By John H. Binning and Robert L. Nefsky
[John H. Binning is Of Counsel with Rembolt Ludtke & Berger LLP, in Lincoln, Nebraska. He is an ARIAS-US certified arbitrator, on the ARIAS- US umpire list, listed on American Arbitration Association Panel of Neutrals and National Umpire Roster for Insurance and Reinsurance Industry, a former insurance company chief executive officer, a director and former Chairman of the Federation of Insurance Counsel, and a former Director of Insurance for Nebraska. Robert L. Nefsky is a partner of Rembolt Ludtke & Berger LLP, in Lincoln, Nebraska, specializing in business organizations (including insurance organizations), acquisitions, dispositions, securities, banking and finance.]
This article addresses vacation of arbitration awards under the Federal Arbitration Act only where the arbitrators are found to have evidenced a manifest disregard of the law. Court decisions vacating domestic arbitration awards due to manifest disregard of the law are based on the general standard for vacation, i.e. "[w]here the arbitrators exceeded their powers." Federal Arbitration Act, 9 U.S.C. § 10(a)(4). Current holdings of all circuits are cited and decisions reaching different conclusions are compared.
The Manifest Disregard Of The Law Standard
Section 10 of the Federal Arbitration Act ("FAA"), 9 U.S.C. §§ 1 et seq., limits the basis for vacating an arbitration award.1 Until the decision of the Supreme Court in Wilko v. Swan, 346 U.S. 427 (1953), the Court had not specifically addressed the general subject. Wilko involved a case for damages under Section 12(2) of the Securities Act of 1933, 15 U.S.C. §§ 77 et seq. In order to pursue arbitration, respondents moved to stay the action and to refer the action to arbitration pursuant to Section 3 of the FAA. The District Court denied that motion. In reversing the District Court, thereby permitting the arbitration to proceed, the Second Circuit addressed the FAA, and raised the "manifest disregard" standard:
[T]he agreement in the case at bar is "subject to" the 1933 Act; consequently the arbitrators are bound to decide in accordance with the provisions of section 12(2). Failure to do so would, in our opinion, constitute grounds for vacating the award pursuant to section 10 of the Federal Arbitration Act, 9 U.S.C.A. § 10.
Wilko v. Swan, 201 F.2d 439, 444-45 (2d Cir. 1953).
The Supreme Court granted certiorari, held that security law actions should not be referred to arbitration and reversed the Second Circuit. Wilko v. Swan, 346 U.S. 427 (1953) In its opinion, the Court set the standard for vacating arbitrators' awards:
Power to vacate an award is limited. While it may be true, as the Court of Appeals thought, that a failure of the arbitrators to decide in accordance with the provisions of the Securities Act would "constitute grounds for vacating the award pursuant to section 10 of the Federal Arbitration Act," that failure would need to be made clearly to appear. In unrestricted submissions, such as present margin agreements envisage, the interpretations of law by the arbitrators in contrast to manifest disregard are not subject, in the federal courts, to judicial review for error in interpretation.
Id. at 436-37 (emphasis added).
The dissenting opinion by Justice Frankfurter, which Justice Minton joined, stated in regard to this issue:
Arbitrators may not disregard the law. Specifically they are, as Chief Judge Swan pointed out, "bound to decide in accordance with the provisions of section 12(2)." On this we are all agreed. It is suggested, however, that there is no effective way of assuring obedience by the arbitrators to the governing law. But since their failure to observe this law "would . . . constitute grounds for vacating an award pursuant to section 10 of the Federal Arbitration Act," 201 F.2d 439, 445, appropriate means for judicial scrutiny must be implied, in the form of some record or opinion, however informal, whereby such compliance will appear, or want of it will upset the award.
Id. at 440.
Thirty-six years later the Supreme Court overruled Wilko v. Swan by holding that the provisions of an arbitration agreement in a securities case were enforceable, but did not discuss the issue of manifest disregard of the law. Rodriguez de Quijas v. Shearson/American Express, Inc., 490 U.S. 477 (1989).
The Supreme Court revisited the "manifest disregard" issue in First Options of Chicago, Inc. v. Kaplan, 514 U.S. 938 (1995) and in its discussion of arbitration procedures stated:
The party can still ask a court to review the arbitrator's decision, but the court will set that decision aside only in very unusual circumstances. See, e.g., 9 U.S.C. § 10 (award procured by corruption, fraud, or undue means; arbitrator exceeded his powers); Wilko v. Swan, 346 U.S. 427, 436-437 (1953) (parties bound by arbitrators decision not in "manifest disregard" of the law), overruled on other grounds, Rodriguez de Quijas v. Shearson/American Express, Inc., 490 U.S. 477 (1989).
Id. at 942.
The Supreme Court in Wilko and First Option considered the issue of manifest disregard of the law as a basis for vacating the award of an arbitration panel and clearly stated its position, albeit in dictum, that manifest disregard of the law is a basis for vacating an arbitration award. The following cases set forth the current holdings of each of the circuits after Wilko and First Option which considered setting aside arbitration awards for manifest disregard of the law.
First Circuit
In Bull H N Information Systems, Inc.,229 F.3d 321 (1st Cir. 2000), the First Circuit confirmed an award which had been vacated by the District Court. In regard to the standards for setting aside awards, the Court held:
Beyond the specific grounds enumerated in Section 10, courts "retain a very limited power to review arbitration awards" . Essentially, arbitration awards are subject to review "where an award is contrary to the plain language of the [contract]" and "instances where it is clear from the record that the arbitrator recognized the applicable law - and then ignored it" . (Citations omitted.) In the parlance of this and other circuits, a reviewing court may vacate an arbitration award if it was made in "manifest disregard" of the law.
Id. at 331 (quoting Advest, Inc. v. McCarthy, 914 F.2d 6, 9 (1st Cir. 1990)).
Second Circuit
The Second Circuit was initially consistent with the other circuits following Wilko and First Options in Merrill Lynch v. Bobker, 808 F.2d 930 (2d Cir. 1986) and Willemijn Houdstermaatschappij, BV v. Standard Microsystems Corporation, 103 F.3d (2d Cir. 1997). However, Halligan v. Piper Jaffray, 148 F.3d 197 (2d Cir. 1998) in considering an appeal from a district court confirming an award denying relief to the petitioner Halligan, the Court made an extensive review of the evidence at the arbitration hearing. The opinion makes reference to a lower court's statement that the record "does not indicate the Panel's awareness, prior to its determination, of the standards for burden of proof." The circuit court without any other reference to disregard of a specific law, after observing the Panel made no explanation of its award and further observing the strength of the evidence that support of the allegations of discrimination (termination due to age) of Halligan, concluded:
At least in the circumstances here, we believe that when a reviewing court is inclined to hold that an arbitration panel manifestly disregarded the law, the failure of the arbitrators to explain the award can be taken into account. Having done so, we are left with the firm belief that the arbitrators here manifestly disregarded the law or the evidence or both.
Id. at 204.
The Second Circuit in Halligan introduced for the first time that consideration and weighing of the evidence by the Court could be a factor in determining whether an award should be confirmed. In addition, the failure of the Panel to explain its award could be considered by the Court.
Third Circuit
Although the issue in the case concerned interpretation of a contract, the Third Circuit in United Transportation Union Local 1589 v. Suburban Transit Corporation, 51 F.3d 376, 380 (1995), recited the following rule:
Only when an arbitrator "acted in manifest disregard of the law, or if the record before the arbitrator reveals no support whatsoever for the arbitrator's determination," may a district court invade the province of the arbitrator.
(Citations omitted.)
The United States District Court for the Eastern District of Pennsylvania in Personnel Data Systems, Inc. v. Openplus Holdings PTY LTD, 2001 U.S. Dist. LEXIS 403 (2001) followed that rule.
Fourth Circuit
The holding of the Fourth Circuit was well expressed in Richmond, Fredericksburg & Potomac Railroad Company v. Transportation Communications International Union, 973 F.2d 276, 282 (1992):
We thus examine the arbitrator's decision to determine only "whether the arbitrators did the job they were told to do - not whether they did it well, or correctly, or reasonably, but simply whether they did it." So long as an arbitrator makes a good faith effort to apply the law as he perceives it, the courts may not upset his decision simply they are able to poke a few holes in the arbitrator's analysis. Reversal is appropriate only where the arbitrator "understand(s) and correctly states the law, but proceeds to disregard the same." (Citations omitted.)
That holding was followed subsequently in Howard Hypes v. Cyprus Kanawha Corp., 40 F.3d 1244 (4th Cir. 1994).
Fifth Circuit
Prior to the decision of First Options v. Kaplan, 514 U.S. 938 (1995), the Fifth Circuit had declined to recognize the manifest disregard standard in FAA cases involving commercial contract disputes between securities brokers and investors. See generally, McIlroy v. PaineWebber, Inc., 989 F.2d 817 (5th Cir. 1993); R. M. Perez & Associates, Inc. v. Welch, 960 F.2d 534 (5th Cir. 1992). Another Fifth Circuit case stated in dictum that judicial review of a commercial arbitration award was limited to Section 10 and 11 of the FAA. Forsythe International, S. A. v. Gibbs Oil Co., 915 F.2d 1017 (5th Cir. 1990). Arthur H. Williams v. Cigna Financial Advisors, Inc., 197 F.3d 752 (5th Cir. 1999), was the first case considered by the Fifth Circuit since the manifest disregard standard was approved by the Supreme Court in Wilko and First Options. The Court held:
In our opinion, clear approval of the "manifest disregard" of the law standard in review of arbitration awards under the FAA was signaled by the Supreme Court's statement in First Options that "parties (are) bound by (an) arbitrator's decisions not in manifest disregard of the law." (Citations omitted.). . . . Accordingly, each of the other numbered federal circuit courts and the DC circuit have recognized manifest disregard of the law as either an implicit or non-statutory ground for vacating under the FAA.
Id. at 760.
After a review of evidence from the verbatim manuscript of the arbitration proceedings, the Court concluded:
Consequently, we conclude that based on the record presented for our review it is not manifest that the arbitrators acted contrary to the [**29] applicable law and that their award should be upheld.
Id. at 764.
Sixth Circuit
The position of the Sixth Circuit Court of Appeals is clearly set forth in Dawahare v. Spencer, 210 F.3d 666, 669 (2000):
An arbitration decision "must fly in the face of established legal precedent" for us to find manifest disregard of the law. An arbitration panel acts from manifest disregard if "(1) the applicable legal principle is clearly defined and not subject to reasonable debate; and (2) the arbitrators refuse to heed that legal principle." (Citations omitted.) Thus, to find manifest disregard a court must find two things: "the relevant law must be clearly defined and the arbitrator must have consciously chosen not to apply it." Citing M & C Corp. v. Erwin, 87 F.3d 844, 851 n.3 (6th Cir. 1996).
A prior Sixth Circuit case, Gibson Guitar Corp. v. MEC Import, 1999 U.S. App. LEXIS 300169 (1999), set forth similar standards for application of manifest disregard.
Seventh Circuit
After reviewing the decisions of other circuits, the Seventh Circuit in Watts v. Tiffany, 2001 U.S. App. LEXIS 6442 (2001), stated:
The law in other circuits is similarly confused, doubtless because the Supreme Court has been opaque. The dictum in Wilko and First Options was unexplained and unilluminated by any concrete application. Dictum in Gilmer v. Interstate/Johnson Lane Corp., 500 U.S. 20, 32 n.4, 114 L. Ed. 2d 26, 111 S. Ct. 1647 (1991), is similarly unhelpful.
Id. at 7.
The Court went on to state its position in regard to manifest disregard of the law which is substantially different from the opinions of other circuits:
There is, however, a way to understand "manifest disregard of the law" that preserves the established relation between court and arbitrator and resolves the tension in the competing lines of cases. It is this: an arbitrator may not direct the parties to violate the law. In the main, an arbitrator acts as the parties' agent and as their delegate may do anything the parties may do directly.
Id.
In a concurring opinion, Circuit Judge Williams agreed with the final decision of her two colleagues in that the District Court had properly enforced the arbitration award. However, she was critical of the reasoning of the Court and its pronouncement of what appeared to be a new, at least different, definition of manifest disregard when she stated:
Because the majority has effectively rejected the manifest disregard doctrine, I will briefly express my concern with that holding. It should be noted that the doctrine of manifest disregard has been substantively uniform in federal courts, requiring that (1) the arbitrator knew of a governing legal principle yet refused to apply it or ignore it altogether, and (2) the law ignored by the arbitrator was well-defined, explicit and clearly applicable to the case. [citing cases] Every court of appeals, including our own, has held that a court may review the decision of an arbitrator for "manifest disregard of the law," and has adopted, in substance, that very definition. Moreover, the words in the doctrine itself are more accord with such an interpretation. (Citations omitted.) The majority's holding conflicts with that precedent, and leaves the doctrine internally inconsistent and effectively impotent.
Id. at 11-12.
The decision by the Seventh Circuit Court of Appeals in Watts differs substantially from its prior holding in National Wrecking Company v. International Brotherhood of Teamsters, 990 F.2d 957 (1993). In response to an argument by National that if the award was enforced National would be forced to violate federal laws and public policy, the Court's holding was consistent with those of the other circuits:
In order for a federal court to vacate an arbitration award for manifest disregard of the law, the party challenging the award must demonstrate that the arbitrator deliberately disregarded what the arbitrator knew to be the law in order to reach a particular result.
Id. at 961.
Eighth Circuit
The Eighth Circuit in Homestake Mining Co. v. United Steelworkers, 153 F.3d 678 (1998), considered an appeal from the District Court which overruled a Motion to Vacate an arbitration award. One of the grounds for the Motion was that the arbitrator's decision evidenced a manifest disregard for law. The Court opinion affirmed the District Court and reinstated the arbitration award:
The arbitrator's interpretation of this regulation in plain language is neither "completely irrational [nor] evidences a manifest disregard for law," Lee v. Chica, 993 F.2d 883, 885 (8th Cir. 1993), and is therefore " insulated from review" .
Id. at 681.
In Hoffman v. Cargill, 236 F.3d 458 (2001), the Eighth Circuit overruled a decision of the District Court which vacated an arbitration award on manifest disregard grounds and because the arbitration panel decision was irrational:
We have allowed that "beyond the grounds for vacation provided in the FAA, an award will only be set aside where it is completely irrational or evidence of manifest disregard of the law." (Citations omitted). These extra-statutory standards are extremely narrow: An arbitration decision may only be said to be irrational where it fails to draw its essence from the agreement, and an arbitration decision only manifests disregard for the law where the arbitrators clearly identified the applicable, governing law and then proceed to ignore it. (Citation omitted). "We may not set an award aside simply because we might have interpreted the agreement differently or because the arbitrators erred in the interpretation interpreting the law or in determining the facts." ( Citation omitted.)
Id. at 461-62.
Ninth Circuit
In Barnes v. Logan, 122 F.3d 820 (1997), the Ninth Circuit reviewed its prior holdings in setting forth their standards of review:
[J]udicial review of an arbitrator's decision "is both limited and highly deferential." Sheet Metal Workers' Int'l Ass'n v. Madison Indus. Inc., 84 F.3d 1186, 1190 (9th Cir. 1996). An award will not be set aside unless it manifests a complete disregard of the law. Id. Thus, an award must be confirmed if the arbitrators even arguably construed or applied the contract and acted within the scope of their authority. United Food and Commercial Workers Int'l Union v. Foster Poultry Farms, 74 F.3d 169, 173 (9th Cir. 1995). We may affirm the judgment of the District Court on any ground fairly supported by the record. Kruso v. Int'l Tel. and Tel. Corp., 872 F.2d 1416, 1421 (9th Cir. 1989).
Barnes at 821-22.
In a subsequent case in the Ninth Circuit, Investors Equity Life Insurance Co. of Hawaii, Ltd. v. ADM Investor Services, Inc., 1997 U.S. Dist. LEXIS 23881, 22 (1997), the District Court held:
Before the Court can conclude that arbitrators acted in "manifest disregard" , "it must be clear from the record that the arbitrators recognize the applicable law and then ignored it." Michigan Mutual, 44 F.3d at 832; see also Prudential-Bache Securities, Inc. v. Tanner, 72 F.3d 234, 240 (1st Cir. 1995) ("there must be some showing in the record, other than the result obtained, that the arbitrators knew the law and expressly disregarded it.").
Tenth Circuit
Kelley v. Michaels, 59 F.3d 1050 (10th Cir. 1995), was an appeal from a district court ruling confirming an arbitration award in a securities law arbitration. One of the grounds for the appeal and for setting aside the award was that punitive damages were awarded in a case where the parties had agreed in a choice of law provision that any dispute would be governed by New York law, which prohibited the award of punitive damages. The uniform submission agreement provided for arbitration pursuant to National Association of Securities Dealers, Inc. (NASD). The NASD arbitrators' manual provided for a possible award of punitive damages. The identical matter had been before the Supreme Court in Mastrobuono v. Shearson Lehman, 514 U.S. 52 (1995). The Supreme Court in that case stated that:
. . . [t]he FAA insures that (parties' ) agreements will be enforced according to (their) terms even if a rule of state law would otherwise exclude such claims from arbitration.
Id. at 58.
In resolving this matter the Supreme Court noted:
The best way to harmonize the choice of law provision with the arbitration provisions is to read "the laws of the State of New York" to encompass substantive principles that New York courts would apply, but not to include special rules limiting the authority of arbitrators. Thus, the choice-of-law provision covers the rights and duties of the parties, while the arbitration clause covers arbitration; neither sentence intrudes upon the other. In contrast respondents' reading sets up the two clauses in conflict with one another; one foreclosing punitive damages, the other allowing them. This interpretation is untenable.
Id. at 63-64.
Based on the holding in the Mastrobuono, the Tenth Circuit in Kelley v. Michaels stated that they were compelled to reach a conclusion that the arbitration panel did not exceed its authority in awarding the Kelleys punitive damages. Kelley, 59 F.3d at 1055.
Mastrobuono and Kelley hold that where there are specific conflicts between the arbitration clause and the choice of law provisions, full effect shall be given to the arbitration clause as it defines the limits of the authority of arbitrators, notwithstanding a conflict with a choice of law provision.
Eleventh Circuit
In Brown v. ITT Consumer Fin. Corp., 211 F.3d 1217 (2000), the Eleventh Circuit disposed of the appeal from the District Court refusal to vacate the arbitrator's award. One of the grounds for vacation of the award was manifest disregard of the law. The Court held that the party alleging manifest disregard had the burden:
Brown has also failed to show that the arbitrator acted with manifest disregard of the law. Arbitration awards will not be reversed due to an erroneous interpretation of the law by the arbitrator. Montes v. Shearson Lehman Bros., Inc., 128 F.3d 1456, 1460 (11th Cir. 1997). "To manifest disregard the law, one must be conscious of the law and deliberately ignore it." Id. at 1461.
Brown at 1223.
District Of Columbia Circuit
In Laprade v. Kidder, Peabody & Co., Inc., 2001 U.S. App. LEXIS 7381 (2001), the DC Circuit considered an appeal from the district court which had rejected an argument that the arbitration panel had acted in manifest disregard of the governing law:
Manifest disregard of the law "means more than error or misunderstanding with respect to the law." Kanuth v. Prescott, Ball & Turben, Inc., 292 U.S. App. D.C. 319, 949 F.2d 1175, 1178 (D.C. Cir. 1991), (citing Sargent v. Paine Webber Jackson & Curtis, Inc., 280 U.S. App. D.C. 7, 882 F.2d 529, 532 (D.C. 1989)). Consequently, "to modify or vacate an award on this ground, the Court must find (1) that the arbitrator knew of a governing legal principle yet refused to apply it or ignored it altogether and (2) the law ignored by the arbitrators was well defined, explicit, and clearly applicable to the case."
Laprade at 6-7.
Conclusion
Nine of the 12 circuits have adopted the following similar criteria in determining whether an arbitration award should be set aside for manifest disregard of the law:
- More than an error or misunderstanding with respect to the law.
- The error in interpretation must have been obvious and capable of being readily and instantly perceived by the average person qualified to serve as an arbitrator.
- The governing law alleged to have been ignored by the arbitrators must be well defined, explicit and clearly applicable.
- Vacation of an arbitration award is allowed only if there is absolutely no support in the record justifying the arbitrators determinations.
- The arbitration decision must fly in the face of established legal precedent for the court to find manifest disregard of the law.
- The court may not set aside an award simply because the court might have interpreted the agreement differently or because the arbitrators erred in interpreting the law or in determining the facts.
- There must be some showing in the record other than the result obtained that the arbitrators knew the law and expressly disregarded it.
- The party alleging manifest disregard to the law has the burden of establishing it to the appellate court.
The Second, Seventh and Tenth Circuits deviate from the above standards.
The Second Circuit in Halligan provides authority to the reviewing court to consider and weigh the evidence before the Panel along with considering the failure of the Panel to explain their award in determining whether there was manifest disregard of the law or of the evidence or both.
The Seventh Circuit in Watts stated the law under the other circuits was confused because the Supreme Court had been opaque in its dictum announcing the manifest disregard of the law concept in Wilko and First Options. The Seventh Circuit has held that the single standard to be applied should be that "an arbitrator may not direct the parties to violate the law."
The Tenth Circuit in Kelley held, that consistent with the holding of the Supreme Court in Mastrobuono, where there is a grant of authority to the arbitrators in the arbitration clause which is in conflict with the rule of law election in the contract, an award which was consistent with the arbitration clause but contrary to the choice of law provision would not be set aside for manifest disregard of the law.
It will be worthwhile for parties and practitioners to follow closely future circuit court and district court decisions which continue or which may alter their holdings in regard to manifest disregard of the law. With consistent holdings in nine of the circuits, it appears doubtful that the Supreme Court will further expand the definition of manifest disregard of the law beyond holding that manifest disregard of the law is grounds for vacation of an arbitration award, leaving to the other federal courts the clear delineation of standards in reaching such a decision based on the facts before them.
Endnotes
1 Section 10(a) of the FAA states, in pertinent part:
In either of the following cases the . . . court . . . may [vacate] the award upon the application of any party to the arbitration -
(1) Where the award was procured by corruption, fraud, or undue means.
(2) Where there was evident partiality or corruption in the arbitrators, or either of them.
(3) Where the arbitrators were guilty of misconduct in refusing to postpone the hearing, upon sufficient cause shown, or in refusing to hear evidence pertinent and material to the controversy; or of any other misbehavior by which the rights of any party have been prejudiced.
(4) Where the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter was not made.
(5) Where an award is vacated and the time within which the agreement required the award to be made has not expired the court may, in its discretion, direct a rehearing by the arbitrators.
The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.
