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Hall Street Associates v. Mattel Supreme
Court Prohibits Parties From Agreeing to Expansive Judicial Review of an Arbitration Award Under the Federal Arbitration Act

03.28.2008

On March 25, 2008, the U.S. Supreme Court invalidated a contract clause that provided for expanded judicial review of an arbitration award. In Hall Street Associates, LLC v. Mattel, Inc., the Court held that the exclusive grounds for a court to vacate or modify an arbitration award under the Federal Arbitration Act ("FAA") are the limited grounds stated in that Act. Clients that have relied on arbitration as an alternative to litigation, and particularly those clients who sought to expand the limited judicial review provided in the FAA, should review their existing contracts and forms of contracts to see whether Hall Street affects them.

Background

Originally enacted to overcome judicial hostility to arbitration, the FAA provides that contracts to arbitrate disputes are "valid, irrevocable, and enforceable." Section 9 of the FAA provides that a court must confirm an arbitration award unless the egregious grounds identified in Sections 10 and 11 of the FAA exist: fraud, corruption, evident partiality, misconduct, exceeding powers, evident material mistake, and the like. Where such grounds exist, the FAA empowers a court to vacate or modify an arbitration award.

In Hall Street, the landlord sued its tenant claiming that the tenant had improperly terminated the lease and seeking indemnification of environmental cleanup costs. The Oregon District Court ruled for the tenant on the termination claim. The parties then entered into a written agreement to arbitrate the indemnification claim, which the district court approved and entered as an order. The parties' agreement provided that the district court could vacate or modify the arbitration award on grounds more lenient than the FAA provided. Specifically, the district court could vacate or modify the award if the arbitrator's findings of facts were not supported by substantial evidence or if the arbitrator's conclusions of law were erroneous.

The arbitrator ruled for the tenant on the indemnification claim. On the landlord's motion, however, the district court vacated the arbitration award, citing errors of law, and remanded the case for further consideration by the arbitrator. On remand, the arbitrator followed the district court's ruling and amended the award to favor the landlord. The district court corrected the arbitrator's calculation of interest but otherwise upheld the award. The Ninth Circuit reversed, ruling that the provision in the parties' contract expanding the scope of judicial review beyond the limited grounds identified in the FAA was unenforceable, and remanded the case to the district court. The district court again held for the landlord, albeit on slightly different grounds, and the Ninth Circuit again reversed.

The U.S. Supreme Court granted the landlord's petition for certiorari and, in a 6-3 decision, agreed with the Ninth Circuit that the FAA provides the exclusive grounds for a court to vacate or modify an arbitration award when enforcement is sought under the expedited judicial review provisions of the FAA. The Court first rejected the landlord's suggestion that prior case law had recognized "manifest disregard of the law" as an additional ground for vacating arbitration decisions and that this judicial expansion of the limited grounds set forth in the FAA suggested that contracting parties also should be able to expand this ground. In doing so, the Court did not hold that "manifest disregard of the law" did not create a new ground for review, but it certainly questioned the suggestion that "manifest disregard of the law" was indeed a new ground for review. Next, the Court looked to the text of Sections 9 through 11 of the FAA and concluded that the listed grounds for overturning arbitration awards were designed to be exclusive and were not simply default provisions that parties could modify by contract. The Court also reasoned that the FAA's policy favoring arbitration is consistent with limiting judicial review to just the amount "needed to maintain arbitration's essential virtue of resolving disputes straightaway." "Any other reading," held the Court, "opens the door to the full-bore legal and evidentiary appeals that can 'rende[r] informal arbitration merely a prelude to a more cumbersome and time-consuming judicial review process.'" The Court declined to assess whether its ruling would, on net, encourage or discourage arbitration, saying that "whatever the consequences of our holding, the statutory text gives us no business to expand the statutory grounds."

The Court stressed, however, that its holding was limited to cases where awards are reviewed under the FAA. When parties seek enforcement of an arbitration award under state statutes or common law, rather than under the expedited review provided by the FAA, other grounds for vacatur or modification may apply. The Court chose to remand the case before it because of its unusual procedural posture: the arbitration agreement was entered into as part of district court litigation, and the Court was unclear whether the arbitration proceedings (including the district court’s rejection of the arbitration award) should have been viewed as an exercise of the district court’s case management authority rather than review under the FAA. The Court raised this ground itself at oral argument; neither of the parties nor any of the amici had mentioned this alternative in their briefs.

Future Consequences

Clients that wish to arbitrate but also wish to avoid an aberrant result may have arbitration clauses in their contracts with judicial review provisions similar to the provision in Hall Street. Clauses that expand judicial review beyond the grounds identified in the FAA are now unenforceable—at least in the usual situation where the party that won the arbitration seeks judicial enforcement under the FAA. Thus, clients should review their existing contracts and forms of contracts for such clauses and consider carefully whether, given the limited judicial review available under the FAA, arbitration is still desirable.

Parties that desire more searching appellate review than the FAA provides and are willing to forgo the FAA's streamlined review procedure may still have several options. First, the Supreme Court recognized that more searching judicial review may be available when the FAA does not govern the proceedings. In response, parties may try to stipulate that their agreements to arbitrate and any proceedings to enforce arbitration awards will be interpreted and enforced under state law rather than the FAA, assuming, of course, that state law permits broader judicial review. Alternatively, the parties could agree that neither the FAA nor state arbitration law applies to their arbitration agreement and provide instead for its enforcement as an ordinary contract, much as was done prior to enactment of the FAA. It remains to be seen whether the courts will accept such work-arounds or find them contrary to the FAA.

Second, parties may rewrite their arbitration agreements to provide for an arbitral appellate panel that would review the trial arbitrator's legal conclusions for legal error, just as appellate courts do when reviewing trial court decisions. No award would be final and subject to enforcement until after the appellate panel had ruled. Of course, the additional cost of an arbitral appellate panel should be considered before including such a provision in a contract.

Sometimes, as in Hall Street, parties are already in court when they decide to arbitrate. In such cases, there may be at least two potential "work-arounds" to the Hall Street decision. First, the parties could petition the court for an order providing for expanded judicial review. (As discussed above, the Hall Street Court expressly declined to rule whether a district court's case management authority extends to ordering the parties to arbitrate while maintaining full review of the resulting arbitration award.) Second, the parties can ask the district court to appoint a special master under Federal Rule of Civil Procedure 53 to hear and rule on the case. Under Rule 53, the special master's findings of fact and conclusions of law will be reviewed for error, unless the parties agree to a different standard. Indeed, the parties may even write one of these work-arounds into their arbitration agreement, though the first certainly remains untested.

Only time will tell whether the landlord in Hall Street was right when it argued that parties will flee from arbitration without the option of expanded judicial review under the FAA. And, of course, as the Hall Street litigation proceeds, we may learn more about the power of courts to expand the scope of judicial review under their own case management authority.