Manifest disregard of the law

Don Murnane, partner at Freehill, Hogan & Mahar, LLP, looks at balancing the need for judicial review of law-based awards with the twin goals of modern ADR - cost efficiency and finality.

AT various times in the past, arbitration has been viewed by the judiciary in the United States and England with suspicion, sometimes even hostility, on the ground that it threatened to "erode judicial authority". Laymen serving as arbitrators were viewed by some judges as lacking in adequate judicial training and thus unskilled in applying the law. For example, in the 1915 maritime case of US Asphalt Refining v Trinidad Lake Petroleum (222 F 1006, 1008, SDNY 1915), English and United States precedent was cited by a federal court in New York to invalidate a charter party arbitration agreement because, in part, "the legal mind must assign some reason in order to decide anything with spiritual quiet…"

The earliest origins of judicial hostility to arbitration may have been more temporal, however. As Lord Campbell explained in the 1855 English case of Scott v Avery (25 LJ Ex 308, 313)

"There was no disguising the fact that, as formerly, the emoluments of the judges depended mainly, or almost entirely, upon fees, and as they had no fixed salaries, there was great competition to get as much as possible of litigation into Westminster Hall, and a great scramble in Westminster Hall for the division of the spoil * * * [T]hey had great jealousy of arbitrations whereby Westminster Hall was robbed of those cases which came not into Kings Bench, nor the Common Pleas, nor the Exchequer. Therefore they said that the courts ought not to be ousted of their jurisdiction, and that it was contrary to the policy of the law to do so." (See Kulukundis Shipping Co v Amtorg Trading Corp, 126 F 2d 978, 983 n.14, 2d Cir 1942).

As with many things, however, times have changed. Today, as society has become far more litigious and the courts overcrowded, a strong public policy in favour of arbitration has developed. A premium is now placed on the "twin goals" of arbitration - settling disputes efficiently and avoiding large and expensive litigation. This is especially so in the commercial context where, for many trades and industries, resolution of disputes may well depend more on custom and practice than on esoteric or complex legal analysis.

Maritime arbitration is perhaps the best example of the success of private dispute resolution in a sophisticated commercial setting. Judicial decisions now uniformly recognise the tremendous benefit of such alternative dispute resolution. the US Supreme Court has noted, "We are well past the time when judicial suspicion…of the competence of arbitral tribunals inhibited the development of arbitration as an alternative means of dispute resolution". (Mitsubishi Motors v Soler, 473 US 626, 626-27, 1985).

As former Supreme Court Chief Judge Harlan Fiske Stone, commented before the Academy of Political Science, "The very refinements and complexities of our court machinery often make it cumbersome and dilatory when applied to controversies involving simple issues of fact or law. This is especially true in the case when the issue of fact turns upon expert knowledge as to the nature or quality of merchandise or the damage consequent upon the failure to perform a contract for its delivery…which can be better determined by a layman having training and experience in a particular trade or business than by a judge and jury who have not had that training and experience."

Statutory Provisions

In line with these overriding practical concerns, and to prevent arbitration from becoming just another layer in the already protracted litigation process, federal and state legislatures in the US have enacted statutes which severely restrict a court's authority to review an award. For maritime arbitration in the US, the standard of review is governed by the Federal Arbitration Act (FAA). Modelled on New York State law enacted in 1920, the FAA specifies, at Section 10(a), the following limited bases for overturning an award:

  • The award was "procured by corruption, fraud or undue means".
  • "Evident partiality or corruption in the arbitrators, or either of them."
  • "The arbitrators were guilty of misconduct in refusing to postpone the hearing, upon sufficient cause shown, or in refusing to hear evidence pertinent and material to the controversy, or any other misbehaviour by which the rights of any party have been prejudiced."
  • The "arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made".

As can be seen, the phrase "manifest disregard of the law" is not contained in the statute. Thus, unlike judicial proceedings where a trial judge's application of the law is generally fully reviewable by an appellate court, the FAA does not explicitly include, as a basis for vacating an award, the requirement that the arbitrators misapplied or ignored the law.

Development of the manifest disregard doctrine under the common law

Despite its absence from the FAA, the doctrine of "manifest disregard of the law" has survived over the years as a common law (judge-made) basis for attacking an award. The doctrine originated in the US Supreme Court's 1874 decision in US v Farragut (22 Wall 406), a civil war prize case wherein disputes concerning the value of various vessels seized was put to arbitration. The Farragut arbitration agreement included a provision that "all questions of law" in dispute were to be "concluded" by the award.

In its decision, the Supreme Court distinguished between an arbitrator's "findings of fact" and "concrete positions of law, unmixed with facts". It held that, like any lower court opinion, an arbitral award could be set aside for "manifest mistake of law" as well as for other reasons such as fraud or that the arbitrators had exceeded their power.

Nearly ninety years later, in the 1953 case of Wilko v Swan, the Supreme Court relied on Farragut to strike down a stock purchase agreement requiring stockbroker misrepresentation claims to be arbitrated. The court held that the arbitration provision violated the Securities Act of 1933 because, under the FAA, "the power to vacate an arbitration award is limited", and Congress would never have intended to permit "waiver of judicial trial and review" of Securities Act claims. The court expressed concern that securities arbitrators could issue "interpretations of the law [which] in contrast to manifest disregard, [would not be] subject, in the federal courts, to judicial review".

Wilko evidences a continuing distrust on the part of the judiciary in relegating to arbitrators the role of deciding cases involving statutorily created and protected consumer rights. The court may well have had concerns that a consumer, perhaps unaware of a fine-print arbitration clause contained in a securities purchase agreement, might subsequently find himself before an arbitration panel comprised of Wall Street stockbrokers possessing an industry bias.

Thirty-six years later, however, in 1989, the Supreme Court changed its mind. In Rodriguez v Shearson/American Express (490 US 484, 1989), the court held that agreements to arbitrate securities claims did not violate the Securities Act but were, instead, consistent with the court's "current strong endorsement of the federal statutes favouring this method [arbitration] of resolving disputes". The doctrine of manifest disregard of the law was not, however, mentioned.

In the interim, the Supreme Court had decided the 1985 case of Mitsubishi Motors v Solar Chrysler/Plymouth ( 473, US 630, 1985) involving the enforceability of arbitration agreements in the anti-trust and unfair competition context. The court upheld the validity of such agreements but noted that federal courts could refuse to enforce anti-trust arbitral awards that were "contrary to public policy".

In a spirited and lengthy dissent, Justice Stevens argued that the public policy aspects of anti-trust law required that such disputes be resolved in court only. Justice Stevens, remaining skeptical of the use of arbitration in statutorily regulated industries, commented that "arbitration awards are only reviewable for manifest disregard of the law…and the evidentiary procedures which make arbitration so desirable in the context of private dispute often mean that the record is so inadequate that the arbitrators' decision is virtually unreviewable".

Echoing the judicial hostility of the past, Justice Stevens went on to describe arbitration as "despotic decision-making" which, though perhaps acceptable for "approximately correct resolution" of disputes in the commercial setting between private parties, was "simply unacceptable where every error [of law] might have devastating consequences for important businesses in our national economy and might undermine their ability to compete in world markets".

Manifest disregard was most recently mentioned by the Supreme Court in 1995. In First Options v Kaplan (514, US 938, 1995), the court was asked to decide whether arbitrators have the power to decide which disputes the parties agreed to submit to arbitration. In evaluating this issue, the court noted in passing that arbitral awards will only be set aside by courts in "very unusual circumstances", which included the bases enumerated under Section 10 of the FAA and "manifest disregard of the law".

Practical guidance for arbitrators and lawyers

Numerous federal courts of appeal and district courts have issued instructive opinions on the meaning and application of the phrase "manifest disregard" of the law. Many decisions attempt to give a practical definition; for example, that an award is subject to vacatur only when there has been a "knowing, willful, or deliberate" refusal to follow a "well established, explicit and clearly applicable" rule of law.

The lower court decisions have also provided some practical guidance to arbitrators and lawyers. For example, the courts have indicated that arbitrators should not feel secure that they can circumvent judicial scrutiny under the manifest disregard standard by simply issuing awards which do not contain discussion of the law. In some cases, "the governing law may have such widespread familiarity, pristine clarity and irrefutable applicability that a court could assume the arbitrators knew the rule, and notwithstanding, swept it under the rug".

Similarly, "a court may infer that arbitrators manifestly disregarded the law if it finds that the error made…is so obvious that it would be instantly perceived by the average person qualified to serve as an arbitrator".

Where an attorney fails to inform the tribunal of a relevant legal standard, a finding of manifest disregard is unlikely in the absence of other persuasive evidence that the arbitrators actually knew of, and intentionally disregarded, the legal rule. In other words, the arbitrators' failure to familiarise themselves with a rule of law does not constitute manifest disregard. (DiRussa v Dean Witter, 121 F3d 818, 823 (2d Cir 1997).

By the same token, where counsel urges the panel to disregard or ignore law on the ground that they are not bound to apply it, a court is more likely to scrutinise the award and overturn it on the basis of manifest disregard. In one case, decided in 1997 by the US Court of Appeals for the Eleventh Circuit, arbitrators were chastised for apparently following the "flagrant and blatant" urgings of counsel to disregard the law. In closing argument, counsel for Shearson Lehman Brothers had challenged the arbitrators to "do what is right and just and equitable in this case" rather than "follow the statutes that have been presented to you". Counsel went on to state that "you know as arbitrators you have the ability [to do what is right in this case], you are not strictly bound by case law and precedent…I now ask you in my closing, not to follow the [statute]" because "in this case the law is not right…the law says one thing, what equity demands and requires is another". (Montes v Shearson Lehman, 128 F3d 1456, 1459 (11th Cir 1997).

Is the doctrine necessary?

In recent years, the decisions discussed in this article, and many others, have been cited and discussed by lawyers and arbitrators in the United States in an ongoing debate concerning the validity of the manifest disregard standard and the scope of its application. Those who oppose the doctrine point out that there is no mention of it contained in Section 10 of the FAA and that the Supreme Court's periodic "recognition" of the doctrine constitutes, in each case, dicta rather than an express holding by the court. Opponents of the doctrine also argue that it has little utility in maritime arbitration between sophisticated commercial interests and should only be applied to awards where the subject matter involves (a) statutory consumer claims, (b) unequal bargaining power between the parties, or (c) issues of public policy rather than private commercial disputes.

Proponents of the doctrine point out that, dicta or not, the Supreme Court has expressly confirmed the validity of the standard as recently as 1995. Moreover, irrespective of practical concerns for "efficient dispute resolution", commercial entities who agree to arbitrate implicitly allocate risks in their contractual relationships on the assumption that the governing law will be applied in resolving any disputes that later arise. As to the statutory construction of the FAA, it can be argued that the phrase "any other misbehavior [of the arbitrator]" under Section 10(a)(3), or the phrase "the arbitrators…so imperfectly executed [their powers]" under Section 10(a)(4) are broad enough to encompass a situation where arbitrators refuse to follow settled law. It can also be argued with some force that it is unlikely that Congress intended, under the Act, that an award should be reversible on procedural deficiencies such as "refusing to postpone the hearing" or "refusing to hear evidence" but not for the arbitrators' substantive fault in refusing to follow the law.

Striking a balance

The debate over the need for, and scope of, the doctrine seems likely to continue. In the last three years, several cases have been filed in the United States District Court for the Southern District of New York alone, challenging maritime awards on the allegation that the arbitrators "manifestly disregarded" the law. The court has shown interest in one of these cases but, for the most part, vacutur motions have not been successful. It seems clear that, in maritime cases, the doctrine will apply only rarely.

The doctrine has its place in encouraging fairness and predictability of legal rulings in the arbitral process, but the vast majority of awards based on custom and practice in the industry do not qualify for judicial scrutiny and will not be overturned by the courts. Most "garden variety" maritime awards are poor candidates for judicial review, and the filing of a motion to vacate under Section 10 will serve little purpose but to increase costs to the parties. On the other hand, parties can expect higher judicial interest and scrutiny if the subject matter involves statutory rights, unequal bargaining power between the parties, or issues of public policy rather than purely private commercial disputes. Parties to maritime arbitration, their counsel, and arbitrators must keep in mind that the goal should be to balance the need for limited judicial review to ensure fairness and predictability in law-based awards with the utility and cost-efficiencies of final awards that are, in fact, "final".