On March 25, 1998, the California Supreme Court granted review, and asked for briefing on the issue of "Whether commercial arbitration decisions have collateral estoppel effect," in Vandenbergv. Superior Court (Sacramento), 59 Cal.App.4th 898, 69 Cal.Rptr.2d 511, review granted (March 25, 1998) 98 Daily Journal D.A.R. 3022, 68 C.D.O.S. 2204, 1998 WL 169. Two weeks later, another District Court of Appeal held that issue preclusion based on a prior arbitral award was not automatic, even where the threshold requirements existed, because of the lack of any meaningful review of the arbitrators' decision and the relaxed rules of law applicable to arbitration. Orrick v. San Joaquin Community Hospital, __ Cal.App.4th __, __ Cal. Rptr.2d __ (5th Dist. April 7, 1998). Those cases and a recent Ninth Circuit decision could alter how private arbitration is viewed in California. Before discussing these decisions, a little background is required.
The California Supreme Court decision in Moncharshv. Heily& Blase, 3Cal. 4th 1, 6, 10 Cal. Rptr. 2d 183 (1992) held that an arbitrator's decision is "not generally reviewable for errors of fact or law," even when errors appear on the face of the award and cause substantial injustice. This understandably gave potential users of arbitration in California pause. While a case may be made that Moncharsh in fact did not change the law and merely overruled some aberrational cases, it clearly changed the perception of arbitration in California.
After Moncharsh, businesses involved in commercial transactions in California sometimes decided against a contractual arbitration provision because of the extremely broad powers attributed to arbitrators and the limited review by a court available under California law. Some lawyers therefore drafted contractual arbitration clauses specifically designed to sidestep Moncharsh, by avoiding application of California's substantive law. More recently, employees and consumers subject to arbitration clauses in standard form contracts have viewed mandatory arbitration with increasing skepticism. Behind this growing trepidation by business and consumers alike is the knowledge that under Moncharsh the arbitrator, who, under California law is generally not bound to follow legal procedure or precedent, has the power to issue virtually nonreviewable awards.
The appellate court decision in Vandenberg held that an arbitration award rendered under Moncharsh is not subject to meaningful review and therefore not entitled to collateral estoppel effect. The case involved Vandenberg's lease of land from Boyd to operate an automobile business. Vandenberg discontinued its business after many years, and Boyd discovered the land had contaminated soil and groundwater. Litigation ensued, but, as part of a judge-supervised settlement with one insurer, Boyd and Vandenberg agreed to submit their disputes over reserved issues to binding private arbitration before a retired federal judge. After hearing evidence and argument, the arbitrator ruled for Boyd and orally announced "some of the whys and why-nots" behind his decision. He indicated that the primary sources of contamination were underground waste oil tanks that had been improperly installed, maintained and used during the many years Vandenberg occupied the land. The arbitral award was confirmed in a judgment. Vandenberg was required to pay Boyd more than $4million.
When insurance carriers refused to provide indemnity, Vandenberg brought suit against them. The trial court granted the insurance carriers' motion for summary adjudication, finding that the arbitrator's decision collaterally estopped Vandenberg from relitigating the source and cause of contamination. Based on the arbitrator's comments, the court found Vandenberg's claim excluded under the terms of the insurance policies. Vandenberg appealed and the court of appeal reversed.
The Third District Court of Appeal held that a decision in a private, nonjudicial arbitration proceeding cannot be used "by nonparties to the arbitration to collaterally estop a party to the arbitration from relitigating the issue in subsequent litigation." Vandenberg, 59 Cal. App. 4th at 902. The court explained that in the context of a "noncourt decision" such as an arbitration, the court first had to determine whether "the prior proceeding is of a type which may be accorded estoppel effect." Id. at 906. In making this determination, "a pivotal consideration is whether the parties can obtain review of the decision" by the arbitrator. Id, at 907-908. Since, under Moncharsh, an arbitrator's decision is generally not reviewable "for errors of fact or law," the court held that this "alone is fatal to the claim that an arbitrator's decision is entitled to collateral estoppel effect." Id., at 908. As noted, the California Supreme Court has granted review and, the Court of Appeal decision is therefore not precedent, and the issue of how Moncharsh impacts application of collateral estoppel to private arbitration awards must await decision by the Supreme Court.
The court also noted that arbitration proceedings do not require the adjudicator to apply principles of dry law and may reject, under considerations of equity and good conscience, a claim that would have been successful if asserted in a judicial action. Further, in arbitration, parties may choose to use summary procedures. These factors, the court held, gave further support to its conclusion that collateral estoppel does not apply to a decision of a private arbitrator. The court rested its decision on "the relaxed standards to which an arbitrator must adhere and the unavailability of judicial review." Id. at 909.
The court explained that an arbitrator's decision is binding between the parties to the arbitration, and is generally entitled to res judicata or claim preclusion. The court added "one caveat to our conclusion." Id. Because arbitration is a creature of contract, and an "arbitration decision may be given any lawful effect to which the parties agree," the parties could agree that an arbitrator's resolution of an issue should be "binding in favor of nonparties." Id. (citation omitted). In such a situation the nonparty would have the status of a third party beneficiary; therefore, "this is a matter of contract law and not of the application of the legal doctrine of collateral estoppel." Id., at 910. This dicta implies that if the parties in Vandenberg had provided, as a matter of contract, for a more searching review of the arbitral award to make it parallel to that accorded a regular court judgment, the court would have been more receptive to giving it collateral estoppel effect. A decision of the Ninth Circuit decided about a week later addressed the enforceability of such an arbitration clause providing for heightened review.
In LaPine Technologyv. Kyocera Corporation, 909F. Supp. 697, 705 (N.D.Cal. 1995), rev'd, 130 F.3d 884, 1997 WL 755261; 97 C.D.O.S. 9183 (9th Cir. Dec. 9, 1997), the district court held that the parties to a contract with an arbitration clause "may not by agreement alter by expansion the provisions for judicial review contained in the Federal Arbitration Act." There, the parties' contract had provided that an award would be subject, in addition to "the grounds for review referred to in the Federal Arbitration Act," to normal standards for appellate review of court judgments. 909 F. Supp. at 702. The arbitration clause directed that the district court shall vacate, modify or correct any award ... "where the arbitrators' findings of fact are not supported by substantial evidence, or [] where the arbitrators' conclusions of law are erroneous." Id.
The district court held that this clause amounted to an attempt to expand subject matter jurisdiction and inappropriately assumed "the prerogative of Congress, in that [it] presume[s] to direct this court as to the substance and parameters of its exercise of judicial power." Id. at 705. The trial court relied on a statement in a 1991 Seventh Circuit decision, Chicago Typographical Unionv. Chicago Sun-Times, Inc., 935F.2d 1501, 1505, (7thCir. 1991), that while parties may contract for review of an award by "an appellate arbitration panel," they "cannot contract for judicial review of that award; federal jurisdiction cannot be created by contract." Lapine Technology, 909F. Supp. at 703.
On appeal, the Ninth Circuit had the benefit of amicus briefing by a large number of business constituencies, including the California Manufacturers Association, Electronic Industries Association and several banking associations, urging reversal. In a 2-1 decision, the Ninth Circuit agreed and reversed the district court's judgment, holding that federal courts should honor the parties' agreement to apply heightened judicial scrutiny of the arbitral award. The Ninth Circuit recognized that the Seventh Circuit's "cryptic assertion about jurisdiction" relied upon by the district court appeared to be dicta. 130 F.3d at 890. If it was not dicta, the Ninth Circuit simply disagreed. "On the contrary, we hold that the district court erred when it decided that it could not expand judicial review of an arbitration award beyond the ground set forth in the [Federal Arbitration Act] to the more generous review for substantial evidence and errors of law agreed to by the parties." Id..
The Ninth Circuit instead endorsed a decision by the Fifth Circuit in Gateway Techs., Inc.v. MCI Telecomm. Corp., 64F.3d 993, 996-97, (5thCir. 1995), adopting the Gateway court's language that "[w]hen, as here, the parties agree contractually to subject an arbitration award to expanded judicial review, federal arbitration policy demands that the court conduct its review according to the terms of the arbitration contract." Lapine, at 889. With the reversal of the district court decision in LaPine, the case law now appears to give consistent support to the parties' ability to expand by contract the scope of review of arbitral awards. See Hochman, Stephen, "Judicial Review To Correct Arbitral Error-An Option to Consider," 13 Ohio St. J. on Disp. Resol. 103, 108-9 (1997).
Orrick v. San Joaquin Community Hospital, __ Cal.App.4th __, __ Cal. Rept.2d __ (5th Dist. April 7, 1998) was a malpractice case. The first proceeding was an arbitration against a physician. The plaintiff prevailed, and satisfied the award in full. The second action was against the hospital. The defendant moved for and obtained summary judgment, arguing that there was only one injury and plaintiff could only recover his full damages once. The appellate court reviewed the requirements for the application of issue preclusion, and agreed with the trial court that all the requirements had been met. But, the court continued, application of the doctrine "requires consideration of whether the public policies underlying it are served." Slip opinion at 10. The court noted that the application of claim preclusion to an arbitral award was "almost universally accepted", but the application of issue preclusion to such an award "is subject to question". Id., at 11. The court analogized to People v. Sims, 32 Cal.3d 468 (1982), holding that an administrative proceeding favorable to a defendant barred a later criminal prosecution, and found the "critical consideration" in that case had been the availability of judicial review. The arbitrator's decision, on the other hand, is not generally reviewable for errors of law and fact. Thus, neither the merits of the controversy nor the validity of the arbitrator's reasoning is subject to judicial review. While the non-reviewability of the arbitrator's award does not work an injustice on the parties to the arbitration agreement who bargained for arbitration, "the same cannot be said when a nonparty to the arbitration agreement attempts to claim issue preclusion based on the arbitrator's decision". Id., at 15. The court added that the relaxed rules of law applicable to an arbitration also justify declining to give issue preclusive effect to an arbitral award. Id., at 16. Thus, the court reversed and remanded, stating that there remained a triable issue concerning damages.
Assuming they are not overturned in later proceedings (and, the California Supreme Court has granted review in Vandenberg), together these decisions provide parties with more flexibility. In the context of commercial contracts, parties may with more certainty provide for an enhanced standard of review to protect against the risk of an aberrational arbitral award contrary to law and/or not supported by substantial evidence. Heightened review, on the other hand, increases the likelihood that an adverse award could be given collateral estoppel effect in favor of a nonparty. This likelihood may increase with a greater scope of review and a more detailed award. Businesses who use standard arbitration clauses in recurring contracts, such as franchises, distributorships, licenses and leases, should carefully evaluate the benefits of heightened review against the potential downside costs of third parties invoking collateral estoppel.
The court of appeals decision in Vandenberg case is also significant to California consumers. An earlier version of pending legislation in Sacramento (Sen. Bill No.19 (1997-98 Reg. Sess.)) would have provided for heightened review of arbitral awards in consumer contracts only when review is requested by the consumer. Current law (i.e., Moncharsh) would apply when review is requested by the business entity. In finding that arbitral decisions should not be accorded collateral estoppel effect, Vandenberg relied heavily on the California Supreme Court decision in Sandersonv. Niemann, 17Cal. 2d 563, 574, (1941). There, the Vandenberg court explained, the Supreme Court rejected collateral estoppel effect and "noted that in a small claims action the judgment was conclusive upon the plaintiff and only the defendant could appeal." Vandenberg, at 908. The Vandenberg court also noted that the Restatement Second of Judgments "flatly states that collateral estoppel does not apply if '[t]he party against whom preclusion is sought could not as a matter of law have obtained review of the judgment in the initial action.' (Rest. 2d Judgments, ' 28, Subd. (1), p. 273.)" Id. (Emphasis added).
This reasoning could suggest that, if S.B. 19 were passed as previously written, there would be no collateral estoppel effect given to an arbitral award against the business entity because it could still obtain review only under Moncharsh. Thus S.B.19 in its present form may have the possible but unintended result of insulating businesses from potential collateral estoppel effect of awards rendered in favor of a first consumer in proceedings brought by a second consumer. We caution, however, against reading too much into the quoted passage from the now superceded passage in Vandenberg. This portion of the decision may have an internal inconsistency: while relying in part on one section of the Restatement of Judgments, it ignored the section of the restatement on the specific subject of the preclusive effect of an arbitration award (section 84). When the decisions in Vandenberg and Lapine are final, they should provide some needed guidance in the rapidly evolving area of the scope of review of arbitral awards.