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New York Appellate Division, First Department, reverses Supreme Court decision vacating ICC arbitration award for “Manifest Disregard of the Law”

In Daesang Corp. v NutraSweet Co., the Appellate Division, First Department reversed the decision of a New York Supreme Court Commercial Division Justice (the court of first instance) that had vacated an international arbitration award under the Federal Arbitration Act (FAA).

The lower court decision, described here, generated no small amount of controversy, as it was based on application of the controversial “doctrine of manifest disregard”, which had never before been used by a court in New York to vacate an international arbitration award.

As such, the decision is a welcome development to many in the US community, as it appears to confirm the conclusion of the 2012 New York City Bar Report of its International Commercial Disputes Committee (ICDC), that the manifest disregard doctrine is available in international arbitration only in the most extreme cases where arbitrators knowingly refuse to apply clearly applicable legal principles.

This blog discusses the manifest disregard doctrine and the importance of the First Department’s decision in Daesang.

The manifest disregard doctrine

The FAA mandates that an arbitral award rendered in the United States “must” be “confirmed” (the US process by which an award is reduced to a court judgment) unless it is vacated pursuant to one of the grounds set forth in the FAA’s section 10(a).

Nonetheless, many US courts continue to accept “manifest disregard of law” as a ground to vacate an award rendered in the United States, although it is not included in Section 10 of the FAA.

The doctrine of manifest disregard has its genesis in the 1953 US Supreme Court decision Wilko v Swan. Although the US Supreme Court expressly overruled Wilko in 1987, the concept of “manifest disregard” survived, as made clear in Shearson/American Express Inc. v McMahon.

The last New York Court of Appeals case to discuss manifest disregard is Wien & Malkin LLP v Helmsley-Spear, Inc., decided in 2006, in which the court emphasised that “an arbitrator’s award should not be vacated for errors of law and fact committed by the arbitrator and the courts should not assume the role of overseers to mold the award to conform to their sense of justice”, and therefore “to modify or vacate an award on the ground of manifest disregard of the law, a court must find “both that (1) the arbitrators knew of a governing legal principle yet refused to apply it or ignored it altogether, and (2) the law ignored by the arbitrators was well defined, explicit, and clearly applicable to the case.”

The Daesang-NutraSweet arbitration

The dispute between Daesang Corporation (Daesang) and the Nutrasweet Company (NutraSweet) arose out of the 2003 sale of Daesang’s aspartame business to NutraSweet.

Daesang brought claims in an ICC arbitration against NutraSweet for failure to pay the purchase price, along with claims for breach of the processing agreement, most notably for NutraSweet’s termination of the agreement without cause. NutraSweet brought defences and counterclaims based on NutraSweet’s alleged right to contractual rescission of the transaction based on false representations made in the asset purchase agreement (APA), particularly the representation that Daesang had “complied in all material respect with all applicable laws… in connection with the operation of the business.” NutraSweet alleged that an affidavit filed in the class action litigation showed that this representation was false. NutraSweet also brought counterclaims for Daesang’s breaches of the APA and a related processing agreement related to Daesang’s continuing production of aspartame, disputing the quality and quantity of aspartame that Daesang had produced for NutraSweet.

As to the first point, the arbitral tribunal held that NutraSweet did not have a claim for equitable rescission based on fraudulent inducement because the representations upon which its claim were based were contained only in the APA itself. The tribunal cited numerous cases holding that New York law “does not permit a claim of fraud in the inducement to be based solely on the express representations contained in the parties’ agreements.” The tribunal further found that NutraSweet had waived its damages for other breaches of the APA and processing agreement during the course of the arbitration. The tribunal accordingly awarded Daesang damages of US $100,766,258. Daesang sought to confirm the award in New York Supreme Court, and NutraSweet sought vacatur.

The Supreme Court decision

The Supreme Court, Commercial Division Justice Charles E. Ramos proceeded to apply the manifest disregard doctrine to vacate and “remand” to the deciding tribunal two of the decisions in the award.

Judge Ramos first held, correctly, that the FAA governed the motion for vacatur, and noted the Court of Appeals’ holding in Wien v Malkin that “an arbitration award must be upheld when the arbitrator “offers even a barely colorable justification for the outcome reached.”

Nonetheless, noting that “deference to arbitrators is not without its limits,” Judge Ramos found that in holding that a claim for fraudulent inducement could not be based upon representations made in a contract, the tribunal “chose to disregard the well-established principle that a fraud claim can be based on a breach of contractual warranties where the misrepresentations are of present facts (in contrast to future performance) and cause the actual losses claimed.”

Judge Ramos also vacated the tribunal’s award that NutraSweet had waived its breach of contract claims after reviewing the arbitration’s procedural record and concluding that the tribunal’s ruling was factually incorrect. No explicit grounds were given for this vacatur.

The First Department decision

After the briefing of the parties, a brief amicus curiae submitted by the ICDC of the New York City Bar (for which the authors of this post served as counsel) and oral argument, the First Department issued a lengthy, well-reasoned decision that left no doubt that the Supreme Court’s holdings of manifest disregard were in error.

As to the vacatur of the tribunal’s denial of rescission, the First Department noted that the arbitrators’ award included an analysis and application of conflicting case law to find that parallel fraud and contract claims can only be brought where, inter alia, it is based on a misrepresentation that is collateral or extraneous to a contact. This alone, the court held:

“[S]uffices to show that the resolution in the partial award of the of the issue of the viability of NutraSweet’s fraud counterclaims — whether or not that resolution was correct (a question on which we express no opinion) — does not meet the high standard required to establish manifest disregard of the law, namely, a showing that ‘the arbitrator[s] knew of the relevant principle, appreciated that this principle controlled the outcome of the disputed issue, and nonetheless willfully flouted the governing law by refusing to apply it.”

The court continued, finding further that the point of law at issue was not sufficiently “well defined” to give rise to a manifest disregard claim. It noted in particular that two of the New York appellate cases cited by NutraSweet to favour its interpretation of the law (one of which had in fact been decided after the issuance of the award at issue, and was thus irrelevant) had in fact included dissents.

The First Department then turned to the vactur of the tribunal’s decision that NutraSweet had waived of its counterclaims. Given that Judge Ramos had not even identified any law that could have been disregarded by the court below, the court analysed the holding under FAA section 10(a)(4), which allows for vacatur “where 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.”

Here, the First Department was equally unequivocal in its disagreement with Judge Ramos. It held:

“[Judge Ramos’] determination, based on its own “careful reading of the traNutraSweetript,” that the tribunal had misinterpreted the procedural history of the arbitration in finding that NutraSweet had waived its breach of contract counterclaim, was misplaced in a proceeding brought to confirm an arbitration award under the FAA… A court is not empowered by the FAA to review the arbitrators’ procedural findings, any more than it is empowered to review the arbitrators’ determinations of law or fact.”

Implications

As stated by the New York City Bar in its amicus submission, and adopted by the First Department, “[a]ny suggestion that New York courts will review the arbitrators’ factual and legal determinations, as if on appeal… will discourage parties from choosing New York as the place of arbitration.”

The First Department’s decision should quiet any such suggestion, and help New York maintain its position as one of the world’s preeminent places of arbitration.

Baker McKenzie Derek A. Soller Grant Hanessian

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