While rare, there are occasions when a party simply refuses to obey an arbitration panel’s order to produce documents during pre-hearing discovery. When confronted with such a situation, panels will typically invoke the sanction of drawing whatever negative inferences are appropriate from a party’s failure to obey their discovery order. Recently, the U.S. Court of Appeals for the First Circuit decided an interesting challenge to a panel’s imposition of such a discovery sanction surprisingly brought by the party who presumably had benefited from the adverse inference.
In this case, the reinsurer who had lost the arbitration challenged the panel’s final award on the grounds that its cedent’s failure to produce certain allegedly privileged discovery documents amounted to a violation of § 10(a)(1) and (3) of the Federal Arbitration Act (“FAA”), which provide for vacatur of an award where it is procured by either “undue means” or “where the arbitrators were guilty of misconduct . . . in refusing to hear evidence pertinent and material to the controversy.”
During discovery, the reinsurer sought certain internal legal assessments regarding various asbestos non-product liability claims settlements ceded by the insurer to determine whether they were justified on a single-occurrence, rather than multiple-occurrence, basis because, under the latter scenario, the reinsurer would have owed less. The reinsurer alleged that the cedent had misrepresented the bases on which the underlying claims were settled to maximize its reimbursement.
In response to the reinsurer’s discovery request, the panel ordered the cedent to produce the legal assessments and warned that the cedent’s failure to turn them over would result in the panel drawing whatever negative inferences it deemed appropriate. The cedent refused to produce the documents claiming that they were privileged and confidential attorney-client communications and subject to the work product doctrine and that to produce them would result in its waiver of any privilege in future dealings with its insureds. Ultimately, the panel ruled in favor of the cedent despite the negative inference sanction. The reinsurer filed an action in federal district court seeking to vacate the panel’s final award on various grounds because of the cedent’s failure to comply with the panel’s production order; however, the district court declined to overturn it. The reinsurer then appealed this ruling to the First Circuit.
In upholding the federal district court’s decision, the First Circuit observed at the outset that its review of arbitral awards was “extremely narrow and exceedingly deferential” such that they are “nearly impervious to judicial oversight.” Then the court addressed the “arbitrator misconduct” allegation. It started with the general proposition that vacatur under the FAA is appropriate when the exclusion of relevant evidence “so affects the rights of a party that it may be said that [it] was deprived of a fair hearing,” noting that not all refusals to hear evidence constitute misconduct. The parties had freely entered into a contract with a broad arbitration clause that relieved the arbitrators of “all judicial formalities” and permitted them to abstain from following “the strict rules of law.” Under such a clause, which did not specifically address discovery and “so fully signs over to the arbitrators the power to run the dispute resolution process unrestrained by the strict bounds of law or of judicial process,” a party would have “great difficulty” showing that their rights were so prejudiced as to justify vacatur.
While a literal reading of § 10(a)(3) suggests that only an outright refusal to hear evidence by a panel could trigger vacatur, the court noted that its sister circuits had adopted a somewhat broader view to encompass, for example, an arbitrator’s failure to compel testimony (e.g., situations in which arbitrators have not refused to hear evidence but instead have “merely failed” in their efforts to bring certain evidence into the proceedings). Nevertheless, the court found no FAA violation because any failure to hear evidence in this case did not so affect the reinsurer that it may be said to have been deprived of a fair hearing. Calling it a “routine remedy,” the court found that the adverse inference sanction (i.e., offering a party the choice between production and a negative inference) was “well within the arbitrator’s powers” and within the discretion committed to the panel by the parties under the FAA. In short, the drawing of the inference against the cedent “offset” any unfairness to the reinsurer that resulted from holding a hearing without giving it access to the documents it sought.
The court also quickly dispatched the reinsurer’s secondary argument that the arbitrators could not have reached the decision they did if they had drawn the proper negative inference, observing that this was simply an oblique attack on the merits of the award and that courts will not generally review what weight arbitrators give to a single piece of evidence, particularly when they do not need to give specific reasons for their decisions.
With regard to the § 10(a)(1) “undue means” prong of the reinsurer’s argument, the court again relied on its sister circuits for guidance as to the meaning of this phrase. Because the words “undue means” follows “corruption” and “fraud” in the statute (i.e., “where the award is procured by corruption, fraud, or undue means”), the First Circuit found that the “best reading” was that it was intended to describe “underhanded or conniving ways of procuring an award that are similar to corruption or fraud, but do not precisely constitute either,” such as when the decision is the result of a physical threat to an arbitrator. Finding nothing even approaching such intentional malfeasance justifying vacatur here, the First Circuit affirmed the district court’s holding that the cedent did not procure the panel’s award by “undue means.”
National Casualty Co. v. First State Insurance Group, 430 F.3d 492 (1st Cir., Dec. 2, 2005).