Supreme Court Says that Parties May Not Agree to
Expanded Grounds for Overturning Arbitration Decisions
Beyond Those Provided in the Federal Arbitration Act

by Ted Olsen 

Since our last newsletter, on March 25, 2008, the Supreme Court issued a decision that could be of great importance to employers that have individual arbitration agreements with their employees.  While the case, Hall Street Associates, L.L.C. v. Mattel, Inc., 552 U.S. --- , 128 S.Ct. 1396 (2008), involves a commercial arbitration dispute, and is procedurally complicated, the Supreme Court's decision indicates that arbitration decisions will seldom be overturned by courts on appeal, at least when the basis for enforcing the arbitration agreement is the Federal Arbitration Act.

In this commercial lease dispute, the landlord (Hall Street) contested the tenant's (Mattel's) right to terminate the lease, and also claimed that Mattel was responsible for paying environmental clean-up at the premises.  Mattel defended its right to terminate the lease and denied its duty to pay the clean-up costs. 

Mattel's right to terminate the lease was upheld in a court trial.  The parties then agreed to refer the remaining dispute - the landlord's claim for the costs of clean-up - to arbitration.  The parties signed an arbitration agreement (entered by the court as a court order), with a provision requiring the court to "vacate, modify or correct" any arbitration award "where the arbitrator's findings of facts are not supported by substantial evidence, or . . . where the arbitrator's conclusions of law are erroneous."  It was proven that the parties would not have agreed to arbitration had they known that the "erroneous conclusions of law" judicial review would not be available.  The arbitration agreement expressly mentioned one FAA section, not pertinent to the case, giving arbitrators the power to compel the attendance of witnesses at arbitration hearings.  (The FAA is one of a number of legal grounds for the enforcement of arbitration agreements and arbitration decisions.)  

The parties' arbitration agreement (and the related court order) provided far greater court  review of an arbitration decision than that provided by the FAA.  Section 10 of the FAA lists only a few narrow grounds for vacating an arbitrator's award, such as when the award is procured by "corruption," "fraud," or "undue means," and when the arbitrators were "guilty of misconduct" or "exceeded their powers."  Section 11 of the FAA also provides for the modification or correction of an award in only a few narrow situations - when there is an "evident material miscalculation," "evident material mistake," and "imperfect[ions] in [a] matter of form not affecting the merits."

The arbitrator ruled for the tenant.  The landlord was then successful asking the court to vacate the arbitrator's award based on "erroneous conclusions of law," as provided in the agreement (and court order).  Although Mattel argued that the FAA restricted the permissible scope of judicial review to those grounds enumerated in the FAA, the court said the FAA left parties "free ... to draft a contract that sets rules for arbitration and dictates an alternative standard of review." 

The arbitrator issued a new award, resulting in another district court decision, this one generally upholding the new arbitration award.  Both parties then took the case to the Ninth Circuit Court of Appeals, which ruled that the "erroneous conclusions of law" provision of the arbitration agreement was unenforceable, as inconsistent with the FAA. 

After the case was sent back to the district court and again appealed to the Ninth Circuit, the case was taken to the U.S. Supreme Court.  In a 6-3 decision, the Supreme Court approved of the Ninth Circuit's decision, holding that the parties could not validly expand the grounds for judicial review of an arbitration award, at least if the parties sought review or enforcement of the award under the FAA. 

The majority of the Supreme Court concluded that, although arbitration is a creature of contract, and the FAA lets parties tailor certain features of arbitration by contract, the FAA has "textual features at odds with enforcing a contract to expand judicial review following the arbitration."  The majority read the provisions of Sections 10 and 11 of the FAA as providing limited and strictly enumerated grounds for overturning an arbitration award, none of which included "erroneous conclusions of law."  

The significance of Hall Street is unclear, because of its narrow scope.  The Court majority emphasized that the FAA "is not the only way into court for parties wanting review of arbitration awards:  they may contemplate enforcement under state statutory or common law, for example, where judicial review of different scope is arguable."  The majority also observed that, throughout the entire case, the parties consistently treated the case only as a FAA case.  Instead of treating this case strictly as an FAA case, the Court said that the parties might have "amended [their pleadings] to raise an independent state-law contract claim or defense specific to the arbitration agreement."   

If an employer currently has arbitration agreements providing for enforcement under the FAA and giving a reviewing court the authority to overturn an arbitration award based on erroneous conclusions of law (or based on a lack of substantial evidence to support factual findings), those review provisions are now invalid.  Employers may wish to enter into new arbitration agreements with their employees, providing for the enforcement of the agreement under laws other than the FAA.  Alternatively, employers - when attempting to obtain a judicial reversal of an arbitration award based on grounds not enumerated in the FAA - should not pursue the court proceedings under the FAA.

Sherman & Howard has prepared this advisory to provide general information on recent legal development that may be of interest. This advisory does not provide legal advice for any specific situation. This does not create an attorney-client relationship between any reader and the Firm. If you want legal advice on a specific situation, you must speak with one of our lawyers and reach an express agreement for legal representation.

© 2008 Sherman & Howard L.L.C.                                                            May 6, 2008