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Litigation Alert: Arbitrators May Order the Loser to Pay Attorney's and Arbitrator's Fees Upon a Finding of Bad Faith Even When the Contract Invokes The American Rule

Date: Jul 08, 2009

In ReliaStar Life Insurance Co. of New York v. EMC National Life Co., Case No. 07-0828 (2d Cir. Apr. 9, 2009), the United States Court of Appeals for the Second Circuit ruled that a provision in an arbitration agreement requiring that each party bear its own attorney's and arbitrator's costs did not prevent an arbitration panel ordering a party that arbitrated in bad faith to pay attorney's and arbitrator's fees to the other party.

In 1997, ReliaStar and EMC entered into two coinsurance agreements with identical terms and conditions ("Agreements"). The Agreements provided that the parties shall arbitrate all disputes before a panel of three arbitrators. With regard to arbitration expenses, the Agreements provided: "Each party shall bear the expense of its own arbitrator . . . and related outside attorneys' fees."

After several disputes arose between the parties, EMC initiated arbitration proceedings. The arbitrators ultimately ruled in ReliaStar's favor and, among other things, ordered EMC to pay ReliaStar's attorney's and arbitrator's fees of $3,169,496 and costs of $691,903.75 because EMC's conduct was "lacking [in] good faith."

EMC appealed the award to a federal district court which relied on the plain language of the Agreements to vacate the part of the arbitrators' award ordering EMC to pay ReliaStar's fees and costs. Upon further appeal, the Court of Appeals reversed and reinstated the award. The appellate court noted that Section 10(b)(4) Federal Arbitration Act grants courts authority to vacate arbitral awards "where arbitrators exceed their powers." Because arbitration is a matter of contract, however, court review should be limited to give effect to the parties' intent of avoiding litigation. Thus, in a review under section 10(b)(4), the principal issue is whether the arbitral award "draws its essence" from the arbitration agreement. If it does, the court should uphold the award as long as the arbitrator offers "a barely colorable justification for the outcome." Under this standard, the court held that the Agreements conferred on the arbitrators inherent authority to sanction bad faith, including with an award of fees and costs.

The Second Circuit concluded that because New York law implies in every contract a covenant of good faith and fair dealing, the Agreements' language on fees and costs merely recited the American Rule of how fees and costs would be borne in the expected context of good-faith dealings. Once the arbitrators found bad-faith conduct, that section in the Agreements became inoperative and the arbitrators were free to invoke the bad-faith exception to the American Rule and award fees and costs. Thus, under ReliaStar, in the absence of specific language prohibiting an award of fees and costs, companies involved in arbitration must exhibit good faith or face the possibility of paying the fees and expenses of the opposing party.

For more information on Keller and Heckman llp's litigation practice, please contact Douglas Behr at 202-434-4213 or behr@khlaw.com.

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