Gallus Investments v. Pudgie's Chicken ( 1998 )

PUBLISHED
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
GALLUS INVESTMENTS, L.P.,
Plaintiff-Appellee,
v.
PUDGIE'S FAMOUS CHICKEN, LIMITED,
Defendant-Appellant,
No. 97-1706
and
PUDGIE'S CHICKEN, INCORPORATED;
STEVEN M. WASSERMAN; HENRY A.
GUINN; MIKE J. BEARSS,
Defendants.
Appeal from the United States District Court
for the Eastern District of Virginia, at Alexandria.
Albert V. Bryan, Jr., Senior District Judge.
(CA-95-890-A)
Argued: October 28, 1997
Decided: January 13, 1998
Before WILKINS and MICHAEL, Circuit Judges, and
CAMPBELL, Senior Circuit Judge of the United States Court of
Appeals for the First Circuit, sitting by designation.
_________________________________________________________________
Affirmed by published opinion. Senior Judge Campbell wrote the
opinion, in which Judge Wilkins and Judge Michael joined.
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COUNSEL
ARGUED: Stanley Steven Zinner, GREEN & ZINNER, P.C., White
Plains, New York, for Appellant. Michael Lee Sturm, WILEY, REIN
& FIELDING, Washington, D.C., for Appellee. ON BRIEF: Thomas
W. Queen, WILEY, REIN & FIELDING, Washington, D.C., for
Appellee.
_________________________________________________________________
OPINION
CAMPBELL, Senior Circuit Judge:
Pudgie's Famous Chicken, Ltd., appeals from the district court's
confirmation of an arbitration panel's award to Gallus Investments,
L.P. As basis for this appeal, Pudgie's challenges the arbitration
panel's consideration of evidence allegedly forming part of a settle-
ment offer that Pudgie's made to Gallus during the litigation. The
admission of this evidence was improper, according to Pudgie's,
because the parties' franchise agreement specified the applicability of
New York law, and New York law generally bars the admission of
settlement offers. Moreover, according to Pudgie's, the admission of
this evidence denied it a fundamentally fair hearing. Disagreeing, we
affirm.
I. Background
The facts are largely undisputed. This case arose from a failed busi-
ness venture between Defendant-Appellant Pudgie's Famous
Chicken, Inc. ("Pudgie's"), a franchiser of take-out chicken restau-
rants, and Gallus Investments, L.P. ("Gallus"). Gallus and Pudgie's
signed a franchise agreement that allowed Gallus to develop Pudgie's
restaurants in several Virginia counties. That agreement contained
two clauses at issue here: an arbitration clause and a choice-of-law
clause specifying that the contract was governed by New York law.
The arbitration clause covered "any dispute with respect to either
this Agreement or the adequacy of either party's performance there-
under," and stated that "arbitration shall be conducted in accordance
with the rules promulgated by the American Arbitration Association."
The AAA's Commercial Arbitration Rule 31 provided that "[t]he par-
ties . . . shall produce such evidence as the arbitrator may deem neces-
sary to an understanding and determination of the dispute," and that
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"[t]he arbitrator shall be the judge of the relevance and materiality of
the evidence offered, and conformity to legal rules of evidence shall
not be necessary."
When the venture failed, Gallus brought the instant diversity-of-
citizenship action against Pudgie's. Gallus alleged that Pudgie's and
its officers, also defendants here, had misrepresented the success of
past Pudgie's franchises. Such misrepresentations were actionable
under the New York Franchise Sales Act, N.Y. Gen. Bus. Law §§ 687
& 691. Pursuant to the franchise agreement, the district court referred
the case to arbitration.
On the sixteenth day of the eighteen-day arbitration, Gallus prof-
fered the evidence that is at issue here. The documents in question
were letters exchanged between the parties' lawyers showing that
Pudgie's offered to pay back the $750,000 in expenses that Gallus had
expended on the franchise agreement. Some of these letters were
marked "Submitted for Settlement Discussion Purposes Only." Over
Pudgie's objection, the all-attorney arbitration panel received the doc-
uments. Gallus then introduced several other documents providing its
version of the $750,000 offer.
The panel decided in favor of Gallus, awarding it a total of
$1,706,704 in compensatory damages and attorneys' fees. The district
court confirmed the arbitration award, and this appeal followed.
II. Discussion
In the district court and in this appeal, Pudgie's argues that the
panel committed a serious error by considering the evidence of settle-
ment offers. Pudgie's first contends that the panel was bound to fol-
low New York's rules of evidence barring the admissibility of
settlement offers, in which event, Pudgie's says, the documents in
question would not have been admitted.
However, while the franchise agreement's choice-of-law clause
specified New York law, the agreement's arbitration clause is equally
clear that conformity to legal rules of evidence was unnecessary. The
plain language of the agreement provided that disputes between the
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parties would be arbitrated in accordance with AAA rules, and those
rules expressly provided that the arbitrators need not apply judicial
rules of evidence.
Despite the arbitration clause's plain language, Pudgie's contends
that to ignore the New York evidence rule would vitiate the parties'
contractual choice of New York law. However, to force the panel to
apply New York's (or any other) evidentiary rules would be to reject
the parties' agreement that legal evidentiary rules need not be fol-
lowed. Fortunately, there is no necessary conflict between the choice-
of-law provision and the arbitration clause. The two clauses can easily
be reconciled if interpreted to mean that New York law governs the
parties' contractual rights and duties, and that the panel is free not to
apply legal rules of evidence from any jurisdiction, New York or else-
where. Such a reading gives effect to the arbitration clause while in
no way undermining the choice-of-law provision.
Our reading is consistent with the Supreme Court's approach in
Mastrobuono v. Shearson Lehman Hutton, Inc., 514 U.S. 52 (1995).
There, the Court considered a contract that, like the one between Pud-
gie's and Gallus, provided for both arbitration and the parties' choice
of law. The Mastrobuono Court upheld the arbitration panel's award
of punitive damages despite the fact that the state law prescribed by
the contract's choice-of-law provision did not provide for punitive
damages (and even though the arbitration clause itself was also silent
on the subject of punitive damages). As the Court explained, "the
choice of law provision covers the rights and duties of the parties,
while the arbitration clause covers arbitration." 514 U.S. at 64. Here,
the admissibility of settlement offers falls even more plainly on the
"arbitration" side, as it is a subject controlled by evidentiary rules
expressly exempted from enforcement under the arbitration clause.
We hold, therefore, that the parties' choice-of-law agreement did not
preclude the panel from receiving and considering the evidence in
question.
Pudgie's insists, nonetheless, that the arbitrators' willingness to tol-
erate the use of evidence of settlement negotiations violated its right
to have a fundamentally fair arbitration, requiring a reversal on that
separate ground alone. We do not agree.
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As an initial matter, the legal basis of Pudgie's claim is not per-
fectly clear. Judicial review of an arbitration award is limited to the
grounds set out in § 10(a) of the Federal Arbitration Act, 9 U.S.C.
§ 10(a) (providing for vacatur of award based on, inter alia, "fraud,"
"corruption," "evident partiality," and"misconduct" on the part of the
arbitrators, and "[w]here the arbitrators exceeded their powers"),
and scrutiny for whether the award evinces a "manifest disregard"
of applicable law, Wilko v. Swan, 346 U.S. 427, 436-37 (1953),
overruled on other grounds, Rodriguez de Quijas v. Shearson/
American Express, Inc., 490 U.S. 477 (1989). Instead of specifying
one of these accepted grounds for vacatur, Pudgie's has chosen to
style its argument in terms of its right to a "fundamentally fair hear-
ing" and "due process." We do not take these terms to connote a con-
stitutional claim, as the arbitrators were not state actors for purposes
of the Fifth or Fourteenth Amendments. Rather, we read Pudgie's
argument to imply that the arbitrators, by admitting evidence of settle-
ment offers, violated one or more unnamed provision of § 10(a),
resulting in a lack of "fundamental fairness" and "due process." With-
out greater specificity, this argument is more rhetorical than real. Still,
even assuming without deciding that, in some other imagined context,
an arbitrator's blatant use of settlement-offer evidence might be so
fundamentally unfair as to violate § 10, we find no such violation
here.
In the instant case, the arbitrators at no time broadly rejected the
policy against utilization of settlement evidence. Rather they narrowly
justified receipt of the documents in question because of their rele-
vance to Gallus's claim to have mitigated damages by, among other
things, entering into negotiations with Pudgie's. The arbitrators
believed this limited use was not inconsistent with the principles for-
bidding the introduction of settlement evidence to establish liability.
Like judges in a bench trial, the arbitrators were presumably capable
of confining their use of evidence to the limited purpose for which
received. In any case, whether the arbitrators were right or wrong
under strict legal evidentiary standards, the use of these materials, in
the manner and context that appears, was plainly not"fundamentally
unfair," much less was it a violation of § 10. Accord, Bowles Fin.
Group, Inc. v. Stifel Nicolaus & Co., 22 F.3d 1010, 1013-14 (10th Cir.
1994) (rejecting fundamental-unfairness challenge to arbitrators' con-
sideration of settlement offers).
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Finally, Pudgie's contends that if it becomes common knowledge
that arbitrators may feel free to consider settlement offers, this will
have a chilling effect on settlement negotiations in other cases, under-
mining one of the rationales for using alternative dispute resolution.
Especially given the limited use made here of these materials, this
contention seems obviously extreme. From what appears, the arbitra-
tors had no intention of sabotaging the general rule, meaning to utilize
the documents only for a purpose believed to be consistent with it.
But even if they were mistaken, and have somehow widened the door
to use of such evidence, with unfortunate implications, any danger is
better corrected by arbitration associations and private parties than by
courts. Rules and contracts can be revised to restrict the use of settle-
ment materials should those persons or groups directly concerned
with arbitrations decide that there is a reoccurring problem.*
AFFIRMED
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*Again, the legal basis for Pudgie's policy argument is unclear. Courts
have long refused to enforce contracts that contravene public policy, but
there is no "broad judicial power to set aside arbitration award as against
public policy." United Paperworkers Int'l Union v. Misco, Inc., 484 U.S.
29, 43 (1987). The Supreme Court has explained that vacatur of an award
on public policy grounds must be based on "explicit conflict with other
`laws and legal precedents' rather than an assessment of `general consid-
erations of supposed public interests.'" Id. (quoting W.R. Grace & Co.
v. Rubber Workers, 461 U.S. 757, 766 (1983)). Since, as we have already
concluded, the panel followed all the laws applicable under the parties'
agreement, this line of argument is unavailing.
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