Arbitration Award Vacated Because Arbitrator Hid Ownership Interest In Arbitration Service

by: Peter J. Gallagher (LinkedIn)

Arbitration awards are rarely overturned. The standard to vacate an award is high, and judicial review of awards is often unexacting. So when a court overturns an award, it is usually worth a closer look. And one recent decision from the U.S. Court of Appeals for the Ninth Circuit, Monster Energy Company v. City Beverages , LLC, is definitely worth a closer look. In Monster, the court vacated an arbitration award based on the “evident partiality” of the arbitrator. The main evidence of the arbitrator’s “evident partiality” was his ownership interest in JAMS, a fact he did not disclose before the arbitration. At the risk of revealing my own ignorance, I did not know that JAMS is owned, at least in part, by some of the neutrals who mediate/arbitrate cases through JAMS. But it is, and after Monster, those owners should disclose that relationship to the parties before beginning an arbitration.

The defendant in Monster was a beer distributor. In 2006, it signed an agreement with plaintiff to be the exclusive distributor of plaintiff’s energy drinks for 20 years in a specific geographical territory. But the agreement contained an out for plaintiff – it could terminate the agreement without cause if it paid a severance fee to defendant in an amount agreed upon by the parties in the agreement. Eight years after signing the agreement, plaintiff exercised this clause, paid the severance fee, and terminated the agreement. Defendant objected, arguing that the termination violated Washington’s Franchise Investment Protection Act.

The agreement between the parties contained an arbitration provision, requiring that any dispute be resolved by JAMS Orange County. After plaintiff served its arbitration demand, JAMS provided the parties with a list of seven neutrals. The parties chose their arbitrator from this list. The chosen arbitrator then provided a disclosure statement, which included the following: “I practice with JAMS. Each JAMS neutral, including me, has an economic interest in the overall financial success of JAMS.” The arbitrator also disclosed that he had arbitrated one matter for plaintiff in the past five years, and that he had ruled against plaintiff in that case, which involved a dispute between plaintiff and another distributor.

After a two-week hearing, the arbitrator ruled in plaintiff’s favor. Plaintiff filed a petition to confirm the award and defendant cross-petitioned to vacate the award. Defendant’s cross-petition was based on information it discovered after the arbitration hearing, which showed (1) that the arbitrator was a co-owner of JAMS, and (2) that JAMS had arbitrated 97 matters for plaintiff in the past five years. Defendant argued that the arbitrator’s failure to disclose both of these relationships – his ownership of JAMS, and JAMS’s frequent dealings with plaintiff – justified vacating the arbitration award. The district court disagreed and ruled in plaintiff’s favor. Defendant appealed.

The Ninth Circuit reversed.  Citing to the U.S. Supreme Court’s decision in Commonwealth Coatings Corp. v. Cont’l Cas. Co. (1968), it noted that “vacatur of an arbitration award is supported where the arbitrator fails to disclose to the parties any dealing that might create an impression of possible bias.” In his concurrence in Commonwealth Coatings, Justice White observed that “when an arbitrator has a substantial interest in a firm which has done more than trivial business with a party, that fact must be disclosed.” By while non-trivial business must be disclosed, the Ninth Circuit previously observed that “long past, attenuated, or insubstantial connections between a party and an arbitrator” did not because they were not evidence of partiality by the arbitrator.

Thus, in Monster, the Ninth Circuit had to determine: (1) whether the arbitrator’s ownership interest in JAMS was substantial; and (2) whether JAMS and plaintiff were “engaged in nontrivial business dealings.” It answered both of these questions in the affirmative.

First, the court held:

[A]s a co-owner of JAMS, the Arbitrator has a right to a portion of profits from all arbitrations, not just those that he personally conducts. This ownership interest – which greatly exceeds the general economic interest that all JAMS neutrals have in the organization – is therefore substantial.

In Monster, the arbitrator disclosed that he, like all JAMS neutrals, had “an economic interest in the overall financial success of JAMS.” The court suggested that this might be acceptable for a non-owner arbitrator, but was not sufficient for the arbitrator in Monster.

Second, the court held that JAMS’s relationship with plaintiff was nontrivial:

[O]ver the past five years, JAMS has administered 97 arbitrations for [plaintiff]; an average of more than one arbitration per month. Such a rate of business dealing is hardly trivial, regardless of the exact profit-share that the Arbitrator obtained.

Accordingly, the Ninth Circuit held that the arbitrator had a “substantial interest” in JAMS and that JAMS had done “more than trivial business” with plaintiff, facts that should have been disclosed to the parties before the arbitration. Because the arbitrator did not disclose them, the award had to be vacated.  

Finally, the court emphasized the importance of its holding beyond the two parties to the Monster case:

Although this litigation involved two sophisticated companies, the proliferation of arbitration clauses in everyday life—including in employment-related disputes, consumer transactions, housing issues, and beyond—means that arbitration will often take place between unequal parties. Clear disclosures by arbitrators aid parties in making informed decisions among potential neutrals. These disclosures are particularly important for one-off parties facing “repeat players.”

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