Arbitration of an agreement subject to Delaware law

Steven D. Goldberg, Esq. Wilmington, DE
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This post will address arbitration under an agreement that is subject to Delaware law. The legal concepts are uniquely applicable to a Limited Liability Company Agreement, however the concepts are also applicable to all “Delaware Agreements” generally.

Arbitration, as a mechanism for dispute resolution, has become increasingly important. There are several business risk of arbitration. Paramount is that an unskilled arbitrator will be selected or appointed depending upon the mechanism provided in the agreement and that arbitrator will “split the baby”. Agreements to arbitrate disputes must be carefully written; they must clearly define what disputes are to be subject to arbitration and which, if any, are not; the agreement needs to address whether or not the determination of whether a dispute is subject to arbitration or not is itself subject to arbitration; how the arbitrator is to be selected or whether the parties will defer to a third party such as the American Arbitration Association, the National Arbitration Forum or the International Council for Commercial Arbitration to select the arbitrator; what rules will govern the arbitration itself including whether the local rules of evidence will apply; the authority of the arbitrator, will the judgment be limited to actual damages, will consequential damages be permitted and will exemplary or punitive damages be permitted; who will pay the costs assesed by the arbitration sponsoring organization as well as the arbitrator’s fee and associated costs of the arbitration itself; and finally will attorney fees and costs of the prevailing party be included in the award.

I personally do not like the traditional 3 arbitrator panel model. My experience with that model has been that the award tends to come in somewhere between the two competing demands rather than one party clearly prevailing. I prefer the model adopted by professional baseball where there is a single arbitrator selected by the parties where the arbitrator has only the power to pick one of the positions submitted by the parties plus award attorneys fees and costs to the prevailing party plus award the costs of the arbitration. The arbitrator may make corrections to computational errors of a party, however, aside from making such corrections the arbitrator is limited to picking a winning position and cannot modify the position of any party and therefore cannot split the baby.

If an arbitration agreement is to provide for the award of counsel fees to the prevailing party the notion of “prevailing” must be defined carefully and the concept of costs must be included with “reasonable counsel fees” as counsel fees does not by definition include the attorney’s costs. Costs of arbitration (arbitrator’s fee, AAA fees, room charges, etc.,) are not “costs” in the general sense and must be addressed specifically.

The decision to arbitrate disputes is a decision to forgo the right to a hearing before a court applying traditional court rules and rules of evidence and forego the right to judicial review of the substantive merits of the arbitrator’s decision. In Delaware the Court of Chancery may review an arbitration order under 5 limited circumstances set out in the statute (10 Del C. § 5714). The Court does not sit  as an appellate court reviewing the arbitrator’s legal findings and procedural actions.

Chancellor Chandler on August 18, 2009 decided the case of World-Win Marketing, Inc. v Granley Management Co. (CA 3905-CC) Decision: world-win v ganley In this case the arbitrator in an AAA arbitration decided that both parties were equally at fault and awarded plaintiff one half of the amount it demanded. The arbitration agreement stated that “the prevailing party shall be entitled to recover all reasonable costs incurred in connection therewith, including attorneys’ fees.” The arbitrator decided that the plaintiff was not entitled to attorneys’ fees as part of the award and the plaintiff sought an order vacating the portion of the award denying attornys’ fees contending that the arbitrator exceeded his authority in not including attorneys’ fees in the award.

The plaintiff contended that “prevailing party” under Delaware practice means the party which receives the award. The Court stated that under Delaware law the “prvailing party” is determined by reference to substantive issues, not damages. In the case under review the arbitrator found that both parties “where equally negligent in the performance of the Agreement, and in the breach of numerour provisions of said Agreement” and therfore denied an award of attorneys’ fees.

The Chancellor addressed several issues of general interest to my readers.

  • He noted that “If the Arbitrator decides an issue outside of those contained in the submission, or if his actions are in direct contradiction to the express terms of the agreement of the parties he has exceeded his authority.” [citation omitted]
  • Even if the arbitrator did not state the grounds for a grant or denial of relief, the grant or denial of relief will be deemed to be within the scope of the arbitrator’s authority “[i]f grounds for the award can be inferred from the facts of the case.” [citations omitted]
  • “…plaintiff is not entitled to vacate an arbitrator’s award merely because the arbitrator interpreted Delaware case law differently than a Delaware Court may have. Plaintiff’s challenge to the arbitrator’s allegedly incorrect interpretation of the term “prevailing party” invites this Court to review the substantive merit of the arbitrator’s decision. As I explained above, this Court does not sit as a Court of appeals to review arbitrator’s decision. “By agreeing to arbitrate, the parties voluntarily relinquish their right to a formal proceeding with strict adherence to court rules complete with precise finding of law and fact.” This Court cannot vacate an arbitrator’s award on the grounds that the arbitrator exceeded its authority merely because this Court disagrees with the arbitrator’s decision on the merits of the claim. This is true even where the issue is a contractual term that has an established meaning under Delaware case law.” [citations omitted]

This case is illustrative of the pitfalls of arbitration and the need to address the meaning of even well understood contractual terms in drafting the agreement to arbitrate disputes within the LLC agrement. As with any agreement to be interpreted under Delaware law, the input and review by a Delaware attorney is required. I have an active Delaware business practice as well as a practice in Delaware’s State and Federal courts. If you or your client have a business matter or a matter which you wish to litigate in Delaware or has a matter pending in Delaware, we would appreciate the opportunity to consult with you regarding our representation. Please remember that we do not accept representation without a written engagement letter.

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