An arbitration award may be vacated because it does not "draw its essence" from the underlying agreement if a party is not afforded proper notice of the proceedings in accordance with the agreement and controlling rules, according to the Fourth Circuit Court of Appeals.

In Choice Hotels Intern., Inc. v. SM Property Management, LLC, Nos. 05-1979, 06-1698, 06-1812, 2008 WL 518807 (4th Cir. Feb. 28, 2008), hotel franchisor Choice executed a contract with franchisee SM. This contract contained an agreement to arbitrate disputes between the parties.

Choice later alleged that SM had failed to meet quality assurance standards. Choice unilaterally terminated the contract and filed suit for liquidated damages. Upon SM's petition, the district court compelled arbitration of the dispute in accordance with the terms of the agreement and the controlling American Arbitration Association (AAA) Commercial Rules.

Choice filed a demand for arbitration with the AAA, but instead of providing the contact information for SM's known designated representative, it provided the AAA with other addresses for certain individual parties allegedly connected with SM. When SM did not respond to the arbitration demand, the AAA arbitrator proceeded on the merits, ultimately issuing an award in Choice's favor.

When Choice moved to confirm the award at the district court, SM moved to vacate the award, alleging that it was not provided proper notice of the arbitration proceedings in accordance with the parties' agreement. The district court granted the motion to vacate, stating that it did not believe proper notice of the proceedings was given to SM.

The Court observed that the AAA Commercial Rules specifically required that the parties were to be provided notice of proceedings by personal delivery or by mail at the parties' designated representatives' address. See AAA Commercial Rule R-39(a). Furthermore, the Court found that the agreement and the applicable rules clearly did not contemplate the entry of an arbitration award against a party that was not properly noticed of the proceedings.

These factors led the Court to conclude that the award "did not draw its essence" from the arbitration agreement when the notice requirements were not followed, in part because Choice did not provide the arbitrator with the correct contact information for the known designated representative in its demand to the AAA.

The Court acknowledged contrary authority under similar factual circumstances in the Seventh Circuit's decision in Gingiss Int'l, Inc., v. Bormet, 58 F.3d 328 (7th Cir. 1995). However, the Court expressed its disapproval of Gingiss, finding that the Seventh Circuit had "disregard[ed] the plain and unambiguous language of those agreements" requiring that all notices comply with the stated notice requirements.