Following an unusual en banc hearing before all the judges sitting on the U.S. Court of Appeals for the Fifth Circuit, a majority of the court denied a motion to vacate an arbitration award due to alleged bias when an arbitrator failed to disclose a prior professional association with a member of one of the law firms that had engaged him as a neutral. In an 11-5 decision, the court ruled that the “evident partiality” standard under the Federal Arbitration Act (“FAA”) does not mandate the “extreme remedy of vacatur” for a nondisclosure of what it characterized as a “trivial” past association.
A Texas software vendor, Positive Software Solutions, Inc., alleged that one of its customers, New Century Mortgage Corp., had copied its proprietary software in violation of the parties' agreement and applicable copyright law. The matter was submitted to arbitration in accordance with American Arbitration Association (“AAA”) rules before a single arbitrator selected by the parties from a list of candidates provided by the AAA. Upon agreeing to serve, the arbitrator stated that he had nothing to disclose regarding past relationships with either party or their counsel. Following a 7-day hearing, the arbitrator ruled that New Century had not infringed Positive Software’s copyrights, misappropriated its trade secrets, or otherwise breached the contract. He denied the relief sought by the software vendor and granted New Century $11,500 on its counterclaims and $1.5 million in attorney’s fees.
In the aftermath of this stunning defeat, Positive Software conducted a detailed investigation of the arbitrator's background and discovered that several years earlier he and his former law firm had represented the same client as New Century’s counsel in complex patent litigation between unrelated parties in the early 1990s. One of the attorneys representing New Century in this arbitration was involved in that prior litigation along with at least 34 other lawyers. Although their names had appeared together on signed pleadings, the arbitrator and the New Century attorney never had any direct contact.
Armed with this new information, Positive Software filed a motion to vacate the arbitration award alleging that it had been procured by fraud, that the arbitrator had manifestly disregarded applicable laws, and that he was biased as evidenced by his failure to disclose his past connection with its opponent’s counsel.
The federal district court below ruled that the arbitrator had failed to disclose “a significant prior relationship” with New Century’s counsel, thus creating an “appearance of partiality” requiring vacatur. On appeal, a Fifth Circuit three-judge panel affirmed the district court's vacatur order on the similar ground that the prior relationship “might have conveyed an impression of possible partiality to a reasonable person.” Notably, neither the district court nor the Fifth Circuit panel found that the arbitrator was actually biased toward New Century.
Granting New Century’s petition for rehearing en banc, the Fifth Circuit observed at the outset that the FAA “narrowly restricts” judicial review of arbitral awards to assure that arbitration serves as an efficient and cost-effective alternative to litigation and to hold parties to their agreements to arbitrate. The FAA’s use of the term “evident partiality” in 9 U.S.C. § 10(a)(2), according to the majority opinion, conveys a “stern standard,” requiring the upholding of arbitral awards unless bias was “clearly evident in the decisionmakers.” It rejected the three-judge panel’s view that the arbitrator selected by the parties displayed evident partiality by his very failure to disclose facts that might create “a reasonable impression of the arbitrator’s partiality.”
After analyzing the plurality opinion in the U.S. Supreme Court’s seminal “evident partiality” decision, Commonwealth Coatings Corp. v. Continental Casually Co., 393 U.S. 145 (1968), scrutinizing Justice White's “pivotal” concurrence, and considering the state of the law in the sister circuits, the majority of the en banc panel concluded that the better interpretation of Commonwealth Coatings was that an award may not be vacated because of “a trivial or insubstantial prior relationship between the arbitrator and the parties to the proceeding” in nondisclosure cases. The “reasonable impression of bias” standard must be “interpreted practically rather than with utmost rigor.”
Based on a close examination of the facts in this case, the majority concluded that the arbitrator's prior relationship with New Century’s counsel was comparatively limited insofar as they never met or spoke to each other before the arbitration, they were two of 34 lawyers involved in the unrelated patent litigation, and that this limited contact ended at least seven years prior to this arbitration. In the majority’s opinion, these contacts were “tangential, limited, and stale” and would not have breached “an impression of possible bias” standard.
From an FAA policy standpoint, the majority agreed that awarding vacatur in situations such as this one would seriously jeopardize the finality of arbitration and give losing parties an incentive to conduct intensive, after-the-fact investigations to discover the most trivial of relationships, most of which they likely would not have objected to if disclosure had been made. Requiring vacatur on these “attenuated facts,” according to the majority, would also rob arbitration of one of its most attractive features apart from speed and finality, i.e., arbitrator expertise. The court perceived a real risk that the best arbitration professionals would not subject themselves to “blemishes on their reputations from post-arbitration lawsuits attacking them as biased.” In short, cases of nondisclosure by an arbitrator do not merit vacatur “unless it creates a concrete, not speculative, impression of bias,” i.e., it must be a nondisclosure that involves “a significant compromising relationship.”
In two spirited dissents, the 5-member minority of the en banc panel vehemently disagreed with the majority’s ruling. One dissenter, for example, proposed that the avoidance of partiality in the selection of the arbitrator can be achieved “only if, in discharging his duty of disclosure, the potential arbitrator objectively disgorges absolutely every conceivable fact of prior or present relationships with parties or counsel, regardless of how tenuous or remote they might seem to him.” Another dissenting judge asserted that the majority was attempting to overrule the Supreme Court’s Commonwealth Coatings decision and advocated that a failure to disclose “any dealings that might create an impression of possible bias” would justify vacatur of the award.
As readers can readily surmise, the contours of the FAA “evident partiality” standard are still evolving in nondisclosure cases when actual arbitrator bias is absent. Arbitrators would do well in this environment to disclose all of their professional and social relationships with the parties and counsel as well as any known potential witnesses and experts, with caveats if necessary, after appropriate due diligence. They should also promptly update their prior disclosures as soon as new information emerges or their recollection is refreshed during the pendency of the arbitration. Erring on the side of full disclosure, even if the prior business or social relationship may seem subjectively trivial, is probably the safest course. However, there will inevitably be those instances when memory fails due to the passage of time and a reviewing court must then determine whether such inadvertent omissions are something more than just “trivial.”
Positive Software Solutions, Inc. v. Century Mortgage Corp., No. 04-11432, 2007 U.S. App. LEXIS 1012 (5th Cir. Jan. 18, 2007).