Law clerks on the Court of Appeals must have been busy last weekend, because on Monday the Third, Fifth and Federal Circuits issued significant opinions. The Federal Circuit addressed the question of when an arbitrator loses power to alter his or her decision. The Third Circuit considered the difference between fraud in the execution of an agreement and fraud in the inducement when deciding the gateway issue of arbitrability. In a very fact intensive case, the Fifth Circuit addressed disqualification of an arbitrator for nondisclosure.
One of the basic concepts in arbitration – and a great Latin phrase to say – is functus officio, Latin for “task performed.” Under that doctrine, once an arbitrator has rendered a final decision on the issue submitted, he or she loses power to redecide that issue. Ramirez v. Dep’t of Homeland Security¸2020 U.S. App. LEXIS 29185 (Fed. Cir.) (Sept. 14, 2020), addressed what constitutes an arbitrator’s prohibited “do over.” Ramirez arose from plaintiff’s removal from his job as a Customs and Border Protection Officer. After a domestic dispute, the agency revoked Ramirez’s authority to carry a firearm and ordered a psychiatric evaluation. That evaluation was inconclusive and the agency ordered a second evaluation which recommended that Ramirez, because of his alleged lack of full cooperation in the evaluation, be prohibited from carrying firearms. Both evaluations were based on a written assessment, an MMPI, which neither evaluating psychiatrist interpreted; rather, both relied on a third-party evaluator, Dr. Frederick. The agency ultimately removed Plaintiff from duty. Ramirez filed for arbitration.
The arbitrator held two evidentiary hearings, after which he entered an award (“Interim Award”) directing an additional psychiatric evaluation, but deferring his decision regarding reinstatement pending the availability of a “clear and conclusive opinion” regarding fitness. Ramirez sought review of the Interim Award in 2018, but the Third Circuit dismissed for lack of finality. After obtaining the results of that third evaluation the arbitrator issued his “Final Award,” affirming Ramirez’s removal. Ramirez contended that the arbitrator’s jurisdiction had expired once he issued the Interim Award and that the Final Award was barred by functus officio.
The court, Reyna, J., held that the issue of “when an interim award by an arbitrator constitutes a final decision which triggers functus officio” was one of first impression in the Circuit. After addressing holdings elsewhere, the court opined that the issue revolves around whether the “award states” that it is final and whether, based on the language of the award, the arbitrator “intended” the award to be final. “When an arbitrator makes clear that an interim award reflects only a preliminary assessment of the evidence and retains jurisdiction to render a final award,” the arbitrator may rule further. Since the Interim Award expressly deferred the issue of just cause for termination and addressed only certain evidentiary issues, it dealt with just part of the question under consideration and the arbitrator had the authority to enter the Final Award. (On the merits of the appeal, the court vacated the arbitration award on the basis that the agency’s failure to provide Dr. Frederick’s data and the original MMPI, coupled with the arbitrator’s failure to compel that production, violated Ramirez’s right to due process.)
The lesson here for arbitrators – if you are drafting an “interim award,” caption it as such, refer to it as such in the text and specifically state that you are retaining jurisdiction to issue a “final award” after further proceedings.
Fraud in execution and fraud in the inducement
MXM Const. Co. v. N.J. Bldg. Laborers Statewide Benefit Funds, 2020 U.S. App. LEXIS 29039 (3rd. Cir.) (Sept. 14, 2020) raises another Latin phrase – ex nihilo, nihil fit, out of nothing comes nothing. The arbitration issue in the case is a common one – is the issue of arbitrability one for the arbitrator or for the court to decide. However, the case has what Judge Restrepo characterized as a “mind-bending” twist – who decides the arbitrability issue when the agreement provides for its resolution by the arbitrator, but one of the parties claims that the agreement which contains the delegation is invalid because of fraud.
The case is dense and fact driven and needs to be read, but it can be summarized as follows. MXM entered into a fairly standard, one-page agreement with the Laborers Union to hire union employees and make contributions to the pension fund. That agreement contained provisions which provided for arbitration, among other things, of “questions or grievances involving the interpretation and application of this Agreement” and that “the Arbitrator shall have the authority to decide whether an Agreement exists, where that is in dispute.” In other words, the issue of arbitrability was delegated to the arbitrator. The twist, though, is that the signatory for MXM believed, based on the circumstances of the execution and misrepresentations by the union representative, that the agreement related only to work at Newark Airport. The Benefit Funds, however, sought to compel contributions for work throughout its jurisdiction. The claim of fraud arose out of this disagreement.
The Third Circuit panel concluded that, under New Jersey law and based on the facts of the case, the misrepresentation as to the scope of the agreement constituted fraud in the execution of the agreement, which invalidated the entire contract. The court distinguished such “fraud in the execution” from the more common “fraud in the inducement,” which, under New Jersey law would mean that there was, in fact, an agreement, but that it was voidable.
So, why did the distinction matter? The court recited the history of “container contract” law, citing Rent-A-Center, W., Inc. v. Jackson, 561 U.S. 63 (2010) and other authorities. Under the “container contract” doctrine, which has been analogized to embedded Russian dolls, an attack based on fraud in the inducement of the arbitration provision of a contract must allege that the fraud goes to that specific provision, not to the agreement as a whole. Likewise, an attack on the delegation provision within the arbitration clause must go to that specific provision, not to the arbitration clause as a whole. Thus, if MXM were claiming that the entire agreement was voidable for fraud in the inducement, the arbitrator would decide the issue of arbitrability, since there would be an agreement, albeit one that was voidable. Here, though, the court found that the evidence established that the agreement was fraudulently executed and, therefore, was void, not just voidable. Since the delegation clause only arose because a contract existed between the company and the union, the voiding of the contract removed the only authority for an arbitrator’s action of any type, including a determination of arbitrability. Ex nihilo, nihil fit. The court recognized that this distinction between fraud in the inducement and fraud in the execution is a close one and discussed at length the difference between the two issues. That difference, per the court, essentially breaks down to whether one signs an agreement which contains the terms to which they intend to agree, but was induced to do so by a material misrepresentation (fraud in the inducement), or the fraud led the signer to believe that the terms of the agreement were actually different from those contained in the writing (fraud in the execution). For example, the court states, if a person who wants cheese is led to believe that they are signing a contract for cheese, but it is really a contract for milk, that is fraud in execution, while, if the signatory knows that it is buying milk from which to produce cheese, but is induced make the purchase because the seller misrepresents that the price of cheese will increase, that is fraud in the inducement.
Having gone through that analysis, the court determined that there was fraud in the execution of the agreement. Since the delegation clause was contained in the voided agreement, the usual presumption that the court determines arbitrability remained intact and the Court of Appeals affirmed the District Court’s refusal to compel arbitration.
The lesson from the case – if you are challenging arbitration based on fraud, be sure to phrase your attack in such a way that applicable state law voids the agreement, not merely makes it voidable.
Disqualification of an arbitrator for a financial interest
In OOGC Am. v. Exploration, 2020 U.S. App. LEXIS 29168 (5th Cir.) (Sept. 14, 2020), the court was faced with the question of whether an arbitrator’s alleged failure to disclose his contacts with a company which, though not a party to the arbitration, had certain contractual relationships with one of the parties, constituted a basis for disqualification. OOGC, which lost the arbitration, sought to have the award vacated and the District Court did so. The Court of Appeals reversed that vacating and remanded with an instruction to confirm the award. The standard to be applied to disqualification, according to the Court, is whether there are “specific facts from which a reasonable person would have to conclude that the arbitrator was partial” to a party, quoting several authorities. (Emphasis added). Reviewing the facts, Judge Elrod held that OOGC raised nothing more than speculation that the arbitrator’s relationships might have incentivized him to favor Chesapeake Exploration, OOGC’s opponent in the proceeding. Therefore, there was an insufficient showing of bias.
In an interesting sidelight, the court affirmed the District Court’s denial of the arbitrator’s motion to intervene in the proceeding below, as he sought to correct what he characterized as misstatements about him in the record and to “demonstrate his veracity, ethics, and integrity.” The issue was resolved on the procedural ground that the District Court lacked jurisdiction to consider the question, as a notice of appeal had already been filed and the award had been vacated. The interesting issue is whether the arbitrator would have had standing, on the merits, to intervene if those procedural complications did not exist.
This report has been a little longer than usual, but the cases were particularly interesting and complex – and this ADR nerd got caught up in them. Have a great couple of days and I will see you Friday.