Reinsurance and Insurance Arbitrator and Umpire Ronald S. Gass
ARIAS-U.S. Certified Arbitrator and Umpire
AAA Roster of Neutrals
Reinsurance and Insurance Dispute Resolution Services Consultant

"Manifest Disregard" Not Quite Dead Yet — New York Federal Court Declines to Vacate Arbitration Tribunal's Award

Although several federal circuit courts have significantly curtailed the application of the "manifest disregard of the law" doctrine to vacate arbitration awards (see Louis J. Aurichio & Joseph P. Noonan III, What's Left of "Manifest Disregard of the Law" as a Basis for Vacatur of Arbitration Awards after Hall Street?, 17 ARIAS-U.S. Quarterly 17 (1st Quarter 2010)), it lives on in the Second Circuit. As a recent New York federal district court case demonstrates, however, winning vacatur on the basis of this doctrine remains an uphill battle.

In this case, the cedent allegedly sustained a $411 million loss under first-party insurance covering a DuPont manufacturing facility in Texas that was substantially damaged by Hurricane Ike in 2008. DuPont sought coverage for both its property damage and business interruption losses under its $500 million policy with the cedent. The cedent retained the first $200 million in losses, and the remaining $300 million was apparently reinsured with numerous facultative reinsurers. When the parties to these reinsurance agreements were unable to resolve their differences over the cedent's valuation of the DuPont losses, the cedent demanded arbitration in early 2011.

In an unusual move (probably because the facultative certificates did not contain arbitration clauses), the parties negotiated and executed a post-loss "Arbitration Agreement," that provided, inter alia, that the tribunal would "not be bound by any faunal rules of evidence," "have the power to fix procedural rules relating to the conduct of the Arbitration," and "issue a reasoned, written explanation of its award." The reinsurers, in what was described by the parties as a "leap of faith," also made a $50 million claim payment to the cedent in reliance on its representation that the DuPont losses would exceed $250 million.

By agreement, discovery was conducted on an expedited basis with a limited number of depositions, and the tribunal subsequently held an eight-day hearing. In its unanimous November 2011 written award, the tribunal held that the cedent failed to sustain its burden of proving that its Hurricane Ike losses exceeded $250 million, and likewise, the reinsurers had failed to sustain their burden of proving that the losses were less than $250 million, thereby apparently denying the reinsurers' counterclaim for the return of their $50 million "leap of faith" claim payment. Following a cedent motion for clarification and/or reconsideration, the tribunal issued a second unanimous decision in December 2011 stating that it was now functus officio and that the cedent had received all the compensation to which it was entitled until such time as it could establish that its DuPont Hurricane Ike losses actually exceeded $250 million, i.e., the $200 million retention plus the $50 million good faith payment advanced by the reinsurers.

The reinsurers petitioned the New York federal district court to confirm the tribunal's award, and the cedent cross-petitioned to vacate it. The cedent attacked the decision on four grounds: that it violated § 10(a)(3) and (4) of the Federal Arbitration Act ("FAA") and was made in manifest disregard of the law and in manifest disregard of the parties' Arbitration Agreement. Section 10(a)(3) provides in pertinent part that a court may vacate an arbitration award if "the arbitrators were guilty of misconduct . . . in refusing to hear evidence pertinent and material to the controversy; or of any other misbehavior by which the rights of any party have been prejudiced." The cedent argued that the tribunal improperly refused to hear certain course of dealing evidence concerning how some (but not all) of the reinsurers had previously agreed to calculate the amount of depreciation in determining the actual cash value ("ACV") of property damage losses similar to DuPont's but in the context of an unrelated Hurricane Katrina loss settlement arising under identical ACV policy language. The reinsurers opposed the introduction of this course of dealing evidence because that information was subject to a confidentiality provision included in the Hurricane Katrina-related settlement agreement. The tribunal twice ruled against the cedent's attempt to introduce this evidence — once during discovery and again during the hearing, despite the cedent's contention that the reinsurers had "opened the door" concerning the parties' prior course of dealing. Citing Second Circuit precedent, the court examined whether the tribunal's proceeding was "fundamentally fair," which requires that "an arbitrator 'give each of the parties to the dispute an adequate opportunity to present its evidence and argument,' but does not require that an arbitrator 'hear all the evidence proffered by a party.'" The court concluded that the tribunal did give the cedent an adequate opportunity to argue why the Hurricane Katrina-related course of dealing evidence should be admitted and gave appropriate weight to the reinsurers' breach of confidentiality concerns, which provided "more than a colorable justification for the outcome reached by the Tribunal."

Regarding the alleged violation of FAA § 10(a)(4), which provides in pertinent part for vacatur if "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," the cedent argued that the tribunal had imperfectly executed its powers by applying an unspecified and improper burden of proof standard without citing any legal precedent or discussing how the damages evidence submitted failed to meet that standard. Observing that this subsection of the FAA is "'accorded the narrowest readings' and 'focuses on whether the arbitrators had the power . . . to reach a certain issue,'" the court ruled against the cedent because (1) the scope of the Arbitration Agreement was broad and empowered the tribunal to resolve the parties' reinsurance dispute, and (2) the cedent was not arguing that the tribunal lacked the power under the parties' Arbitration Agreement to decide which party bore the burden of proof or that it exceeded its power by not choosing to apply a specific burden of proof standard. Because the tribunal was arguably acting within the scope of its authority, the award could not be vacated under § 10(a)(4).

With regard to the cedent's "manifest disregard of the law" contentions, the court reiterated well-settled Second Circuit precedent that application of this doctrine requires that the challenging party satisfy a twoprong test: (1) that the "governing law" was "well defined, explicit, and clearly applicable," and (2) that the arbitrator knew about "the existence of a clearly governing legal principle but decided to ignore it or pay no attention to it" (quoting Schwartz v. Merrill Lynch & Co., Inc., 665 F.3d 444, 452 (2d Cir. 2011)). Emphasizing that this doctrine was "severely limited," extremely deferential to arbitrators, and a "doctrine of last resort" whose use is limited to those "exceedingly rare instances" where some egregious impropriety on the part of the arbitrators is apparent but where none of the provisions of the FAA apply, the court held that it was inapplicable to the facts of this case.

The cedent presented two "manifest disregard of the law" arguments. First, it contended that the tribunal manifestly disregarded what the cedent claimed was the applicable contract principle of contra proferentem, i.e., that a contract's ambiguities should be construed against the drafters. The tribunal found that the cedent actually participated in drafting the disputed contract language and that the final wording was, in fact, proposed by the cedent; hence, the contra proferentem was inapplicable. The cedent did not meet the first prong of the "manifest disregard" standard because it failed to show that the tribunal was obligated to apply the contra proferentem doctrine or any other "governing law." That the tribunal disagreed with the doctrine's proposed application in this instance was "plainly insufficient" to support vacatur of the award.

Second, the cedent unsuccessfully argued that the tribunal "manifestly disregarded" the relevant case law it provided during the arbitration in support of its position that lost business income needed to be proved only by a "reasonable degree of certainty" as opposed to being proved with "absolute certainty" or "scientific rigor." It claimed that the tribunal never discussed this burden of proof case law or specified what burden of proof standard it applied in reaching its decision that the cedent failed to sustain its burden. The court ruled that the cedent (1) again failed to show that the tribunal was bound by any "governing law" regarding proof of damages, and (2) even if it were so bound, the fact that the tribunal did not explain why the cedent failed to meet its burden of proof did not "clearly demonstrate" the doctrine's second prong, that the tribunal "intentionally defied" those cases.

Lastly, the court ruled against imposing an unusual variation of the "manifest disregard" argument, that an award could be vacated where it is in manifest disregard of the terms of the parties' relevant agreement. The cedent contended that the tribunal "manifestly disregarded" the parties' Arbitration Agreement in ruling on the disputed business interruption claims. Again citing Second Circuit precedent holding that courts can apply "'a notion of manifest disregard to the terms of the agreement analogous to that employed in the context of manifest disregard of the law'" (quoting Yusuf Ahmed Alghanim & Sons, W.L.L. v. Toys "R" Us, Inc., 126 F.3d 15, 25 (2d Cir. 1997), cert. denied, 522 U.S. 1111 (1998)), the district court rejected as unprecedented the application of this doctrine to the parties' Arbitration Agreement, as opposed to their underlying reinsurance contract, noting that the tribunal was not charged with interpreting the terms of the Arbitration Agreement. Furthermore, that document clearly provided that the tribunal was not bound by any formal rules of evidence and had the power to fix procedural rules relating to the conduct of the arbitration. Thus, the cedent's complaints about (1) the tribunal rejecting live testimony from two of its witnesses, and instead relying on their depositions, and (2) its not providing a "reasoned basis for rejecting" one element of the cedent's tendered business interruption losses, did not adequately demonstrate that the tribunal "intentionally defied" a binding provision of the parties' Arbitration Agreement.

This case aptly demonstrates the difficulties inherent in seeking vacatur of an arbitration award, in general, and invoking § 10(a)(3) and (4) of the FAA and "manifest disregard of the law," in particular. It also underscores the point that, even in a jurisdiction in which the "manifest disregard" doctrine appears to be alive and well notwithstanding the United States Supreme Court's decision in Hall Street Associates, L.L.C. v. Mattel, Inc., 128 S. Ct. 1396 (2008), it will only be applied sparingly.

Ace American Insurance Co. v. Christiana Insurance, LLC, No. 11 Civ. 8862 (ALC), 2012 U.S. Dist. LEXIS 51863 (S.D.N.Y. April 12, 2012).

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