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Awarding Punitive Damages in Arbitral Disputes

By Gerald M. Levine

Awarding punitive damages may be available as a remedy in arbitral disputes but the question is: Who gets to decide the issue, court or arbitrator? There have been a number of cases recently in New York on this point. The "who" depends on which law applies, the Federal Arbitration Act or CPLR Article 75. In In re Flintlock Construction Services, LLC v. Weiss, 2014 NY Slip Op 05818 (1st Dept. August 14, 2014) and Cusimano, et al v. Schnurr, 2014 NY Slip Op 05702 (1st Dept. August 7, 2014) (discussed in last week's blog) the courts first have to decide which law applies before they reach the ultimate issue. Cusimano dealt with "waiver" (for the court) and "statute of limitations"(for the arbitrator).

Who decides depends to a large extent on both the factual matrix and the parties' agreement. On the issue of arbitrability, for example, the U.S. Supreme Court has held that "Courts should not assume that the parties agreed to arbitrate arbitrability unless there is 'clea[r] and unmistakabl[e]' evidence that they did so." First Options of Chi., Inc. v. Kaplan, 514 U.S. 938, 944 (1995). If the parties have incorporated Rule 7 of the Commercial Rules of the American Arbitration Association, for example, they will be deemed to have agreed that "[t]he arbitrator shall have the power to rule on his or her own jurisdiction, including any objections with respect to the existence, scope, or validity of the arbitration agreement or to the arbitrability of any claim or counterclaim."

If the evidence is not clear and unmistakable, the question of arbitrability is reserved to the court--- and "presumptively" so according to the court in Werner Schneider v. Thailand, 688 F.3d 68(2d Cir. 2012). But where parties "agree to include claims ... within the issues to be arbitrated, the FAA ensures that their agreement will be enforced according to its terms even if a rule of state law would otherwise exclude such claims from arbitration," Mastrobuono v. Shearson Lehman Hutton, 514 US 52, 58 (1995). Mastrobuono dealt specifically with a New York case,Garrity v. Lyle Stuart, Inc., 40 NY2d 354, 356 (1976), that reserved the decision on punitive damages to the court. The Supreme Court rejected the reasoning of the 7th Circuit that New York law prevented the arbitrator from ruling on punitive damages.
The explanation for this reasoning lies in the concluding clause in Mastrobuono---"even if a rule of state law would otherwise exclude such claims from arbitration"---the court is obliged to look at both the applicable law and the parties' agreement for the scope of the arbitrator's jurisdiction. Moreover, if the issue arises under the FAA, federal law applies even though the arbitration clause contains a choice-of-law provision.

In re Flintlock Construction Services, LLC v. Weiss, 2014 NY Slip Op 05818 (1st Dept. August 14, 2014)clarified how these disparate elements are reconciled. As in Mastrobuono, the issue in Flintlock Construction concerned who gets to decide punitive damages. If the claim includes a request for punitive damages and the dispute involves interstate commerce, it is properly before the arbitrator. Over a vigorous dissent the court rejected application of the Garrity rule.

The parties' operating agreements in Flintlock Construction provided that they "shall be construed and enforced in accordance with the law of the State of New York." The key terms "construed" and "enforced" would appear to apply to both the substantive and procedural law of New York. As the New York Court of Appeals explained in the Matter of Diamond Waterproofing Sys., Inc. v. 55 Liberty Owners Corp., 4 NY3d 247 (2005), the choice of language is critical. Diamond Waterproofing involved the application of the statute of limitations, a question which would ordinarily be reserved to the court (CPLR 7502[b]). But because the parties' agreement did not provide that New York law shall govern the enforcement of the parties' agreement, the court held that the issue was reserved to the arbitrator under the FAA. The parties have to employ the correct lexical formula to assure the application of New York law, and, if they do, it is sufficient to override other principles.

Petitioners in Flintlock Construction (and the dissent) argued that the issue of punitive damages was for the court relying on Garrity's statement that New York law arbitrators "ha[ve] no power to award punitive damages, even if agreed upon by the parties." The argument for a court determination further urged that Mastrobuono "is not dispositive on this issue" because it dealt only with a general choice-of-law provision, i.e.,"[it] shall be governed by the laws of the State of New York," which is a different lexical formula. In Flintlock Construction, the parties included in their agreement the proper lexical formula as directed by the Court of Appeals in Diamond Waterproofing.

Given that the parties properly expressed their intention, why did they not get what they asked for? Although the dissent's argument was unpersuasive to the majority, it cannot be said to be unreasonable.
The majority in Flintlock Construction offered three reasons for denying petitioners' application to prevent the arbitrator from deciding the issue of punitive damages. First, a New York choice-of-law provision does not constitute a manifestation of unequivocal intent sufficient to invoke the Garrity rule. "Merely stating, without further elaboration that an agreement is to be construed and enforced in accordance with the law of New York" does not make it so. "The Supreme Court has made clear that in order to remove the issue of punitive damages from the arbitrators, the agreement must 'unequivocal[ly] exclu[de]' the claim" (Mastrobuono at 60).

The second reason stems from the rule against rendering an advisory opinion. Here, the arbitration panel "had denied the motion to dismiss the punitive damages claim without prejudice to renewal upon a complete record." Because it "remains to be determined whether, on this record, the contracts evidence a 'transaction involving commerce' such that the FAA, and not state law, applies," it would be premature to weigh in on the issue.

The third reason for denying petitioners' application rests on CPLR 7503(b), which authorizes motions to stay arbitration by parties "who ha[ve] not participated in the arbitration." In this case, "[p]etitioners participated in the arbitration process for nearly eight months - selecting arbitrators, participating in preliminary proceedings - before registering an objection to the arbitrability of respondent's claim for punitive damages." The objection took the form of a motion to the arbitrator to dismiss the claim, thereby
"squarely placing the issue of the arbitrability and availability of punitive damages before the arbitrators." In doing that, the court explained, petitioners "chartered their own course ... and cannot now avail themselves of the mechanisms set forth in CPLR 7503(b).

Since Flintlock Construction is a 3-2 decision the appellate court's reasoning may not be the last word on the application of the Garrity rule although petitioners may well have "chartered their own course." Having done that, the issue of punitive damages is squarely before the arbitration panel, at least until it makes a ruling, at which time (if it awards punitive damages) the issue will presumably return to the court.

Gerald M. Levine is a member of Levine Samuel, LLP. He practices in New York City and is on the list of neutrals of the American Arbitration Association. Mr. Levine runs an ADR blog on domain names and cybersquatting at http:www.iplegalcorner.com. He is the author of a forthcoming book to be published in March 2015 on domain name arbitration under the Uniform Domain Name Dispute Resolution Policy.

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This page contains a single entry from the blog posted on October 21, 2014 2:41 PM.

The previous post in this blog was ABA Mediation Week and 13 Top Reasons for a Failed Mediation.

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