July 6, 2016

Rethinking Conventional Wisdom, Part 2: More on Mandatory Arbitration Clauses

The ongoing theme of this series is that legal and business advice needs to be tailored to each individual client, and you should be wary of so-called “truisms” that “everyone knows” apply to pro-business laws.  In Part 1 of this series, we looked at one such truism: the notion that mandatory arbitration clauses favor the employer, examining arguments such as juror bias, cost, and efficiency.

That post left you with a cliffhanger, though:  the “major disadvantage” of the arbitration process.  And now it’s time to lift that veil:  an arbitrator’s award is (essentially) final.  Unlike a jury’s verdict – to which the losing party always has at least one appeal as of right — the arbitration decision cannot be appealed except on very narrow grounds.  Specifically, U.S. arbitrations[1] are generally governed by the Federal Arbitration Act, 9 U.S.C. § 1 et seq., which provides that an appropriate court “must” confirm any valid arbitration award in its entirety unless the opposing party can demonstrate that:

(1)   the award was procured by corruption, fraud, or undue means;

(2)   there was evident partiality or corruption in the arbitrators;

(3)   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; or

(4)   where the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made.

9 U.S.C. § 10(a).[2]

This finality is often thought of as a double-edged sword to the employer; on the one hand, the employer knows that an arbitration award is essentially final and that the company will not be burdened with years of potential appeals.  On the other hand, if the facts of a case are less-than-clear-cut (as most high-end disputes are), arbitration gives the employer essentially only one bite at the apple.  If the employer loses at arbitration, courts almost universally confirm arbitration awards, no matter their size, and even if such awards contain factual or legal errors that would merit reversal of a jury’s verdict.

For example, in 2012, a U.S. District Court denied Merrill Lynch’s petition to vacate an arbitration panel’s award of $10.2 million to two of its former advisors, Tamara Smolchek and Meri Ramazio.  The award – split almost evenly between $5.2 million in compensatory damages for deferred compensation and $5 million in punitive damages – was a high-profile victory by the “little guy” (here, two high-level executives) over the nation’s 22nd-largest company, so it’s worth examining in some depth, even though these kinds of results seem to be happening fairly frequently.

In this case, Merrill Lynch had a standard-form arbitration clause with its upper-level employees requiring that any dispute be submitted for arbitration before a panel of arbitrators appointed by the Financial Industry Regulatory Authority (FINRA), applying the FINRA Code of Arbitration Procedure for Industry Disputes.

Former Merrill Lynch brokers Tamara Smolchek and Meri Ramazio brought such a complaint two years after they resigned from Merrill following its acquisition by Bank of America, asking that the arbitration panel award them immediate vesting and payment of certain long-term compensation bonuses.  Smolchek and Ramazio claimed that their resignation constituted “good reason” under the terms of their employment agreements because of the change in control of Merrill Lynch, and thus triggered the immediate vesting of those benefits.

After a 17-day arbitration hearing – exactly as burdensome and expensive as a two-and-a-half-week trial, by the way – the arbitration panel found in favor of the brokers, awarding them $5.2 million in vested bonuses and an additional $5 million in punitive damages.

Merrill Lynch attempted to vacate the arbitrator’s $10.2 million award pursuant to 9 U.S.C. § 10(a)(2), (3), and (4), alleging that the arbitrators demonstrated “evident partiality,” “refused to hear evidence pertinent and material to the controversy,” and “exceeded their powers” by imposing sanctions without providing Merrill Lynch the opportunity to explain itself.  Complaint ¶¶ 8-10, 17-76.

The bulk of Merrill Lynch’s complaint focused on the claim of “evident partiality.”  To that end, Merrill Lynch claimed that the arbitration panel:  (1) failed to disclose certain conflicts of interest on the part of the arbitrators, id. ¶¶ 24-29; (2) permitted opposing counsel to review privileged documents, id. ¶¶ 32-34; (3) imposed various allegedly punitive discovery sanctions while Merrill Lynch prepared a privilege log, id. ¶¶ 35-36; (4) imposed sanctions, sua sponte, for Merrill Lynch’s use of medical records during cross-examination at the hearing, id. ¶ 44; (5) precluded Merrill Lynch’s corporate representative from attending the hearing, id. ¶ 56; and (6) issued numerous inconsistent rulings that supposedly evidenced a consistent partiality in favor of the brokers, id. ¶¶ 54-55, 57-61.

After concluded that Merrill Lynch waived its objections with respect to (1) (because Merrill Lynch had conducted an independent investigation prior to the hearing and failed to object to the arbitrator with the alleged conflict), the Court considered the specific instances of alleged misconduct raised by Merrill Lynch in the light that it “should defer to an arbitrator’s decision wherever possible” (quoting Robbins v. Day, 954 F.2d 679, 682 (11th Cir. 1982) and summarily finding – in less than a paragraph in a twelve-page decision – that “the panel had at least some reasonable basis for the actions it took” for each of the claimed grievances and thus did not deny Merrill Lynch a “fundamentally fair hearing.”

In other words:  the court was unwilling to dig into the substantive merits of whether the arbitration panel’s decisions systematically reflected a bias in favor of the employees – in fact, the Court noted that “the panel’s decisions were in some cases detrimental to Merrill Lynch’s case.”  But so long as those decisions had “at least some reasonable basis,” the court – like many courts that we’ve seen reviewing motions to vacate arbitration awards – was going to uphold the arbitration award.

The lesson is clear:  when writing an arbitration clause into an employment agreement (employers) or signing said agreement (employees), both parties should be aware that the arbitrator’s decision will likely be final, regardless of the merits or how it was reached.


[1] Foreign arbitration awards are given even more deference; they are typically subject to the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards, codified at 9 U.S.C. § 201 et seq., which provides that such awards can be refused only where the party demonstrates a procedural defect in the hearing itself, or shows that the award would be contrary to state law or public policy in the country in which the prevailing party is seeking to enforce the award.

[2] Arbitration awards can be “modified” or “corrected” – but not set aside in their entirety – on similar grounds set forth in 9 U.S.C. § 11; that discussion is beyond the scope of this post.