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Positive Software, Inc. v. New Century Mortgage Corp.

Issue Discussed: Bias/Evident Partiality

Submitted by Rick Rosenblum

Date Promulgated: January 11, 2006

Issues Addressed: Arbitrator bias

In Positive Software, Inc. v. New Century Mortgage Corp., the Fifth Circuit U.S. Court of Appeals affirmed the decision of a federal district court that vacated an arbitration award because the arbitrator displayed “evident partiality,” one of the grounds specified under Section 10 of the U.S. Arbitration Act on which a court may vacate an arbitrator’s award. Positive Software, a software development company, licensed “LoanForce,” a software product used in the mortgage lending business, to New Century Mortgage. Positive alleged that New Century had copied and used the licensed software in violation of the terms of the parties’ license agreement. Positive sued New Century seeking damages and injunctive relief for breach of contract, theft of trade secrets, and copyright infringement. The district court compelled arbitration pursuant to the terms of the License Agreement.

The parties conducted the arbitration under AAA procedures using a single arbitrator to preside. During the arbitrator selection process, all of the arbitrator candidates received information about the case, including the names of the lawyers and law firms representing the parties to the dispute. In addition, the arbitrator candidates received “important reminder” notices several times advising them of their “obligation to disclose any circumstance likely to affect impartiality or create an appearance of partiality” and to “disclose any past or present relationship with the parties, their counsel, or potential witnesses, direct or indirect, whether financial, professional, social or any other kind.”

The selection process resulted in the installation of Peter Shurn as arbitrator. Mr. Shurn’s disclosures revealed no prior relationships with anyone in thePositive case. After a seven day hearing, Shurn concluded Positive should take nothing against New Century.

Promptly after the issuance of the award by Mr. Shurn, Positive conducted a detailed investigation into Shurn’s background. This investigation uncovered that Shurn and his former law firm had previously served as co-counsel with the law firm and one of the primary lawyers wh represented New Century in the recently concluded arbitration over which Shurn presided. The district court found that the prior relationship between Shurn and the New Century lawyers involved protracted and significant litigation that lasted over a period of years. Based upon this information, Positive moved to set aside the take-nothing award. The district court agreed that Shurn’s failure to disclose this prior relationship created a reasonable impression of possible partiality warranting vacating the award.

The Fifth Circuit affirmed the trial court’s vacatur of the arbitration award. The court of appeals relied heavily upon the U.S. Supreme Court’s decision inCommonwealth Coatings Corp. v. Continental Cas. Co., 393 U.S. 145, 89 S.Ct. 337, 21 L.Ed.2d 301 (1968), which held that an arbitrator’s failure to disclose significant business relationships amounted to evident partiality under the U.S. Arbitration Act, 9 U.S.C. Sec. 10. The Supreme Court found that while no evidence existed of actual bias, and arbitrators are not expected to sever ties with the business world, the law mandates the “simple requirement that arbitrators disclose to the parties any dealings that might create an impression of possible bias.”

The Fifth Circuit first noted some disagreement among circuit courts of appeal as to the controlling effect of Commonwealth due to the existence of a concurring opinion in Commonwealth that arguably narrows the scope of the majority opinion. Compare Morelite Constr. Corp. v. NY City Dist. Council Carpenters Ben. Funds, 748 F.2d 79 (2d Cir. 1984) (finding Commonwealth to be a plurality opinion, and, thus, not controlling, and requiring more than an “appearance of bias” to disqualify an arbitrator) with Schmitz v. Zilveti, 20 F.3d 1043 (9th Cir. 1994) (reasonable impression of partiality best expression of applicable standard in non-disclosure case). Ultimately the Fifth Circuit found Commonwealth better reasoned and controlling. The Fifth Circuit concluded that in a nondisclosure case, a showing of “reasonable impression of partiality” suffices to establish evident partiality and, thus, vacate an arbitration award. The court found this standard conformed with Canon II of the AAA’s Code of Ethics for Arbitrators. Finally, the court noted it was not creating an “inflexible per se” rule for nondisclosure cases, but was encouraging arbitrators to “always err in favor of disclosure.”

* Rick Rosenblum is a partner at Akin Gump Strauss Hauer & Feld. Mr. Rosenblum has represented U.S. and European insurers and reinsurers in state and federal courts and before arbitration panels across the U.S. for 18 years.