How Scared Should We Be? Arbitrator Disclosure and Award Enforceability in the Wake of Monster Energy

In Monster Energy, the Ninth Circuit broadly interpreted the Federal Arbitration Act’s “evident partiality” standard for vacating arbitration awards, finding that the arbitrator’s failure to disclose a partial ownership interest in the arbitration provider (JAMS), combined with the fact that JAMS had administered 97 arbitrations for Monster in the preceding five years, created an impression of bias and partiality that required the award be vacated. This decision will likely spawn many more motions to vacate arbitration awards, especially in cases where the arbitrator has an ownership interest—however small—in the arbitration service provider.

It is also significant that the Ninth Circuit vacated the award despite the arbitrator’s disclosure, during the arbitrator selection process, that he had an “economic interest” in the financial success of JAMS. The court narrowly construed the “constructive knowledge” standard for waiver. This interpretation will make it difficult for parties opposing motions to vacate to argue that any claim of bias was waived because not raised at the time of arbitrator selection.

The Arbitrator’s Disclosures in Monster Energy

In Monster Energy Co. v. City Beverages, LLC, 940 F.3d 1130 (9th Cir., Oct. 22, 2019), the parties arbitrated a dispute over whether Monster had improperly terminated a contract with distributor City Beverages (d.b.a. Olympic Eagle). At the outset of arbitration, the arbitrator provided a series of standard disclosure statements to the parties, which included the following:

I practice in association with JAMS. Each JAMS neutral, including me, has an economic interest in the overall financial success of JAMS. In addition, because of the nature and size of JAMS, the parties should assume that one or more of the other neutrals who practice with JAMS has participated in an arbitration, mediation or other dispute resolution proceeding with the parties, counsel or insurers in this case and may do so in the future.

The arbitrator found in favor of Monster. The district court confirmed the award and denied Olympic’s motion to vacate brought on the ground of later-discovered information that the arbitrator was a co-owner of JAMS. Olympic appealed.

Waiver: A Narrow View of the “Constructive Knowledge” Standard

In the first part of its opinion, the Ninth Circuit majority rejected Monster’s argument that Olympic had waived its “evident partiality” claim by failing to timely object when the arbitrator disclosed his economic interest in JAMS. 1134-35. Such a waiver requires that the objecting party have had constructive notice of the potential bias, yet fail to timely raise the issue. Id. The Ninth Circuit held that the arbitrator’s disclosure of his “economic interest” in JAMS was akin to a “partial disclosure” because Olympic did not know the nature of the interest—specifically, that it was an ownership interest. 1134. Because the arbitrator “expressly likened his interest in JAMS to that of ‘each JAMS neutral,’” and disclosed his previous arbitration activities that directly involved Monster (in which he ruled against Monster), “these disclosures implied only that the Arbitrator, like any other JAMS arbitrator or employee, had a general interest in JAMS’s reputation and economic wellbeing, and that his sole financial interest was in the arbitrations that he himself conducted.” 1134-35. Instead, the arbitrator was “potentially non-neutral based on the totality of JAMS’s Monster-related business.” 1135. Disclosure of the arbitrator’s ownership interest was part of his duty to investigate and disclose potential conflicts. Id. Accordingly, Olympic’s lack of constructive notice of the arbitrator’s ownership interest was “the key fact that triggered the specter of partiality.” Id.

The Two-Prong “Evident Partiality” Test

The Ninth Circuit applied a plurality holding, from the 1968 Supreme Court decision, Commonwealth Coatings Corp. v. Cont’l Cas. Co. (393 U.S. 145), that vacatur is supported where the arbitrator fails to disclose “any dealings that might create an impression of possible bias.” 1135. According to the Ninth Circuit, vacatur based on evident partiality requires a two part showing: (1) that an arbitrator’s undisclosed interest in an entity (such as JAMS or a law firm connected to the case) is substantial; and (2) that entity’s business dealings with a party to the arbitration are nontrivial. 1135.¹

The Ninth Circuit acknowledged the disclosures that the arbitrator made prior to the arbitration: within the prior five years, he had served as a neutral arbitrator for one of the parties, firms, or lawyers in the arbitration; within the prior two years, he or JAMS had been contacted by a party or attorney regarding prospective employment; he previously arbitrated a dispute between Monster and another distributor in which he issued an award against Monster for almost $400,000; and, as noted above, he had “an economic interest in the overall financial success of JAMS.” 1136.

However, the Ninth Circuit emphasized the arbitrator did not disclose his ownership interest in JAMS and JAMS’s “substantial business relationship” with Monster. 1136. Under the first prong, as a co-owner of JAMS, the arbitrator has a right to a portion of profits from all JAMS arbitrations. Id. This interest “greatly exceeds the general economic interest that all JAMS neutrals” have in the organization, and is one which “only” about one-third of JAMS neutrals have, making this interest “substantial.” 1136 & n. 2. The court did not consider the size of the ownership interest in determining that it was “substantial.”

Under the second prong, Monster’s form contracts designated JAMS as the arbitration provider, which has resulted in 97 arbitrations for Monster, more than one per month over a five-year period. 1136. Thus, the Ninth Circuit found JAMS’s business dealings with Monster were “nontrivial.” Id.

Confusingly, the court declared that the actual value of the arbitrator’s monetary interest in JAMS is irrelevant in determining whether JAMS’s business dealings were “nontrivial” under the second prong, without answering the obvious question under the first prong of whether the actual value of an arbitrator’s ownership interest in JAMS matters in determining if that interest is “substantial.” 1136 n. 3. Is even a nominal ownership interest “substantial”? The opinion does not say.²

Ramifications of the Broader, But Murky, Vacatur Standard

The Monster Energy majority maintained that the disclosure obligations it laid out are “easily satisfied,” and that organizations such as JAMS “will have no difficulty fulfilling, and even exceeding, the requirements described here.” 1137 & 1138. The majority overlooked the broad potential ramifications of its decision, including uncertainty about disclosure obligations and the potential to undermine the finality of arbitration awards.

For example, the majority acknowledged that parties may make further inquiries of an arbitrator based on the initial disclosures, but failed to explain why Olympic should not have been required to do so in that case. As dissenting Judge Friedland noted, the arbitrator disclosed both that (1) he had a financial interest in JAMS’s success; and (2) Monster was a repeat customer of JAMS. 1139-40. Yet the majority found that Olympic was still not on constructive notice that there may be further inquiries to be made, such as the nature of the financial interest or the specifics of how significant of a repeat customer Monster was. 1134. How was Olympic not on constructive notice of those issues? Where is the line? If one-third of JAMS neutrals have ownership interests, aren’t parties on notice to ask about the nature of an arbitrator’s financial interest if that is something that matters to them?

The same “constructive notice” problem comes up on the “repeat customer” issues. As Judge Friedland pointed out in dissent, specific information on Monster’s status as a repeat customer was publicly available on JAMS’s website, and Olympic was clearly aware that Monster was a “repeat customer” of JAMS because Olympic signed Monster’s form contract designating JAMS as the dispute resolution provider. 1140. As Judge Friedland put it, the majority opinion requires disclosures “about the elephant that everyone knows is in the room.” 1143. It is unclear what is left of the constructive notice standard for waiver in the wake of Monster Energy.

Perversely, the decision could incentivize parties to future arbitrations to not inquire further into an arbitrator’s initial disclosures, and then, if they lose, move to vacate the adverse award based on later-learned information, taking advantage of the fact that a “substantial interest” under the first prong can apparently be a nominal interest as long as the organization at issue (a law firm; the dispute resolution provider; any company with a business relationship with one of the parties; etc.) has “nontrivial” dealings with a party.

As Judge Friedland also warned, this decision will incentivize parties that lose in arbitration to “think up after the fact some argument that an arbitrator’s disclosure did not fully convey the arbitrator’s financial interest in the potential future arbitration business of the winning party or its lawyers.” 1142. Indeed, Olympic only objected to the arbitrator’s lack of disclosure after it lost the arbitration. Id.

Practical and Strategic Considerations in the Wake of Monster Energy

Seek to confirm award in state court, not federal court. Generally, the Monster Energy decision should apply only in federal court. Under the Federal Arbitration Act (FAA), the grounds for vacating an arbitral award (9 U.S.C. § 10(a)) are “procedural” matters, meaning that state courts would likely follow their respective state-law procedures for vacating or enforcing an arbitration award, even in cases where the FAA substantively applies. See, e.g., Cable Connection Inc. v. DIRECTV Inc., 44 Cal. 4^th 1334 (Cal. 2008). Therefore, Monster Energy is not binding on state courts when presented with a motion to vacate or confirm. Because the FAA does not confer an independent ground for federal jurisdiction, Monster Energy should not apply unless there is an independent basis for federal jurisdiction (i.e., diversity or federal question). However, some arbitration agreements specify that awards should be enforced (or vacated) under the FAA—or in the same way that judgments are enforced under federal law or in federal courts—which could bring Monster into play. See, e.g., Countrywide Financial Corp. v. Bundy, 187 Cal. App. 4^th 234, 246-47 (Cal. Ct. App. 2010). And if the award falls under the New York Convention—i.e., there is a foreign party or there is a reasonable relation with a foreign state (9 U.S.C. § 202)—then federal courts have enforcement jurisdiction (9 U.S.C. § 203) and Monster would be relevant.

Spend more time considering disclosures. After the arbitration process begins, parties should spend more time reviewing and considering disclosures. A party should not only review disclosure for its own satisfaction, but also should consider whether there are gaps, omissions, uncertainties or contradictions—yellow flags of any kind—in the disclosures that the opposing party could use “after the fact” to try to vacate an unfavorable award. If there are such yellow flags, any party could ask for additional disclosures to ensure both sides have any potentially relevant information. For similar reasons, a party or its counsel may choose to volunteer “repeat player” information, such as the number of matters that a party or law firm has had with the arbitration provider, especially if the arbitration provider has not fully disclosed this information. After disclosures are complete, the parties may consider a stipulation that specifically consents to the arbitrator and waives any challenges to sufficiency of disclosure.

Avoid the ownership interest issue altogether. Another option to promote finality of arbitral awards is to draft an arbitration agreement to mandate the selection of arbitrators without an ownership interest in the dispute resolution provider, or who work outside of such an organization. As Judge Friedland observed, even if an ownership interest were prospectively disclosed by the arbitrator, Monster leaves unclear how detailed the disclosure must be. 1141. Merely the fact of ownership? The value of the interest? The arbitration firm’s profits from the past year, or past five years, and how much went to the arbitrator? Judge Friedland noted that the ruling “is likely to generate endless litigation.” 1141. But at the pre-dispute stage, parties could minimize that danger by agreeing the arbitrator should have no ownership interest in—or to be even safer, work independently of—a dispute resolution provider.

Avoid the Ninth Circuit. If reasonable based on the resources and locations of the parties to the arbitration agreement, the parties may choose an arbitral forum outside the Ninth Circuit to prevent the losing party from trying to vacate an award by citing Monster Energy in a court where it is binding precedent. This consideration (again, at the contract drafting stage) is more important if a party foresees a possible basis for federal jurisdiction. Other circuits’ vacatur standards are stricter. See, e.g., Scandinavian Reinsurance Co. v. Saint Paul Fire & Marine Ins. Co., 668 F.3d 60, 72 (2d Cir. 2012) (evident partiality “where a reasonable person would have to conclude that an arbitrator was partial to one party to the arbitration” (emphasis added), quoting Morelite Constr. Corp. v. New York City Dist. Council Carpenters Ben. Funds, 748 F.2d 79, 84 (2d. Cir. 1984). Many circuits have adopted the Morelite standard. See, e.g., Freeman v. Pittsburgh Glass Works LLC, 709 F.3d 240, 251-53 (3d Cir. 2013) (affirming Morelite’s standard and listing cases from the 1st, 4th, 5th and 6th Circuits doing the same); see also Republic of Argentina v. AWG Grp. Ltd., 894 F.3d 327, 335-37 (D.C. Cir. 2018) (parties challenging awards based on evident partiality must meet a “heavy burden” in reaching the “onerous” vacatur standard by presenting “specific facts that indicate improper motives on the part of an arbitrator.” In reaching its decision, the court took into account the quantitative amount of the interest in question—unlike the Monster court—and warned of the upending effect that granting motions to vacate such as the one before it would have on arbitral awards in general).

Blaine I. Green and Dustin Chase-Woods successfully defended an arbitral award against a motion to vacate based on Monster Energy, winning confirmation in the San Francisco Superior Court. See JRV, LLC and Bill Leigon v. Winery Exchange, Inc., S. F. Sup. Court Case No. CPF-19-516943, Order on Petitions to Confirm and Vacate Final Arbitration Award, filed January 21, 2020 (Judge Ethan P. Schulman).

This article was published in the Los Angeles Daily Journal on August 28, 2020.

^{1   This test is derived from the concurring opinion of Justice White in Commonwealth Coatings, 393 U.S. at 151. Although only two Justices (White and Marshall) subscribed to this test, it is arguably the proper one for courts to apply because it is a narrower formulation than Justice Black’s plurality “impression of possible bias” standard for determining “evident partiality.” It is poetic that, read together, the opinions of Justices Black and White create a standard so gray.}

^{2   In a footnote, the court admitted the record did not reveal the arbitrator’s specific monetary interest in Monster-related arbitrations. 1136 n. 3. Presumably (although the court did not say this), the record also did not reveal the arbitrator’s specific monetary interest in JAMS as a whole. Apparently, under Monster Energy, an arbitrator must disclose any ownership interest in the arbitration organization, if the organization has nontrivial business relations with a party.}