In re Cragwood Managers, L.L.C. (Reliance Ins.)

• Decision Date: 26 February 2001
• Docket Number: No. 00 CIV 9314 LLS.,00 CIV 9314 LLS.
• Citation: 132 F.Supp.2d 285
• Parties: In the Matter of the Arbitration Between CRAGWOOD MANAGERS, L.L.C., Petitioner, and RELIANCE INSURANCE COMPANY, Respondent.
• Court: U.S. District Court — Southern District of New York

Page 285

132 F.Supp.2d 285

In the Matter of the Arbitration Between CRAGWOOD MANAGERS, L.L.C., Petitioner and RELIANCE INSURANCE COMPANY, Respondent.

No. 00 CIV 9314 LLS.

United States District Court, S.D. New York.

February 26, 2001.

Shearman & Sterling, New York City (Henry Weisberg, Brian H. Polovoy, Mark S. McNeill, of counsel), Broderick, Stirn & Regan, Washington, DC (Richard P. Regan, of counsel), for Petitioner.

Paul, Weiss, Rifkind, Wharton & Garrison, New York City (Brad S. Karp, Claudia L. Hammerman, of counsel), for Respondent.

OPINION AND ORDER

STANTON, District Judge.

Petitioner Cragwood Managers, L.L.C. ("Cragwood") moves pursuant to Section 10 of the Federal Arbitration Act to vacate or modify an interim arbitration award¹ requiring it to post a $4 million bond payable to Respondent Reliance Insurance Company ("Reliance") to secure a portion of Reliance's counterclaims. Reliance cross-moves to confirm the arbitration award.

It is evident that Cragwood's current expenditures, in large part to pay its own and its chief executive officer John E. Pallat III's legal fees,² if allowed to continue will eventually deplete its assets³ so that nothing will be left for Reliance to recover if it wins the arbitration. For that reason, the arbitrators required $4 million in security, which would allow Reliance to recoup its costs and have some recovery should it prevail in the arbitration.

Cragwood now argues that the award should be vacated primarily because, if forced to post the award, it will no longer have any funds to pay its legal fees in the arbitration or in a number of other legal proceedings in which it is currently involved.⁴

Everything presented to the court was previously presented to the arbitrators before they made their decision, except for Pallat's affidavit disclaiming liability on the merits. Although Pallat had the opportunity to present that material to the arbitral panel, he chose not to do so.

Discussion

"Arbitration awards are subject to very limited review in order to avoid undermining the twin goals of arbitration, namely, settling disputes efficiently and avoiding long and expensive litigation." Folkways Music Publishers, Inc. v. Weiss, 989 F.2d 108, 111 (2d Cir.1993).

The party seeking to vacate the award bears the burden of proof. Id. at 112. If "a barely colorable justification" for the arbitration award exists, the award should be confirmed. Landy Michaels Realty Corp. v. Local 32B-32J, Service Employees Int'l Union, 954 F.2d 794, 797 (2d Cir.1992).

Under Section 10 of the Federal Arbitration Act (the "F.A.A."), a court may vacate an arbitral award:

(1) Where the award was procured by corruption, fraud, or undue means.

(2) Where there was evident partiality or corruption in the arbitrators, or either of them.

(3) Where the arbitrators were guilty of misconduct in refusing to postpone the hearing, upon sufficient cause shown, or in refusing to hear evidence pertinent and material to the controversy; or of any other misbehavior by which the rights of any party have been prejudiced.

(4) Where the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made.

9 U.S.C. § 10(a)(1)-(4).

The gravamen of Cragwood's argument rests on the concept of "fundamental fairness". Under section 10(3) of the F.A.A., courts may review arbitral awards to determine whether parties have been denied a fundamentally fair hearing. See Tempo Shain Corp. v. Bertek, Inc., 120 F.3d 16, 20 (2d Cir.1997)("Courts have interpreted section 10(a)(3) to mean that except where fundamental fairness is violated, arbitration determinations will not be opened up to evidentiary review.... Federal courts do not superintend arbitration proceedings. Our review is restricted to determining whether the procedure was fundamentally unfair.") (internal quotations omitted); Areca, Inc. v. Oppenheimer & Co., Inc., 960 F.Supp. 52, 54-55 (S.D.N.Y.1997)("the [arbitrator's] misconduct must amount to a denial of fundamental fairness of the arbitration proceeding to warrant vacating the award.") (quotation omitted). Arbitral "[m]isconduct typically arises where there is proof of either bad faith or gross error on the part of the arbitrator." Shamah v. Schweiger, 21 F.Supp.2d 208, 214 (E.D.N.Y.1998)(quotation omitted).

Whether the amount of the interim security award violates "fundamental fairness" under the F.A.A.

Cragwood argues that requiring it to post a bond equal to almost all of its current cash assets is "fundamentally unfair," because it currently has only $4.07 million in cash and, if required to post the bond, will likely be forced into bankruptcy and be unable to pay its counsel to prosecute its claims in the arbitration, defend itself against Reliance's counterclaims, or litigate the other actions in which it is involved.

While at first blush that argument has strong appeal, it does not overcome the arbitrators' interim award.

It is only conjecture whether the award will force Cragwood into bankruptcy. Cragwood may yet have available other unexplored sources of funds (Reliance suggests Mr. Pallat may be such a source). Nor does posting the security inevitably deprive Cragwood of counsels' services: even in bankruptcy, the Trustee's counsel pursue and defend claims for the debtor's advantage.

Most significantly, Cragwood is no longer a going business firm. It is already winding down; it has no clients and only a few employees who primarily assist in Cragwood's litigation. In Texaco Inc. v. Pennzoil Co., 784 F.2d 1133 (2d Cir.1986), rev'd on other grounds, 481 U.S. 1, 107 S.Ct. 1519, 95 L.Ed.2d 1 (1987), the Second Circuit expressed concern that if a huge supersedeas bond were required, Texaco "would probably be forced into bankruptcy or litigation." Id. at 1138. In this case, Cragwood is already effectively in liquidation.

District courts have not hesitated to confirm drastic interim security awards. See British Ins. Co. of Cayman v. Water Street Ins. Co., Ltd., 93 F.Supp.2d 506, 513, n. 9 (S.D.N.Y.2000) (confirming interim security award even though respondent argued that it "equals approximately 85% of the available assets of Water Street, and about 140% of its net worth and would have the effect of putting Water Street out of business [and] would provide BICC with an unwarranted preference over all policy-holders of Water Street.") (internal quotations omitted)(brackets in original); Blue Sympathy Shipping Co. Ltd. v. Serviocean Int'l, S.A., No. 94 Civ. 2323, 1994 WL 597144, at *2 (S.D.N.Y. July 6, 1994)(confirming interim security award "fully within the arbitrators' power to impose" despite respondent's representation it was "financially incapable of posting the security"); Polydefkis Corp. v. Transcontinental Fertiliser Co., No.Civ.A.95-0242, 1996 WL 683629, at *3 (E.D.Pa. Nov. 26, 1996)("Respondent's efforts to justify a stay of confirmation [of an interim security award] because of the consequences a denial would have on its ability to continue its business are unavailing."); Forum Insurance Co. v. First Horizon Insurance Co., No. 87 C 2177, 1989 WL 65041, at *6 (N.D.Ill. June 8, 1989) (stating that "A party's financial inability to pay has never been the basis for declining to confirm an arbitration award.").

Finally, in ordering such interim relief, the arbitrators did nothing which diminishes their responsibility to allow the parties to develop the record, and to accord them a full and fair hearing on the merits of their claims. A "threshold security order that deprives a party of a fair opportunity to contest the merits of a dispute may well constitute misconduct under the FAA," Northwestern Nat'l Ins. Co. v. Generali Mexico Compania De Seguros, S.A., No. 00 Civ. 1135, 2000 WL 520638, at *9 (S.D.N.Y.2000), and a final award may not be confirmed if both parties are not accorded a full fair hearing on the merits of their claim. See British Ins., 93 F.Supp.2d at 507-508 (that "the extremely large amount of the security ... may make it impossible for Water Street to obtain a resolution on the merits ... would present issues of fundamental fairness if a final award were issued without the development of an additional record on the merits.").

Cragwood cites cases which do not involve arbitrations, but judicial actions involving supersedeas bonds, preliminary injunctions, and denial of counsel by ex parte freezing of a criminal defendant's assets. Those cases rest on a criminal defendant's Sixth Amendment right to counsel, or proper court procedures. They are not applicable to arbitration.

"[B]y agreeing to arbitrate, a party trades the procedures and opportunity for review for...