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Applied Industrial Materials Corp. v. Ovalar Makine Ticaret Ve Sanayi

Issue Discussed: Judicial Review/Manifest Disregard

Submitted by Sylvia Kaminsky

Date Promulgated: July 9, 2007

Issue Decided: Arbitrator’s continuous duty to disclose conflicts; evident partiality of an arbitrator

In Applied Industrial Materials Corp. v. Ovalar Makine Ticaret Ve Sanayi, A.S., the Second Circuit Court of Appeals affirmed the District Court’s finding vacating an arbitration award where one of three arbitrators acted with “evident partiality” by failing to either investigate what he knew to be a potential business relationship between his corporation and one of the parties or by failing to inform the parties that he had created a “Chinese Wall” to insulate himself from learning more about the relationship.

Applied Industrial Materials Corp. (“Aimcor”) and Ovalar Makine (“Ovalar”) had entered into a Joint Venture Agreement (“Agreement”) relating to the sale in Turkey of petroleum coke. A dispute arose over the distribution of profits under the Agreement, which contained an arbitration clause providing that the dispute be resolved by arbitration in New York. The arbitration was to be heard before a tripartite panel consisting of two party appointed arbitrators who jointly selected the third arbitrator to serve as chairman. The chairman, Charles Fabrikant, was the Chairman, President and CEO of Seacor Holdings (“Seacor”), a multi-billionaire dollar company.

The arbitration provision in the Agreement contained the following disclosure requirements: “all arbitrators are required to disclose any circumstance which could impair their ability to render an unbiased award based solely upon an objective and impartial consideration of the evidence present to the Panel. Such disclosure shall include relations with anyone of: a) the parties to the arbitration; b) other affiliates or associated companies of the parties.”

In April 2005, after the arbitration hearings commenced, Fabrikant disclosed to the parties that Seacor’s affiliate was negotiating a contract with Oxbow Industries (“Oxbow”), the parent of Aimcor. Fabrikant decided not to inquire further into the extent of the dealings between Seacor and Oxbow and did not advise the parties that he would make no further inquiries.

The arbitration proceeding had been bifurcated into liability and damages phases. In September 2005, the Panel issued a 2-1 decision against Ovalar on the liability issue with Fabrikant writing the decision and rendering the decisive vote. Several months later, Ovalar discovered a contract existed for over a year between Seacor’s affiliate and Oxbow which generated $275,000 in revenue. With the issue of damages still to be decided, Ovalar requested that Fabrikant withdraw from the Panel due to the commercial relationship between Seacor’s affiliate and Oxbow. Fabrikant refused stating that the amount of the business conducted with the affiliate was less than one-third of 1% of the affiliate’s revenue and amounted to an imperceptible fraction of his employer’s revenue.

In February 2006, when Aimcor moved to confirm the partial arbitration award, Ovalar moved to vacate the award on the grounds that Fabrikant’s failure to recuse himself violated the Federal Arbitration Act (“FAA”), 9 U.S.C. § 10. In finding against Aimcor, the District Court focused on the disclosure requirements in the arbitration clause, Fabrikant’s statement that, subject to later clarification, no conflict existed, and his later disclosure that talks were occurring between Seacor’s affiliate and Oxbow but that he did not know about them or intend to get involved. Based upon Fabrikant’s disclosures, the District Court found that Ovalar had a reasonable expectation that it would be notified of any actual contracts with Oxbow. The District Court held that by insulating himself from learning about any such relationship, and failing to tell the parties that he had done so, Fabrikant created an “appearance of partiality.” The District Court observed that Fabrikant’s failure to investigate the status of his company’s negotiations with Oxbow and his subsequent lack of knowledge did not excuse his lack of disclosure. Citing the American Code of Ethics for Arbitrators and the International Bar Association’s Guidelines on Conflicts of Interest in International Arbitration, the District Court found there to be a continuous obligation on the part of the arbitrator to avoid partiality or the appearance of partiality.

In determining the standard to be applied in construing the meaning of “evident partiality” to vacate an arbitration award as required under the FAA, the Second Circuit found that the District Court’s focus on whether there was an “appearance of partiality” on the part of the arbitrator set too low a standard. Reviewing its own precedent in Morelite Construction Corp. v. New York City District Council Benefit Funds, 748 F. 2d 79 (2d Cir. 1984) and Justice White’s concurrence in Commonwealth Coatings Corp. v. Continental Cas. Co., 393 U.S. 145 (1968), the Second Circuit stated that the standard to be applied must be based upon whether a reasonable person would have to conclude that an arbitrator was partial to one party in the arbitration. In circumstances of actual knowledge of a potential conflict, the Court noted that this can be dispositive of evident partiality while the absence of actual knowledge may not be. The Second Circuit, in placing an affirmative duty on the part of arbitrators to investigate nontrivial relationships, held that arbitrators must take steps to ensure that the parties are not misled into believing that no nontrivial conflict exists. The Court emphasized that, “The mere failure to investigate is not, by itself, sufficient to vacate an arbitration award. But, when an arbitrator knows of a potential conflict, a failure to either investigate or disclose an intention not to investigate is indicative of evident partiality.” The Second Circuit specifically ruled that “where an arbitrator has reason to believe that a nontrivial conflict of interest might exist, he must 1) investigate the conflict (which may reveal information that must be disclosed…) or 2) disclose his reasons for believing there might be a conflict and his intention not to investigate.”

The Second Circuit found that Fabrikant had an ongoing obligation to disclose conflicts and that he had previously assured the parties that he intended to comply with that obligation. Once he learned that negotiations were proceeding, he knew at a minimum that a potential conflict existed. His possible subjective good faith reasons for not further investigating did not meet the test. The Court noted that had he investigated further, Fabrikant would have discovered that there already existed a relationship generating $275,000 in revenue that the Court did not consider a trivial amount. Fabrikant also failed to advise the parties of the “Chinese Wall.” Under these circumstances, the Court found that a reasonable person would have to conclude that evident partiality existed.

*Sylvia Kaminsky is currently an ARIAS certified umpire and arbitrator as well as a consultant to the insurance/reinsurance industry. She is a lawyer licensed in New York. She was formerly General Counsel, Senior Vice President and Corporate Secretary of Constitution Reinsurance Corporation and Sirius Reinsurance Corporation; Deputy General Counsel of Gerling Global and Senior Vice President of Claims; and was in private legal practice for 15 years serving the industry.