Azteca Construction, Inc. v. ADR Consulting, Inc.

Opinion

This case requires us to resolve a conflict between the rules of the American Arbitration Association (AAA) and the provisions of the California Arbitration Act (the Act) (Code Civ. Proc., § 1280 et seq.)^[1] pertaining to the disqualification of a proposed neutral arbitrator based on pre-arbitration disclosures that might affect his or her impartiality.

The parties here agreed to private arbitration in accordance with the AAA’s then entitled “Construction Industry Dispute Resolution [Rules and] Procedures” (hereafter AAA Rules). Those rules included a provision which stated that where one party objects to the continued service of an arbitrator, the AAA shall decide whether the arbitrator should be disqualified, and that its determination of the issue shall be conclusive.

On the other hand, the Act permits either party uncomfortable with the disclosures of any proposed arbitrator to disqualify him or her within 15 days after receiving the disclosure statement. (§ 1281.91, subd. (b)(1).) If the arbitrator fails to disqualify himself or herself upon timely demand, there is a drastic remedy—vacation of the award. (§ 1286.2, subd. (a)(6)(B).)

In this case, plaintiff Azteca Construction, Inc. (Azteca) demanded disqualification of the proposed arbitrator within 15 days after receiving his disclosure statement. Acting pursuant to its internal rules, the AAA determined that there was no good cause for disqualification, affirmed the appointment of the arbitrator, and the arbitration proceeded to its conclusion.

Azteca filed a petition to vacate the arbitration award for noncompliance with relevant provisions of the Act. The trial court ruled that Azteca had waived these provisions by agreeing to AAA arbitration, and more specifically the rule giving the AAA conclusive authority over challenges to the arbitrator’s neutrality.

The trial court erred. The provisions for arbitrator disqualification established by the California Legislature may not be waived or superseded by a private contract. The arbitrator’s refusal to disqualify himself following Azteca’s timely demand rendered the award subject to vacatur. We shall reverse with directions.

PROCEDURAL AND FACTUAL BACKGROUND

This case involves a dispute between Azteca and defendant ADR Consulting, Inc. (ADR Consulting) arising out of a written contract whereby

ADR Consulting agreed to provide consulting services to Azteca. The contract contained a clause that provided that any dispute arising out of the agreement “shall be resolved through the American Arbitration Association using the [AAA] Rules . . . .” At the time of the events in question, former rule R-20(b) of those rules (Rule R-20(b)) provided that “[u]pon objection of a party to the continued service of a neutral arbitrator, the AAA shall determine whether the arbitrator should be disqualified and shall inform the parties of its decision, which shall be conclusive.”

In October 2002, ADR Consulting served a demand on Azteca for arbitration in accordance with the AAA Rules. Because the parties were unable to agree on a neutral arbitrator from the AAA list, the AAA proposed that Attorney Paul W. Taylor arbitrate the dispute. In compliance with section 1281.9,^[2] Taylor submitted a disclosure statement, which was distributed to both sides on November 12, 2002.

Taylor’s disclosure statement revealed that he had, within the past five years, served as a neutral arbitrator on matters in which George Gore (ADR Consulting’s counsel) had represented one or more parties. Specifically, Taylor recalled only that “these matters have included administrative hearings on behalf of the University of California.” Taylor also disclosed that he had a prior relationship with Gore in that in approximately 1985 and for about a year, the same construction company employed both him and Gore. Finally, a conflicts check run by the law firm to which Taylor was “of counsel” reported a case in which Azteca was listed as a potential adverse party to one of its clients; Taylor stated that he had no “personal recollection of any knowledge of this matter,” nor had he made inquiry of the attorney at his firm responsible for handling it.

On November 13, 2002, Azteca, through its vice-president, wrote to the AAA formally objecting to Taylor’s proposed appointment and requesting his removal as arbitrator, based on his disclosed relationship with Gore. After conducting an investigation, the AAA determined that Taylor should not be disqualified, and notified the parties on November 27, 2002, that it had reaffirmed Taylor’s appointment as arbitrator.

An arbitration hearing was conducted and on March 20, 2003, Taylor rendered an interim award, ordering Azteca to pay ADR Consulting $39,140, plus the costs of the arbitration.

Counsel for Azteca then wrote to Taylor, requesting that he forthwith disqualify himself as arbitrator, reminding him that Azteca had served notice of his disqualification on November 13, 2002. Responding to the letter, the AAA reasserted its authority under its Rule R-20(b) to adjudicate any objection - to Taylor’s continued service. Taylor issued a final award on April 21, 2003.

Azteca filed a petition to vacate the award, claiming that Taylor was required to disqualify himself upon timely receipt of Azteca’s objection under section 1281.91, subdivisions (b)(1) and (d), and the California Ethics Standards for Neutral Arbitrators in Contractual Arbitration, adopted by the Judicial Council. Former stds. 8(a)(2) (now std. 10(a)(2)) & 10(b) (now std. 12(b)) (hereafter Ethics Standards).)

The trial court denied the petition. Although it found that Azteca submitted a timely demand for disqualification prior to the arbitration, the court ruled that Azteca had waived the right to disqualify Taylor under the Act by agreeing to arbitration in conformance with the AAA Rules. The court indicated that were it to consider the matter of the AAA’s refusal to disqualify Taylor de novo, it would conclude that there was nothing in Taylor’s disclosure statement that required disqualification.

DISCUSSION

In

2001, the Legislature significantly revised the disclosure requirements and procedures for disqualifying arbitrators pursuant to private or contractual arbitration. (§ 1281.9, as amended by Stats. 2001, ch. 362, §§ 4-8.) Section 1281.9, subdivision (a), was amended to require an appointed arbitrator’s disclosure of any fact that might reasonably lead a person to doubt his or her ability to be impartial.^[3] The Judicial Council was directed to adopt “ethical standards for all neutral arbitrators effective July 1, 2002” (§ 1281.85) and the Ethics Standards, which now appear in division VI of the Appendix to the California Rules of Court, were made applicable to proposed arbitrators. (§ 1281.9, subd. (a)(2).) Section 1281.91 was also added, clarifying the procedure for party-initiated disqualification of proposed arbitrators. (Stats. 2001, ch. 362, § 6.)

Under the Act, proposed neutrals have 10 days from the date of service of their proposed nomination or appointment to make the disclosures

required by law. (§ 1281.9, subd. (b).) The parties then have 15 days to file a notice of disqualification either for failure to comply with disclosure duties (§ 1281.91, subd. (a)), or if full disclosure was made, based on the facts actually disclosed. (§ 1281.91, subd. (b)(1).)

Until Azteca demanded Taylor’s removal, the arbitrator selection process here conformed in all aspects to the Act. By letter of November 12, 2002, the AAA selected Taylor as the proposed arbitrator and attached his disclosure statement, in ostensible compliance with section 1281.9.^[4]

Taylor’s statement listed several disclosures reflecting on his neutrality, including a prior working relationship with Gore, the fact that Azteca was a potential adverse party to a client of a law firm with which Taylor was associated, and the fact that Taylor had previously arbitrated cases in which Gore represented one or more parties.

Section 1281.91, subdivision (b)(1), provides that a proposed arbitrator who complies with his or her disclosure obligations under section 1281.9, “shall be disqualified on the basis of the disclosure statement'' if either party serves a notice of disqualification within 15 days. (Italics added.) This subdivision confers on both parties the unqualified right to remove a proposed arbitrator based on any disclosure required by law which could affect his or her neutrality. (See also Ethics Standards, former std. 10(a)(2) [now std. 12(a)(2)].) There is no good faith or good cause requirement for the exercise of this right, nor is there a limit on the number of proposed neutrals who may be disqualified in this manner. (Knight et al, Cal. Practice Guide: Alternative Dispute Resolution (The Rutter Group 2003) ][ 7:238, p. 7-49 (Knight).)^[5] As long as the objection is based on a required disclosure, a party’s right to remove the proposed neutral by giving timely notice is absolute.

Azteca’s November 13, 2002 letter demanding Taylor’s removal was based on one of his disclosures and was served within 15 days as required by statute. Moreover, the trial court made the unchallenged finding that the letter was a “timely demand for disqualification.” Thus, if the provisions of the Act had been followed, Taylor’s disqualification should have been automatic.

As the California Supreme Court noted in Moncharsh, the Legislature has severely restricted judicial interference in the merits of an arbitrator’s decision. (Moncharsh, supra, 3 Cal.4th at pp. 10-11.) Arbitrators are not bound by rules of law, but may base their decisions on broad principles of justice and equity. (Id. at p. 10.) With narrow exceptions, the courts are not permitted to review the validity of an arbitrator’s reasoning or the sufficiency of the evidence to support the award. (Id. at p. 11; Crowell v. Downey Community Hospital Foundation (2002) 95 Cal.App.4th 730 , 735-737 [ 115 Cal.Rptr.2d 810 ] (Crowell).)

Precisely because arbitrators wield such mighty and largely unchecked power, the Legislature has taken an increasingly more active role in protecting the fairness of the process. (Moncharsh, supra, 3 Cal.4th at pp. 12-13.) In 1994, section 1281.9 was added, enumerating required disclosures for proposed arbitrators. (Stats. 1994, ch. 1202, § 1, p. 7420.) While awards have traditionally been subject to vacatur if procured by fraud, corruption or misconduct of the arbitrator or if the arbitrator exceeded his or her powers (§ 1286.2, subd. (a)(1), (2), (3) & (4)), in 1997, the Legislature added as a ground for annulment of an award that the arbitrator “was subject to disqualification upon grounds specified in Section 1281.9 but failed upon receipt of timely demand to disqualify himself or herself as required by that provision.” (Crowell, supra, 95 Cal.App.4th at p. 737, quoting former § 1286.2, subd. (f), as amended by Stats. 1997, ch. 445, § 4, italics added.)^[6]

The 2001 legislation arose out of a perceived lack of rigorous ethical standards in the private arbitration industry.^[7] Cosponsored by the Governor and the Judicial Council, the bill sought to provide “basic measures of consumer protection with respect to private arbitration, such as minimum ethical standards and remedies for the arbitrator’s failure to comply with existing disclosure requirements.” (Bill Analysis, supra, p. 1.) Recent developments thus evince an unmistakable legislative intent to oversee and enforce ethical standards for private arbitrators.

Finally, the neutrality of the arbitrator is of such crucial importance that the Legislature cannot have intended that its regulation be delegable to the unfettered discretion of a private business. The California Supreme Court has termed the requirement of a neutral arbitrator “essential to ensuring the integrity of the arbitration process.” (Armendariz, supra, 24 Cal.4th at p. 103, citing Graham v. Scissor-Tail, Inc. (1981) 28 Cal.3d 807 , 825 [ 171 Cal.Rptr. 604 , 623 P.2d 165 ].) “Participants who agree to binding arbitration are giving up constitutional rights to a jury trial and appeal. [Statutory] [d]uties of disclosure and disqualification are designed to ensure an arbitrator’s impartiality.” (Knight, supra, ¶ 7:13, p. 7-7.) As the Court of Appeal stated in Britz, Inc. v. Alfa-Laval Food & Dairy Co. (1995) 34 Cal.App.4th 1085 [ 40 Cal.Rptr.2d 700 ] (Britz): “[E]ven though state and federal policy favors private arbitration and the AAA is certainly a respected forum for such arbitration, AAA nevertheless is a business enterprise ‘in competition not only with other private arbitration services but with the courts in providing—in the case of private services, selling—an attractive form of dispute settlement. It may set its standards as high or as low as it thinks its customers want.’ ” (Id. at p. 1102, quoting Merit Ins. Co. v. Leatherby Ins. Co. (7th Cir. 1983) 714 F.2d 673 , 681.) Only by adherence to the Act’s prophylactic remedies can the parties have confidence that neutrality has not taken a back seat to expediency.^[8]

We conclude Azteca could not, by agreeing to submit to arbitration before the AAA, waive its statutory rights to disqualify an arbitrator under the methods set forth by the Act. In resolving Azteca’s objection to the proposed arbitrator, the AAA was required to follow section 1281.9 and section 1281.91.

Under section 1281.91, Taylor should have been disqualified before the arbitration began since, as discussed in part I, ante, Azteca properly exercised its right to remove him within 15 days of service of his disclosure statement.