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Civil Litigation FlashPoints May 2008

Reviewing recent decisions from diverse state and federal jurisdictions for this month’s edition, it becomes clear that courts in Illinois and throughout the nation continue to strengthen the contract arbitration dispute resolution process. Consistent with the Civil Litigation title of this FlashPoints article, however, it can be easily seen that arbitration and other methods of alternative dispute resolution do not necessarily avoid the courthouse. Indeed, the overall utility and cost-effectiveness of arbitration as a dispute resolution tool remain subject to debate. One criticism has long been the vast and virtually non-reviewable discretion that’s vested in arbitrators under the uniform arbitration laws. As a consequence, dispute resolution by means of arbitration carries with it the risk of getting stuck with an erroneous final award that is not subject to judicial review. The fourth district appellate court in the following noteworthy decision observed that “once parties bargain to submit their disputes to the arbitration system (a system essentially structured without due process, rules of procedure, rules of evidence, or any appellate procedure), we are disinclined to save them from themselves.”

Arbitration Award — Judicial Review.
In International Association of Firefighters, Local No. 37 v. City of Springfield, 378 Ill.App.3d 1078, 883 N.E.2d 590, 318 Ill. Dec 359, 2008 WL 249537 (4th Dist. 2008), both the City and the Union filed petitions requesting a trial court to partially vacate and amend an arbitrator’s award rendered pursuant to the grievance-arbitration procedures of the parties’ collective bargaining agreement. The trial court took the bait and partially vacated the arbitrator’s rulings concerning how the City administered leaves of absence under the labor contract.

On appeal, the appellate court, citing its decision in Hawrelak v. Marine Bank, Springfield, 316 Ill.App.3d 175, 178, 735 N.E.2d 1066, 1068 (4th Dist. 2000), emphasized that the scope of judicial review available for an arbitration award is far different from appellate review of a trial court’s decision. This is because the Uniform Arbitration Act (710 ILCS 5/12, 13) allows a court to vacate an arbitrator’s award only under the following circumstances: (1) If the award was procured by corruption, fraud, or other undue means; (2) where there was evident partiality or corruption by the arbitrator or misconduct that prejudiced any party; (3) where the arbitrator exceeded his or her power; (4) where the arbitrator refused to postpone a hearing upon sufficient cause or declined to hear material evidence, so as to prejudice the rights of a party; or, (5) where there was no arbitration agreement, the issue was not adversely determined, and the party did not participate in the arbitration hearing (710 ILCS 5/12). Because neither the City nor the Union presented evidence of such egregious conduct or circumstances, the appellate court concluded that the circuit court on review lacked authority under the Act to vacate or modify the arbitrator’s decision. The appellate court, therefore, vacated the trial court’s judgment and reinstated the arbitrator’s award in its entirety.

The appellate court’s decision in Firefighters, Local No. 37 serves as a reminder to parties electing to participate in contractual arbitration agreements that they are choosing to have their dispute decided not by a judicial determination, but rather by an arbitrator. As a consequence, under the Illinois Uniform Arbitration Act courts are justifiably hesitant to deprive the parties of the benefits and burdens of their bargained-for form of alternative dispute resolution. Under the Act, a reviewing court should not set aside an arbitration award simply because of errors in judgment, or on account of mistakes as to matters of law or fact. In the absence of evidence that: (1) the arbitrator’s award was made in bad faith; (2) the arbitrator was guilty of engaging in fraud or corruption; (3) the arbitrator exceeded his or her power; or, (4) the arbitrator deliberately chose not to follow the law, the appellate court held that a trial court should never address the merits of a party’s arguments to set aside or modify an arbitrator’s determination. The appellate court reiterated that under Illinois law the presumption exists that arbitrators act within their authority, and that whenever possible reviewing courts should uphold their awards. The court reminds parties that “they get what they bargain for and that arbitration is far different from adjudication.” A party asking a trial court to vacate an arbitration award “must provide clear, strong, and convincing evidence that the award was improper.”

Recently, the United States Supreme Court found that the same degree of deference must be shown arbitration awards under the Federal Arbitration Act (FAA), (9 U.S.C. §1 et seq.). Hall Street Associates, LLC v. Mattel, Inc., No. 06-989, ____ U.S. ___, 128 S.Ct 1396, 2008 WL 762537 (Mar. 25, 2008), began as a lease dispute between a landlord, Hall Street, and its tenant, Mattel. When environmental contamination was discovered on the leasehold premises, Mattel notified Hall Street of its intent to terminate the lease. Hall Street responded by filing a lawsuit against Mattel not only contesting the termination, but also seeking indemnification for the clean-up costs. After the federal district court resolved the termination dispute in Mattel’s favor, the parties agreed to submit the indemnification issues to arbitration under an agreement providing that “[t]he Court shall vacate, modify, or correct any award: (1) where the arbitrator's findings of fact are not supported by substantial evidence, or (2) where the arbitrator's conclusions of law are erroneous.”

The FAA (9 U. S. C, §§ 9-11) provides for expedited judicial review to confirm, vacate, or modify arbitration awards. Under section 9, a court must confirm an award unless it is vacated, modified, or corrected as prescribed in the FAA’s sections 10 and 11. Section 10 lists the grounds for vacating an award, including where the award was procured by corruption, fraud, or undue means, and where arbitrators are guilty of misconduct or exceeded their powers. Under section 11, the grounds for modifying or correcting an award include evident material miscalculation, evident material mistake, and imperfections in a matter of form not affecting the merits.

The standard agreed upon by the parties was relatively deferential to the arbitrator—similar in many respects to the deference provided to administrative agencies under the Federal Administrative Procedure Act — but considerably more stringent than those prescribed by the FAA. Specifically, under the parties’ agreement, the district court could review the award for legal error, and the arbitrator's factual findings were required to be supported by substantial evidence. The expanded grounds for judicial review called for by the parties’ agreement adopted the “have your cake and eat it too” approach that was becoming popular in private arbitration agreements. In an attempt to protect themselves from flawed or legally insupportable awards, while still preserving the assumed benefits of arbitration, sophisticated parties were negotiating arbitration clauses permitting more thorough judicial review prior to confirmation of an award. The underlying theory was that, just as parties can select both the kinds of claims to be arbitrated and the procedures to be used by the chosen arbitrators, they should also be able to elect the relative level of scrutiny to be applied in the judicial review process.

After the arbitrator found for Mattel, Hall Street filed a motion with the district court to vacate the award due to what Justice Stevens later characterized as a “rather glaring” legal error. The district court, reviewing the award under the parties’ expanded review clause, agreed, vacated the award correcting the error, and remanded the case to the arbitrator. On remand, the arbitrator issued a second award finding for Hall Street. Both parties then petitioned for review. This time the district court, aside from correcting the arbitrator’s interest calculation, upheld the award. Mattel appealed to the Court of Appeals for the Ninth Circuit. The Ninth Circuit reversed the district court’s order confirming the arbitration award, holding that because the FAA specifies that arbitration awards can be vacated only in limited cases such as fraud, corruption, partiality, or where the arbitrators exceed their powers, an award has to be upheld even though it contains errors of law. The Ninth Circuit also concluded that the terms of the parties’ arbitration agreement controlling the scope of judicial review were invalid, unenforceable, and severable, and instructed the district court on remand to confirm the original arbitration award, unless the award could be vacated according to the grounds allowed under section 11 of the FAA. After the district court again held for Hall Street and the Ninth Circuit again reversed, the stage was set for review by the Supreme Court to decide whether the grounds provided by the FAA for overturning or modifying an award are exclusive.

The Supreme Court agreed with the Ninth Circuit that the grounds prescribed by the FAA for vacating, modifying, or correcting an arbitration award subject to federal law are exclusive, resolving a long-standing circuit split. Accordingly, the Court held that the parties may not seek to enforce in the federal courts an arbitration agreement that either supplements the statutory grounds for vacating an award or provides for heightened judicial review under the FAA. Central to the Court’s decision is a concern about undermining the national policy favoring arbitration expressed in the FAA by slowing the process and making it a precursor to litigation. In the view of the majority, allowing parties to elect the relative level of scrutiny to be applied to the process of judicial review can undermine the effectiveness of arbitration as an effective mechanism for resolving disputes. The FAA, however, is not the only way into court for parties desiring judicial review of arbitration awards. The Court observed that they may contemplate enforcement under state statutory or common law where the scope of judicial review may be different. The Supreme Court’s decision, therefore, leaves open the possibility of heightened review of awards issued in arbitrations that are not governed by the FAA. Those other possibilities, however, may be limited in light of a second recent arbitration-related decision of the Supreme Court.

Federal Arbitration Act Can Preempt State Law.
In another case arising under the Federal Arbitration Act, and citing the strong federal policy favoring the enforcement of arbitration agreements, the Supreme Court held that when parties agree to arbitrate all questions arising under a contract, then the FAA supersedes applicable state laws that lodge primary jurisdiction in another forum. Specifically, in Preston v. Ferrer, No. 06-146, 552 U.S. ___, 128 S.Ct 978, 169 L.Ed 917 (Feb. 20 2008), the Court determined that where a party challenges the enforceability of a contract that contains an arbitration clause, it is the role of the arbitrator designated under the agreement to determine the validity of the agreement. State laws giving primary jurisdiction under such circumstances to another forum, whether judicial or administrative, are pre-empted by the FAA, the Court concluded in its February 20 ruling.

In Preston, an entertainment attorney, Arnold Preston, initiated an arbitration proceeding against Alex E. Ferrer, a television performer who appeared as “Judge Alex” on a television show, to recover the fees to which he claimed he was entitled under their management contract. The attorney invoked the contract’s rather standard American Arbitration Association (AAA) arbitration clause setting forth the agreement to arbitrate “any dispute . . . relating to the terms of [the contract] or the breach, validity, or legality thereof” in accordance with the rules of AAA. The performer, however, proceeded to file suit in California state court seeking to stay the arbitration on the basis the contract was invalid and unenforceable under the California Talent Agencies Act (TAA) because the attorney had acted as a talent agent without the required license in violation of the TAA. The TAA gives the California Labor Commissioner exclusive jurisdiction to resolve such disputes. In response, the attorney filed a motion in state court to compel arbitration. The California courts found state law controlling and refused to enforce the arbitration agreement unless or until the Labor Commissioner determined that it lacked jurisdiction over the dispute.

During the pendency of Preston’s appeal of the California state court’s decision, the United States Supreme Court issued its decision in Buckeye Check Cashing, Inc. v. Cardegna, 546 U.S. 440 (2006), holding that challenges to the validity of a contract providing for arbitration ordinarily should be considered by an arbitrator rather than a court. As to Preston’s appeal, the California Court of Appeal, Second District, affirmed the lower court’s ruling, holding that the TAA vested the Labor Commissioner with exclusive original jurisdiction over the parties’ dispute, and distinguishing the Supreme Court’s Buckeye Check Cashing decision on grounds that case involved the question whether a court, and not an administrative agency, had jurisdiction over a dispute that otherwise fell within the scope of an arbitration clause. The California Supreme Court denied Preston’s petition for review teeing-up the U.S. Supreme Court’s grant of certiorari to determine whether the FAA overrides a state law that vests initial adjudicatory authority in an administrative agency such as the TAA.

The Supreme Court reversed, holding that when a contract contains an arbitration provision, any challenge to the validity of the contract as a whole must be considered by the arbitrator, not by a court or an administrative agency. According to the Supreme Court, the FAA preempts all state laws directing primary jurisdiction in another forum, whether judicial or administrative, when it comes to disputes covered by an arbitration agreement subject to the FAA. In contrast, the Court concluded that state law governs where the challenge is only to the enforceability of the arbitration provisions.

The Supreme Court’s decision also rejected Ferrer’s argument that the TAA was compatible with the FAA because arbitration would merely be postponed. The Court found that the arbitration would likely be long delayed and that such delay would contravene Congress’ intent to “move the parties to an arbitrable dispute out of court and into arbitration as quickly and easily as possible.” The Court said the best way to harmonize the contract’s adoption of the AAA’s rules and its choice of California law was to use California law to interpret the parties’ substantive rights and obligations, but not to allow California law to limit the arbitrator’s authority.

The Illinois Appellate Court for the Fifth District recently found that arbitration is at odds with the law and public policy expressed in the Nursing Home Care Act (210 ILCS 45/1-101). In Carter v. SSC Odin Operating Co., No. 5-07-0392, 2008 WL 94376 (Ill. App. 5th Dist Apr. 4, 2008), Joyce Gott was a resident at defendant’s nursing home located in Odin, Illinois on two separate occasions. Each time at the beginning of her stay at the facility, Joyce’s legal representative signed a written “Health Care Arbitration Agreement” with the defendant. The agreement required all disputes relating to her care at the facility to be submitted to binding arbitration under the Federal Arbitration Act (FAA) (9 U.S.C. § 1 et seq.). Contracts containing arbitration clauses are common within the nursing home and rehabilitation facility service industry.

Following Joyce’s death in January 2006, the plaintiff filed a two-count complaint in the circuit court alleging in count I a survival action pursuant to the Probate Act of 1975 (755 ILCS 5/27-6) and the Nursing Home Care Act (210 ILCS 45/1-101) along with a statutory action under the Wrongful Death Act (740 ILCS 180/0.10 et seq.) in count II. Plaintiff alleged that the decedent had suffered pain, emotional distress, mental anguish, and ultimately her own demise on account of the defendant facility’s negligent acts and omissions. The defendant answered the complaint denying the allegations in relevant part and asserting a number of affirmative defenses, including the defense that the lawsuit was precluded by the parties’ arbitration agreement. The decedent‘s representative responded opposing the motion to compel arbitration on grounds, inter alia, that the contractual arbitration clause was unenforceable because it violated the public policy contained in the Nursing Home Care Act, and the FAA cannot preempt legitimate state law-based contract defenses. The trial court denied defendant’s motion to compel arbitration reasoning that a plaintiff bringing a wrongful death claim on behalf of an estate cannot be bound by the arbitration agreement; and, that with regard to the survival action finding the arbitration clause void in light of sections 3-606 and 3-607 of the Nursing Home Care Act that provides as follows:

Any waiver by a resident or his legal representative of the right to commence an action under Sections 3-601 through 3-607, whether oral or in writing, shall be null and void, and without legal force or effect. (210 ILCS 45/3-606)

Any party to an action brought under Section 3-601 through 3-607 shall be entitled to a trial by jury and any waiver of the right to a trial by a jury, whether oral or in writing, prior to the commencement of an action, shall be null and void, and without legal force or effect. (210 ILCS 45/3-607)

The defendant took an appeal from the trial court’s denial of its motion to compel arbitration as allowed by Supreme Court Rule 307 (a)(1) because an order to compel arbitration is injunctive in nature. On appeal, the fifth district appellate court observed that even though the defendant had waived the issue (by failing to argue the point in the opening brief under Supreme Court Rule 341 (h)(7)), “there is voluminous case law in Illinois holding that a violation of public policy can be a legitimate generally applicable defense to all contracts in Illinois.” Turning to defendant’s argument that the state law provisions of the Nursing Home Care Act were preempted by the FAA, the appellate court concluded that was not the case because the public policy expressed in the Nursing Home Care Act concerns the validity, revocability, and enforceability of contracts generally, and does not specifically target arbitration. Accordingly, the principles of state law set forth by the General Assembly in the Nursing Home Care Act comported with the text of the FAA under the pronouncements of the United States Supreme Court in Doctor’s Associates, Inc. v. Casarotto, 517 U.S. 681 (1996) (quoting Perry v. Thomas, 482 U.S. 483 (1987).) The trial court was, therefore, affirmed on appeal.

Arbitrators Usually Get the First Shot.
Focusing on the Illinois experience with arbitration under the Uniform Arbitration Act (710 ILCS 5/1 et seq.), the fourth district appellate court recently considered the threshold issue whether an initial determination of “standing,” in terms of whether a party agreed to submit to arbitration in the first place, is a predicate question to be resolved by the courts rather than arbitrators, or whether standing itself is an arbitrative issue. In Equistar Chemicals, LP v. Hartford Steam Boiler Inspection & Ins. Co., ____ Ill.App.3d ____, 883 N.E.2d 740, 318 Ill.Dec 509, 2008 WL 613132 (Ill. App. 4th Dist. March 3, 2008), the trial court had determined that the issue of standing, meaning whether the parties have an agreement to arbitrate a particular dispute, is for the arbitrator to decide. Turning to the Uniform Arbitration Act itself, the appellate court found that the statutory language governing whether a court should stay arbitration (Section 2, 710 ILCS 5/2) supports the opposite conclusion that courts, and not arbitrators, should determine the question whether the parties had an agreement to arbitrate:

Proceedings to compel or stay arbitration. (a) On application of a party showing an agreement [to arbitrate], and the opposing party’s refusal to arbitrate, the court shall order the parties to proceed to arbitration, but if the opposing party denies the existence of the agreement to arbitrate, the court shall proceed summarily to the determination of the issue so raised and shall order arbitration if found for the moving party, otherwise, the application shall be denied.

(b) On application, the court may stay an arbitration proceeding commenced or threatened on a showing that there is no agreement to arbitrate. That issue, when in substantial and bona fide dispute, shall be forthwith and summarily tried and the stay ordered if found for the moving party. If found for the opposing party, the court shall order the parties to proceed to arbitration. (710 ILCS 5/2(a), (b).)

Relying upon the Illinois Supreme Court’s decision in Donaldson, Lufkin & Jenrette Futures, Inc. v. Barr, 124 Ill.2d 435, 530 N.E.2d 439 (1988), the appellate court reviewed the applicable procedural framework when a party files suit in the circuit court to stay or compel arbitration. According to the appellate court, the Uniform Arbitration Act initially confers jurisdiction in the courts to determine whether the parties in fact have an agreement to arbitrate. If there is an arbitration agreement, and it is apparent that the dispute falls within the scope of the agreement, then the appellate court reasoned that the Arbitration Act mandates that “the court should decide the arbitrability issue and compel arbitration.” On the other hand, where it is clear that the parties’ dispute lies outside of the agreement, then the court should rule against arbitration. But, where the questions whether the parties have an agreement to arbitrate and whether the dispute falls within the arbitration agreement are “unascertainable, reasonably debatable, or unclear,” then the court should defer to the arbitrator. According to the appellate court, the Uniform Arbitration Act stands at the foundation for this framework because a primary purpose of the Act is to enforce the parties’ agreement to arbitrate, so a court should not deprive those parties the benefits of an arbitrator’s skilled judgment in attempting to resolve any ambiguities.

In Equistar Chemicals, the appellate court proceeded to decide the threshold issue specific to the case, being whether an insurance carrier proceeding in the capacity of a subrogee has the right or “standing” to invoke the arbitration clause in a commercial contract between its insured-subrogor and the third-party whose employees caused the property damage for which the insurer paid its insured under the applicable policy. Recognizing the question as one of first impression for Illinois courts, the fourth district appellate court surveyed decisions from sister states and chose to follow the opinion of the New York Court of Appeals in Solomon v. Consolidated Resistance Co., 97 A.D.2d 791,468 N.Y.S.2d 532 (1983), rather than a contrary holding of the California Court of Appeal (Valley Casework, Inc. v. Comfort Construction, Inc., 76 Cal. App. 4th 1013, 90 Cal. Rptr. 2d 779 (1999)), in concluding that a nonsignatory subrogee may invoke an arbitration agreement signed by others with respect to the claim being pursued. Once the initial “arbitrability” question was decided, the appellate court confirmed the trial court’s judgment referring the next question, whether the subrogation claim was arbitrable under the applicable arbitration agreement, to the arbitrator.

Agreements to Arbitrate — Can the Right to Arbitration Be Waived?
In Woods v. Patterson Law Firm, P.C., No.1-08-0066, 2008 WL 901169 (Ill. App. 1st Dist., Mar. 31, 2008), the first district appellate court considered whether the parties pursuit of litigation in the courts operates to waive their rights to arbitrate the underlying dispute. The defendants, Patterson and his law firm, represented the plaintiffs pursuant to a written engagement agreement that contained an arbitration provision, as follows:

Any controversy, dispute or claim arising out of or relating to our fees, charges, performance of legal services, obligations reflected in this letter, or other aspects of our representation shall be resolved through binding arbitration in Chicago in accordance with the rules then in effect of the American Arbitration Association, and judgment on the award rendered may be entered in any court having jurisdiction thereof. You acknowledge that by agreeing to arbitration, you are relinquishing your right to bring an action in court and to a jury trial.

During the course of representing the plaintiffs in a series of commercial disputes, the attorney-client relationship evidently soured to the extent that the Patterson firm proceed to file a complaint in the circuit court alleging that plaintiffs owed them over $47,000 in unpaid legal fees. After some procedural wrangling, the plaintiff filed an answer and served the law firm with discovery requests. The law firm did not respond to discovery requests. Rather it proceeded to voluntarily dismiss the case pursuant to section 2-1009 of the Illinois Code of Civil Procedure (735 ILCS 5/2-615). Subsequently, the plaintiff-clients filed a legal malpractice case against the law firm. The defendant law firm responded by filing a motion to dismiss, issuing a subpoena for the records of a third-party, serving plaintiffs with requests to produce documents and written interrogatories, and by noticing a plaintiff’s deposition. When the trial court denied defendants’ first motion to dismiss, they filed a second one. The second dismissal motion was denied as well, and in response to the trial court’s order to answer plaintiff’s complaint, the defendants filed a demand for a bill of particulars along with an answer that raised the arbitration provision in the parties engagement letter as an affirmative defense. The defendants next filed a motion to compel arbitration, approximately one year after the lawsuit was filed.

The trial court denied defendants’ motion to compel arbitration. The court found that defendants had waived their right to arbitrate by filing two motions to dismiss and a demand for a bill of particulars, and by actively and voluntarily participating in discovery by issuing interrogatories and subpoenas for documents.

The defendants appealed. As a preliminary matter, the appellate court observed that Illinois courts disfavor finding waiver of a known right. Yet, as the appellate court commented, the right to compel arbitration can be waived like any other contract right. Specifically, Illinois courts will find waiver of a party’s arbitration rights if that party’s conduct is inconsistent with the arbitration clause indicating an abandonment of the right to arbitration. Additionally, the appellate court said that waiver of the right to arbitration may be effected by submitting arbitrable issues to a court for decision. Finally, Illinois courts will consider the length of a party’s delay in asserting its right to arbitrate a dispute.

In affirming the trial court, the First District Appellate Court in Woods found that the defendants had waived their right to compel arbitration by their own conduct in defending plaintiffs’ legal negligence case against them. The appellate court noted that discovery through the use of interrogatories, subpoenas, and depositions is not readily available in arbitration according to the rules of the American Arbitration Association. In an arbitration, generally those procedures are left to the agreement of the parties or to the discretion of the arbitrator. The focus of the appellate court’s inquiry was whether the defendants acted inconsistently with their right to arbitration by attempting to further their defense of plaintiffs’ lawsuit by actively participating in the judicial forum, not whether they were actually successful in that regard. For example, no depositions had actually been taken.

Finding that the defendants had participated in litigation procedures that are not readily available in arbitration, the appellate court could not conclude that the trial court had abused its discretion by finding that the defendants by their conduct had waived their right to arbitrate the dispute. Responding to a dissenting justice, the appellate court cautioned that parties to an arbitration agreement should not be allowed to file or defend a preemptive lawsuit with the intent of obtaining discovery in the courthouse, where discovery is not a matter of right in the arbitration process, and then demand arbitration once discovery is concluded. According to the appellate court, the entire alternative dispute resolution process would lose its major objective of saving time and money if that tactic were allowed.

The dissenting justice (Wolfson) would not have allowed the plaintiffs to “slip out of their contractual duty to arbitrate in light of Illinois’ policy preference for enforcement of arbitration clauses, especially where the parties have adopted the American Arbitration Association’s (AAA) Rule 48. The rule provides that“[n]o judicial proceeding by a party relating to the subject matter of the arbitration shall be deemed a waiver of the party’s right to arbitrate.” Am. Arb. Ass’n Conn. R. 48(a) (2007). According to the dissent, the AAA Rule and Illinois case law create a bright line test: “No waiver of arbitration unless an issue presented in the judicial proceeding relates to the subject matter of the arbitration.”