Case Law Update: Who decides whether an arbitration clause is rendered unenforceable by an illegal provision – the court or the arbitrator?

In Life Receivables Trust v. Goshawk Syndicate 102 at Lloyd’s, 14 N.Y.3d 850, 901 NY.S.2d 133 (May 4, 2010) the parties included a provision in their arbitration agreement that the parties had the right to challenge an arbitration decision on the grounds that the panel made an error of law. This type of provision appears very logical and at first blush, it is difficult to understand why a provision such as this agreed to by the parties would not be enforceable.

But, in Hall Street Associates, LLC v. Mattel, 128 S.Ct. 1396 (2008), the United States Supreme Court held that a provision calling for judicial review of alleged errors of law by arbitration tribunals was unenforceable. The Court based its decision on the conclusion that the Federal Arbitration Act does not permit parties to expand the scope of judicial review beyond that authorized by the Act. Under section 10 of the Federal Arbitration Act (FAA), a district court has only limited powers to vacate an arbitral award – for reasons such as the arbitrator's fraud or corruption, but not for faulty legal conclusions. In effect, the Court held that parties could not expand a court’s jurisdiction by contract. This decision appears correct, but it leaves open the question as to whether the parties would have agreed to arbitrate in the first place without the safeguard of being able to appeal the arbitrator’s decisions based upon legal errors.

Does the inclusion of the illegal provision invalidate the arbitration agreement altogether? Who decides whether the arbitration agreement is invalid, the court or the arbitration tribunal?

These questions were addressed, at least partially, by the New York Court of Appeals in Life Receivables Trust v. Goshawk Syndicate 102 at Lloyd’s.  In this case, the Court decided that where the contract arbitration provision required that "[a]ll disputes and differences arising under or in connection with this [contract] . . . be referred to arbitration under the American Arbitration Association Rules," the arbitrator, and not the court, would decide whether the arbitration agreement would be enforceable. This is because the AAA rules authorize the arbitrator to determine its own jurisdiction, including issues relating to the existence, scope and validity of the arbitration agreement.

In effect, the Court of Appeals held that it is up to the arbitrator to decide whether the parties would have agreed to arbitration had they known that the provision in the arbitration agreement permitting judicial review of claimed legal errors in the award. 

One interesting aspect of this decision is that since arbitration decisions are generally not published, we may never know how the arbitrator decided this issue.  And, because of the holding of Hall Street Associates, LLC v. Mattel, we will also have no way of examining whether this decision was made in accordance with applicable legal principles.