In a surprising and controversial 2-to-1 split decision, the influential U.S. Court of Appeals for the Second Circuit ruled that an arbitration panel did not exceed its authority in awarding attorney’s and arbitrator’s fees as a sanction for a party’s failure to arbitrate in good faith notwithstanding a clause in the parties’ arbitration agreement requiring that each party bear it own such fees.
As is typical in many arbitration clauses addressing the allocation of arbitral costs, the provision at the heart of this appellate court ruling, appearing in two nearly identically worded 1997 coinsurance agreements between ReliaStar Life Insurance Company of New York (“ReliaStar”) and National Travelers Life Company (the predecessor-in-interest to EMC National Life Company (“EMC”)), provided as follows:
“Each party shall bear the expense of its own arbitrator . . . and related outside attorneys’ fees, and shall jointly and equally bear with the other party the expenses of the third arbitrator.” [Emphasis added.]
When various disputes arose between the parties over whether the coinsurance agreements had terminated and the methodology for conducting a terminal accounting, an arbitration ensued. Following a two-week hearing in 2006, the arbitration panel entered an interim award finding that the coinsurance agreements remained in force and ordering EMC to pay ReliaStar over $21 million past due under them. Without explanation, a majority of the panel also awarded ReliaStar its attorney’s and arbitrator’s fees and costs. EMC complied with the panel’s interim award except for the payment of ReliaStar’s fees and costs, and the parties agreed to submit that issue to the panel for reconsideration. Subsequently, the panel majority awarded ReliaStar its attorney’s and arbitrator’s fees of $3,169,496, costs of $691,904, and interest on the basis that it viewed the conduct of EMC in the arbitration “as lacking good faith.”
Later in 2006, when ReliaStar petitioned the New York federal district court to confirm the final arbitration award, EMC contended that the panel had exceeded its authority in awarding ReliaStar’s fees and costs in light of the above-quoted costs allocation provision in the coinsurance agreements. The district court agreed and vacated that portion of the final award granting ReliaStar its attorney’s and arbitrator’s fees but confirming the rest. ReliaStar subsequently appealed the district court’s vacatur of the panel’s fee awards to the Second Circuit.
Before the Second Circuit, a majority of the three-judge panel reversed the district court’s vacatur of the fee awards because (1) the arbitration agreement conferred broad authority on the arbitrators, (2) inherent in such authority is the power to sanction bad faith conduct, and (3) bad faith is “a well-recognized exception to the American Rule for attorney’s fees [i.e., each party bears their own attorney’s fees].” Therefore, the “simple statement” of the American Rule in the costs allocation clause of the coinsurance agreements “is insufficient by itself to swallow the exception.” Given the plain wording of that provision, this conclusion is remarkable. To get there, the majority’s analysis focused primarily on the following four key points.
First, the majority examined § 10(a)(4) of the Federal Arbitration Act, which authorizes courts to vacate arbitral awards “where the arbitrators exceeded their powers.” Observing that the federal courts have “consistently accorded the narrowest of readings” to this provision, the majority considered only whether, in light of the arbitration agreement, the arbitrators were authorized to sanction bad faith conduct by awarding attorney’s and arbitrator’s fees and not whether the arbitrators correctly identified bad faith conduct or whether the amount of fees awarded was an appropriate sanction for that conduct.
Second, the majority analyzed what it viewed as the coinsurance agreements’ “broad arbitration clause” and the range of sanctions available to arbitrators when bad faith is identified giving rise to an exception to the American Rule. The arbitration clause provided in pertinent part:
“In the event of any disputes or differences arising hereafter between the parties with reference to any transaction under or relating in any way to this Agreement as to which agreement between the parties hereto cannot be reached, the same shall be decided by arbitration. Three arbitrators shall decide any dispute or difference . . . .”
Based on this wording, the majority concluded that it conferred “inherent authority on arbitrators to sanction a party that participates in the arbitration in bad faith and that such a sanction may include an award of attorney’s or arbitrator’s fees.” Such sanctions are “appropriately viewed as a remedy within an arbitrator’s authority to effect the goals of arbitration.”
Third, the majority rejected EMC’s argument that the plain language of the costs allocation provision limited the panel’s available sanctions by specifically excluding awards of attorney’s and arbitrator’s fees and, in effect, imposing the American Rule on the parties. It concluded that the proper construction of this clause must be viewed in the context of the parties’ expected good faith dealings in light of the covenant of good faith and fair dealing inherent in every contract. However, the costs allocation clause said nothing about whether the arbitrator’s authority to sanction bad faith conduct was similarly limited such that it may not award attorney’s or arbitrator’s fees consistent with the widely-recognized “bad faith” exception to the American Rule.
Fourth, if the parties, as sophisticated commercial entities, had intended to avoid the majority’s interpretation of the costs allocation clause when bad faith is identified, they could have clearly articulated their intent to exclude attorney’s and arbitrator’s fees from the otherwise broad range of sanctions generally available to arbitrators in that context. “We require only that [the parties] explicitly and clearly state that intent as part of their agreement to arbitrate.” According to the majority, “a more explicit statement would be necessary to manifest any intent to override the bad-faith exception to the American Rule and to preclude the arbitrators from awarding attorney’s and arbitrator’s fees as a sanction for bad faith conduct.”
Concluding that the arbitral panel “clearly awarded relief expressly forbidden by the agreement of the parties,” the dissenting judge attacked what she viewed as the majority’s departure from the general principle that vacatur of an arbitral award is appropriate only if it contradicts “an express and unambiguous term of the contract” or if the award so far departs from the terms of the agreement that it is not even arguably derived from the contract. Concurring with the district court judge’s assessment below that the costs allocation clause was “clear as a bell,” she found it to be “unqualified” and not admitting of certain exceptions, even in a bad-faith context. In this case, the arbitrators had the discretion to order remedies they determined appropriate “so long as they do not exceed the power granted to them by the contract itself.” Stated another way, “arbitrators cannot award forms of relief which are plainly in contradiction with the authority afforded them under the contract between the parties, even when the relief appears to be in furtherance of the arbitrator’s reasonable notion of what fairness or good sense requires.” The dissent also took exception to the majority’s “inherent authority to sanction bad faith” argument because it clearly conflicted with the very specific wording of the costs allocation clause, which unambiguously provided that the parties shall bear their own attorney’s and arbitrator’s fees. The concept of arbitral “inherent authority” to sanction, she observed, was “problematic” because it directly contradicted the principle that an arbitrator’s authority is circumscribed by the agreement of the parties.
It is difficult to reconcile the specific and seemingly unambiguous wording of the costs allocation provision in this case with the arbitrators’ expansive inherent power to sanction bad faith inferred by the Second Circuit majority from its broad reading of the arbitration clause. Nevertheless, insurance and reinsurance contract drafters have now been forewarned. If you intend to restrict arbitral discretion to impose on the parties sanctions such as attorney’s and arbitrator’s fees in both good- and bad-faith contexts, at least in the Second Circuit, you must now do so by explicitly manifesting the requisite intent to override the panel’s otherwise broad and inherent authority to award such fees. Failing to do so may be construed as tacit approval of the arbitrators’ power to impose, for example, the bad-faith exception to the American Rule sanction in appropriate cases.
ReliaStar Life Insurance Company of New York v. EMC National Life Company, Docket No. 07-0828-cv, 2009 U.S. App. LEXIS 7647 (2d Cir. April 9, 2009).