Seventh Circuit Creates Novel Rule That Parties May Waive Objection To Appointment Of Substitute Arbitrators Unless They Immediately Apply To A Court For Appointment

Matthew Slater is a partner in the Washington, D.C. office of Cleary Gottlieb Steen & Hamilton LLP, where he focuses on international arbitration and litigation. He has represented clients in a diverse range of matters, including international arbitration and litigation for sovereigns and sovereign instrumentalities; government regulatory and enforcement matters in the securities, antitrust, banking, professional liability, and environmental areas; constitutional law; commercial and securities matters; and product liability litigation. Mr. Slater is also active in the firm's pro bono practice. Nowell Bamberger is an associate in the Washington, D.C. office of Cleary Gottlieb Steen & Hamilton LLP, where he focuses on corporate and securities litigation and arbitration. Copyright 2009 by Matthew D. Slater and Nowell D. Bamberger. Replies to this commentary are welcome.

Introduction

What happens when one member of an arbitration tribunal resigns or becomes unable to serve after the arbitration has commenced? If the arbitration is proceeding under institutional rules, those rules often provide the answer, sometimes allowing the remaining members to proceed alone — particularly where vacancy results from an arbitrator's unwillingness or outright failure to participate in the arbitration1 — and other times providing a mechanism for a substitute to be appointed.2

When the parties are engaged in a strictly ad hoc arbitral proceeding, or when the arbitral rules they have adopted do not provide specifically for the situation, the answers are also mixed. The Second Circuit has long held that, unless the tribunal has already reached the point of a final award, the process must start anew.3 Other courts have recognized that the parties may agree on a procedure for replacement.4

But what happens if the parties disagree and the arbitrators decide on a method for selecting a replacement themselves? If the method conflicts with the method for initial selection provided in the parties' arbitration agreement, and one of the parties objects clearly and unmistakably at the time, it has generally been thought that the objecting party may seek to have the final award annulled, or resist its enforcement, in the event of an unfavorable outcome.5

In a novel decision, WellPoint, Inc. v. John Hancock Life Insurance Company,6 the United States Court of Appeals for the Seventh Circuit took a dramatically different approach. The court rejected a challenge under Section 10(a)(4) of the Federal Arbitration Act (the "FAA")7 brought by the John Hancock Life Insurance Company ("John Hancock"), which, having prevailed in the arbitration, was nonetheless dissatisfied with the amount of the award. Although debatable on the facts as found by the lower court, the court of appeals concluded that John Hancock failed to object satisfactorily during the seating of a substitute arbitrator and the conclusion of the arbitration.8

It was not surprising, therefore, that the court wrote that the FAA does not "permit a party like [John] Hancock to sit silently by while a substitute arbitrator is selected . . . and then raise an objection to the process only after it has lost."9

What was surprising was the Seventh Circuit's stated assumption that even a clear objection would not have sufficed. As the court of appeals construed it, Section 5 of the FAA, which authorizes the district courts to appoint arbitrators in various circumstances, requires that a party dissatisfied with the method of appointment obtain interlocutory review of that appointment, and that failure to so proceed under Section 5 may bar the party from challenging an award under Section 10(a)(4) based on the appointment process. "No 'reservation of right' to challenge the issue on appeal absolves [the party] from this requirement."10 The court's conclusion is thus at odds with both the district court's conclusion that "[s]ections 5 and 10 of the FAA confer distinct forms of relief,"11 and with the vast majority of prior decisions from throughout the country, which have recognized that "[a]rbitration awards made by arbitrators not appointed under the method provided in the parties' contract must be vacated."12

The WellPoint Setting

WellPoint arose out of an arbitration clause in an agreement by WellPoint Inc. ("WellPoint") to purchase various business operations from John Hancock. A panel of three arbitrators was initially selected in accordance with the arbitration clause, which did not incorporate the rules of any arbitral institution.13 WellPoint and John Hancock each appointed its own party arbitrator, and, after those two failed to agree, the American Arbitration Association appointed the third. Over the next two years, the parties conducted extensive discovery, with the panel actively involved in resolving discovery disputes and other procedural issues.14 Then, in mid-2005, John Hancock sent WellPoint a letter increasing its damages demand more than ten-fold, from $42.4 million to $464.6 million. Shortly thereafter, and after obtaining new counsel, WellPoint requested that its party-appointed arbitrator resign from the panel. John Hancock strenuously objected to WellPoint's attempt to remove the arbitrator, but neither WellPoint's resigning arbitrator nor the remaining panel members were sympathetic to the objection.15

Over the ensuing weeks there were many communications between the parties and the panel. John Hancock continued to object to WellPoint's demand that its arbitrator resign, but the arbitrator concluded that it would be impractical for him to continue, and the panel accepted his withdrawal.16 When WellPoint attempted to appoint a new arbitrator in his stead, John Hancock objected to the replacement arbitrator. It argued that either it should be permitted to select WellPoint's arbitrator (treating the withdrawal of WellPoint's prior appointment as a failure to timely appoint an arbitrator under the agreement), that the replacement should be selected by the remaining panel members, or that the American Arbitration Association should be asked to fill the vacancy. But John Hancock did not argue that the entire panel should be disbanded and the arbitration should start over.17

At a perceived deadlock, John Hancock's partyappointed arbitrator suggested that the Chair propose a venire of three substitute arbitrators from which WellPoint would be permitted to select one. When WellPoint objected, John Hancock's counsel responded "I believe there is case law that will support this."18 WellPoint eventually acceded, and selected former Nebraska Supreme Court Chief Justice Norman Krivosha as its party-arbitrator from among several proposed by the remaining members of the panel. Although John Hancock renewed its objection to the first arbitrator's removal, it conceded that Justice Krivosha met the requisite qualifications, and the panel accepted his appointment.19

Two more years of arbitration proceedings followed in two phases. On April 23, 2007, the panel issued an award directing WellPoint to pay John Hancock almost $30 million in damages, a substantial portion of its original demand, but a mere fraction of the $464.6 million it ultimately sought.

After each phase of the proceeding, WellPoint filed a petition with the district court seeking confirmation of the resulting award under 9 U.S.C. § 9. After the panel's final award was entered, John Hancock, dissatisfied with the damages it had been awarded, filed a cross-petition seeking to vacate the award under Section 10(a)(4), arguing that the panel was without power to render an award because Justice Krivosha was improperly appointed.20

The Interaction Of The Relevant Federal Arbitration Act Provisions

Under Section 9 of the FAA, any party to an arbitration may present a final award to a district court for confirmation to convert the award into a judgment. Section 10 also provides that, whether or not the award has been presented for confirmation, a party dissatisfied with the award may apply to a district...

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