December 10, 2012

Nitro-Lift Technologies v. Howard: Judicial Review and the Contractarian Model of Arbitration

By Paul Kirgis

In my previous post on Nitro-Lift, I argued that arbitration agreements involving covenants not to compete could be susceptible to challenge under the Federal Arbitration Act’s savings clause. Because it equates arbitrators with courts sitting in other jurisdictions, that analysis rests on an assumption that arbitrators act as quasi-public dispute resolvers, determining rights and obligations while assuming responsibility for the application of both state and federal statutory and common law.

But there is another way to understand arbitration, as a species of private contract. And this “contractarian” understanding may provide states with a more effective way of slowing the arbitration express. But it delays the exercise of state sovereignty until the judicial review stage of an arbitral proceeding.

My complete explanation of this theory is contained in my article Judicial Review and the Limits of Arbitral Authority: Lessons from the Law of Contracts. Rather than explicate the entire theory again, I will apply its principles to the context of Nitro-Lift and trust the reader to seek out the full article if elements seem unclear.

The contractarian model of arbitration rests on the assumption that arbitrators are not public actors, such that, as courts have consistently held, arbitration is not state action. (This assumption is an important structural element in the Supreme Court’s arbitration edifice, because if arbitration were state action, due process would apply, and the Court assuredly does not want due process to apply.) Under the contractarian model, arbitrators are private “contract readers,” whose job is to fill in the gaps in the parties’ agreement when the parties have a dispute about what they agreed to. The arbitral award, in this model, is not equivalent to a court judgment, but to a contract term. It is the term that the parties would have agreed to ex ante if they had anticipated the circumstances that subsequently arose.

Seen through the lens of contract, the rules on judicial review of arbitral awards require much greater court oversight than the Supreme Court has been willing to concede. To see why, reconsider Nitro-Lift from a contractarian perspective.

Remember that in Oklahoma, a contract that imposes an unreasonable restraint on an employee’s ability to compete is void. It is not a contract at all. Further, we know from the Oklahoma Supreme Court’s decision that the covenant at issue in Nitro-Lift was unreasonable under Oklahoma law. So the parties did not have the power to enter into that agreement at the time they signed the contract.

Now assume that on remand, the claim in Nitro-Lift is sent to arbitration. An arbitrator issues an award that has the effect of preventing the employee from competing. In so doing, the arbitrator has effectively supplied a contract term that could not legally have been included in the contract.

Can an Oklahoma court do anything about that? A logical reading of the FAA suggests it can. FAA section ten provides that an arbitral award may be vacated “where the arbitrators exceeded their powers,” among other reasons. 9 U.S.C. § 10(4). If the parties would have been acting in excess of their own contracting powers by including a particular employment restriction in their contract, then the arbitrator must also have exceeded his powers by supplying an award term that imposes the same restriction.

Nitro-Lift is an especially easy case, because the Oklahoma Supreme Court had already declared the covenant unreasonably restrictive. But the same analysis should apply whenever an arbitrator issues an award that, had it been a judgment of a court, would have been overturned on appeal. Such an award amounts to an “arbitral waiver” of the substantive rights at issue—it is equivalent to an exculpatory contract waiving those rights.

Not all exculpatory contracts are void. But there are many contexts in which exculpatory contracts are unenforceable, including those that waive liability for intentional torts, those that involve the provision of important public services, and those between parties of radically unequal bargaining power.

Consistent application of the contractarian model, in tandem with FAA § 10, could thus provide state courts with a legal basis for scrutinizing arbitral awards in a much greater range of cases than has heretofore been recognized.

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