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The Other 'Nessie': An Order Vacating an Arbitral Decision

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July 31, 2013
By: Morris James LLP
Delaware Business Court Insider

In Steiner v. Meyerson, 1995 Del. Ch. LEXIS 95 (Aug. 16, 1995), former  Delaware Court of Chancery Chancellor William T. Allen famously described claims  of corporate waste as "rarest of all — and indeed, like Nessie, possibly  non-existent." Perhaps equally rare are decisions vacating an arbitral award.  Both the Federal Arbitration Act and the Delaware Uniform Arbitration Act  provide for limited judicial review of arbitral decisions and awards, leaving  the losing party to an arbitration very little room to argue the award should be  vacated. One of the grounds often cited by disgruntled parties as a reason for  vacating an award is that the arbitrator exceeded or imperfectly executed his or  her powers by issuing an incorrect decision. In keeping with the public policy  of limiting judicial review of arbitral awards, however, courts have construed  those grounds narrowly, requiring more than a mere disagreement with the  arbitrator's interpretation of the law. Instead, courts have uniformly held that  to exceed or imperfectly execute his or her powers, the arbitrator must act with  "manifest disregard" for the law. As such, most petitions to vacate an arbitral  award relying on an arbitrator "imperfectly executing his powers" will fail, and  it is the rare case in which an arbitral award is vacated because of manifest  disregard for the law.

In Garda USA v. SPX, C.A. No. 7115-VCL (Del. Ch. June 4, 2013), that  rare case occurred. In a bench ruling, the Court of Chancery granted the  plaintiffs' motion for summary judgment and entered an order vacating the  arbitrator's award on the grounds that the arbitrator "manifestly disregarded  controlling contractual language and, consequently, so imperfectly executed its  powers that a final and definite award on the subject matter submitted was not  made." Not only was this the first time a Delaware court had vacated an award on  these specific grounds, but the court applied for the first time a three-part  test to analyze the request.

The underlying arbitration arose out of Garda's acquisition of Vance  International from SPX Corp. As is often the case with the sale of an operating  subsidiary that does not maintain separate financial records, the seller was  required to provide an estimate of Vance's working capital, subject to a later  adjustment after the sale. Working capital, or current assets minus current  liabilities, can have a profound effect on the sale price; by underestimating a  current liability, such as workers' compensation reserves, a party can make its  working capital appear to be larger than it actually is, and cause the buyer to  overpay.

In the transaction documents for the Vance sale, the parties specifically  negotiated terms defining how current liabilities would be calculated in  determining working capital. The contract excluded "incurred but not reported"  liabilities (IBNR) related to risk-management programs from the calculation of  current liabilities, except with respect to workers' compensation, which the  contract stated "shall be included in the calculation of current liabilities."

Prior to closing, SPX informed Garda that it maintained a reserve for  Vance's workers' compensation claims of approximately $1.4 million. After  closing, Garda learned that SPX's actuary had estimated that the appropriate  reserve for Vance's workers' compensation claims was almost twice what SPX had  reserved. The actuary subsequently revised its estimate upward to approximately  $1.8 million more than SPX's original estimate. After learning this information,  although not the underlying reasons why the actuarial estimate differed so  greatly, Garda formally disputed SPX's workers' compensation reserve  calculation. After three years of efforts to resolve the dispute, Garda invoked  the dispute-resolution mechanism of the sale agreement requiring a proceeding  before an independent accountant.

During the proceedings before the independent accountant, Garda learned for  the first time that SPX had not included IBNR in its calculation of the workers'  compensation reserve for purposes of the sale agreement. Garda argued to the  independent accountant that SPX violated the agreement by failing to incorporate  IBNR as required by its plain language. SPX countered by arguing that other  language in the agreement permitted SPX to calculate reserves as they had been  calculated historically, but SPX did not deny that its calculation of Vance's  workers' compensation reserve did not include IBNR.

The independent accountant subsequently rendered a decision and award that  did not adjust the working capital of Vance or the workers' compensation reserve  in any way. The independent accountant did not explain its conclusions or cite  to any portion of the record to support his decision. Garda then filed an action  in the Chancery Court seeking an order vacating the award on the grounds that,  among other things, the independent accountant exceeded his powers by ignoring  the plain language of the agreement and not including workers' compensation IBNR  liabilities in the working capital of Vance.

Although other courts had found that the failure of an arbitrator to follow  contractual language constituted manifest disregard, no Delaware court had  expressly addressed the issue. The court, however, readily followed prior  precedent and agreed with the concept that failure to follow the plain language  of a contract justified vacating an arbitral award, citing dicta in RBC  Capital Markets v. Thomas Weisel Partners, 2010 Del. Ch. LEXIS 36 (Del. Ch.  Feb. 25, 2010). Having cleared that hurdle, the court applied a three-part test  to Garda's request to vacate the arbitral award.

First, the court needed to determine whether the contractual language was  clear and unambiguous. That was the core issue because "under Delaware's version  of the Uniform Arbitration Act, an arbitration award can be vacated if the  arbitrator acted in manifest disregard of the law and controlling contractual  provisions." The court found that the agreement between the parties set forth a  clear and unambiguous formula for calculating current liabilities that required  IBNR to be included in the calculation of workers' compensation liabilities. The  court rejected SPX's argument that whether to include IBNR was within the  judgment of the independent accountant, and therefore entitled to deference:

"If the issue were whether IBNR had been calculated appropriately, that  would be the type of accountant's judgment where the reading might be arguably  more colorable. You'd give deference to the colorable reading, and the idea that  the accountant could exercise its judgment and experience. ... This isn't that  type of question. This is a question of, 'Do you add back in the variable Z?'  That's not a judgment call. That's not an accountant call. That's a specific  aspect of the formula under this agreement."

Second, after determining that the law — here, the contract — was clear and  plainly applicable, the court then could only vacate if "the law, in fact, was  improperly applied, leading to an erroneous outcome." The court easily found  this to be true here, as the failure to include IBNR in the workers'  compensation reserve resulted in a conclusion "directly opposite to the  calculation required" by the agreement.

Third, the court had to determine whether the arbitrator had knowledge of  the error. While ordinarily this part of the test means whether the arbitrator  knew of a statute or regulation, here it meant whether the arbitrator knew of  the calculations required by the agreement. The court held that there was no  question that the arbitrator had the contract provision and applicable formula  before him but failed to follow it.

Does the decision in Garda presage a new era of judicial review of  arbitral awards? Hardly. Garda had unique facts not easily found  elsewhere: plain and unambiguous language in the contract and little  disagreement that the arbitrator did not follow that language. Garda is  most notable for being the first instance in which a Delaware court has  expressly addressed whether failure to follow a contract constitutes manifest  disregard of the law. Moreover, the court made plain the three things a party  seeking to vacate an arbitral award on these grounds must show to earn vacatur.  Parties in arbitration should take note of these factors, including making sure  the arbitrator is aware of the relevant contractual provision.

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