In the recent series of articles we have been looking at what I call commercial arbitration “potholes.” These are issues that come up during arbitration infrequently, but can be tricky and distract us from the merits when they do. If we see them coming, we can usually find a way to work around them and keep things on track.
Today’s pothole gets us into discovery problems.
Discovery in arbitration can be critical to a fair presentation of the parties’ positions. AAA Commercial Rules, for example, recognize this and require the arbitrator to “manage any necessary exchange of information among the parties with a view to achieving an efficient and economical resolution of the dispute, while at the same time promoting equality of treatment and safeguarding each party’s opportunity to fairly present its claims and defenses.” Rule 22(a). This requires a balancing of need for the information against the expense of getting it.
Arbitrators have considerable flexibility in balancing the parties’ interests. Given the more relaxed rules of evidence in arbitration, the information needed may be a little more informal and less comprehensive than in formal litigation. Depending on the practicalities of the dispute, it may well be that some forms of evidence are reliable enough to meet a party’s need for information even though it may not meet all the technical rules of evidence applied in court. But still, there are bound to be disputes. Striking the right balance between need and expense is a critical part of the arbitrator’s role if arbitration is to meet the promise of fast and fair determinations.
Occasionally, though, a more basic dispute may arise: a party may simply fail or refuse to provide discovery.
Let’s consider an example. Assume that a claimant has a trade secrets claim. It is claiming either lost profits for sales it says it lost due to the Respondent’s stealing and use of its trade secrets or at least a reasonable royalty on sales. It wants all information about all the sales by the respondent of the product claimed to be made based on the claimed trade secrets. The parties have an arbitration provision in their supply contract that reads just as the standard AAA clause does, that is:
Any controversy or claim arising out of or relating to this contract, or the breach thereof, shall be settled by arbitration administered by the American Arbitration Association under its Commercial Arbitration Rules, and judgment on the award rendered by the arbitrator(s) may be entered in any court having jurisdiction thereof.
Respondent believes it has been falsely accused. In fact, it is sure that the Claimant is just fishing around to learn more about its business and wants to keep it from designing competitive products, keeping it captive to Claimant and its higher prices. The parties present their discovery dispute to the Arbitrator. Claimant demands “any and all documents, in any form existing, relating to , referring to, or concerning in any way all sales of the Widget 2000 or similar products.”
That is a little too broad for the Arbitrator. But she orders the Respondent to provide documents sufficient to show the sales of the Widget 2000, when sales were made, to whom, and the amount of each sale. All the information is subject to an “attorneys and experts eyes only” protective order. If specific questions arise as to a particular sale, Claimant can seek to follow up, asking for more information. The Arbitrator rules that the documents must be produced within three weeks.
Three weeks pass, but Respondent provides no documents. Claimant reports the lack of response to the Arbitrator. The Arbitrator schedules a phone conference and asks where the documents are. Counsel for Respondent says his client has not provided them to him, but he’ll check again with his client. The Arbitrator orders them to be provided within a week.
One week later, Claimant again reports that Respondent has provided no documents. The Arbitrator again has a quick phone conference. At this conference, the Arbitrator again asks what the problem is. Respondent’s counsel then reiterates his client’s earlier opposition to providing the documents and notes that his client feels the request is invasive because the claims are “bogus” in all respects. He respectfully declines to produce these “sensitive documents,” sought only to disrupt his client’s legitimate business, protective order or not. His will never provide them.
A litigation model
What are the Arbitrator’s options? A few possibilities come to mind, based on experience in federal court and Fed. R. Civ. P. 37:
(1) enter a default against the Respondent for the whole claim;
(2) give the Respondent one last chance to respond and then enter default for the whole claim; or
(3) hold the Respondent in contempt and levy a fine of $1000 a day until it produces the documents.
An arbitration rule
But this isn’t federal court. Arbitrators don’t enter defaults under AAA Commercial Rules. “An award shall not be made solely on the default of a party. The arbitrator shall require the party who is present to submit such evidence as the arbitrator may require for the making of an award.” Commercial Rule 31. So default is not in the cards. And arbitrators don’t have contempt powers. Only courts do.
So what are the Arbitrator’s options here? AAA Commercial Rule 23 governs this unfortunate situation. In cases of “willful non-compliance” with any order issued by the arbitrator, he or she may draw adverse inferences, exclude evidence and other submissions, and/or make special allocations of costs or an interim award of costs arising from non-compliance. The arbitrator may also issue any other enforcement orders which the arbitrator is empowered to issue under applicable law.
With that in mind, now what?
Simply drawing an adverse inference on liability is not very satisfying. It may be difficult to conclude from the party’s reticence regarding financial discovery that it is actually stole any trade secrets. And that still doesn’t provide the Claimant with the information it claims it needs to determine damages.
Still, if the refusal is egregious enough, the Arbitrator may be able to draw an adverse inference on liability on the theory that failure to cooperate in information exchange justifies an inference it is covering up its culpable behavior.
In some cases, it may be that the Claimant has some way of making a good approximation of the Respondent’s sales based on information it can obtain from literature review, services estimating market share, or the like. Perhaps the Arbitrator could rule that if the Respondent refuses to provide the information, it will be forbidden from providing any information to contradict whatever evidence the Claimant puts forward on sales. This may cause the Respondent to rethink its position on providing information.
Whatever she does, the Arbitrator should make it clear to the non-cooperating party how things could end up and a chance to respond. Rule 58 says:
(a) The arbitrator may, upon a party’s request, order appropriate sanctions where a party fails to comply with its obligations under these rules or with an order of the arbitrator. In the event that the arbitrator enters a sanction that limits any party’s participation in the arbitration or results in an adverse determination of an issue or issues, the arbitrator shall explain that order in writing and shall require the submission of evidence and legal argument prior to making of an award. The arbitrator may not enter a default award as a sanction.
(b) The arbitrator must provide a party that is subject to a sanction request with the opportunity to respond prior to making any determination regarding the sanctions application.
Any enforcement order allowed by applicable law
What about the Arbitrator “issuing “any other enforcement orders which the arbitrator is empowered to issue under applicable law,” as allowed under Rule 23? The orders the arbitrator may issue will be governed by the law applicable to the dispute, which will vary by state. There are, however, indications that arbitrators have a fair amount of discretion in issuing enforcement orders, particularly when a party has behaved dishonestly. But the legal analysis involved can get complicated.
A striking example is provided by Seagate Technology, LLC v. Western Digital Corp., 854 N.W.2d 750 (Minn. 2014). Seagate initiated an arbitration against a former employee, Sining Mao and his new employer, alleging that Mao had misappropriated and used eight of Seagate’s trade secrets. Before the arbitration hearing, Seagate sought sanctions against Respondents based on evidence it claimed Mr. Mao had fabricated to try to show three of the trade secrets had been made public in a PowerPoint presentation Mao had made at a conference. Seagate alleged that the slides showing the trade secret had been added after the conference presentation. The arbitrator held the sanctions request in abeyance until after the hearing.
After the hearing, the arbitrator found for Respondents on all but the three secrets that were the subject of the sanctions motions. He found, as to the three claimed secrets that “the fabrications were obvious” and that Western Digital was “complicit” in submitting the evidence to the arbitrator. He then precluded any evidence to show that three claimed secrets were not trade secret or were not used by Western Digital. He found in favor of claimant and awarded over $500 million.
Respondents successfully sought to have the award vacated in state court. The court determined that the arbitration agreement did not allow imposition of sanctions, that the arbitrator exceeded his authority by not allowing Respondents to rebut the presumption that their fabricated evidence rendered their defense without foundation, and that the arbitrator had refused to hear evidence material to the controversy, as required by Minnesota’s Arbitration Act.
The Minnesota Court of Appeals reversed. It found that Respondents had waived their challenge by not first raising the matter to the arbitrator. But the Court went on to the merits of the sanctions, finding a broadly worded arbitration agreement inherently allowed the arbitrator to issue sanctions.
The Minnesota Supreme Court took review. It found no waiver because the Act did not require first objecting to the arbitrator to preserve a right to vacate on the grounds Respondents alleged.
After noting that courts in other jurisdictions were divided on the power of arbitrators to impose sanctions, the Court first looked to the arbitration clause itself. It said the arbitrator could grant “relief” in any dispute arising from the parties’ contract. That “relief” could include sanctions, the Court reasoned.
The Court next examined whether sanctions would have “have been available to the parties had the matter been heard in court” as allowed by the arbitration rules that applied. In this case, that was Rule 39(D) of the AAA Employment Rules. It found that a court could have awarded sanctions, so the arbitrator could.
Finally, it found no “refusal to hear evidence” in violation of Minnesota’s Arbitration Act. In fact, the Court noted, the arbitrator did hear the evidence. He just disregarded it as part of the sanction. The Act’s prohibition was on how the hearing was to be conducted, not whether the arbitrator chose to factor the evidence he heard into a final award, the Court reasoned. There was no violation. The over $500 million award was confirmed.
Application to our case
The Seagate case shows us a few things. First, we have to look to the arbitration agreement itself to see how far the arbitrator’s power goes. In Seagate, the clause was broad and allowed the arbitrator to fashion any “relief” a court could. In our example case, the clause does not mention a broad power to grant “relief,” but does mention AAA rules will apply.
This leads to the next inquiry. We need to look to the arbitration rules that apply. In our case, it is AAA commercial rules, which specifically allow the arbitrator to grant any relief a court could. Based on Seagate, sanctions would be available.
Finally, one must look at the involved arbitration statute. In all aspects important to our example case, Minnesota’s statute mirrors the Federal Arbitration Act. The idea that the arbitrator would actually refuse to hear any evidence from the Respondent to refute the Claimant’s evidence on damages could be problematic. Recall, that in Seagate the arbitrator still heard the evidence, but disregarded it. Imposing a sanction that doesn’t allow presentation of any damages evidence by Respondent at all would be different.
But relying on the arbitrator actually hearing the evidence before ignoring it may have just been a convenient way for the Seagate court to dispose of one ground of attack on the award based on the specific facts of the case before it. It seems unusual for the parties to specifically agree to rules that allow preclusion of evidence based on failure to cooperate, but then assume the arbitration statute will deem excluding evidence to be “refusing to hear evidence pertinent and material to the controversy,” as is required to be a ground for vacating an award. After the sanction is invoked, the evidence is neither pertinent nor material.
Any sort of sanctions in arbitration are tricky, but also may be necessary to make the arbitration fair. The goal should be to try to encourage compliance with the process by making non-compliance the least attractive way to proceed.
Still, if an arbitrator must impose sanctions to make the process fair, he or she should do so. In our example case, following the specific AAA rules providing how sanctions are to be imposed, including notice and an opportunity to be heard, are critical. And the arbitrator must still require a claimant to prove its claim and must come to an independent conclusion on the merits. Defaults are not allowed.
Relying on the ability to issue any enforcement order allowed by law might provide some further room to tailor a fair way to deal with a non-cooperating party. But, as can be seen from the analysis that three courts undertook in the Seagate case, an arbitrator will need to become quite conversant with the applicable law before going that route.