One of the principle benefits of a commercial arbitration agreement is that it provides for an efficient, formal decision-making process instead of protracted and expensive litigation. A considerable reason that arbitration is a more efficient then litigation is because most arbitration decisions are final and very few issues can be appealed. This long-standing principle, however, has changed and changed in a significant way.
In the past, courts could not review an arbitration decision on the merits
Generally speaking, a court will not review an arbitration proceeding on the merits to determine whether the law has been correctly stated and correctly applied. This has created problems because arbitration awards generally must be enforced by courts even if it appears that the arbitrators incorrectly applied the law to the facts, or ignored the law altogether. Despite this glaring problem, this has been each court’s duty since the Moncarsh v. Heily & Blase case in 1992 (see Moncarsh, 3 Cal. 4th 1) (stating that “in the absence of some limiting clause in the arbitration agreement, the merits of the award, either on questions of fact or of law, may not be reviewed except as provided in the statute”)).
In California, courts may now review arbitration decisions for legal error
The law in California (and possibly in Nevada in the near future) has changed. The California Supreme Court recently held that the parties to a contract can agree to allow for judicial review of legal error by an arbitrator as long as the parties structure the arbitration clause to trigger a statutory ground for review. (Cable Connection, Inc. v. DirectTV, Inc. (2008) 44 Cal. 4th 1334).
The arbitration clause in the DirectTV contract stated that “the arbitrators shall not have the power to commit errors of law or legal reasoning, and the award may be vacated or corrected on appeal to a court of competent jurisdiction for any such error.”
The key here is the statutory trigger the clause referred to – California Code of Civil Procedure § 1286.2(a), which states “a court shall vacate the award if the court determined . . . the arbitrators exceeded their powers.” The genius of the language in this arbitration clause is that by defining an arbitrator’s powers so that they have no power to commit legal error, CCP 1286.2(a) is triggered and a court is allowed to vacate an award because of legal error. Put differently, before DirectTV a party could not appeal an arbitrator’s award because a legal error was committed. However, if the arbitration clause is properly drafted, a party can now appeal a decision based upon legal error by utilizing CCP 1286.2(a).
The DirectTV decision may run afoul of federal arbitration law
Interestingly, the DirectTV opinion comes glaringly close to running afoul of a United States Supreme Court case, Hall Street Associates, L.L.C. v. Mattel, Inc. There, the Court stated that under the Federal Arbitration Act, parties could not expand the scope of judicial review of arbitration decisions. However, by cleverly relying upon statutory authority (CCP 1286.2(a)), the California Supreme Court may have nullified the application of Hall Street.
What does the DirectTV decision mean for your business?
The DirectTV decision will undoubtedly be tested by businesses and their attorneys. As it stands, the DirectTV decision only applies to review of legal errors and not factual errors. However, the opinion can be construed as allowing for review of factual errors as well.
It is highly advised that businesses modify their arbitration clauses to include the language necessary to allow a court to review an arbitrator’s decision for at least legal errors. While binding arbitration may be a better business option than full blown litigation, if the arbitrator's decision is based upon incorrect legal reasoning, the arbitration is a failure. Allowing a court to review a decision for legal error is a necessary protection that every business should have access to.
How your business should modify your arbitration clause in all its contracts
In California, your arbitration clause must trigger a statutory ground for review. The clause in DirectTV provides an excellent example of what language you can add to your arbitration clause to ensure a court has the power to review your arbitrator’s decision for legal error.
"The arbitrator(s) shall not have the power to commit errors of law or legal reasoning, and the award may be vacated or corrected on appeal to a court of competent jurisdiction for any such error."
However, an arbitration clause could even conceivably include review for factual errors. An example could read as follows:
"The arbitrator shall not have the power to commit errors of law, fact, or legal reasoning, and the award may be vacated or corrected by a court of competent jurisdiction. The parties agree that the court shall have jurisdiction to review, and shall review, all challenged findings of fact and conclusions of law based on a de novo review of the arbitration record and evidence."
While allowing a court to review an arbitrator’s award for factual errors may allow for peace of mind, doing so takes away several benefits of arbitration including the relative informal presentation of evidence and increased efficiency in reaching a decision. Whether your business decides to modify your arbitration clause for review of legal error or legal and factual errors, the decision must be based on sound business principles and business goals.
Stay tuned – the DirectTV decision will undoubtedly be tested and revisited as businesses seek to extend review of arbitration decisions.