Arbitrating with the Enemy

A case before the Supreme Court of Texas has far-reaching implications for corporate arbitrations.

In a matter of months, the Supreme Court of Texas could change the way companies do business. The case of Tenaska Energy Inc. v. Ponderosa Pine Energy LLC concerns a $125 million award in Ponderosa’s favor over the sale of a Cleburne power plant. The award was vacated by a trial court, which found the arbitrator had failed to fully disclose the nature and extent of his relationship with Ponderosa’s attorney.

On appeal, the Dallas Court of Appeals reversed and rendered judgment confirming the award, saying that the arbitrator had disclosed enough, and that by not objecting or investigating further, Tenaska had waived further complaint. Tenaska took the dispute to the state’s highest court, essentially arguing, “How can we waive our right to information that the arbitrator deliberately kept from us?”

The case has far-ranging implications about what, when, and how much an arbitrator has to share with the parties about his or her potential bias. After all, binding arbitration is “binding” for a reason—one of the only grounds to appeal an arbitration award is bias on the part of the arbitrator. As companies seek to obtain finality and minimize the cost and time-consumption of litigation—the American Arbitration Association (AAA) points to studies showing that even large, complex cases can be resolved within five months—binding arbitration provisions have become common in contracts. Nationwide, the AAA reported 2,239 business-to-business arbitrations were filed last year—a 13.1 percent increase over 2012. Of these cases, 448 were filed in Texas—a staggering 44 percent increase.

With more transactional disputes bypassing the courtroom in favor of arbitration, and with limited grounds on which to challenge arbitration awards, claims of arbitrator bias have been on the rise. In 2011, a California court threw out an $11.6 million award against Citigroup in favor of the late actor, Larry Hagman, after Citigroup argued arbitrator bias. (The parties later settled.) In June 2011, the Dallas Court of Appeals in Karlseng v. Cooke threw out a $22 million arbitration award after finding that an arbitrator failed to disclose “a direct, personal, professional, social, and business relationship” with the lawyer for one of the parties.

To help ensure the finality of arbitration awards, arbitrators under Texas law are required to disclose “facts that might, to an objective observer, create a reasonable impression of the arbitrator’s partiality.” At the same time, however, Texas and federal courts have also been sensitive to the backseat role played by judges in reviewing an arbitrator’s impartiality, and have placed the lion’s share of responsibility on the parties themselves to weigh an arbitrator’s knowledge and experience against potential conflicts. 

The National Arbitration Forum requires potential arbitrators to disclose not only actual “financial, personal, or material interest in the outcome of the arbitration,” but also any relationship “that may affect impartiality or might reasonably create an unfavorable appearance of partiality or bias.” As Fort Worth attorney and longtime arbitrator John Allen Chalk Sr. puts it, arbitrators “should always resolve the doubt about a potential disclosure by making the disclosure. When in doubt, disclose.”

But what does a company do when the disclosure that’s made turns out to be just the tip of the iceberg? 

Such was the case in the Tenaska arbitration. To resolve the disputes over the power plant sale, the parties each selected an arbitrator, who in turn chose the third, with all three serving as neutrals. Ponderosa, through its lawyers at Nixon Peabody in New York, selected Washington, D.C. lawyer Samuel Stern, and provided his C.V. Later, Stern provided a disclosure statement describing his prior contacts with Nixon Peabody and mentioning LexSite, an Indian legal services outsourcing company for which he served as a representative in a “general discussion” of services pitched to Nixon Peabody. 

For Tenaska—and potentially for any other Texas business that places its trust in arbitration—the stakes are high.

When additional disclosures were requested, Stern provided a statement saying he had “no professional or other relationship with the 16 listed financial institutions and companies connected with the underlying sale.” After a five-day hearing chaired by the third arbitrator, the late former Texas Supreme Court Justice James Baker, the 2-1 majority award was in favor of Ponderosa, to the tune of $125 million. Tenaska Energy’s appointed arbitrator, Thomas Fraser, was the lone dissenting vote.

A much more complete picture of Stern’s relationship with the Nixon Peabody lawyers emerged when the parties went to Dallas’s 191st Judicial District Court, with Ponderosa seeking to confirm the award and Tenaska seeking to vacate it. After two days of evidentiary hearings that featured more than 400 exhibits, expert witnesses, and the depositions of both arbitrator Stern and the Nixon Peabody lawyers, Judge Gena Slaughter issued a 14-page findings statement that was stinging in its indictment. 

The court found that Stern and Ponderosa’s counsel deliberately misled opposing counsel and obfuscated Stern’s relationships and conflicts, that they created a “misimpression” in the disclosures in an attempt to “stack the deck” in favor of Ponderosa, and that Stern made “intentionally incomplete and inaccurate” disclosures. Among the most damning evidence were emails revealing the extent of Stern’s ties to LexSite and his activities on its behalf; his jockeying for more arbitration work with Nixon Peabody; comments by Stern in which he repeatedly referred to Tenaska and its counsel as the “opponents,” while using the term “we” to refer to himself and Ponderosa; and how Stern allowed the Nixon Peabody lawyers to modify his disclosures before they were sent to Tenaska’s counsel. 

Although Stern’s disclosures minimized his role with LexSite, the evidence painted a very different picture—documenting his status as “U.S.-based director,” giving the company space in his law office, having his firm provide it “services, advice, and so forth” for $5,000 a month, and actively marketing the firm while outwardly encouraging Nixon Peabody throughout arbitration.

Reeling from the scathingly worded decision and vacatur of the $125 million award, Ponderosa appealed the ruling to the Dallas Court of Appeals, where it found a surprisingly receptive audience. A different panel of justices reversed the trial court and reinstated the award, finding that when Stern’s disclosures were made, Tenaska could have lodged objections or asked more questions. Having done neither, and having gone forward with the arbitration proceedings, Tenaska, as far as the appellate court was concerned, had waived its right to object.

Before the highest court in the state, the battle lines are clearly drawn. For Ponderosa, the message is twofold. First, Tenaska should have pursued more answers if it felt that disclosures were not complete, and its decision to proceed with the arbitration waived any later cries of “foul.” Second, expanding the opportunity to challenge arbitration awards on grounds of arbitrator bias defeats the purpose of arbitration as a quicker, less expensive alternative to litigation. 

For Tenaska—and potentially for any other Texas business that places its trust in arbitration—the stakes are high. 

Deborah Hankinson of Dallas’ Hankinson LLP, who argued on behalf of Tenaska, asks if Ponderosa’s theory prevails, “is it not now the duty of lawyers involved in Texas arbitration to collude with prospective neutral arbitrators to deliberately manipulate, minimize, and obfuscate the arbitrators’ potential conflicts—lest the lawyers be accused of not zealously representing their clients?” 

Locke Lord’s Bradley Weber, lead trial counsel for Dynergy subsidiary Illinova Generating Co., a party in the case aligned with Tenaska, says a ruling against the company “will establish a terrible legal principle that parties and arbitrators can deliberately mislead other parties in an arbitration. It will also send a disturbing message to Texas companies  trying to decide whether to include arbitration provisions in their contracts. Contracting parties want a fair and unbiased dispute resolution process, not one that permits deception and gamesmanship.”

Texas companies, and the lawyers who represent them, await the answers to these questions, even as they continue to sign contracts with binding arbitration provisions in them.


Keep me up to date on the latest happenings and all that D Magazine has to offer.