Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—6thCir: Arbitration Panel’s “Neutral” Arbitrator in Dispute Between Art Company and Dealer Exhibited Evident Partiality, (Apr 3, 2013)

By Peter Reap, J.D., LL.M.

Mark Kowalsky, appointed to act as the neutral arbitrator on a three-person arbitration panel in a dispute between art company Thomas Kinkade Co. and one of its "Signature Dealers," operated by Nancy and David White (the "Whites"), exhibited evident partiality in entering a $1.4 million award in the White’s favor, the U.S. Court of Appeals in Cincinnati has decided (Thomas Kinkade Co. v. White, April 2, 2013, Kethledge, R.). Thus, a district court’s ruling vacating the award was affirmed.

Background. Under their dealer agreements, Kinkade and the Whites agreed to arbitrate any disputes between them "in accordance with the Commercial Arbitration Rules of the American Arbitration Association." In 2002, Kinkade commenced an arbitration in which Kinkade claimed that the Whites had not paid for artwork worth hundreds of thousands of dollars, and the Whites counterclaimed that they had been fraudulently induced to enter into the dealer agreements.

Per the arbitration rules, each party was entitled to appoint one arbitrator, who would de facto advocate that party’s position on the panel. Kinkade chose Burton Ansell as its arbitrator; the Whites chose Mayer Morganroth as theirs. Together Ansell and Morganroth chose Mark Kowalsky as the panel’s neutral arbitrator, who would chair the panel and de facto decide the issues in the arbitration.

Nearly five years and 50 hearing days into their arbitration, however, Kowalsky announced to Kinkade that its adversary, David White, and the Whites’ advocate on the arbitration panel, Mayer Morganroth, had each hired Kowalsky’s firm for engagements that were likely to be substantial. Consequently, Kinkade filed a motion with the AAA seeking to disqualify Kowalsky. The AAA denied Kinkade’s motion. Kinkade then submitted a demand for disqualification directly to Kowalsky, which he denied.

Meanwhile, the arbitration itself began to move forward again. The Whites had neglected to include any documents or other evidence in support of the damages calculations that they had submitted pursuant to Kowalsky’s direction back in December 2006—an omission normally fatal to a party that bears the burden of proof as to its claim.

Instead, Kowalsky gave the Whites a chance to remedy that omission on July 6, 2007, when he ordered them to provide backup for their damages calculations. They did so on August 9, with an 8,800-page production of financial records relating to the actual operation of the Whites’ galleries. Those documents—statements, invoices, checks, ledgers for the galleries, and so on—were exactly the kinds of documents that Kinkade had requested four years earlier and that, in response, the Whites had said did not exist.

Kinkade therefore objected to the documents’ admission and moved to bar the Whites from relying upon anything but their damages expert as to causation and damages. Kowalsky denied the motion.

On May 9, 2008, the panel issued an "Interim Award." Arbitrator Ansell dissented. The award was conclusory, stating as to each claim merely that the proofs did or did not "support[] recovery[.]" The Award found that the Whites had proved five of their claims, and awarded them $567,300 in damages. The Award denied recovery on Kinkade’s breach of contract claim for paintings that the Whites had not paid for—notwithstanding that the claim was virtually uncontested.

The Interim Award did not give the Whites everything they asked for. The Whites had requested an award of attorneys’ fees in their January 2008 closing brief to the panel, and the Award had not granted them any; so by the terms of the Award ("[a]ll claims that are not expressly granted are hereby denied") Kinkade thought that claim had been denied.

However, Kowalsky apparently thought otherwise: on June 3, 2008, he ordered the parties to submit applications for "fees and costs." Kinkade objected, arguing that an award of fees to the Whites would modify the Interim Award in violation of AAA rules, and separately that the Interim Award was untimely.

On February 26, 2009—again over Ansell’s dissent—the panel majority issued a Final Award. The Final Award granted the Whites $487,000 in attorneys’ fees, $215,846.20 in costs, and $258,121 in prejudgment interest. About Kinkade’s pending objections, the Award had nothing to say. All told, the Whites’ net award exceeded $1.4 million.

The next day, Kinkade filed a petition to vacate the Final Award in federal district court in Detroit. In a 21-page opinion that canvassed the arbitration’s history and the relevant law, the district court vacated the Final Award in its entirety and this appeal followed.

Analysis. The Federal Arbitration Act authorizes federal courts to vacate arbitration awards on certain specified grounds. Among those grounds is "evident partiality or corruption in the arbitrators[.]" That is the ground upon which the district court vacated the award here, the appellate court noted.

To establish evident partiality, the challenging party must show that "a reasonable person would have to conclude that an arbitrator was partial to one party to the arbitration." Andersons, Inc. v. Horton Farms, Inc., 166 F.3d 308, 328 (6th Cir. 1998). "This standard requires a showing greater than an appearance of bias, but less than actual bias"; and to meet it, a party "must establish specific facts that indicate improper motives on the part of the arbitrator." Id. at 329.

Here, Kinkade established several undisputed facts that, considered together, showed a motive for Kowalsky to favor the Whites and multiple, concrete actions in which he appeared actually to favor them, according to the appellate court.

As for motive: nearly five years into this arbitration, and in the space of eight weeks, the purportedly neutral arbitrator’s law firm—of all the law firms that practice commercial litigation in Michigan—was hired by one party’s arbitrator-advocate (Morganroth) and then again by that same party (David White) for engagements that by all appearances would be substantial.

Kowalsky’s actions only added to the concern, the court observed. He gave the Whites a second and then a third chance to bolster the proofs for their claims. He allowed the Whites to rely upon 8,800 documents they had deliberately and wrongfully withheld for more than four years. He denied Kinkade any relief on a straightforward breach-of-contract claim that was virtually uncontested during the hearings.

Further, Kowalsky failed to offer any response to serious objections that Kinkade had raised to his decisions as an arbitrator. And Kowalsky awarded the Whites nearly $500,000 in attorneys’ fees after the plain terms of the Interim Award indicated that the Whites’ request for fees had been denied. These actions, when combined with the late-arbitration dealings between the Whites and Kowalsky’s firm, were more than sufficient to show his evident partiality, the appellate court ruled.

It was no answer to assert, as the Whites dido at length in their briefs to the appellate court, that Kowalsky fully disclosed these arrangements to the parties. Five years into an arbitration, those disclosures were little better than no disclosure at all, in the court’s view.

The appellate court entirely agreed with the district court that, "[w]hen the neutral arbitrator engages in or attempts to engage in mid-arbitration business relationships with non-neutral participants, it jeopardizes what is supposed to be a party-structured dispute resolution process."

A party who pays a neutral arbitrator to prepare for, and then sit through, nearly 50 days of hearings over a five-year period, deserves better treatment than this, the court commented.

The case is No. 10-1634.

Attorneys: Steven Z. Cohen (Cohen, Lerner, Rabinovitz & Witus, PC) for Nancy White. Dana Levitt (Zuber & Taillieu LLP) for Thomas Kinkade Co.

Companies: Thomas Kinkade Co.

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