Manifest Disregard Of The Law — For Factual Errors? The Debate Continues

The number of disputes being resolved by arbitration continues to increase annually, because arbitration can offer numerous advantages over court litigation—particularly in commercial disputes—including specialized adjudicators, rational discovery, and confidentiality. For commercial disputes, arbitration also offers the real advantage of finality, because courts can only review arbitral awards for serious due process irregularities, and are not supposed to review the merits of the underlying dispute, or perceived factual or legal errors.

What is supposed to happen though, and what actually does, can be very different things, particularly when parties raise enforcement defenses like manifest disregard of the law, which virtually necessitate some level of merits review of supposed legal errors. This article: (1) examines how the manifest disregard enforcement defense can impact finality and arbitration's efficiency promises in light of the Ninth Circuit's recent decision in VIP Mortgage Incorporated v. Gates (VIP Mortgage), which stated that dispositive factual errors can constitute manifest disregard of the law, and (2) suggests that it is time for the U.S. Supreme Court to definitely address the manifest disregard defense to announce a single rule on the subject.

Judicial Review of Arbitral Awards in the United States

The end-result of an arbitration is an arbitral award. Like a final court judgment, a final arbitral award is a written decision that resolves the parties' claims and defenses. Like court judgments, final arbitral awards—particularly under the rules chosen for most commercial disputes—typically state factual findings, and explain the rationale for the conclusions reached, so that the parties can understand how and why the arbitrators reached the outcome they did.

Unlike judgments, however, arbitral awards are merely directives from private adjudicators to perform the relief the award orders. Even if they are final and binding, arbitral awards are not self-enforcing, because they are not issued by state representatives acting in their official capacities, so if a party fails to comply with an arbitral award, the state's coercive power has to be invoked to secure that compliance. The vehicle for invoking that coercive power is a judicial enforcement proceeding, which is the process by which an arbitral award is presented to a court for a review that generally either: (1) converts the award into a judgment of the reviewing court (with which compliance can be compelled); or (2) rejects enforcement, which effectively renders the award a legal nullity in that jurisdiction (essentially leaving it as a paper directive that the recalcitrant party can continue to ignore).

Given that enforcement proceedings involve judges reviewing another adjudicator's decisions, there is a natural tendency to liken enforcement proceedings to court appeals. The comparison is a poor one, though, because enforcement courts play a much more circumscribed role than appellate courts generally do (even if the ultimate success rates in both contexts may not actually differ as much in the U.S. as many people presume).

For instance, unlike most court appeals, award enforcement actions are summary proceedings that are supposed to do nothing more than ensure that the underlying arbitration was not marred by some serious defect or irregularity that resulted in what amounts to a due process violation. Awards are presumptively enforceable in enforcement proceedings, the underlying merits of the dispute are not supposed to be considered, and factual and legal errors are not supposed to permit awards to be vacated.

Indeed, since 1925, the bases stated in Section 10(a) of the Federal Arbitration Act (FAA) for refusing to enforce arbitral awards have been limited to things like corruption, fraud, evident partiality, failure to provide notice, or serious arbitrator misconduct, and the bases stated in Article V.1 of the 1958 Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York Convention) for refusing to enforce international awards are substantively undistinguishable.

The Introduction of Manifest Disregard of the Law as an Enforcement Defense

In 1953, the U.S. Supreme Court introduced—in dicta—the possibility that arbitral awards issued in the U.S. could also be vacated when arbitrators manifestly disregard the law. While courts have articulated different formulations of the manifest disregard theory since its introduction, a widely accepted one is that manifest disregard occurs when arbitrators intentionally ignore a clear and applicable law about which they were aware. Stated differently, manifest disregard is meant to address those (hopefully extraordinary) instances when arbitrators knew about a clear controlling law, but willfully refused to follow it, presumably because they wished to achieve an outcome that the clear law did not permit.

Under that classic formulation, manifest disregard sounds like a perfectly reasonable basis for vacating an arbitral award, as well as one that fully comports with the notion that judicial review should be limited to ensuring that the underlying arbitration was fair, because few would argue that a party's due process rights were respected if arbitrators intentionally ignored clear controlling law so that they could dispense their own brand of justice. In practice, however, manifest disregard has rarely been so anodyne, and has always been complicated for a host of reasons.

First, manifest disregard is not one of the grounds expressly stated in Section 10(a) of the FAA for challenging arbitral awards, which arguably cover situations where arbitrators engage in some meaningful misconduct that tarnishes the arbitral process or the award, like intentionally refusing to follow the law. Second, even though perceived legal errors do not provide a basis for overturning awards, manifest disregard challenges frequently ask courts to do just that (i.e., vacate awards on the basis that the arbitrator supposedly applied the law incorrectly, rather than consciously ignored it). Third, and most significantly, manifest disregard challenges almost always require some level of merits review by the enforcement court, which can impair finality, despite a clear prohibition against revisiting the underlying merits of the dispute at the enforcement stage.

The manifest disregard doctrine has therefore developed a controversial reputation, and many parties have sought to have the U.S. Supreme Court clarify the boundaries of it for many decades now.

The Supreme Court Signals that It Is Disinclined to Definitively Decide the Manifest Disregard Issue

Despite many parties' efforts, the Supreme Court has been reluctant to take up the manifest disregard defense since first introducing it (perhaps inadvertently) back in 1953.

For instance, in 2006, the Supreme Court denied certiorari in a case from the New York state courts that refused to apply the manifest disregard standard. In 2008, the Supreme Court held in Hall Street Associates v. Mattel (Hall Street) that Sections 10 and 11 of the FAA provide the exclusive grounds for vacating or modifying arbitral awards, but declined to expressly state whether manifest disregard survived that ruling.

In 2010, the Supreme Court was again presented with an opportunity to clearly define the contours of the manifest disregard defense in Stolt-Nielsen S. A. v. AnimalFeeds Int'l Corporation, but refused (in a footnote) to state whether it even survived Hall Street.

Since that time, the Supreme Court has also rejected several certiorari petitions seeking to address the circuit split that with the Fifth, Seventh, and Eleventh circuits holding that Hall Street ended manifest disregard challenges, and the Second, Fourth, Sixth, Eighth, Ninth, and Tenth circuits concluding that manifest disregard remains valid.

Lastly, in early January of this year, the Supreme Court once again avoided the manifest disregard issue by denying certiorari in a high-profile case in which the Eighth Circuit vacated an award for manifest disregard after a district court refused to do so. While there will undoubtedly be further efforts to put the issue before the Supreme Court, it is unclear whether or when the court will broker them.

What is clear, however, is that the manifest disregard debate will continue in the meantime, and it is equally clear that parties will continue to try to find new and creative ways to push the permissible boundaries of the manifest disregard defense to avoid the impact of finality. As the following Section discusses, the Ninth Circuit's recent VIP Mortgage decision will give those parties plenty of ammunition for their efforts.

Manifest Disregard of the Law — For Factual Errors?

In VIP Mortgage, after recognizing that awards cannot be vacated for mere "legal error," or for "manifest disregard of the facts," the Ninth Circuit went on to state that some factual errors can be "so critical, obvious, and intentional that... [they] amount[] to manifestly disregarding the law." In short, despite recognizing that factual and legal errors cannot provide a basis for vacating awards, the Ninth Circuit concluded that ignoring "legally dispositive facts" can constitute manifest disregard of the law.

While people can debate the merits of the Ninth Circuit's views, it is indisputable that: (1) litigants seeking to avoid an arbitration loss might deploy VIP Mortgage to construe any number of factual errors as legally dispositive ones that amount to a manifest disregard of the law; and (2) courts would have to delve into merits, factual, and legal issues to address those claims. In short, whether one agrees with the Ninth Circuit's view or not, it seems unavoidable that some parties in enforcement proceedings will deploy VIP Mortgage to challenge awards on

the basis that perceived factual errors amount to manifest disregard of the law, with all the attendant finality and the efficiency consequences those endeavors will undoubtedly bring. Only the U.S. Supreme Court can answer whether or not that is what it ever intended when it created the manifest disregard defense, and it is time that the Supreme Court do so.

Conclusion

Efficient enforcement proceedings are crucial to finality, and finality is critical for maintaining arbitration as a real alternative to court litigation. Conclusively clarifying the contours of the manifest disregard defense would immensely benefit finality, and a definitive ruling from the Supreme Court would provide the uniform standards and certainty that parties, arbitrators, and enforcement courts need on the subject.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.