Recent Third Circuit Ruling Will Subject Many Pennsylvania Common-Law Arbitration Awards To Increased Federal Court Scrutiny
By Howard J. Bashman
Monday, Jul 16, 2001

Experienced appellate practitioners know that an advantageous standard of review can be crucial to winning on appeal. Orders granting motions to dismiss on the pleadings and motions for summary judgment are among the most often reversed on appeal, because appellate courts apply a non-deferential plenary review. By contrast, an appeal that challenges a judge's findings of fact at a non-jury trial, or argues that a jury's verdict is against the manifest weight of the evidence, rarely will succeed, because the applicable standards of review require an appellate court to show great deference to those types of decisions.

Perhaps the most deferential of all standards of review is the one that Pennsylvania law applies to a common-law arbitration award. The Supreme Court of Pennsylvania has ruled that the grounds for denying enforcement of a common-law arbitration award are "extremely limited." Newspaper Guild of Greater Phila. v. Philadelphia Daily News, Inc., 164 A.2d 215, 220 (Pa. 1960). Pennsylvania's highest court has further explained that "arbitrators are the final judges of both law and fact, and an award will not be reviewed or set aside for mistake in either." Patriotic Order Sons of Am. v. Hartford Fire Ins. Co., 157 A. 259, 262 (Pa. 1931). Indeed, the Supreme Court of Pennsylvania has ruled that "an arbitration award is conclusive even if it has the effect of varying the terms of the contract" and even if the award is "blatantly at odds with the contract involved." Runewicz v. Keystone Ins. Co., 383 A.2d 189, 192-93 (Pa. 1978).

By contrast, the Federal Arbitration Act (FAA), which governs contracts containing an arbitration provision if the contract "evidenc[es] a transaction involving commerce," 9 U.S.C. 2, gives a reviewing court greater leeway to set aside or alter an arbitration award. Under the FAA, a court may set aside an arbitration award that manifestly disregards the law or fails the test of fundamental rationality. Roadway Package Sys., Inc. v. Kayser, No. 99-1907, 2001 WL 629276, at *4 n.2 (3d Cir. June 7, 2001). In its recent opinion in Roadway, the Third Circuit agreed that Pennsylvania's "vacatur standards for common law arbitration awards are so much narrower than the FAA's."

In Roadway, the Third Circuit finally resolved a thorny arbitration-related standard of review question that the court first noted some fourteen years ago in Apex Fountain Sales, Inc. v. Kleinfeld, 818 F.2d 1089, 1094-95 & n.4 (3d Cir. 1987). Put simply, the question is this: where a contract evidencing a transaction involving commerce contains both an arbitration clause and a generic choice of law provision stating that Pennsylvania law governs the contract, is an arbitration award due the all but complete deference provided under Pennsylvania law, or is the award subject to a lesser degree of deference under the FAA?

The answer the Third Circuit supplied last month may come as a surprise. The court held that the generic choice of law provision was insufficient to establish the parties' intent to select Pennsylvania's highly deferential standard of review applicable to common-law arbitrations. Thus, the FAA's less deferential standard of review applied, the Third Circuit held, and under that standard of review the federal appellate court set aside the arbitrator's award because it appeared plainly to violate the terms of the parties' agreement.

Importantly, the Third Circuit ruled in Roadway that the FAA permits parties to agree in the contract between them that any arbitration award is subject to Pennsylvania's standard of review, rather than the FAA's. But, the court held, a generic choice of law provision stating that the contract "shall be governed by and construed in accordance with the laws of the Commonwealth of Pennsylvania" was insufficient to evidence such an agreement. Rather, the court explained, parties that wish to opt for Pennsylvania's standard of review instead of the FAA's should include in their contract language providing that "any controversy shall be settled by arbitration in accordance with the terms of the Pennsylvania Uniform Arbitration Act."

Putting aside the readily apparent irony that the Third Circuit has invoked the FAA, a statute that reflects "a liberal federal policy favoring arbitration," Moses H. Cone Mem. Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 24 (1983), to make it easier for a court to set aside the result of an arbitration proceeding, the importance of the Third Circuit's recent ruling in Roadway can hardly be overstated. As the panel's opinion explains, the question whether parties may ever opt-out of the FAA's standard of review was already the subject of a split among the U.S. Courts of Appeals. In answering that question in the affirmative, the Third Circuit sided with the vast majority of federal appellate courts to have addressed that issue. The opinion further explains that another circuit split exists over whether a generic choice of law provision sufficiently evidences the contracting parties' intent to elect the chosen state's standard of review in lieu of the FAA's. Greatly complicating this second circuit split is the fact that it arises from doubt about how to reconcile two apparently conflicting U.S. Supreme Court decisions that give vastly different effects under the FAA to contractual choice of law provisions.

In Volt Info. Scis., Inc. v. Board of Trustees of Leland Stanford Junior Univ., 489 U.S. 468 (1989), the Supreme Court concluded that the FAA did not preempt a California law that permitted a state court to stay arbitration pending the resolution of related litigation involving third-parties who were not bound by an agreement to arbitrate. Volt arose in the California state court system, and before the case reached the U.S. Supreme Court a California state court had ruled that the parties' forum selection clause mandating application of California law demonstrated the parties' intent to apply California's body of arbitration law. The U.S. Supreme Court in Volt stated that the California state court should have the last word on whether the contractual forum selection clause sufficed to invoke California's body of arbitration law.

Exactly six years to the day later, the Supreme Court announced its ruling in Mastrobuono v. Shearson Lehman Hutton, Inc., 514 U.S. 52 (1995), by means of an opinion that charitably can be said to be in some tension with the Court's earlier ruling in Volt. In Mastrobuono, customers filed a claim in arbitration against their securities broker. The contract between these parties contained a choice of law provision specifying that "[t]his agreement . . . shall be governed by the laws of the State of New York." After the arbitration panel returned an award that included punitive damages in the customers' favor, the broker sought judicial review in federal district court, arguing that New York's law of arbitration prohibited arbitrators from awarding punitive damages. Both the district court and the court of appeals agreed and vacated the arbitrator's award of punitive damages. The Supreme Court, however, disagreed and reversed, holding that the choice of law provision failed to demonstrate with sufficient clarity that the parties had intended to invoke New York's law of arbitration, which would have prohibited the award of punitive damages.

Reasonable minds can certainly disagree over how best to harmonize the Supreme Court's rulings in Volt and Mastrobuono. In Roadway, Chief Judge Edward R. Becker's majority opinion for himself and Circuit Judge Richard L. Nygaard concluded that Mastrobuono established that a generic choice of law provision is insufficient to demonstrate the parties' agreement to be bound by the designated state's law governing review of arbitration awards. In so concluding, Chief Judge Becker's opinion closely followed the reasoning found in Justice William J. Brennan's dissenting opinion in Volt. Circuit Judge Thomas L. Ambro, who issued a separate opinion in Roadway concurring only in the judgment, argued that the Pennsylvania choice of law provision sufficed to demonstrate that the parties wished to be bound by Pennsylvania's stricter standards for setting aside a common-law arbitration award. Judge Ambro's argument in this respect followed Justice Clarence Thomas's dissenting opinion in Mastrobuono.

One very interesting question that arises in the aftermath of the Third Circuit's Roadway decision is whether Pennsylvania state courts will agree that a contractual choice of law provision selecting Pennsylvania law in a contract requiring arbitration of disputes and evidencing a transaction involving commerce fails to demonstrate the parties' intent that the arbitration award be reviewed under Pennsylvania law rather than under the FAA. The U.S. Supreme Court has ruled that the FAA applies in both federal and state courts. Southland Corp. v. Keating, 465 U.S. 1, 15-16 (1984). Yet, a search of Westlaw's "Pennsylvania cases" database conducted in late June 2001 revealed only nine reported Pennsylvania state court opinions that mentioned the "Federal Arbitration Act," which Congress enacted in 1925.

The U.S. Supreme Court's ruling in Volt establishes that Pennsylvania state appellate courts have the discretion to rule that a contract's Pennsylvania choice of law provision suffices to demonstrate the parties' intent that an arbitration award be governed by the very restrictive Pennsylvania common-law rules of arbitration review. The Third Circuit's ruling in Roadway does not bind Pennsylvania state courts; rather, state courts have an independent duty to apply federal law as they understand it, and state courts are only bound by the U.S. Supreme Court's pronouncements of what federal law is. Lockhart v. Fretwell, 506 U.S. 364, 375-76 (1993) (Thomas, J., concurring) ("neither federal supremacy nor any other principle of federal law requires that a state court's interpretation of federal law give way to a (lower) federal court's interpretation"). While the U.S. Supreme Court has observed that "Congress would not have wanted state and federal courts to reach different outcomes about the validity of arbitration in similar cases," Allied-Bruce Terminix Cos. v. Dobson, 513 U.S. 265, 272 (1995), precisely that result would occur if Pennsylvania state courts disagree with the Third Circuit's decision in Roadway.

Until the state appellate courts of Pennsylvania make clear whether they will follow the Third Circuit's holding in Roadway, parties that are on the losing side of an arbitration award will greatly prefer to have their challenges to the award heard and decided by a federal court. The FAA, however, does not itself confer subject matter jurisdiction on federal courts, and thus only arbitration challenges in which diversity of citizenship or federal question jurisdiction exists can be filed in or removed to federal court. Kaplan v. First Options of Chicago, Inc., 143 F.3d 807, 814 (3d Cir. 1998). At least one thing is certain in the aftermath of Roadway -- the FAA is about to be litigated much more often in Pennsylvania state court actions challenging common-law arbitration awards.

This article is reprinted with permission from the July 16, 2001 issue of The Western Pennsylvania Legal Intelligencer 2001 NLP IP Company.



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