By Deborah Rosenthal | Photograph by Mojgan Azimi
"A first-year law student will tell you a penalty provision like the one in the contract between Omni and the contractor was unenforceable," says Mouton. He argued that at the arbitration hearing. He also argued that his client's obligation to pay did not arise until Omni showed the landlord in writing that it had paid the contractor, which Omni never did.
Mouton expected a slam-dunk win. At worst he supposed the arbitrator might award the tenant $37,000-the alleged cost of cabinetry work that Omni claimed it had installed-but he really never thought that would happen. So when he read the award, his composure crumbled. "Upon consideration of all the evidence received, the testimony of each witness, and the arguments of counsel," it read, "the Arbitrator hereby awards... OMNI MEDICAL CENTERS, INC., the sum of FIVE HUNDRED SEVENTY SEVEN THOUSAND FOUR HUNDRED DOLLARS ($577,400.00), plus reasonable attorney fees in the sum of FIVE THOUSAND DOLLARS ($5,000.00) and all costs of arbitration by Southern California Arbitration Association."
"I will never forget that moment," Mouton says. "I immediately sent of a letter to the arbitrator at SCAA saying 'This must be a mistake.' I never heard from the guy."
As bad as that moment was, though, a worse one followed two days later when Mouton went to his client's office and, for the first and only time in his professional life, apologized. "I said, 'I can't explain this to you. I'm so profoundly sorry,'" Mouton recalls. He then advised his client to find another attorney to fight the award.
But attacking an arbitration award is difficult under California law. The only way to do it successfully is to prove that the award resulted from serious misconduct by the winning party, such as coercion or fraud, or serious misconduct by the arbitrator, such as the arbitrator's failure to disclose personal or business connections to any of the lawyers or parties that might create an appearance of bias. Otherwise the court will uphold an arbitration award, even if the arbitrator ignored the law or relied on facts that a court would have refused to consider. Moncharsh v Heily & Blase (1992) 3 C4th 1, 11-12.
Mouton's client decided to take its chances. The landlord retained new counsel and, with the help of a private investigator, uncovered a host of business connections between Omni, the contractors and subcontractors, and several of the principals and arbitrators of SCAA. None of these ties had been disclosed prior to the arbitration. Yet even with this information before it, the trial court confirmed the SCAA award and denied the landlord's motion for reconsideration. "Once you've lost, you then have you own cost-benefit analysis to do-how much more money are you going to sink in to overturn something that by law is extremely difficult to overturn?" say Mouton. Rather than assume the risk and cost of appealing the trial court's decision, Mouton's former client settled with Omni in June 1996 for a confidential six-figure sum.
After the settlement, Mouton thought that he would never feel anything but grief at the mention of Omni or SCAA. But the perspective changed six months later when a Century City attorney called to ask him about the case. It just so happened that this particular attorney had an uncannily similar set of facts-except that he had not yet been through the scheduled arbitration. He was calling to see what he could do to save his clients from the fate that had befallen Mouton's client.
The arbitration industry in California has flourished since the early 1980s, when the courts began to push ADR as a way to alleviate their overburdened dockets. Touted as a less expensive and more expedient process than litigation, private arbitration has become a major commercial enterprise. Clauses specifying arbitration as the exclusive means of resolving disputes between parties are increasingly included in business and consumer contracts. The U.S. Supreme Court has held that such mandatory arbitration clauses are generally enforceable. Circuit City Store, Inc. v Adams (2001) 121 S Ct 1302; Green Tree Financial Corp. v Randolph (2000) 531 US 79.
The California Arbitration Act (CCP §1280 et seq.) sets forth the rules governing contractual arbitration in California. The statutes provide minimal directions, however, because simplicity and informality are considered virtues. According to proponents of private arbitration, no further law is needed because the free market ensures the integrity of the process: As long as parties have their choice of arbitrator, neutrals and provider agencies must commit to rendering quality service or risk failure in the increasingly competitive marketplace.
For example, the American Arbitration Association (AAA) and JAMS-two of the largest arbitration service providers in the country-attempt to assure quality service by conducting client satisfaction surveys, giving their panelists feedback about their performance, using advisory committees to discuss issues of quality and ethics that arise, and requiring that their neutrals participate in extensive training programs. In additions, before accepting applicants onto their arbitrator panels, both AAA and JAMS claim to carefully review the candidates' backgrounds and references and retain only those who have demonstrated good ethics, subject matter expertise, and adroitness at settlement negotiations. Nor are the neutrals the only ones subjected to preapproval: Both companies claim to screen potential clients as well and to reject cases that come to them through contractual arbitration clauses that do not comport with their fairness policies and due process protocols.
But even the most reputable providers cannot assure that justice will be rendered in a private, profit-driven system of dispute resolution. "The macro problem is that it tremendously favors those who bring repeat business," says Los Angeles attorney Raphael Cotkin, whose professional liability and insurance coverage practice lands him in several arbitrations each year.
"The arbitrators have basically no overhead, and they are billing $500 or $600 an hour. Who are they going to tend to favor: some poor schlemiel who has just one case, or the insurance company or employer who has numerous claims to arbitrate and is probably not going to go back to an arbitrator who rules against them? It's a real gravy train, and even the most fair-minded individual in the world is going to feel the pressure of that. It's human nature," Cotkin says.
Arbitrations advocates argue that big plaintiffs firms bring in as much repeat business as firms that represent corporations and insurers. Furthermore, California's statutory disclosure requirements (CCP §1281.9) addresses the repeat-user problem because a party can theoretically choose whether to proceed with an arbitrator who has disclosed prior dealings with any of the other parties or attorneys.
But because arbitration is a private system, the parties don't have a simple, reliable way to verify that a prospective arbitrator has properly disclosed all potential conflicts, and they can spend-and potentially waste-a lot of time, and money trying to find out. Cotkin discovered this firsthand when his firm was called in to represent agribusiness Britz, Inc. in its appeal of a $2.7 million judgment against it. In 1990 Brits opened a tomato-processing plant in Fresno County and contracted with Alfa-Laval Food & Dairy Company to buy the necessary equipment. The plant shut down during its first season of operation, and Britz lost millions of dollars. It then sued Alfa-Laval to rescind the contract and for damages, claiming that Alfa-Laval had defrauded Britz and sold Britz defective machinery. Alfa-Laval then countersued. Before Cotkin came on board, Britz was represented by Coalinga attorney Ted Frame. Alfa-Laval was represented by attorneys from the Chicago law firm of Wildman, Harrold, Allen & Dixon and the Fresno law firm of McCormick, Barstow, Sheppard, Wayte & Carruth. First Britz contended that the court should preclude Alfa-Laval from enforcing the mandatory arbitration clause because it had fraudulently induced Britz into signing the contract. The court ruled that Britz's claim did not nullify the arbitration clause, and the parties submitted the dispute to Fresno attorney and AAA arbitrator John E. Peterson.
Peterson says that he had received business referrals from the McCormick firm over the years, but he failed to disclose these contacts before the arbitration began because he did not realize that the McCormick firm had enough involvement in the case to warrant a disclosure. After Peterson issued an interim ruling against Britz on the issue of liability, Frame investigated the possibility that Peterson had business contacts with the McCormick firm.
Peterson then revealed that in addition to referrals back and forth between Peterson and the McCormick firm, the firm had retained Peterson as an expert witness shortly before the Britz arbitration, and Peterson continued to serve in that capacity while at least some of the arbitration proceedings were pending. Frame requested appointment of a new arbitrator, but after hearing from Alfa-Laval and Peterson, AAA declined to disqualify Peterson. Ultimately, Peterson awarded Alfa-Laval a total of $2.7 million.
Frame moved to vacate Peterson's award as a result of his nondisclosure, but the court found that Britz had waived its right to object and that AAA's resolution of the conflict issue was a "plausible interpretation of the law and facts and was rendered with a minimum standard of fair dealing." Britz, Inc. v Alfa-Laval Food & Dairy Co. (Fresno County Superior Ct) Civ No. 425766-3 (judgment entered July 16, 1993). Judgement was entered against Britz for the full $2.7 million, plus costs.
At that point Cotkin's partner, Joan M. Dolinski, substituted in as Britz's appellate counsel. Two years later the Fifth District Court of Appeal reversed and remanded for a determination of whether Peterson had failed to fulfill his "legal duty to disclose any dealings that might create an impression of possible bias." Britz, Inc. v Alfa-Laval Food & Dairy Co. (1995) 34 CA4th 1085,1103.
The next judge to review the case invalidated the award on the grounds that Peterson's nondisclosure and his contacts with the McCormick firm created an appearance of bias. Britz, Inc. v Alfa-Laval Food & Dairy Co. (Fresno County Superior Ct) Civ No. 425766-3 (order entered October 1, 1996). The case was sent to arbitration before a three-member panel of JAMS arbitrators, and in June 1998 the JAMS panel awarded Alfa-Laval $900,000. That case was dismissed on July 16, 1998. Meanwhile, Britz had also sued AAA, Peterson, the McCormick firm, and Alfa-Laval for fraud in connection with the initial arbitration proceeding. That case was dismissed in 1998, although not before Britz and AAA reached a confidential settlement, according to Dolinski. Britz, Inc. v American Arbitration Association (Los Angeles County Superior Ct) Civ No. BC 172451 (venue transferred to Fresno County Superior Ct, Civ No 599551-9, dismissal entered in Fresno County Superior Ct on March 17, 1998, and in Los Angeles County Superior Ct on August 27, 1998).
Peterson, who served as president of the Fresno County Bar Association in 1998, admits that he made a mistake in failing to disclose his business relationship with the McCormick firm. But, he adds, "I'd rather be thought of as being wrong than as someone skewing an arbitration result. Unfortunately, the law forces anyone challenging an arbitration award to attack the arbitrator's integrity, and that's what happened here."
For Cotkin, the years-long Blitz dispute was "a real eye-opener as far as the functioning of arbitration is concerned." Such a realization, Cotkin claims, is reached sooner or later by all commercial litigators for whom arbitration has become a commonplace method of dispute resolution. Certainly Cotkin wouldn't get any argument on this point from Kent Mouton. Nor would Century City business and real estate litigator Gregg Martin disagree. In late 1996, while Mouton was still reeling from his own disastrous arbitration experience, Martin also became ensnared in a complex legal dispute over an allegedly fraudulent lease agreement bound for arbitration. Martin, it turned out, was opposing the same tenant and facing the same arbitration provider involved in Mouton's case: Omni Medical Centers and SCAA.
In February 1996 a commercial landlord called Topanga & Victory Partners entered into a long-term lease agreement with Omni Medical Centers. The lease contract granted Omni a tenant improvement allowance and also provided that disputes between the parties would be resolved in binding arbitration through SCAA.
According to allegations in court documents filed by Topanga, Omni first requested indemnification from Topanga for tenant improvements five days after signing the lease. Topanga replied with a request for proof that the contractor was licensed and had insurance. Omni then demanded arbitration for "wrongful withholding of improvement payments under the lease," and days later SCAA sent a list of five potential arbitrators.
By the end of February, however, the parties had agreed to hold the arbitration in abeyance. According to Martin, over the next several months Omni made additional requests for payment, and by the end of April, Topanga had paid Omni $84450 - the full tenant improvement allowance provided for in the contract. Then Omni folded and failed to pay rent, and when Topanga requested payment, Omni demanded reinstatement of the arbitration on an expedited basis.
The case took an unexpected turn one Sunday in January 1997. Martin, enjoying a rare moment of quiet at home as his wife and newborn twins slept, was thumbing through the Los Angeles Times business section when one of the headlines caught his eye. "Caveat: Know Your Arbitrator," by Myron Levin, described a case that not only included familiar characters such as SCAA and Omni, it also described an all-too-familiar set of facts involving a lease for office space and a dispute over tenant improvements. To Martin's horror he saw that that case had culminated in a half-million-dollar award against the landlord. "First thing Monday morning, I'm on the phone trying to find the attorney who represented the landlord," Martin recalls. That attorney was Kent Mouton.
Armed with the information that Mouton's client had gathered against Omni, Martin and his associated, David Almaraz, embarked on a meticulous three-year investigation of Omni, SCAA, the contractor, a host of apparently related businesses, and their principals. "There was a tremendous amount of information that had to be collected, reviewed, and managed," says Martin. So, using a computer program called CaseMap, Almaraz created a database that could cross-check the names of the players as they appeared in different contexts and documents.
"Initially, I was shocked by what I saw," Martin remembers. "The part that really struck me as pernicious was that they seemed to be using this arbitration association to get the judicial body to assist them in their private fraud scheme. It was frightening. You start scratching your head saying, "This can't be happening.'"
In the course of his investigation Martin also learned of two other landlords who were involved in similar disputes with Omni over tenant improvements and unpaid rent. In both cases Omni had demanded arbitration with an SCAA arbitrator-even though one of the leases actually designated JAMS as the arbitration service provider.
In June 1997 Martin filed a preliminary injunction to prevent Omni from compelling arbitration with any of the three landlords. In November he filed a complaint in Los Angeles County Superior Court on the landlords' behalf, naming as defendants Omni, the contractor, SCAA, and related individuals and business entities. The complaint alleged fraud, racketeering, and unfair business practices. It accused the defendants of conspiring to defraud the landlords by entering into lease agreements that included sizable tenant improvement allowances and arbitration clauses requiring that disputes be settled through SCAA. After the landlords paid for improvements to their properties (which were allegedly never made or inflated in price), then the conspirators would create disputes that allowed them to demand arbitration before SCAA, which the complaint averred was controlled by the conspirators. The landlords would be charged for the cost of arbitration, and then, according to documents filed in support of Martin's preliminary injunction motion, a biased arbitrator would "issue a baseless and substantial award in defendants' favor, and defendants would then petition California courts to confirm the award." Topanga & Victory Partners v Omni Medical Centers, Inc. (CD Cal) Civ No 97-4135 WMB, voluntarily dismissed and refilled as Topanga & Victory Partners v Omni Medical Centers, Inc. (Los Angeles County Superior Ct) Civ No. BC 180940.
Gary Brown represented Omni, the contractor, and several of the individual defendants in the action. Brown denounces the bulk of the charges against his clients as sensational legal theories advanced to obtain money from the only solvent defendants. He argues that for the individual officers of the corporations to be potentially liable, Martin had to use the charges of fraud or racketeering.
"My clients were business people who knew each other, but does that make them criminals?" asks Brown. If they were criminals, he asserts, then when Martin raised an issue about SCAA's legitimacy, they would not have offered to take their dispute before another arbitration provider, which Brown says they did. "Eventually we agreed not to arbitrate at all, because Omni was defunct, but they went ahead with their lawsuit anyway," Brown says.
The trial began in January 2000 and concluded while the second witness was testifying. At that time, the contractor and four principals of Omni and SCAA settled in exchange for payment of $50,000 to the landlords. The remaining defendants were corporations that had apparently ceased doing business before trial and defaulted either before or during trial. The defaults were entered into the record along with the settlement, and court was adjourned to allow Martin time to prove-up his clients' damages. In June 2000 the judge issued a $5.1 million judgment in favor of Martin's clients, the landlords. Because the corporate defendants had all gone out of business, however, the money remains uncollected and seemingly uncollectable.
Despite inclusion of mandatory arbitration clauses designed to minimize the time, formality, and expense of dispute resolution, the Omni lease contracts generated years of litigation and millions of dollars in costs for the dozens of people affected. Nonetheless, Brown maintains that the Topanga case does not illustrate the potential pitfalls of an unregulated arbitration system but rather reflects a growing problem of creative plaintiffs lawyers misusing RICO statutes.
"This was a contract dispute about build-out and rent. There was no other issue here," Brown says. He calls the fraud and racketeering charges "vivid imagination and exaggeration" and questions the accuracy of some of the testimony that Martin introduced to the court in support of his prove-up. After the trial, Martin obtained a declaration from Wayne Schultz, the arbitrator who ruled against Mouton's client in its 1996 arbitration with Omni. In it Schultz stated that he had intended to award Omni only $50,000 or less and that he believed that SCAA would prepare a formal award based on this determination and send it to Schultz to sign. But Schultz declared that he never received a formal award, never saw or signed the document SCAA sent to Mouton, and was never paid for the services he provided in that arbitration.
Martin says that he did not obtain the declaration until February 2000 because he expected to elicit Schultz's testimony at trial. Schultz was named on the plaintiffs' witness list, but before Schultz could take the stand, the trial was cut short by the settlement and entry of the default. Martin obtained the sworn statement in support of his prove-up application to obtain a judgment against the defaulting parties.
Brown says that Schultz's sworn statement is "obviously wrong," although he could only speculate as to why Schultz would give such a statement. He points out that Martin drafted the declaration and that Brown never had an opportunity to question Schultz about the statements in the declaration because Schultz, who suffered from cancer, "was dying when he gave it, and he was dead by the time I found out about it."
Gregg Martin did a brilliant job of painting a picture that I consider to be not accurate at all," Brown remarks. "I respect advocacy, and I understand that we can all have different values, but I thought this one went way too far."
In the glass-walled conference room of his Century City office, Martin waxes philosophical about how the Topanga case came to pass. "There is a strong sense among the judiciary and perhaps also the Legislature that it's a good thing to have private bodies handling dispute resolution," he observes. "The field is mostly dominated by lawyers whose influence on the Legislature and the judiciary is profound, and deference is given for that reason."
But Martin questions whether that reverence isn't somewhat misplaced. "There's a lack of accountability in the system," he says, pointing out that there is no certification procedure for arbitrators, no legal requirement that they obtain a certain degree of education or experience before practicing, and no governing body or professional association to report their misconduct to. "Unless the courts are going to become activists on the issue of trying to reign in potential abuses," Martin warns, "private arbitration is going to continue to have strong potential for abuse."
And the courts are not showing any sign of doing to. Although some recent rulings by the California Supreme Court, such as Armendariz v Foundation Health Psychare Services, Inc. (2000) 24 C4th 83) and Engella v Permanente Medical Group, Inc. (1997) 15 C4th 951), have attempted to reconcile due process concerns with public policies favoring contracts and arbitration, none have specifically addressed the fact that the current system forces the judiciary to become complicit in wrongdoing or unwittingly sanction outright fraud if it is asked to confirm an award unsupported by law. On the contrary, two decisions issued by the state's high court last year reinforced the holding in Moncharsh v Heily & Blase that arbitrators have broad discretion and their decisions cannot be reviewed for errors of fact or law. See Moore v First Bank of San Luis Obispo (2000) 22 C4th 782; Moshonov v Walsh (2000) 22 C4th 771.
"The fact that an incorrect result had to be confirmed-that is not a justice system," says San Francisco plaintiffs attorney Cliff Palefsky, a longtime advocate for arbitration reform. "That is a dispute resolution system, and there is a very big difference between a system designed to get it right, even if it takes time, and a sophisticated flip of the coin."
So what can be done to curb abuses likely to arise out of a dispute resolution system aimed at finality rather than justice and driven by profit rather than precedent? To begin with, private neutrals can take matters into their own hands. In April Los Angeles arbitrator and mediator Richard Chernick founded the College of Commercial Arbitrators (CCA) to bring together "high-end commercial arbitrators who can set standards [and] share experiences and talk about practices, ethics, standards, and techniques." Chernick, who serves as vice president and managing director of JAMS's Arbitration Practice, modeled the CCA after the National Academy of Arbitrators, which consists of labor law specialists and is often named in mandatory arbitration clauses in collective bargaining agreements. Chernick anticipates that membership in such professional bodies will eventually become "a credential that identifies the people who have the kind of experience necessary for important disputes."
Attorneys can also do their part to protect their clients. Before heading into an arbitration and when reviewing contractual arbitration clauses, lawyers should always inquire into the history, qualifications, and interests of the proposed arbitrators and arbitration providers. "If you're going to castigate anyone, castigate the lawyers who don't do their lawyering," says Brown. He adds that attorneys drafting or revising contractual arbitration provisions should be more specific and elaborate in writing those clauses, adopting portions of the Evidence Code and Code of Civil Procedure, and negotiation the details of the process for which they are bargaining.
But in the wake of his experience with SCAA, Martin worries that self-regulation and due diligence can only go so far. He proposes legislative regulation as a necessary measure toward safeguarding the rights of litigants in the private arbitration system.
"This is a private entity performing a public service," says Martin, comparing arbitration providers to other quasi-legal service providers such as insurance and escrow companies. "The fact that they are performing a public service through a private organization does not relieve our state government or judicial body from taking notice of how they are conducting themselves."
Ultimately, this may be the one major point on which opposing counsel in the Topanga case agree. Brown also complains that the current arbitration system suffers from a lack of reliability and consistency, attributable at least in part to an absence of regulation. "We can trim the justice system down a lot-we can say testimony should be by declaration and not live, we can loosen up hearsay rules unless you can show you are being prejudiced, we can say discovery is going to be limited-but to completely throw away the rule of law is a horrible mistake, and that is what has been done [with private arbitration]," he says.
Brown supports enacting laws that would make arbitration "sufficiently predictable," such as adding a default provision to the code that says that if the parties have not explicitly agreed to certain rules or terms in the arbitration clause, then they will be deemed to have agreed to what is provided for in the statutes.
Perhaps the most impassioned advocate for government regulation of private arbitration is Mouton, who continues to feel the sting of his SCAA encounter. "In this state we regulate hairdressers, and we regulate dog catchers," he says. "But we don't regulate arbitrators whose decisions have a far, far greater impact on people's lives."
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