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Arbitrators Exceeding Scope of Authority

First published in Dispute Resolution Section Blog of the New York State Bar Association October 15, 2013 (http://nysbar.com/blogs/ResolutionRoundtable/2013/10/)

An arbitratator’s conduct or decision must be egregious before an appelate court finds the panel exceeded the scope of authority. Parties in two recent cases, one in the Appellate Division, 1st Department and the other in the 2nd Circuit have been disappointed by decisions reversing trial court orders to vacate awards on the grounds that the arbitrators exceeded the scopes of their authority. The results illustrate two points: (1) the difficulty in vacating awards; and, (2) strategic missteps by counsel in presenting their evidence.

In Caruso v. Viridian Network, LLC, 2013 NY Slip Op. 05780 (9-10-2013) the Appellate Division reversed the trial term’s order vacating an arbitration award and remanding the case to a new arbitrator. Petitioner complained she was excluded from certain portions of the arbitration proceedings (approximately 5% of the proceedings). There was no dispute that the arbitrator had “exceeded the scope of his authority” (CPLR §7511(b)(iii), as well as violated Rule 23 of the American Arbitration’s Commercial Arbitration Rules, but the Appellate Division held that “the exclusion [was] harmless error, since the result would have been the same had she been present.” The arbitrator had found that “petitioner was fired for her repeated, and severe, violation of the conflict of interest provisions of her contract.” Although not fully detailed, the arbitrator had also sanctioned petitioner’s counsel “for violating the confidentiality order.” Thus, in reversing the vacatur despite a finding that the arbitrator had exceeded the scope of his authority, the Appellate Court in Caruso set a high bar for vacating an award: Procedural error cannot trump affirmative findings in favor of the confirming party where the arbitrator’s challenged act was not so “imperfectly executed” as to warrant vacatur.

In the Second Circuit case, LJL 33rd Street Associates, LLC v. Pitcairn Properties Inc. 11-5425-cv (7-31-2013) the Court was presented with two issues: the arbitrator’s refusal to receive hearsay evidence and the scope of his authority. LJL 33rd involved a dispute between parties who were the equity owners of a limited liability company whose sole asset was a luxury high-rise apartment complex in Manhattan. Their underlying agreement contained a contingency that triggered plaintiff’s right to purchase defendant’s interest in the property. The arbitration followed plaintiff’s election to exercise its right. Plaintiff contended that the arbitrator was required to decide both the “Stated Value” of the property (essentially its fair market value) and the “Purchase Price” to be paid by plaintiff for defendant’s interest (defined as the fair market value minus liabilities). The arbitrator determined Stated Value, but refused to determine the Purchase Price, putting plaintiff in the rare position of moving to confirm one branch of the award and vacate another. Defendant also moved to vacate the award on the grounds that the arbitrator had excluded evidence on the issue of Stated Value.

On the issue of Purchase Price, the problem for plaintiff was the limited scope of the arbitrator’s authority. The Court of Appeals found that the parties “elected arbitration of narrow precisely specified issues” by virtue of an arbitration clause that read:

In rendering such decision and award, the arbitrators shall not add to, subtract from or otherwise modify the provisions of the Agreement and may only determine the issue or question present as their award.

The arbitrator had determined that the Purchase Price was not within his jurisdiction, a finding which the district court upheld. However, the district court vacated the arbitrator’s determination of fair market value based on its conclusion that the arbitrator had violated the Federal Arbitration Act by excluding certain evidence offered by defendant. The Court of Appeals affirmed the district court’s order on the issue of the arbitrator’s authority, but disagreed with the district court that the arbitrator’s exclusion of evidence violated Section 10(a)(3) of the FAA – “refusing to hear evidence pertinent and material to the controversy.”

In reversing the district court’s order for partial vacatur, the Court of Appeals pointedly laid fault with defendant’s strategic decision in proffering only hearsay evidence, which consisted of an asset summary report, a valuation of the property, a letter, and a non-binding “letter of intent” to purchase the property. Defendant’s submissions posited that the Stated Value was as much as 20% higher than that testified to by the appraiser retained to make the appraisal. In siding with the defendant, the district court held that “the arbitrator’s decision to exclude this evidence constituted illegal ‘misconduct’.” Section 10(a)(3) of the FAA provides that “a reviewing court may vacate an arbitration award ‘where the arbitrator [is] … guilty of misconduct in … refusing to hear evidence pertinent and material to the controversy.” In the district court’s view, this exclusion “prevented Pitcairn from effectively demonstrating” that the property had a higher market value than the arbitrator determined.

While “it is indisputably correct [in the words of the Court of Appeals] that arbitrators are not bound by the rules of evidence and may consider hearsay, it does not follow that arbitrators are prohibited from excluding hearsay.” Instead of calling the “makers of the exhibits as witnesses,” Pitcairn offered only the fruits of their work. Although, the Court noted, “Pitcairn may well have been harmed by the exclusion of its exhibits,” the harm was self-created. If counsel’s strategy in offering only the exhibits was to keep the makers away from cross-examination, it backfired. The court cited Rule 31(b) from the American Arbitration Association’s Commercial Arbitration Rules that “[t]he arbitrator shall determine the admissibility, relevance, and materiality of the evidence offered and may exclude evidence deemed by the arbitrator to be cumulative or irrelevant.” By denying plaintiff the “opportunity to test the makers’ conclusions by cross-examination” counsel’s decision not to call the makers created risk inherent in offering hearsay evidence, that it will be deemed inadmissible.

Two lessons can be gleaned from the Court of Appeals’ decision in LJL 33rd: (1) parties are bound by the jurisdictional scope they agreed to; and (2) self-created problems “can[not] be considered unfair” where, as in this case, the moving party “could have cured the problem simply by calling the makers of the exhibits as witnesses.” On neither issue did the arbitrator ‘s determination constitute “illegal misconduct” or “impair the ‘fundamental fairness’ of the proceeding.”

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