Arbitration is a contractual creation, intended to provide flexibility in the resolution of disputes that is usually invoked to achieve a relatively swift and inexpensive resolution. But in California, it sometimes can be invoked to achieve the opposite effect: adding another layer of litigation on top of the three-tiered state court system.
In the recent case of Housing Authority of the City of Calexico v. Multi-Housing Tax Credit Partners XXIX, L.P., California’s Court of Appeal gave further clarity about the extent to which parties may contract to have California courts review the merits of an arbitral award. For corporations doing business in California, understanding this nuance is critical to ensuring the dispute resolution provision in a contract operates to their advantage.
Cable Connection and Contracting for Appeal in California
Both the Federal Arbitration Act (“FAA”) and its California counterpart, the California Arbitration Act (“CAA”), provide only a limited set of grounds for judicial review of an arbitration award, such as corruption or misconduct on the part of parties or the arbitrator. See 9 U.S.C. § 10(a); Cal. Code of Civ. P. § 1286.2(a). However, because arbitration is a creation of contract, a natural question arises: may parties agree to expand the bases for appealing an arbitration award beyond the limited set of grounds set forth in the FAA and CAA? For example, may parties contract to allow the court to invalidate an arbitration award where the court finds that the arbitrator incorrectly applied the law?
In 2008, the Supreme Court of the United States and the Supreme Court of California considered this question of whether parties may agree to expand the bases for appealing an arbitral award. In decisions issued just months apart, the two courts issued decisions pointing in opposite directions. In Hall Street Assocs. LLC v. Mattel, Inc., 552 U.S. 576 (2008), the U.S. Supreme Court held that the FAA did not allow such an agreement. Conversely, in Cable Connection, Inc. v. DirecTV, Inc. (2008) 44 Cal. 4th 1334, the California Supreme Court held that under the CAA, parties may expand the bases for appealing an arbitration award: “The California rule is that the parties may obtain judicial review of the merits by express agreement.” Id. at 1340.
The different outcomes of Hall Street and Cable Connection are traceable to the policy question that is central to arbitration as a dispute resolution mechanism: is arbitration intended to be a quicker, informal, and inexpensive dispute resolution system relative to the court system, or, rather, a flexible dispute resolution system that the contracting parties may shape to suit their needs? The U.S. Supreme Court answered in the former while the California Supreme Court answered in the latter, creating a significant divergence between the federal law and the state law.
City of Calexico: How Much Flexibility?
California’s emphasis on respecting the contracting parties’ intent in an arbitration agreement invited a secondary question: is there any limit to the flexibility? In the recent City of Calexico decision, the California Court of Appeal, Fourth Appellate District identified one such limitation—parties cannot choose which California court will review the award in the first instance.
City of Calexico involved a dispute between a real estate developer and the housing authority of Calexico regarding a tax credit program for building affordable housing. The developer initially filed suit with the California Superior Court, but later agreed to submit the dispute to arbitration pursuant to the parties’ pre-existing arbitration agreement.
The arbitration agreement, in relevant part, provided that the parties “shall have the right of appeal as specifically provided in accordance with the laws relating to appeals then in effect in the State of California.” Op. at 4. The housing authority lost the arbitration and subsequently filed the motion to vacate the award with the Superior Court. The Superior Court denied the motion to vacate the award, finding that the parties’ intent as set forth in the arbitration clause was to have the judicial review of the award take place with the Court of Appeal in the first instance.
In the appeal by the housing authority, the Court of Appeal reversed. The Court expressed skepticism that the arbitration clause in question mandated that the judicial review of the award must begin with the Court of Appeal rather than the Superior Court. See Op. at 16 n.8. Further, the Court held that even if the arbitration clause could be construed in such a manner, the parties cannot be permitted to “leapfrog the Superior Court.” Op. at 13.
The Court of Appeal found that such limitation on the parties’ contractual rights extended from the principle that a private agreement cannot control or compel the exercise of judicial power. Thus, for example, an agreement that a court will have the power to review an arbitral award, but the court must conduct such a review by casting lots, would not be enforceable. Because the California State constitution limits the original jurisdiction of the Court of Appeal to habeas corpus proceedings and writs for extraordinary relief, parties cannot expand the Court of Appeal’s original jurisdiction through a private agreement. See Op. at 21.
Practice Tips: Arbitration, Fast and Slow
Typically, parties enter into an arbitration agreement to establish a faster, cheaper and less formalistic mechanism for dispute resolution. But California courts’ emphasis on party autonomy can turn this conventional understanding on its head.
Pursuant to the California Supreme Court’s holding in Cable Connection, parties may agree to judicial review of the merits, which could result in an arbitration under the CAA that is slower, more expensive, and more formalistic. And, now under City of Calexico, parties cannot agree to bypass California Superior Court by contracting to have the arbitration award reviewed in the first instance by the Court of Appeal or the California Supreme Court.
For many practitioners, a slower, more expensive arbitration may come across as counter-intuitive. But in international business transactions, in which parties choose from a wide variety of dispute resolution mechanisms, leveraging “too much procedure” is a relatively common practice. For example, in transactions involving parties from two different countries, savvy negotiators often bargain for arbitration under United Nations Commission on International Trade Law (“UNCITRAL”) or Permanent Court of Arbitration (“PCA”) rules, arguing that an international arbitral tribunal is likely to be more impartial than, say, the national courts in New York or London.
But in practicality, because an UNCITRAL or PCA arbitration is significantly more costly than American or English litigation, such an arbitration agreement operates as a hurdle against litigating disputes at all. If the size of the transaction is small in relation to the cost of litigation, contracting for “too much procedure” effectively forecloses the possibility of litigation, forcing the aggrieved party to seek a commercial resolution.
The same principle could operate with California courts’ holdings in Cable Connection and City of Calexico. For parties that are relatively cost-insensitive as to litigation (such as the housing authority in City of Calexico) or parties in a superior negotiating position that seek to place a significant hurdle against litigation, CAA arbitration may be an attractive option over FAA arbitration. On the other hand, parties seeking a faster and more inexpensive dispute resolution should be aware of the potential implications of agreeing to arbitrate with the right to appeal under California state law.
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