Submitted by: Michael H. Rosenthal, Partner, Rosenthal Lurie LLC

Arbitration proceedings are supposed to be simple, quick and final.  But the finality of arbitration has a potential downside as the stakes get higher.

A recent case highlights the problem.  Schaffer v. Multiband Corp. grew out of dispute between trustees of an employee stock ownership plan (ESOP) and the parent company over an indemnification claim.  The US Department of Labor claimed that the trustees had breached their fiduciary duties by permitting the ESOP to pay an inflated price for employer stock.  The trustees settled the claims for $1.45 million each and then demanded contractual indemnification from Multiband.  Multiband refused and the dispute went to arbitration.

The arbitrator concluded that the indemnification agreements were invalid.  In reaching that conclusion, he relied on a particular provision of the Employee Retirement Income Act (ERISA) that makes certain exculpatory agreements unenforceable.  A different part of ERISA, however, permits trustees to obtain insurance for fiduciary breaches.  The arbitrator ignored that part of the statute, DOL guidance, and case law that permitted indemnification. This should have been an easy win for the trustees.  So they filed suit in federal court to vacate the decision.

Under the Federal Arbitration Act (FAA), a court must confirm an arbitration award except under very limited circumstances, like a blatantly impartial arbitrator.  Despite the FAA’s high hurdle, the trustees were successful – at least at first.  The district court vacated the award because the arbitrator acted in “manifest disregard of the law” by ignoring clearly established legal precedent.  Now it was Multiband’s turn to appeal.

Multiband argued that “manifest disregard of the law” is not listed in the FAA as one of the reasons to vacate an arbitrator’s award.  Thus, according to Multiband, there is no basis for vacating the arbitrator’s award even if he is plainly wrong about the meaning of a law.  The appeals court agreed.  Not even a “manifest error of law” was sufficient to vacate the award.  The arbitrator must have done something even worse.  What can be worse for a business that plays by the rules than an arbitrator that seems to ignore them?  That’s hard to imagine.

The arbitrator’s decision likely would have been reversed had it been issued by a court.  But because the arbitrator could point to one isolated ERISA provision and the terms of the indemnification contract, his decision was upheld.  Finality, not legal correctness, was the guiding principle here.

The prospect of using a quick and simple process for dispute resolution is tempting.  As the Schaffer case shows, however, an arbitrator’s decision might be upheld e