Wednesday, July 16, 2014

Partial Disclosure of a Source of Potential Bias Justifies Vacating an Arbitration Award in Texas

When compared with traditional litigation judgments, it is much harder to vacate arbitration awards after they are issued. The Texas Supreme Court recently addressed the standard by which an award can be vacated due to inadequate disclosures by the arbitrator.  In particular, the Court had to evaluate whether an award should be vacated due to an arbitrator’s partial disclosure of a source of potential bias or conflict. Tenaska Energy, Inc. v. Ponderosa Pine Energy, LLC, 57 Tex. Sup. J. 617 (Tex. 2014).

The AAA Commercial Arbitration Rules require that “any person appointed or to be appointed as an arbitrator shall disclose…any circumstance likely to give rise to justifiable doubt as to the arbitrator’s impartiality or independence, including any bias or any financial or personal interest in the result of the arbitration or any past or present relationship with the parties or their representatives.” 

The underlying arbitration proceedings were based on a contract dispute between Tenaska and Ponderosa.  The parties’ arbitration agreement provided for a panel of several arbitrators. Lawyers from Nixon Peabody represented Ponderosa and selected Samuel Stern as their arbitrator.  After his selection Stern disclosed the following information to the parties regarding his relationship with Ponderosa and Nixon Peabody: (1) Nixon Peabody had designated him as an arbitrator in three other proceedings, (2) Stern, on behalf of a company named LexSite, had discussions with Nixon Peabody about outsourcing litigation discovery tasks to LexSite, and (3) “Nixon Peabody and LexSite have done no business, and it is not clear that Nixon Peabody would ever have any business to give LexSite.”  Stern, as part of a divided panel, eventually awarded $125 million to Ponderosa.

Tenaska moved to vacate the award in state court, arguing Stern was neither impartial nor free from bias.  The parties conducted extensive discovery on the issue prior to the hearings on the opposing motions. Ultimately, the trial court vacated the arbitration award based on Stern’s failure to disclose that his only contacts at Nixon Peabody were the two lawyers representing Ponderosa, he owned stock in the litigation services company that was pursuing business from Nixon Peabody, he served as president of the company’s U.S. subsidiary, he conducted significant marketing for the company, he had additional meetings and contact with the Nixon Peabody lawyers to solicit business from the firm, and he allowed one of the Nixon Peabody lawyers to edit his disclosures to downplay the relationship with the firm. The court of appeals reversed, holding that Stern’s disclosures were sufficient to put Tenaska on notice of a potential conflict. 

The Texas Supreme Court ultimately upheld the trial court’s vacation of the arbitration award, reasoning that Stern’s failure to disclose the extent of his relationship with LexSite and his attempts to solicit business from Nixon Peabody demonstrated evident partiality and supported vacating the award.  The Federal Arbitration Act allows a court to set aside an arbitration award “where there was evident partiality.” 9 U.S.C. § 10(a)(2).  The U.S. Supreme Court has interpreted the statute to impose a requirement on arbitrators to “disclose to the parties any dealings that might create an impression of possible bias.”  Commonwealth Coatings Corp. v. Cont’l Cas. Co., 393 U.S. 145, 147 (1968). Moreover, the Texas Supreme Court had previously held that “if the arbitrator does not disclose facts which might, to an objective observer, create a reasonable impression of the arbitrator’s partiality,” then the arbitrator exhibits evident partiality. 

Based upon these cases, the Texas Supreme Court held an arbitration award can be vacated if an arbitrator fails to disclose facts which might, to an objective observer, create a reasonable impression of the arbitrator’s partiality. However, information that is trivial will not rise to this level and need not be disclosed.  Looking at the facts regarding Stern’s business relationship, his potential financial gain from procuring Nixon Peabody’s business, and his decision to allow Ponderosa’s attorneys to downplay their relationship, the Court held that the information was not trivial and might have conveyed an impression of partiality toward Nixon Peabody’s client to a reasonable person. Accordingly, the failure to disclose the information demonstrated evident partiality, and the trial court properly vacated the award. 

While this case was decided under Texas law, the Texas Supreme Court’s interpretation of the Federal Arbitration Act suggests that its reasoning could be applied more broadly to cases across the country. In particular, the Court’s decision to evaluate the extent to which a partial disclosure could be misleading could give rise to more challenges to arbitration awards based on disclosure issues.

Thanks to J.P. Neyland at Griffith Davison & Shurtleff, P.C. for assistance with preparing this post.

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