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The California Supreme Court has ruled that California law allows parties to an arbitration agreement to contract for heightened judicial review of arbitration awards regardless of whether heightened review is available under the Federal Arbitration Act (FAA). The Court's ruling does not raise any preemption concerns because it upholds the terms of the arbitration agreement and thus advances the purpose of the FAA.
In Cable Connection, Inc. v. DIRECTV, Inc., No. S147767, 2008 WL 3891556 (Cal. Aug. 25, 2008), several DIRECTV dealers (the Dealers) filed a demand for class arbitration, alleging that DIRECTV had withheld commissions and assessed improper charges. The Dealers filed their demand with the American Arbitration Association (AAA) in accordance with the parties' arbitration agreement.
Two aspects of the arbitration agreement had particular relevance in this case. First, the arbitration agreement was silent on the permissibility of class-wide arbitration, which meant that under Green Tree Financial Corp. v. Bazzle, 539 U.S. 444 (2003), the arbitrator(s) had exclusive authority to decide whether the agreement would permit class arbitration. Second, the arbitration agreement contemplated heightened judicial review in providing that "[t]he 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."
By a 2-1 majority, the arbitrators determined that the arbitration agreement permitted class-wide arbitration. In reaching this determination, the arbitrators relied on two factors: (1) that California law authorizes class arbitration; and (2) that the AAA rules and policy governing class arbitration.
DIRECTV filed a petition to vacate the arbitration award, arguing that the arbitrators had exceeded their authority by improperly applying the law. The trial court accepted this argument and vacated the award, but the California Court of Appeal reversed this ruling, holding that the provision for heightened review was unenforceable under California law. See Cable Connection, Inc. v. DIRECTV, Inc., 49 Cal. Rptr. 3d 187 (Cal. Ct. App. 2006).
The California Supreme Court (the Court) granted review to answer the question of whether parties to an arbitration agreement may contract for heightened judicial review. In analyzing this question, the Court first examined the United States Supreme Court's decision in Hall Street Associates, L.L.C. v. Mattel, Inc., 128 S.Ct. 1396 (2008), holding that under the Federal Arbitration Act (FAA), the statutory grounds for vacatur are exclusive and, accordingly, that parties cannot obtain heightened review by contracting for additional, non-statutory grounds for vacatur.
The Court found that the FAA, as construed by Hall Street, would not preempt a ruling that the California Arbitration Act (CAA) allows parties to contract for heightened review because preemption in such instance "would be quite inimical to the FAA's primary purpose of ensuring that private agreements to arbitrate are enforced according to their terms."
Based on the legislative history of the CAA and on previous case law, the Court held that under California law, parties to an arbitration agreement "may obtain judicial review of the merits by express agreement." In reaching this holding, the Court noted that "[t]here is a statutory as well as a contractual basis" for the California rule permitting heightened review. The Court also advised parties contracting for heightened review "to provide for that review explicitly and unambiguously."
Given the enforceability of the provision for heightened review, the Court reviewed the merits of the arbitrators' determination that the arbitration agreement allowed for class-wide arbitration. The Court found that the arbitrators erred in their reasoning, if not their determination, because the arbitrators relied largely on the AAA Supplementary Rules for Class Arbitrations in finding that the agreement permitted class-wide arbitration, but those rules expressly provide that their existence must not be considered a factor in favor of class-wide arbitration. Accordingly, the Court vacated the arbitrators' award and remanded the matter to the arbitrators to reconsider the permissibility of class-wide arbitration.
Two of the Justices concurred in the result but dissented in part. They concluded that parties to an arbitration agreement may contract for "some measure of review" but found that the CAA "does not permit review of ordinary legal error, when an arbitrator has acted reasonably in addressing the legal questions before him or her."
Two aspects of the Court's ruling bear further discussion. The first is the question of FAA preemption. Quite obviously, the Court's holding does not raise any preemption concerns because the Court upheld the terms of the arbitration agreement and thus advanced the FAA's purpose of ensuring that arbitration agreements are enforced according to their terms.
Moreover, if one takes a narrow view of Hall Street, the Court's holding is not necessarily inconsistent with that decision because in this case, the parties obtained heightened review through the operation of a statutory basis for vacatur, whereas in Hall Street, the parties attempted to obtain heightened review by contracting for a non-statutory basis for vacatur. The Court in this case recognized that important distinction in noting that Hall Street did not "address whether the FAA provision for vacatur 'where the arbitrators exceeded their powers' is applicable when the agreement specifically limits the arbitrators' powers by providing for an award governed by law and reviewable for legal error." See also Edstrom Indus., Inc. v. Companion Life Ins. Co., 516 F.3d 546, 549-50 (7th Cir. 2008) (distinguishing the issue raised by Hall Street).
The other aspect which bears further discussion is the Court's suggestion that the California rule allowing heightened review might not apply if the matter were proceeding in federal court. In light of this suggestion and the operation of the Erie doctrine, parties seeking heightened review pursuant to California law should draft the agreement to provide (1) that confirmation proceedings are governed by the California Arbitration Act and (2) that California state courts have exclusive jurisdiction over all confirmation/vacatur proceedings.
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