Three Is The Magic Number: Courts Cannot Authorize Panel of Five Arbitrators When Contract Specifies Three

[author: Liz Kramer]

In a dispute over how faithful a court must be to the parties’ arbitration agreement when it is asked to resolve an impasse in arbitrator selection under Section 5 of the FAA, the Fifth Circuit decided the court must give effect to the letter of the agreement, even if that defies its spirit.

In BP Exploration Libya Ltd. v. ExxonMobil Libya Ltd., __ F.3d __, 2012 WL 3065317 (5th Cir. 2012), the parties’ contract provided for three arbitrators to decide any disputes.  Each party would appoint one arbitrator, and those two party-appointed arbitrators would choose the third.  However, a dispute arose between three parties (all of whom were bound by the arbitrator selection process).  The parties could not resolve their dispute over how to select arbitrators.  If they each appointed one arbitrator, there would be no neutral arbitrator.  But the two responding parties would not agree on a “joint” second arbitrator.  Their dispute came before a federal district court in Houston, with two parties claiming there was a “lapse in the naming of an arbitrator” that authorized the court to appoint an arbitrator under Section 5 of the FAA.

The district court fashioned a solution:  each of the three parties should appoint their own arbitrator, and those three appointed arbitrators then would unanimously select two neutral arbitrators.  In other words, there would be five arbitrators hearing the dispute.  While that seems like an appropriate, Solomonic solution, the party who originally initiated the arbitration appealed the court’s decision.  It argued that the district court erred in ordering a five-member panel when the parties’ agreement explicitly provided for three arbitrators.

The Fifth Circuit agreed with the appellant and reversed the district court’s decision.  The appeals court confirmed that this situation was the type of “lapse” that authorizes court intercession under Section 5, but held that “where the parties’ agreement provides for three arbitrators, such as here, the district court is limited under Section 5 to appointment of three arbitrators.”  In support of its decision, the court pointed to the FAA’s deference to the parties’ agreement, the FAA’s model of “circumscribed judicial involvement in the arbitral process,” and the fact that arbitration awards have been vacated when arbitrators were not selected according to the method chosen in the contract.

So, how did the Fifth Circuit resolve the problem?  It required the two respondents to jointly appoint a second arbitrator, but if they could not agree, the district court could appoint the second arbitrator.  That second arbitrator would then work with the claimant’s arbitrator to select a neutral third arbitrator to fill out the three-person panel.  And, if the parties don’t like that result, the Fifth Circuit pointed out that “nothing in this opinion prohibits the parties from reaching an agreement between or among themselves upon which they can agree for the appointment of arbitrators to hear this dispute.”

This is not an unusual circumstance.  Multi-party disputes frequently arise under an arbitration agreement whose method of arbitrator selection appears to contemplate only two parties.  Drafters should consider providing for a separate selection process in the case of multi-party disputes.