As businesses embrace alternative dispute resolution instead of trial litigation, private contracts increasingly call for arbitration of commercial conflicts. Under New York law, parties can enter into a written agreement to submit any controversy to arbitration, with the courts having jurisdiction to enforce the agreement and enter a judgment on an award. In most instances, the scope of judicial review of the results of private arbitration is limited. One perceived advantage of contracts calling for private arbitration is the ability to limit the kinds of damages — specifically, to exclude punitive damages claims. For nearly two decades, all businesses in New York relied on a state high court ruling that arbitrators could not award punitive damages. Unnoticed by many businesses, the landscape began to change a few years ago, and now many have learned the hard way that they can be hit for punitive damages, even where the underlying contract precludes them.
For many years, New York law seemed clear: privately appointed arbitrators had no authority to award punitive damages, even if the parties’ contract allowed them. The reason was that New York courts considered punitive damages a severe sanction reserved for the judiciary to impose in rare circumstances. Appellate decisions reflected a concern that a party in a superior bargaining position could take unfair advantage to manipulate the process, and that the unfettered discretion of arbitrators to impose punitive damages would destroy the usefulness of arbitrations because awards would be unpredictable, uncontrollable, and free from judicial review of law and fact. See, Garrity v. Lyle Stuart, Inc., 40 N.Y.2d 354, 386 N.Y.S.2d 831, 353 N.E. 2d 793 (1976).
Garrity held sway in New York until a security dealer’s dispute arose in Mastrobuono v. Shearson Lehman Hutton, Inc., 514 U.S. 52, 115 S.Ct. 1212 (1995). There, following an arbitration under the Federal Arbitration Act (“FAA”), the lower courts had followed Garrity by invalidating an award of punitive damages. The United States Supreme Court reversed and upheld the punitive damages award. Relying on prior cases under the FAA, the Court held that punitive damages could be awarded unless excluded by contract, even where the host state’s substantive law would otherwise bar such claims from arbitration. Although the contract had provided that New York’s substantive law would apply, the Supreme Court concluded that the contract did not expressly preclude punitive damages (even though the substantive law of New York did).
The Supreme Court was influenced by a contract provision directing that the private rules of the industry (the National Association of Securities Dealers rules) would apply. The Court found those rules were silent on the issue of punitive damages. The Court thought it unlikely that the parties were even aware of New York’s common law barring punitive damages in private arbitration. It then concluded that even though the common law by which the parties agreed to abide prohibits punitive damages in private arbitrations, such damages could still be awarded.
The Supreme Court may have believed that parties were unaware of the proscription against punitive damages in Garrity and its progeny, but it seems more businesses are unaware of Mastrobuono’s overriding effect. Recently, a New York trial court extended Mastrobuono by allowing an arbitrator’s award for punitive damages even where the contract expressly excluded them. In Lian v. First Asset Management, 273 A.D. 2d 163; 710 N.Y.S.2d 52 (2000), the Court found that the contract’s failure to expressly acknowledge Mastrobuono rendered unenforcable an express waiver of punitive damages. The Lian court also rejected the waiver of punitive damages as violative of industry-wide professional rules.
In many commercial contexts, as in Mastrobuono and Lian, there may be overarching professional rules or industry-wide agreements which permit punitive damages. Still, parties may be able to waive liability for punitive damages with forethought and careful contractual drafting. Contractual clarity and a thorough understanding of industry rules and customs may steer parties around Mastrobuono, allowing them to maximize the benefit of commercial arbitration by eliminating punitive damages.
*article courtesy of Lisa Mellas of White and Williams, mellasl@whitewms.com.