Avoiding a punitive damage award in arbitration

Introduction

While arbitrators have the power to award punitive damages in FAA arbitrations, this power does not exist under New York law. The decision in Flintlock provides some guidance on the language necessary to exclude punitive damages in FAA arbitrations arising from contracts governed by New York law.

Contracts in international transactions may contain a New York choice-of-law clause and an arbitration clause that provides the arbitration will be seated in the United States. When a claim concerning that contract is asserted, the tribunal will apply the Federal Arbitration Act, 9 U.S.C. § 1 et seq. (FAA) and not New York law, to determine whether the arbitrator has the power to determine an issue. This point becomes significant when New York law and the FAA differ on the issue of arbitrability.

Under New York law, an arbitrator cannot award punitive damages. In Garrity v Lyle Stuart, Inc., the New York Court of Appeals held that an “arbitrator has no power to award punitive damages, even if agreed upon by the parties. Punitive damages is a sanction reserved to the State, a public policy of such magnitude as to call for judicial intrusion to prevent its contravention.”¹ Consequently, the Court vacated a punitive damages award.

Importantly, Garrity did not purport to address the award of punitive damages under the FAA, which applies to the enforcement and review of international arbitral awards. The FAA permits an arbitrator to award punitive damages. However, parties to a FAA-governed arbitration may also agree to exclude punitive damages directly (by expressly agreeing to do so) or indirectly (by invoking New York’s arbitration limitations, including the Garrity rule).

Arbitration agreements in contracts for international transactions frequently specify that they are “governed” by New York law. The US Supreme Court held in Mastrobuono v Shearson Lehman Hutton, Inc. that merely stating that the arbitration shall be “governed by the laws of the State of New York” did not suffice to invoke New York”s arbitration limitations, Garrity included.² The Court held that the reference in the governing law clause to “the laws of the State of New York” was limited to “substantive principles that New York courts would apply, but not… special rules limiting the authority of arbitrators” (as with Garrity). Therefore, despite its reference to New York law, the arbitration agreement did not specifically exclude awards of punitive damages, and the underlying award would stand.

Punitive damages are not the only subject where New York law differs from the FAA. Under New York law, the court determines whether a claim asserted in an arbitration is barred by the 1 Garrity v Lyle Stuart, Inc., 40 N.Y.2d 354, 356. 2 Mastrobuono v Shearson Lehman Hutton, Inc., 514 U.S. 52 (1995). Statute of Limitations. Under the FAA, however, the arbitrator decides this issue. The New York Court of Appeals has held that the New York rule would be applied to determine the issue when the parties agreed that New York law would govern the “enforcement” of their contract. The Court believed that language constituted an agreement to arbitrate only to the extent permitted by New York law.

A question that has not been answered definitively is whether an arbitrator can adjudicate a punitive damages claim when the choice-of-law clause provides that New York law applies to the “enforcement” of the contract. In Flintlock Construction Services, LLC v Weiss, a divided ruling by the New York intermediate appellate court that sits in Manhattan suggests that the answer is no.³ The Flintlock decision provides guidance on the language necessary to exclude punitive damages in the arbitration of a claim for breach of a contract governed by New York law.

The Flintlock decision

Post-Mastrobuono decisions by New York courts on the arbitrability of a statutes of limitation defense have suggested that stating that the “enforcement” of the contract would be governed by New York law evidences the parties’ intent to invoke New York’s arbitration limitations in arbitrations governed by the FAA (for an example, see Matter of Diamond Waterproofing v 55 Liberty Owners, 4 N.Y.3d 247, 793 N.Y.S.2d 831 (2005)). In Flintlock, the Court considered a related issue: whether a clause stating that the contract “shall be construed and enforced in accordance with the laws of the State of New York” sufficed to establish the requisite intent to deprive the arbitrators of the authority to award punitive damages.⁴

In a three-two decision, the Flintlock court held that “merely stating… that an agreement is to be construed and enforced in accordance with the law of New York does not suffice to invoke the Garrity rule.’⁵ Rather, “language expressly invoking the Garrity rule, or expressly excluding claims for punitive damages” is required.⁶ As a result, the majority supported a lower-court order denying a petition to stay arbitration of punitive damages claims. The Flintlock minority, by contrast, found the aforementioned authority on statutes of limitation to be persuasive, opining that a clause providing for the “enforcement” of an agreement under New York law sufficed to “invoke the limitations on arbitration under New York State law” including Garrity’s prohibition on punitive damages.⁷

Contracting out of punitive damages

The holding in Flintlock only applies to arbitral agreements governed by the FAA; arbitrations purely within New York state will remain governed by the Garrity rule. Flintlock illustrates, however, that a party that wants to avoid the possibility of an arbitral punitive damages award for breach of a cross-border contract governed by New York law must specify that the arbitrator does not have the power to award punitive damages. It may address punitive damages expressly, it may invoke Garrity, or it may adopt institutional arbitral rules prohibiting awards of punitive damages, such as those of the International Centre for Dispute Resolution. However, a “no punitive damage” provision in a limitation-of-liability clause is not likely to be sufficient. It would be difficult for a court to set aside an arbitrator”s award where the arbitrator erred by awarding damages precluded by a limitation-on-liability clause. In contrast, a court clearly has the power to vacate an award of punitive damages where the arbitrator did not have the power to award such damages.