By Iris (Yeonjae) Lim.
Parties in a dispute have several options as to how they want to resolve their issues, and arbitration is one of those options for parties to manage their disputes without going to court. According to the American Bar Association (ABA), arbitration is defined as “a private process where disputing parties agree that one or several individuals can make a decision about the dispute after receiving evidence and hearing arguments.” In other words, these individuals, or arbitrators, potentially act as judges and may provide a final decision for the parties. Usually, arbitrators handle a case from start to finish, and they sometimes have the power to make award decisions that a court would not be able to do. Therefore, arbitrators’ roles are very important and influential in an arbitration.
One of the reasons parties select arbitration instead of litigation is the opportunity to choose the neutral arbitrators themselves. The process of choosing arbitrators depends on the type of arbitration: (1) ad hoc arbitration, or (2) administered arbitration. In both types of arbitration, parties should be able to choose the arbitrators through several different ways. However, in an administered arbitration, an arbitration institution usually gets involved in selecting arbitrators, which may limit the parties’ choices.
Having qualified and neutral arbitrators is crucial to a fair hearing and a successful arbitration. However, arbitrators may be biased. According to the Federal Arbitration Act, a court may vacate an award if “there was evident partiality . . . in the arbitrators.” The following case specifically discussed the issue of a biased arbitrator.
In 2006, City Beverages, working as Olympic Eagle, created a contract with Monster Energy to “promote and sell Monster energy drinks for twenty years in an exclusive territory.” Monster was allowed to terminate the agreement without providing a cause as long as it paid a severance fee. After eight years, Monster decided to terminate its contract with Olympic Eagle. However, Olympic Eagle responded by invoking the Washington’s Franchise Investment Protection Act (FIPA), “which prohibits termination of a franchise contract absent good cause.” The two parties decided to arbitrate before JAMS Orange County, which was in the agreement between the two parties. Based on this agreement, “JAMS provided a list of seven neutrals to conduct the arbitration, and the parties chose the Arbitrator.” The Arbitrator provided a general disclosure statement to the parties at the beginning of arbitration and issued an award for Monster at the end. Monster asked the district court to confirm the award while Olympic Eagle argued that the award should be vacated because it was later discovered that the Arbitrator was JAMS’s co-owner, “a fact he did not disclose prior to arbitration.” Thus, the court discussing this case focused on two issues: (1) “whether Olympic Eagle waived its evident partiality claim,” and if it did not, (2) whether the award should be vacated.
First, the court applied the constructive knowledge standard in order to determine “whether a party has waived an evident partiality claim.” In other words, the court looked into whether Olympic Eagle knew or should have known that the arbitrator had ownership interest in JAMS. This inquiry was important because the Arbitrator’s ownership interest was “the key fact that triggered the specter of partiality.” Moreover, arbitrators have a “duty to investigate and disclose potential conflicts,” which the Arbitrator in this case failed to do. The court reasoned that the Arbitrator only provided a partial disclosure—disclosing his “‘economic interest’ in JAMS prior to arbitration” but not his ownership interest—which only implied that “the Arbitrator, like any other JAMS arbitrator or employee, had a general interest in JAMS’s reputation and economic wellbeing, and that his sole financial interest was in the arbitrations that he himself conducted.” The court also noted that the Arbitrator’s ownership interest could not be found through public sources and that JAMS “repeatedly stymied Olympic Eagle’s efforts to obtain details about JAMS’s ownership structure.” Thus, the court held that Olympic Eagle did not have “constructive notice of the Arbitrator’s potential non-neutrality” stemming from the ownership interest, and therefore, “did not waive its evident partiality claim.”
Second, the court set a two-fold inquiry to determine whether to vacate the arbitration award: “the arbitrator’s undisclosed interest in an entity must be substantial, and that entity’s business dealings with a party to the arbitration must be nontrivial.” The court reasoned that the Arbitrator being JAMS’s co-owner was substantial because he had a “right to a portion of profits from all of its arbitrations, not just those that he personally conducts.” The court further reasoned that JAMS administered 97 arbitrations over the past five years for Monster, which is “hardly trivial.” Therefore, the court held that the award should be vacated because “the Arbitrator’s ownership interest in JAMS was sufficiently substantial” and “JAMS and Monster were engaged in nontrivial business dealings.”
Thus, the court reversed and vacated the arbitration award, which initially ruled in favor of Monster, due to the Arbitrator’s failure to disclose potential partiality.
Arbitration is not perfect; however, it should continue being part of our legal system. Arbitration provides an opportunity for parties to resolve their disputes privately with less hostility and much more flexibility, which is not possible through litigation. Moreover, there are many ways to prevent biased arbitrations, such as disclosure requirements and potential court enforcement. Parties also have the option to challenge arbitrators based on lack of independence or impartiality. Litigation is not always the best option for parties in dispute, and arbitration often allows parties to avoid issues they would face in court by providing a formal alternative to litigation.
For more information on arbitration, Staff Writer Cole Cribari overviews that topic here.