Arbitration in the Courts

February 2023 | Vol. 9
Where Advocacy Meets Business

Functus Officio gets a new exception:

Second Circuit holds that district courts remand of unreasoned award to arbitrator does not violate the functus officio doctrine.

Smarter Tools, Inc. v. Chongqing SENCI Import & Export Trade Co., Ltd., No. 21-724, (2d Cir. January 17, 2023).

The functus officio doctrine – Latin for having “completed one’s office” – dictates that “once arbitrators have fully exercised their authority to adjudicate the issues submitted to them, their authority over those questions is ended, and the arbitrators have no further authority, absent agreement of the parties, to redetermine those issues.”  Its principal purpose is to prevent “re-examination of an issue by a nonjudicial officer potentially subject to outside communication and unilateral influence.”  But courts have developed a number of exceptions to the doctrine, permitting arbitrators to revisit their awards to make non-substantive modifications, lest the doctrine waste tremendous efforts and resources.

In Smarter Tools v. SENCI, the Second Circuit Court of Appeals held that the doctrine warranted another exception – permitting remand to the arbitrator to provide the requisite reasoning for his award.

The underlying arbitration arose out of a series of contracts between Smarter Tools Inc. (STI) and Chongqing SENCI Import & Export Trade Co. Ltd. (SENCI) for the supply of gas-powered generators.  After STI failed to pay the purchase price for a number of generators, SENCI commenced arbitration before the Arbitration Association’s International Centre for Dispute Resolution (“ICDR”) to recover the outstanding amounts.  STI counter-petitioned, claiming that it was SENCI who had breached the contract by delivering generators that failed to comply with California Air Resources Board (CARB) standards. The arbitrator ultimately issued an award in favor of SENCI, finding that the parties’ contract did not specify that the generators had to comply with CARB standards.  However, although the parties had agreed that the arbitrator would issue a reasoned award, the arbitrator’s award contained scant reasoning.

STI petitioned the United States District Court for the Southern District of New York to vacate the award, arguing the arbitrator had exceeded his authority by issuing an unreasoned award.  The district court agreed, finding the award contained no rationale for rejecting STI’s counterclaims.  But, rather than vacate the award, the court remanded the case to the arbitrator “for clarification of his findings.”  The arbitrator issued an amended award granting the same relief and providing further reasoning and explanation for his findings.  STI again moved to vacate the award on the ground that remand was improper because the arbitrator was functus officio after issuing his original award.  SENCI cross-moved to confirm the award.  The district court confirmed the award and STI appealed.

On appeal, the Second Circuit noted that it was an “open question” as to “whether a court may remand for an arbitrator to produce a reasoned award,” but it was a “permissible choice” under these circumstances because “[i]t simply makes no sense to redo an entire arbitration proceeding over an error in the form of the award issued.”  Remand to provide further reasoning was analogous to well-recognized exceptions to functus officio, such as permitting arbitrators to clarify an ambiguous award.  As with such other exceptions, the arbitrator was not changing his merits determination and therefore remand would not “undermine the functus office doctrine’s purpose” of protecting against the risk the arbitrator would change his ruling “after issuance due to outside influence by an interested party.”

The court also rejected STI’s argument that the arbitrator had exceeded his powers by issuing an unreasoned award, and the lower court’s only option under the Federal Arbitration Act (FAA) was to vacate the award under Section 10(a)(4).  Awards are presumptively valid and vacatur is narrowly construed, and here “the question was whether the arbitrator’s original award was reasoned; there was no question that the arbitrator here had the power to reach the issues addressed.”  Accordingly, the failure to issue a reasoned award “best fits under Section 11 of the FAA,” which permits a court to “make an order modifying or correcting the award … where the award is imperfect in matter of form not affecting the merits of the controversy.”  The award’s failure to provide the requisite reasoning rendered it “imperfect in matter of form,” and remand to the arbitrator to produce an award comporting to the parties’ agreement best “effects the intent” of the parties and “promotes justice” between them.

Read the court’s full decision here.

Ninth Circuit holds that FAA Chapter 1 grounds are available to vacate New York Convention awards seated in the U.S.:

Confirming the award, the court reinforced that an arbitrator’s mere error of law does not warrant vacatur under FAA, §10(a)(4).

HayDay Farms, Inc. v. FeeDx Holdings, Inc., 55 F.4th 1232 (9th Cir. 2022).

The Convention on the Recognition and Enforcement of Arbitral Awards (New York Convention) is codified in Chapter 2 of the FAA,  9 U.S.C. § 201 et seq.  It governs not only awards issued outside of the U.S., but also “non-domestic” awards – those awards issued by tribunals seated in the U.S., but involving one or more foreign parties or having some other reasonable relation with one or more foreign states.  HayDay v. FeeDx concerned whether the grounds for vacating domestic awards under Chapter 1 of the FAA apply to non-domestic awards governed by the Convention.  This was a question of first-impression for the Ninth Circuit Court of Appeals, which has jurisdiction over appeals from U.S. district courts in several western states, including California.  The Ninth Circuit joined the Second, Third, Fifth, Sixth, Tenth and D.C. Circuits in finding that Chapter’s 1’s vacatur standards (set forth in FAA, § 10) apply to non-domestic awards.  (The Eleventh Circuit is the only federal appeals court to have addressed the issue and found chapter 1 inapplicable to nondomestic awards, although the Eleventh Circuit is now in the process of reconsidering the issue.  See Corporacion AIC, SA v. Hidroelectrica Santa Rita S.A., 50 F.4th 97, 98 (11th Cir. 2022).)

The arbitration in HayDay arose out a series of contracts between Cayman corporation FeeDx and California corporation HayDay, which culminated in an exclusive global distribution agreement signed in 2014, under which FeeDx would purchase and distribute HayDay’s forage crops and pay Hayday $8 million to expand its operations.  Under a supplemental agreement, Hayday agreed to provide FeeDx at least 170,000 metric tons of crops per year at $360 per ton.  After disputes arose between them, the parties entered into a settlement agreement under which HayDay would pay FeeDx $8 million in monthly installments, and once this amount was fully paid, the parties would mutually release all claims under their distribution agreement, with their respective obligations to buy and sell HayDay’s crops terminating in December 2016.  Neither party performed the settlement.  HayDay paid only $1 million of the $8 million due.  FeeDx failed to continue purchasing HayDay’s crops through December 2016.  Arbitration ensued before a panel of three arbitrators seated in California before the American Arbitration Association’s International Centre for Dispute Resolution.

Over four years, the arbitrators issued various partial awards finding that: (i) the settlement agreement supplemented rather than supplanted the distribution agreement; (ii) FeeDx had breached the settlement agreement by failing to continue purchasing crops through December 2016; (iii) FeeDx breached the distribution agreement prior to entering into the settlement; and (iv) the settlement agreement did not release HayDay’s claims under the distribution agreement because FeeDx breached the settlement agreement. The Tribunal awarded HayDay approximately $21 million in lost profits. The tribunal rejected FeeDx’s argument that HayDay’s damages should be reduced by the remaining $7 million it owed under the settlement agreement, finding that FeeDx’s breach of the settlement agreement excused HayDay’s payment obligation.

FeeDx petitioned the United States District Court for the Central District of California to vacate the award under Section 10(a)(4) of the FAA on the grounds that the arbitrators had exceeded their authority.  The district court agreed in part and vacated $7 million from the award, finding that the arbitrators’ refusal to reduce HayDay’s damages by the $7 million outstanding under the settlement agreement violated California law precluding a party from receiving a windfall on a breach of a contract claim.  FeeDx appealed the court’s refusal to vacate the entire award; HayDay appealed the partial vacatur of the award.

On appeal, the Ninth Circuit first addressed the threshold question whether the vacatur grounds in Section 10 of Chapter 1 of the FAA applied to Convention awards in arbitrations seated in the U.S.  The court held that Section 10 applied.  In doing so, it adopted the Second Circuit’s oft-cited decision in Yusuf v. Toys “R” Us, 126 F.3d 15 (2d Cir. 1997), which held that Article V(1)(e) of the Convention – permitting an enforcing court to refuse enforcement of an award that “has been set aside or suspended by a competent authority of the country in which … [it] was made” – necessarily contemplates that the courts at the seat may apply the seat’s domestic arbitration laws to vacate a Convention award.

Turning to the merits, the court reversed the lower court’s partial vacatur.  Section 10(a)(4) permits vacatur of an arbitration award “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.”  The court held that Section 10(a)(4) permits only an “extremely limited” review of the award, and an arbitrator exceeds its authority in two circumstances – (i) when the arbitrator manifestly disregards the applicable law or (ii) his or her decision is completely irrational.  An arbitrator manifestly disregards the law only when there is “some evidence in the record other than the result, that the arbitrators were aware of the law and intentionally disregarded it.”  An award is “completely irrational” only where it “completely ignores controlling terms of the parties’ contract.”  If the arbitrator even “arguably construes the contract,” the court “must defer to the arbitrator’s decision.”  Neither standard is met by showing that the arbitrator merely “committed an error–or even a serious one.”

The court agreed with the lower court that the arbitrator likely erred in deciding that FeeDx was not entitled to credit for HayDay’s failure to make the $7 million payment, which resulted in a “seemingly unfair damages award that likely violates” California law.  Nevertheless, this error, without more, was insufficient to meet the stringent standard for vacatur.  To hold otherwise would frustrate the FAA, which reflected Congress’s decision to “carefully limit” judicial review of arbitration awards to protect the contractual choice to “forego the procedural rigor and appellate review” of judicial proceedings in favor of expediency and finality of arbitration.

Read the court’s full decision here.

SDNY holds that Section 1782 does not authorize discovery for use before ICSID tribunal:

ICSID panel does not qualify as a “foreign or international tribunal” under Section 1782 because it is not “imbued with governmental authority.”

In re Webuild S.p.A., 22-mc-140(LAK) (S.D.N.Y. Dec. 19, 2022).

28 U.S.C. § 1782 authorizes U.S. courts to order persons in the United States to give testimonial or document discovery “for use in a proceeding in a foreign or international tribunal.”  Whether Section 1782 discovery is available in aid of foreign arbitrations had split federal appellate courts.  In June 2022, the Supreme Court took up this issue in ZF Auto. US, Inc. v. Luxshare, Ltd., 142 S. Ct. 2078 (2022).  The Court held that neither commercial arbitration tribunals nor ad hoc investor-state tribunals qualified as foreign or international tribunals under the statute.  In so holding, the Court explained that a “foreign tribunal” is “imbued with governmental authority by one nation,” and an “international tribunal” is “imbued with governmental authority by multiple nations.”  Neither the commercial tribunal nor ad hoc investor-state tribunal before it fit either definition.

Webuild applied ZF Auto to determine whether Section 1782 permitted discovery for use before an International Center for Investment Disputes (ICSID) tribunal.  The case arose after an Italian investor arbitrating claims against Panama under the Italy-Panama bilateral investment treaty (BIT) before an ICSID tribunal obtained an ex parte order pursuant granting it Section 1782 discovery from a non-party U.S. company for use in the arbitration.  The non-party moved to vacate the order and quash the ensuing subpoena.

The court granted the motion and quashed the subpoena, finding that under ZF Auto, the ICSID tribunal did not constitute “a foreign or international tribunal” within the statute because Italy and Panama did not “imbue it with governmental authority.”  The court noted that although ZF Auto “did not provide a test for lower courts to apply, it did set forth several factors that it considered in determining that such an intent did not exist.”  In a methodical opinion, the court explained how, under each of the factors set forth in ZF Auto, the ICSID tribunal here was analogous to the private commercial and ad hoc investor-state panels ZF Auto found not to be governmental or intergovernmental authorities

The court highlighted the following attributes demonstrating that the ICSID tribunal was not akin to a governmental body: (i) “ICSID does not have standing or pre-existing arbitration panels,” but rather it convenes tribunals in response to requests from the parties; (ii) the Panama-Italy BIT did not create the ICSID tribunal, but merely provides the set of rules that govern the tribunal’s formation; (iii) the ICSID tribunal “functions independently of and is not affiliated with either” Italy or Panama, with arbitrators chosen by the parties, who lack “any official affiliation” with either state; (iv) the ICSID tribunal is funded by the parties and “does not receive any government funding;” (v) the ICSID tribunal’s proceedings are confidential and not public; and (vi) the panel derives its authority from the “parties’ consent to arbitrate,” rather than any state law.

Accordingly, the court held that “Italy and Panama did not intend to imbue the ICSID Panel with governmental authority,” and therefore the ICSID panel was not a “foreign or international tribunal” under Section 1782.  In October 2022, the United States District Court for the Eastern District of New York likewise held that an ICSID tribunal empaneled pursuant to the Malta-China BIT did not constitute a “foreign or international tribunal” for purposes of Section 1782.  See In re Alpene, Ltd., 2022 WL 147008 (E.D.N.Y. Oct. 27, 2022).  It remains to be seen whether other federal courts will likewise hold that Section 1782 discovery is not available for use in ICSID arbitrations.

Read the court’s full decision here.

“Service of Suit” Clause complements rather than supersedes agreement to arbitrate: 

Parties’ agreement to submit to jurisdiction of court of competent jurisdiction merely ensured a judicial forum for enforcing the agreement to arbitrate and the arbitrator’s awards.

Upper Room Bible Church, Inc. v. Sedgwick Delegated Auth., No. 22-340 (E.D. La. Dec. 16, 2022).

Insurance contracts, particularly those issued by foreign insurers, often include both an arbitration clause requiring that all disputes be resolved in arbitration, and a “service of suit” clauses providing that the foreign insurer will submit to the jurisdiction of local courts.  Upper Bible Room confirmed that the two clauses can co-exist without vitiating the right to arbitrate.

Upper Room Bible Church was seeking coverage from a group of insurance companies under two policies of commercial property insurance for property damage allegedly sustained from Hurricane Ida and Tropical Storm Nicholas.  After the insurers denied these claims, Upper Room brought suit in the United States District Court for the Eastern District of Louisiana.  The insurers moved to compel arbitration based on the arbitration clause in the policies requiring that “all matters in difference between the Insured and the Companies … shall be referred to an Arbitration Tribunal.”

Upper Room opposed the motion, arguing that the policies’ arbitration clause was superseded by a separate policy endorsement stating that the “insurance shall be subject to the applicable state law to be determined by the court of competent jurisdiction as determined by the provisions of the Services of Suit Clause (USA).”  The “Service of Suit Clause,” in turn, stated, “in the event of failure of the Underwriters hereon to pay any amount claimed to be due hereunder, the Underwriters hereon … will submit to the jurisdiction of a Court of competent jurisdiction within the United States.”  Upper Room therefore argued that the endorsement reflected the parties’ intent that all coverage disputes be resolved in court, rather than through arbitration.

The court disagreed and granted the motion to compel arbitration.  Drawing on twenty years of precedent rejecting similar arguments, it noted that “courts have consistently held that endorsements and service of suit clauses like those in Upper Room’s policy do not nullify otherwise valid arbitration agreements.”  Rather, the arbitration and service of suit provisions were in harmony, and the service of suit clause was properly construed “as complementing the arbitration clause by providing a judicial forum for compelling or enforcing arbitration.”

Read the court’s full decision here.

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