Vacating a Reinsurance Arbitration Award for Evident Partiality

FAA Provides Only Limited Reasons To Vacate an Arbitration Award

The FAA provides only a few limited bases to seek vacatur of an arbitration award. To vacate an arbitration award, there must be an affirmative finding that there was corruption or fraud in procuring the award, a complete violation of due process or other misconduct by the arbitrators, the arbitrators must go beyond (exceed) their powers, or where there was evident partiality or corruption by the arbitrators. See 9 U.S.C. § 10(a). Courts are loath to vacate arbitral awards and regularly confirm awards based on the slightest rational basis. The FAA severely limits the court's review of an arbitration award based on the strong deference courts afford to the arbitration process.

As long as the award is derived from the arbitrators' interpretation of the contract, a court will confirm the award, even if the court itself would have decided the matter differently. In other words, a court's review of an arbitration award under the FAA is not an appeal based on the facts or the law; rather, it is merely a determination that there is no basis to vacate the award under the limited bases granted by section 10(a) of the FAA. Let me repeat that. There is no "appeal" of an arbitration award under the FAA. The FAA only provides for confirmation, modification, or vacatur of an arbitration award.

What Is Evident Partiality?

That brings us to one of those limited bases permitted by the FAA: whether there is "evident partiality" by the arbitrators in rendering the award. See 9 U.S.C. § 10(a)(2). Evident partiality will be found where a reasonable person would have to conclude that the arbitrator was partial to one party in the arbitration.

In "traditional" reinsurance arbitrations in the United States, the arbitration panel is typically made up of two party-appointed arbitrators, each of whom may be predisposed toward the position of the party that appointed them, and a third arbitrator or umpire, who is neutral. In some cases, albeit only a small minority, the arbitration panel may be completely neutral, but that is, unfortunately, not the current norm in arbitrating reinsurance disputes in the United States.

Where an arbitration award is issued and one of the parties challenges the award based on the evident partiality of one of the arbitrators, consideration must be given to the burden of proof necessary to convince a court to vacate the award. Does the burden of proof change based on whether the arbitration award was issued by a single, neutral arbitrator or an all neutral arbitration panel, or where a traditional US reinsurance arbitration panel, with party-appointed and predisposed arbitrators, issued the award? What does the challenging party need to show to obtain vacatur based on evident partiality? The standard used by the courts to determine how to assess the evident partiality claim between neutral arbitrators and nonneutral arbitrators is an esoteric point of law and had not been directly addressed by the Second Circuit Court of Appeals until recently.

The Court Speaks

In Certain Underwriting Members of Lloyd's of London v. State of Florida, No. 17-1137, 2018 U.S. App. LEXIS 15377 (2d Cir. Jun. 7, 2018), the district court had vacated a reinsurance arbitration award in the ceding insurer's favor based on the evident partiality of the ceding insurer's party-appointed arbitrator for failure to disclose close relationships with parties associated with the ceding insurer. Basically, the ceding insurer's party-appointed arbitrator's business venture shared office space with the ceding insurer, had hired employees from the ceding insurer, and the arbitrator clearly knew the ceding insurer's witnesses.

The district court found that the arbitrator's preexisting and concurrent relationships with the ceding insurer's representatives were considerably more extensive than what the arbitrator disclosed during the arbitration. The district court held that the failure to disclose those relationships were significant enough to demonstrate evident partiality. Accordingly, the district court vacated the arbitration award in the ceding insurer's favor.

In reversing and remanding the case for reconsideration by the district court, the circuit court found that the district court weighed the arbitrator's conduct under the standard governing neutral arbitrators and not party-appointed arbitrators that are predisposed to their appointed party's position. The court noted that the district court did not connect the arbitrator's conduct to the arbitration panel's decision in rendering the arbitration award. The district court also made no finding that the arbitrator had a personal or financial interest in the outcome of the arbitration.

In discussing the burden of proof, the Second Circuit held that "a party seeking to vacate an award under Section 10(a)(2) [of the FAA] must sustain a higher burden to prove evident partiality on the part of an arbitrator who is appointed by a party and who is expected to espouse the view or perspective of the appointed party." The court noted that while evident partiality will be found where a reasonable person would have to conclude that an arbitrator was partial to one party in the arbitration, the challenging party must prove the existence of evident partiality by clear and convincing evidence.

The court distinguished between what must be shown in a neutral arbitration setting from a party-appointed setting. In determining that there will now be a distinction in the Second Circuit between party-appointed and neutral arbitrators in considering evident partiality challenges, the court stated that "[e]xpecting of party-appointed arbitrators the same level of institutional impartiality applicable to neutrals would impair the process of self-governing dispute resolution." In other words, because reinsurance counterparties continue to seek out arbitrators with expertise by using party-appointed arbitrators who are expected to serve as de facto advocates, the degree of partiality tolerated is set in part by the parties' contractual bargain.

The distinction, held the court, "is salient in the reinsurance industry, where an arbitrator's professional acuity is valued over stringent impartiality." But, said the court, "a party-appointed arbitrator is still subject to some baseline limits to partiality." For example, an undisclosed relationship is material if it violates the arbitration agreement. If, in this case, the party-appointed arbitrator had a personal or financial stake in the outcome, it would violate the "disinterested" qualification in the arbitration clause. Also, if the undisclosed fact results in a prejudicial effect on the award, it is material and warrants vacatur. But in "the absence of a clear showing that an undisclosed relationship (or the non-disclosure itself) influenced the arbitral proceedings or infected an otherwise-valid award, that award should not be set aside even if a reasonable person (or court) could speculate or infer bias."

The court made clear that the principles and circumstances that counsel tolerance of certain undisclosed relationships between a neutral arbitrator and a party are even more indulgent of party-appointed arbitrators, who are expected to serve as de facto advocates. In other words, if the courts do not consider past relationships material to warrant vacatur of arbitration awards in a neutral arbitrator setting, then when party-appointed arbitrators are involved, broader relationships are likely to be tolerated, as long as there is no direct connection between the arbitrator and the outcome of the arbitration.

On remand, the district court is charged with determining whether the reinsurers have shown by clear and convincing evidence that the failure to disclose by the ceding insurer's party-appointed arbitrator either violates the qualification of disinterestedness or had a prejudicial impact on the award. This might require further proceedings.

Reducing Risk Associated with Party-Appointed, Partisan Arbitrators

Notably, the same "expertise" that the Second Circuit discusses that comes with using party-appointed arbitrators in reinsurance disputes is still available to the parties by using the ARIAS US Neutral Panel Rules. A fully neutral panel would reduce the heightened scrutiny now required in the Second Circuit (and other circuits) when challenging an award for evident partiality where the arbitrator is party-appointed and nonneutral. A true neutral panel would not require that same heightened scrutiny to determine if there was evident partiality warranting the award being vacated.

But that doesn't mean arbitration awards will be vacated more frequently. Most commercial arbitrations require neutral arbitrators and the clear and convincing burden still applies. The undisclosed relationships still have to go to the rendering of the award. There still must be a material relationship between the undisclosed information and the subject of the arbitration and the award itself.

While failure to disclose relationships between the arbitrator and a party may be a violation of ethical guidelines (unless the failure to disclose is material to the award, violates the arbitration agreement, or is prejudicial to the award), an ethical breach is not enough to vacate a reinsurance arbitration award.