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Like Rodney Dangerfield, Commonwealth Coatings “Don’t Get No Respect” – and it Shouldn’t!
Posted on Categories Court Decisions, Non-Securities ArbitrationTags , , , , ,

By George H. Friedman*

[This is a summary of the lead article in this month’s Securities Arbitration Commentator]

Introduction

As reported in the June 18th issue of the Securities Arbitration Alert, the Supreme Court of Alabama in a unanimous decision in J. Don Gordon Construction, Inc. and Western Surety Co. v. Brown, No. CV-10-901832 (Ala. June 5, 2015), held that a “mere appearance” of arbitrator bias is not enough to satisfy the “evident partiality” ground for vacating an Award under the Federal Arbitration Act (“FAA”). The Court instead embraced a “reasonable impression of partiality” standard.

In so doing, Alabama becomes the latest state or federal circuit to reject the “impression of bias” standard apparently[1] adopted by a plurality holding in Commonwealth Coatings Corp. v. Continental Casualty Corp., 393 U.S. 145, 89 S. Ct. 337 (1968), reh. den. 393 U.S. 1112, 89 S. Ct. 848 (1969). At this point, almost fifty years after Commonwealth Coatings, few courts cling to the broad arbitrator disclosure standard articulated in Commonwealth Coatings.

It’s time for SCOTUS to pull the plug[2] on this arcane holding and articulate a clear reasonableness standard; that standard would be applied when a party challenges an Award based on an arbitrator’s failure to disclose a relationship with an arbitration participant.

The Federal Arbitration Act

Let’s start with the statutory language. FAA section 10(a)(2) states that courts can vacate an Award “where there was evident partiality or corruption in the arbitrators, or either of them…” (emphasis added). Attempts to vacate on this ground tend not to deal with allegations of overt bias on the part of an arbitrator, but with an arbitrator’s failure to disclose a relationship with someone involved in the arbitration.

The Murky Commonwealth Conundrum

Commonwealth involved a construction dispute using the party-appointment method of arbitrator selection. The neutral Arbitrator failed to disclose that one of his regular customers was a party to this case. There had not been any dealings, though, in about a year and the Court describes the past dealings as “sporadic” but significant: about $12,000 in the prior four or five years (these are 1967 dollars; it would be $86,000 in today’s dollars). The losing party challenged the Award based on the Arbitrator’s nondisclosure. While the district and circuit courts confirmed the Award, the Supreme Court vacated the Award in a plurality holding. The key point articulated in Justice Black’s[3] opinion: the mere failure of the Arbitrator to make a disclosure created “an impression of possible bias."

The Post-Commonwealth Rebellion

Commonwealth generally came to be understood to mean the failure of an arbitrator to make a disclosure -- no matter how trivial, and irrespective of whether there is actual bias -- creates an impression of bias such that the Award may be vacated under the “evident partiality” language of FAA section 10(a)(2). Except, the great weight of subsequent case law has rejected Commonwealth Coatings and embraced a reasonableness standard.

How can state or federal circuit courts refuse to follow a Supreme Court holding? After all, doesn’t the Constitution (Article III, section 1) vest in the Supreme Court “the judicial Power of the United States”? And doesn’t the Supremacy Clause (Article VI, paragraph 2) provide that “This Constitution, and the laws of the United States which shall be made in pursuance thereof … shall be the supreme law of the land; and the judges in every state shall be bound thereby, anything in the Constitution or laws of any State to the contrary notwithstanding”? Lower courts of course do have to abide by SCOTUS precedent, but there’s the rub: is a plurality decision, complete with multiple caveats by the concurring Justices, a “precedent”? Apparently not.

The Scorecard: Reasonableness wins by TKO

A reasonableness standard has been adopted by the overwhelming majority of courts, with Commonwealth being rejected expressly by many. What is the reasonableness standard? As articulated in Morelite Constr. Corp. v New York City District Council, 748 F2d 79 (2d Cir. 1984), evident partiality "will be found where a reasonable person would have to conclude that an arbitrator was partial to one party to the arbitration."

ADR Provider Rules are already there

As a matter of policy, the major ADR providers seemingly track the Commonwealth Coatings “impression of bias” standard, strongly encouraging arbitrators to err on the side of disclosure (a view I echo), and warning them that failure to do so may result in their award being vacated. For example, FINRA’s arbitrator training materials[4] instruct arbitrators that it “is important to remember that not every arbitrator disclosure will result in your disqualification, but failing to disclose even a minor conflict may jeopardize your award. When in doubt, arbitrators should always err in favor of disclosure.”

Arbitration forum rules, however, seem to follow a reasonableness standard. For example, the FINRA Code of Arbitration Procedure for Customer Disputes Rule 12405(a) provides “Each potential arbitrator must make a reasonable effort to learn of, and must disclose to the Director, any circumstances which might preclude the arbitrator from rendering an objective and impartial determination in the proceeding..."

Time to Lay Commonwealth to Rest

As far as I can tell, only the Ninth Circuit still applies Commonwealth (see Schmitz v. Zilveti, 20 F.3d 1043 (9th Cir. 1994)). Although there hardly seems to be a major split to resolve, I still think SCOTUS should administer a coup de grâce to the Commonwealth standard. First, the Ninth Circuit is an important one. Second, although the “impression” standard won’t be applied in most jurisdictions, that won’t stop challenges to awards based on it. Last, judicial economy and respect for arbitration demand no less. Rodney would want it that way.

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*George H. Friedman, an ADR consultant and Chairman of the Board of Directors of Arbitration Resolution Services, Inc., retired in 2013 as FINRA’s Executive Vice President and Director of Arbitration, a position he held from 1998. In his extensive career, he previously held a variety of positions of responsibility at the American Arbitration Association, most recently as Senior Vice President from 1994 to 1998. He is an Adjunct Professor of Law at Fordham Law School. Mr. Friedman serves on the Board of Editors of the Securities Arbitration Commentator. He is also a member of the AAA’s national roster of arbitrators. He holds a B.A. from Queens College, a J.D. from Rutgers Law School, and is a Certified Regulatory and Compliance Professional (Wharton-FINRA Institute).

[1] Read on for why I say “apparently.”

[2] Sooner or later, there will be another petition for cert. in an arbitrator nondisclosure case.

[3] That Justice Black authored this arbitration-unfriendly opinion is not surprising. He, along with Justice Douglas and Chief Justice Warren, joined the majority in the arbitration-unfriendly Wilko v. Swan, 346 U.S. 427 (1953), and came together again 15 years later in Commonwealth Coatings.

[4] See Your Duty to Disclose (May 2015), available at http://www.finra.org/sites/default/files/FINRA-Duty-to-Disclose-Training-May-2015.pdf <visited June 21, 2015>.

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