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In re Arbitration Between The Home Indemnity Co. v. Affiliated Food Distributors, Inc.

Issue Discussed: Security

Submitted by Michael T. Carolan, Thomas J. Kinney*

Date Promulgated: December 12, 1997

 

In re Arbitration Between The Home Indem. Co. v. Affiliated Food Distributors, Inc., No. 96 Civ. 9707 (RO), 1997 WL 77312 (Dec. 12, 1997)

Court: U.S. District Court for the Southern District of New York

Issues Decided: Whether an order conditioning a party’s ability to engage in discovery upon the posting of prehearing security was fundamentally unfair or within the scope of the arbitration panel’s authority.

 

In Home Indem. Co. v. Affiliated Food Distributors, Inc., the U.S. District Court for the Southern District of New York vacated an arbitration panel’s interim order conditioning a party’s ability to engage in full discovery on their posting of pre-hearing security for the disputed amount.  In doing so the court articulated two separate bases for doing so, finding that the award was fundamentally unfair under §10 (a)(3) of the Federal Arbitration Act (“FAA”), and outside the scope of the arbitrator’s authority under §10(a)(4) of the FAA.

The Arbitration

As part of a workers compensation and employers liability insurance policy, Home Indemnity Company (“Home”) and Affiliated Food Distributors (“Affiliated”) entered into a deductible agreement pursuant to which Affiliated was required to pay a $500,000 deductible on each claim filed under the policy.  To protect against Affiliated’s non-payment or insolvency, Affiliated was required to establish a $600,000 irrevocable letter of credit (“LOC”) with Home as the drawee.

Initially, Affiliated met its obligations under the agreement on its own.  However, at some point Affiliated’s apparent company, Associated Wholesalers Inc. (“Associated”), began making payments on its behalf.  On March 21, 1994, Home became aware of Affiliated’s pending dissolution.  The next month, Home voluntarily released $400,000 under the LOC to Affiliated, leaving Home with $200,000 on the LOC.

In releasing the bulk of the credit, Home apparently relied on Associated’s past willingness to satisfy Affiliated’s obligations.  In December 1995, however, Associated informed Home that it would not pay on Affiliated’s behalf for any claims settlements reached without its prior knowledge or consent.  This left an unpaid balance of $672,627.62 that Home claimed it was owed under the parties’ agreement.  In response, Home exercised its right to draw the remaining $200,000 from the letter of credit, and demanded arbitration seeking to recover the remaining $472,627.62.

Notably, while Associated made the majority of payments on Affiliated’s behalf,  it was not a signatory to the original agreement and thus was not a party to the arbitration.  In November 1996 Home and Affiliated submitted statements of position and appeared for an organizational meeting.  At that time, Home raised concerns about Affiliated’s ability to pay a final award, and asked the panel to order Affiliated to post pre-hearing security in the outstanding amount.  In turn, Affiliated disputed the amount of damages that Home was seeking to recover, noting that Home had refused to permit it to access and review its files to verify the amount.

Following the hearing, the panel granted Home’s request, and directed Affiliated to either (1) establish a letter of credit in the allegedly outstanding amount, (2) deposit that amount in escrow, or (3) furnish a letter of guaranty from its parent corporation.  Importantly, the panel also conditioned Affiliated’s access to discovery on its compliance with the interim pre-hearing security award.

The District Court Opinion

Home sought confirmation of the interim award in the U.S. District Court for the Southern District of New York.  Affiliated opposed confirmation and cross-moved to vacate the award, arguing that it was in manifest disregard of the law and in violation of the principles of fundamental fairness.

The court found that the panel had overstepped its authority, and vacated the order for two reasons.  First, the court found that the panel’s order violated FAA § 10(a)(3)’s mandate for fundamental fairness.  The court acknowledged that awards of pre-hearing security are generally not considered “fundamentally unfair,” but found that in this case the process by which the security was awarded was flawed.  The court noted that the panel’s award did not make “rational sense” given the stage of the proceedings, and took particular umbrage with the panel’s reliance on Home’s representations in awarding pre-hearing security “without even a glance at the underlying dispute or its possible merits.”  As the parties presented no cases supporting the proposition that “an arbitration panel can properly bar a party from defending itself by precluding discovery of files central and dispositive to the dispute before it,” the court found good cause to vacate the panel’s order under §10(a)(3).

Second, the court found good cause to vacate the award under §10(a)(4), as it deemed the award to be in excess of the panel’s authority.  The court based this conclusion on the fact that, at the time the panel issued its interim order, it “ruled as if Associated and Affiliated are clearly one entity, and that Associated is liable as Affiliated’s guarantor.”  Quoting the Second Circuit’s decision in Orion Shipping & Trading Co., Inc. v. Eastern States Petroleum Corporation of Panama, S.A., 312 F.2d 299, 301 (1963), the court noted that “it is for the court, not the arbitrator, to decide whether a non-signatory to an arbitration clause is bound by an arbitration award.”  While the panel’s order was directed to Affiliated, and not Associated,  the court believed that its intent was to secure payment from Associated, a non-party to the agreement to arbitrate.  As such, the court found that the panel had stepped into the shoes of the courts and in doing so had exceeded the scope of its authority, thus justifying reversal under §10(a)(4).

 

* Michael T. Carolan and Thomas J. Kinney are partner and associate, respectively, in the Insurance & Reinsurance group of Crowell & Moring LLP.  They each represent cedents and reinsurers in disputes involving a broad spectrum of issues.