Thursday, May 7, 2015

Respondent Refuses to Pay Arbitration Fee/Deposit - What is the Remedy? Recent Article Advocates for an Immediate Default

The Problem: Respondent purposefully does not pay its share of the arbitration fee/deposit out of a motivation to delay the adjudication process and/or make it more difficult for the claimant to proceed with the contractual arbitration process.  Upon non-payment, and following a cure period, the arbitrator terminates the arbitration.

Options for Claimant:

     (1) Proceed in court litigation. This denies claimant of the bargained-for choice of arbitration.

     (2) Seek an order from court to compel payment. There is no certainty with this approach.  The court may regard the respondent's breach of arbitration agreement to mean that the parties must proceed with litigation in court.  Or, the respondent may still refuse to pay thereby dragging out the process further with increased transactional costs.

     (3) Pay Respondent's portion of the fee. This is not fair.  Especially because most arbitration agreements and arbitration rules call for an equal sharing of the initial fees/deposit.  Also, fronting the full cost of the arbitration changes the dynamics of the case and could create greater concern from the claimant about the ability to recover the amount awarded plus the arbitration costs.   
Despite its unfairness, and where collectability against Respondent is not a major concern, a claimant is most likely to proceed with Option #3.  Option #3 (paying 100%) enables the claimant to have the benefit of its choice of dispute resolution and it gives respondent fewer options to evade a prompt resolution of the matter as could be the case in litigation. 


A recent article, published by the Harvard Negotiation Law Review, suggests a fourth option:
Where a commercial party fails to pay for its share of arbitrator compensation and the proceeding is terminated as a result, that, in and of itself, constitutes a default on the merits of the parties' underlying dispute, thereby entitling the paying party to proceed to court to an inquest on damages.    
In Stiffing the Arbitrators: The Problem of Nonpayment in Commercial Arbitration, Neal Eiseman and Brian Farkas advocate for a default on liability followed by a hearing on the award of damages in Court. 

The authors state the three options cited above are not equitable for the paying party and do not provide a remedy for the material breach of the contract by the non-paying respondent.  Like a defendant's failure to follow the rules of civil procedure and timely respond to a complaint in court proceedings, a respondent's failure to follow the arbitration rules by paying its share of the arbitration fees should similarly result in a default. 

This approach makes sense, but as stated in footnote 27 of the article, courts are not always receptive of that approach. See Whitestone Constr. Co., Inc. v. Varied Constr. Corp., 118 A.D.3d 418 (1st Dep't. 2014) (Eiseman/Farkas advocated for a default in this matter). 

As it relates to the AAA's Construction Arbitration Rules, Rule 56(b) permits an arbitrator, in the event of non-payment, to take certain measures:

Such measures may include limiting a party's ability to assert or pursue their claim. In no event, however, shall a party be precluded from defending a claim or counterclaim . . .
AAA Rule 56(b) states, at least as interpreted by the Whitestone Court, that such a default remedy cannot be ordered by an arbitrator based solely on nonpayment. 

Can a court enter a default against a respondent/defendant following respondent's failure to pay its share of the arbitration fees?

If so, under what rule of civil procedure assuming the only basis is non-payment of the fee? Federal Rule of Civil Procedure 55 does not fit unless the defendant fails to answer the complaint. 

Is it collateral estoppel or issue preclusion? Can't be unless there is a final adjudication on the merits. The termination of the arbitration appears to be an administrative termination rather than a substantive conclusion of the case with binding and preclusive effect.  Even if this theory worked, or assuming a valid theory of material breach without disputed material facts, the end result would be a dispositive motion on liability -- not a default.   
As acknowledged by the law review article, the prevailing judicial mindset is that a Court's primary function (and limitation) is simply to confirm or vacate arbitration awards and to go no further (even if equity warrants it).

Thus, where there is an enforceable arbitration clause, a court is likely to presume that the finding of a default is an issue for the arbitrator -- not the courts. See, e.g., Benihana, Inc. v. Benihana of Tokyo, LLC, Docket No. 14-841 (2d Cir. April 28, 2015), quoting McDonnell Douglas Fin. Corp. v. Pa. Power & Light Co., 858 F.2d 825, 832 (2d Cir. 1988) (Trial Court erred in issuing an injunction preventing a party from introducing a claim in the arbitration proceeding because "[o]nce arbitrators have jurisdiction over a matter, 'any subsequent construction of the contract and of the parties' rights and obligations under it' is for the arbitrators to decide.")

Eiseman/Farkas suggest that attorneys work around the problem of the non-paying respondent in their clients' arbitration clauses.  What would such an arbitration clause look like? If any Division 1 member has seen one, please post it for review/comment.

If working with the AAA Construction Rules, must the clause specifically override Rule 56(b) and expressly empower the arbitrator with the ability to enter a final default against a party for non-payment?  If default is entered by an arbitrator, should the damages hearing immediately go to court or should it stay with the arbitrator?  If the scope of the arbitration was an evidentiary hearing on damages, a claimant may be much more likely to front 100% of the arbitration costs.

Check out this thought-provoking law review article - http://www.hnlr.org/wp-content/uploads/HNLR-Eiseman-and-Farkas-.pdf - and share ideas on how to deal with the problem of party nonpayment in arbitration. 





1 comment:

  1. Tom -- I believe that the "smaller dispute" arbitration rules that the AAA promulgated last year allow for a default if a party refuses to pay.

    http://abaconstructionforumdivision1.blogspot.com/2014/06/american-arbitration-association.html

    See Rule SR-22, discussed near the bottom of that post.

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