisdiction exists, and invited the parties to brief the issue by December 9. Virginia Surety Co. v. Certain Underwriters at Lloyd’s, 2009 U. S. Dist LEXIS 110320 (N.D. Ill Nov. 25, 2009).

It may be assumed that the issue arises because the underlying arbitration, and the action for vacatur brought in the Illinois court, are between two parties of non-U.S. nationality. Thus the case falls within that anomalous lacuna of federal diversity jurisdiction: that an action between a French corporation and a German corporation, for example, must be brought in a state court unless a federal statute or treaty, or the U.S. Constitution, is involved.

Chapter Two of the FAA, enacted in 1970, was motivated by the desire to pass enabling legislation to adopt the New York Convention as a fully effective treaty of the United States within the body of domestic law. Section 201 of the FAA states that the Convention “shall be enforced in accordance with this Chapter.” But does this mean that Chapter Two’s jurisdiction-conferring sections only operate to confer jurisdiction over an action or proceeding that the Convention and/or Chapter Two recognizes expressly, i.e. an action to enforce an agreement to arbitrate or to recognize and enforce an award?

Parsing of the text of Chapter Two suggests that it is not so limited. Section 202 sets about to define when an arbitration agreement or award — not an action or proceeding — “falls under the Convention.” These are defined to be arbitral agreements and awards “arising out of a legal relationship…which is considered as commercial,” but excluding those relationships that are entirely between U.S. citizens unless that relationship involves property located abroad or some other substantial relationship with a foreign state.

Section 203 then confers subject matter jurisdiction on federal courts by stating that “any action or proceeding falling under the Convention” shall be deemed to arise under the laws and treaties of the United States.” There is no definition given of “action or proceeding falling under the Convention.” Had the drafters intended “falling under the Convention” in Section 203 to have a more limited scope than what “falls under the Convention” in Section 202 — i.e. had they meant only actions to enforce agreements or awards — one would think Section 203 would have been written in a different way. It could have referred, narrowly, to the actions and proceedings authorized by Chapter Two. The compelling inference from the consecutive repetition of “fall[…] under the Convention” in Sections 202 and 203 is that any action or proceeding authorized by law that involves a Convention agreement or award is within the subject matter jurisdiction conferred on the federal courts by Section 203 — and it would be for a federal court also to decide whether a particular action or proceedings relating to a Convention agreement or award does in fact exist as a matter of law.

The Court in Virginia Surety points out that Section 207 of the FAA expressly provides for an application in federal court to confirm a Convention award. The Court then goes on to note the absence of any similar express reference to an application to set aside an award.

The piece missing from the Court’s discussion is Section 208. It provides that Chapter 1 of the FAA shall apply “to actions and proceedings brought under this chapter” to the extent Chapter One is not in conflict with Chapter Two or the Convention.

But Section 208 is not necessarily dispositive. Strictly construed, Section 208 could be interpreted not as folding into Chapter Two the “actions and proceedings” mentioned only in Chapter One, but only as applying Chapter One procedures, residually, to actions and proceedings authorized by Chapter Two. But this interpretive dilemma perhaps does not need to be resolved. Instead, one may refer back to the jurisdiction-conferring Section 203. Notably, it speaks in terms of “actions and proceedings falling under the Convention” and not merely those actions and proceedings authorized by Chapter Two. If, as seems evident, Section 203 “actions and proceedings” includes more than the Section 206 motion to compel arbitration and the Section 207 motion to confirm an award, then the “more” almost certainly includes a motion to vacate, modify, or correct an award. And Section 208 would seem to be corroborative of that construction of Section 203, even if it is not unambiguously and autonomously the source of the incorporation of Sections 10 and 11 into Chapter Two.

Sections 10 and 11 of the FAA, providing the procedures and grounds to vacate, modify, or correct an award are not in conflict with Chapter Two or the Convention. Neither Chapter Two nor the Convention prohibits such a motion in regard to a Convention award. Indeed the Convention, while it does not state grounds or procedures for a motion to vacate, does provide in Article V(1)(e) that recognition and enforcement may be refused if an award has been set aside by a competent court of the country in which, or under the law of which, an award was made.

Chapter One of the FAA does not provide for federal subject matter jurisdiction over a motion to vacate, and so in a non-Convention case the motion may be made in federal court only if the parties to the vacatur proceeding have diverse citizenship under the diversity statute, or if a federal question claim was adjudicated in the award and thus could have appeared on the face of a well-pleaded federal complaint had there been no agreement to arbitrate. But in a non-Convention case this allocation of jurisdiction is simply one aspect of a Congressional judgment made when the FAA was enacted in 1925, to overcome hostility to arbitration in state courts not by divesting them of jurisdiction, but only by requiring them to apply federal law where the “commerce” requirement is met.

Chapter Two’s jurisdiction-conferring provisions reflect a policy choice to ensure uniform national application of the Convention and of its core undertaking to secure enforcement of international arbitral awards except of the very limited grounds for refusal or recognition and enforcement that are stated in the Convention. The policy decision very decidedly was the opposite of the one made in 1925 — uniformity is to be achieved by application of federal law by federal judges. Whereas vacatur of an award by a competent court at the seat of the arbitration is one of the grounds for denial of recognition and enforcement stated in the Convention, a construction of Chapter Two that places motions to vacate an award within the federal subject matter jurisdiction conferred by Section 203 is entirely consistent with the underlying goal of uniformity of treatment.

Further, a decision to the contrary could have serious practical consequences. Suppose a motion to vacate a Convention award is brought in state court and may not be removed under Chapter Two. The winning side may feel pressure to seek recognition and enforcement in the state court, to avoid multiple actions. Alternatively the winning side might move in federal court for recognition and enforcement. The state court vacatur movant then would ask the federal court to stay the proceedings until the vacatur action runs its course. If the stay is granted, the federal court effectively cedes control over the pace and the substance of the enforcement process to the state court. If the stay is denied, the federal court effectively adjudicates the vacatur action by permitting the award to become an enforceable federal judgment while the vacatur action may still be in the starting gate. Possibly this situation could be addressed by removal of the vacatur action based on principles of Supplementary Jurisdiction. But this is relatively uncharted territory: Removal would have to be under the general removal statute, not Section 205 of the FAA, and 28 USC 1441(a) permits removal of state court actions over which federal courts would have “original” (not Supplementary) jurisdiction.

Perhaps a bit of common sense helps to solve the problem as well. A motion to vacate a Convention award made by a losing U.S. party against a French party may be adjudicated in federal court, based on diversity if not on the jurisdiction conferred by Chapter Two. If the award is instead against a Canadian party and in favor of a French party, it simply makes no sense that the Canadian party should have lesser access to the federal courts on a matter related to the effectiveness of a Convention award than would a U.S. party. Indeed that outcome discriminates against the foreign party that consented to arbitrate in the United States, giving it different (if not necessarily less favorable) procedural rights under the New York Convention than a U.S. party would have. In this situation, then, the operative principle of statutory construction should be that legislation implementing a multilateral treaty like the New York Convention should be construed where possible so as not to accord different treatment to U.S. nationals and nationals of our treaty partners. This principle should trump the more general principle that grants of federal subject matter jurisdiction should be narrowly construed.

A recent decision of the U.S. Tenth Circuit Court of Appeals assesses sanctions in the form of an award of attorneys’ fees against counsel for a party appealing the confirmation of an arbitration award on grounds of “manifest disgregard of the law.”

While allowing that “manifest disregard” has some continuing vitality after Hall Street Assocs. v Mattel, Inc., the Court here found the arguments foir vacatur completely meritless.

The arbitration community should be encouraged at the Court’s explicit linkage of the attorney’s fee sanction issue to the very limited prospects for vacatur based on manifest disregard, and to the essential conflict between protracted post-award litigation and arbitration’s promise of efficient dispute resolution. Said the Court: “[U]njustified, protracted attempts to vacate arbitration awards destroy the ‘promise of arbitration’ and will not be tolerated….Thus, one who ‘assumes a never-say-die attitude and drags the dispute through the court system without an objectively reasonable belief that it will prevail’ does so at the risk of being sanctioned.” (DMA Int’l Inc. v. QWest Communs. Int’l, Inc., 2009 U.S. App. LEXIS 24165 at *9 (10th Cir. Nov. 5, 2009) (internal quotation marks and citations omitted).

An arbitration lawyer immersed in the U.S. jurisprudence of the New York Convention, but not necessarily versed in all of the nuances of the Supremacy Clause of the U.S. Constitution, might be tempted to conclude that international arbitration scored a remarkable upset victory, against long odds, in the U.S. Fifth Circuit Court of Appeals last week. (Safety Nat’l Cas. Corp. v. Certain Underwriters at Lloyd’s, 2009 U.S. App. LEXIS 24585 (5th Cir. Nov. 9, 2009)).

By a vote of 15 to 3, the judges of that Court sitting en banc ruled — sustaining the original decision of a three-judge Fifth Circuit panel — that the Convention preempts and nullifies a provision in the Louisiana state insurance law requiring that insurance disputes be resolved only by judges and juries.

To reach that outcome, the majority needed to overcome what is perhaps the most notorious “reverse preemption” statute in U.S. law, the McCarran-Ferguson Act. That Congressional enactment, from 1945 — 25 years before the United States implemented the New York Convention — provides that “No Act of Congress shall be construed” to invalidate any state law enacted “for the purpose of regulating the business of insurance” unless the impairment is by an Act of Congress that “specifically relates to the business of insurance.” In simplest terms, McCarran-Ferguson states that only federal statutes dealing specifically with insurance can preempt state insurance regulation.

Clearly the Convention in its inception was not an “Act of Congress,” it was an international treaty. Its implementing legislation, Chapter Two of the Federal Arbitration Act (sometimes called the “Convention Act”), surely is an “Act of Congress.” But is the Convention, once implemented, an Act of Congress for domestic law purposes, or does it have from that point forward the same force of law domestically as would a treaty that is “self-executing,” i.e. that did not require implementing legislation to have domestic legal effect?

The question before the Fifth Circuit was, in essence, this: To reach the conclusion that the Convention’s command to enforce arbitration contracts preempts Louisiana’s law denying enforcement of such contracts in the insurance industry, must the federal courts “construe” an Act of Congress, FAA Chapter Two, and thus collide with McCarran-Ferguson — or do they merely “construe” the Convention itself, such that McCarran-Ferguson does not come into play?

The dissenting opinion in Safety National methodically demonstrates that the New York Convention has the force of law in the United States only by virtue of its implementation by the Convention Act, and that courts, when they preempt state laws based on treaties that required implementation by Acts of Congress, have consistently stated that they were assigning the preemptive effect to the implementing statutes, not the treaties themselves. The dissent reasons further that the phrase “shall not be construed to invalidate,” in McCarran-Ferguson, does not refer to a process of interpreting the words of an Act of Congress, but rather means simply that Acts of Congress shall not be given legal effect to preempt state law (unless the Act regulates insurance explicitly).

This makes a great deal of sense. And so those of us inclined the handicap whether the Supreme Court of the United States might seize an opportunity here for an important New York Convention decision review carefully the majority opinion to see if its answers to the dissent are convincing.

The majority’s lead-off position is that implementation of the Convention by the Convention Act does not transform the Convention from a treaty into an “Act of Congress.” But this position would seem to beg the fundamental question: whether for McCarran-Ferguson purposes what is being “construed,” in case of a treaty implemented by Act of Congress, is the treaty as a stand-alone legal unit, or the treaty as an incorporated element of the implementing statute.

On this point, the majority declares that “it is the treaty (the Convention), not an act of Congress (the Convention Act), that we construe to supersede Lousiana law.” But one reads on in the majority opinion yearning to be convinced that “construed” in McCarran-Ferguson does not mean “to be assigned preemptive effect,” as the dissent convincingly posits. The majority relies heavily on the notion that the Convention Act merely declares that the Convention shall be enforced, and hence any “constru[ing]” is done in relation to the treaty not the statute. But this reasoning fails to address whether, when a treaty requires implementing legislation to have effect as domestic law, it retains or acquires a domestic legal status after implementation that is separate and distinct from the implementing statute.

The majority defends its position with extensive and rather speculative discussion about what the Congress might have intended, concerning treaties implemented by statute, when McCarran-Ferguson was enacted. But it seems most probable that Congress thought the term “Act of Congress” was not ambiguous and that, treaty implementation having long been a familiar species of legislation, such statutes were among those to which McCarran-Ferguson makes reference.

The majority then states that “[o]ur conclusion that referral to arbitration is proper in this case is bolstered by the congressionally sanctioned national policy favoring arbitration of international commercial agreements.” Indeed. “Bolstered” puts the case mildly; one might well say the majority’s analysis is driven by that policy. But as there is no jurisprudentially-sound basis to say that the pro-arbitration policy of the Convention has priority over the pro-state regulation of insurance policy of McCarran Ferguson, this statement on the majority opinion adds little to its persuasive force.

The persuasive force of the dissent in Safety National, coupled with an apparent split in the Circuits based on a Second Circuit decision in 1995, makes this case a ripe prospect for the grant of certiorari by the Supreme Court. The case will surely be closely-watched for the filing of a certiorari petition and the disposition of that petition.

It will be interesting to see whether the Lloyd’s underwriting syndicate that prevailed in the Fifth Circuit would elect to rely mainly on the majority’s rationale if the case does reach the Supreme Court. The majority opinion did include an elaborate footnote indicating that a strong case could be made that the forum-selection provision of the Louisiana statute is simply not a regulation of insurance within the meaning of McCarran-Ferguson. This could be the path of less resistance to a pro-arbitration solution in the Supreme Court.

Our U.S. Court of Appeals for the Fifth Circuit has issued an important en banc decision, refusing to enforce a Louisiana state insurance law whose effect is to prohibit arbitration of international insurance disputes, on the basis that the Louisiana law is pre-empted by the New York Convention and Chapter Two of the Federal Arbitration Act.

This outcome might on the surface appear to be unsurprising. But the federal McCarran-Ferguson Act provides that no Act of Congress shall interfere with the rights of the states to regulate the business of insurance. Therefore the Court had to struggle with the question whether there was a “reverse pre-emption” of the New York Convention, if it were concluded that the Convention’s implementing legislation, FAA Chapter Two, is an “Act of Congress” that “interferes with” state regulation of insurance insofar a state regulates insurance by requiring a judicial forum to resolve disputes.

Useful analysis of the main opinion, concurrence, and dissent in the case will require some time. I will post a full commentary to Arbitration Commentaries in a day or two. But given the importance of the decision I did not want to delay reporting it to you. The case is: Safety National Casualty Corp. v. Certain Underwriters at Lloyd’s, 2009 U. S. App. LEXIS 24585 (5th Cir. Nov. 9, 2009).

According to a recent decision of the U.S. Court of Appeals for the Third Circuit, a retrocession agreement (reinsurance of reinsurance) that incorporates by reference all terms of a reinsurannce contract that contains an arbitration clause, does provide for arbitration of disputes under the retrocession contract. Further, the Court held, courts must address the question of incorporation-by-reference of an arbitration clause just as they would address the incorporation of any other contract term. To impose a more stringent legal standard for incorporation of an arbitration clause, as compared to other commercial terms, would violate the command of the Federal Arbitration Act (“FAA”) that arbitration agreements be enforced “save upon such grounds as exist in law or in equity for the revocation of any contract.” (Century Indem. Co. v. Certain Underwriters at Lloyd’s, 2009 U. S. App. LEXIS 22619 (3d Cir. Oct. 15, 2009)).

Incorporation-by-reference is a pervasive arbitrability problem in complex, multi-layered commercial relationships. Reinsurance and large-scale construction projects are typical contexts in which the issue may arise.

In reaching the conclusion that the retrocession agreement did indeed incorporate the reinsurance contract’s arbitration clause, the Third Circuit had occasion to work through and clarify two relatively murky issues in the federal law of arbitrability.

First, the Court examined Supreme Court arbitrability jurisprudence to ascertain if federal policy favoring arbitration fosters any presumption in favor of the existence or validity of an arbitration agreement. The Court found little support for such a presumption, as the federal policy favoring arbitration would seem to be triggered only once parties are found — according to applicable state-law principles governing formation of any contract — to have made an agreement to arbitrate.
The presumption of arbitrability, the Court stated, probably applies only in determining the scope of arbitrable issues under a valid arbitration agreement. But the Court, acknowledging some ambiguities in its own decisions, found it unnecessary to make a definite ruling on this point because a valid arbitration agreement could be found here without the benefit of a presumption.

The second issue addressed involved the effect of prior Third Circuit case law requiring an arbitration agreement to be “express” and “unequivocal” to merit enforcement. Did such language refer to a substantive standard? And if so, was the standard at odds with the FAA’s basic command to enforce arbitration agreements on the same basis as other contracts? Alternatively, did this “express” and “unequivocal” language merely refer to the circumstances in which an arbitration clause would be enforced by summary judgment despite one party’s claim that factual disputes about the formation of the agreement required a trial
of that question?

The Court rejected use of these terms as a substantive standard, on the basis that both the text of the FAA and decisions of the Supreme Court require that the validity of an arbitration agreement be decided upon ordinary state law contract principles generally applicable to all
contracts.