Daily Development for Thursday, September 23, 2004

by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri

ALTERNATIVE DISPUTE RESOLUTION; ARBITRATION: Arbitrator has authority to award punitive damages even when arbitration agreement prohibits it is the agreement refers to a forum state that restricts the ability of parties to obtain waivers of claims for their misconduct. Consequently, foreclosing lender stuck with $6 million punitive damages for unlawful seizure of property pre-foreclosure.

Stark v. Sandberg. Phoenix & von Gontard, No. 03-2366, 2004 WL 1900319 (8/26/04)

Interestingly (to the editor), this major damages award was obtained by a lawyer who took all of the editors real estate law courses in law school and went on to a varied international career, winding up in a small practice in suburban Kansas City. It appears he took on the case of a harried and impecunious debtor and wound up with a gold mine due to lender’s malfeasance. (Or it least it seems that way so far - the case involves an interpretation of federal laws concerning arbitration and may fascinate the en banc panel or even the Supremes.) The defendant’s pocket appears deep enough to fund the award.

Borrowers took out a mortgage on their home in order to get funds for their business. The business failed, borrowers defaulted and declared bankruptcy. At about the same time, the first lender sold the note to EMC. This subjected EMC to responsibilities as a “debt collector” under the Fair Debt Collection Practices Act. Borrowers anticipated that EMC would foreclose, and vacated (but did not abandon) the house and moved to an apartment. EMC obtained leave from the bankruptcy court to foreclose on the house and initiated foreclosure proceedings.

Attorney Roy True represented Borrowers both in the bankruptcy and in their dealings with EMC, and fact that he had made plain to EMC. Nevertheless, on EMC contacted Borrowers directly after True had notified EMC that he represented Borrowers and instructed EMC not to contact them. As a consequence of this, Borrowers, through True, filed an FDCPA action. Pursuant to a provision in the mortgage, EMC invoked the right to go to binding arbitration.

During the course of the arbitration, and before the foreclosure was completed, an agent of EMC, without Borrowers’ consent, forcibly entered the house and posted a sign on the window stating: “Property has been secured and winterized. Not for sale or rent,” and giving a number to call in case of emergency. The agent then proceeded again to contact both the Borrowers without going through True. After the entry into the home, the borrowers amended their complaint to allege intentional torts - trespass and infliction of emotional distress - and sought punitive damages.

EMC argued that the arbitration agreement expressly prohibited any award of punitive damages. The arbitrator, however, concluded that the contract was ambiguous, because, despite containig an express waiver of punitive damages, the agreement stated at three places that parties could seek all damages allowed by law.

The arbitrator found for the Borrowers on the FDCPA count and awarded statutory damages and fees, but then it proceeded to award punitive damages in the amount of $6 million dollars (actually, he first issued an opinion awarding $60 million, but withdrew it as a calculating error.) This award was based upon the arbitrator’s conclusion that the entry into the premises was “reprehensible and outrageous and in total disregard of plaintiff’s [sic] legal rights.” [In fact - Missouri probably follows the “modified title theory” and if Borrowers, as it appears, were clearly in default, the Lender likely had the right to take possession. There is, however, an obscure and difficult case that finds forcible entry tortious even in such cases and also awards punitive and emotional distress damages .Wheeler v. Community Federal Sav. & L.
Assoc., 702 S.W. 2d 83 (Mo App. 1985) Most Missouri lawyers think the case is wrong and hasn’t changed existing law. ]

The District Court refused to confirm the punitive damages award, but the Eighth Circuit Court of Appeals reinstated it.

The Court of Appeals emphasized that arbitral awards are to be accorded great deference by the courts. The opinion is unclear as to whether this deference extends to questions of law, because the court also says that questions of law are to be reviewed de novo. It does say, however, that an award is to be regarded as “irrational” and therefore not deserving of confirmation if it “manifests disregard for the law where the arbitrators clearly identify the applicable, governing law and then proceed to ignore it.” In light of the Wheeler decision, cited above, it is unlikely that the court could construe the aribtrator’s agreement as “irrational” on the law, even though a Missouri court might have taken a broader view of the overall movement of the common law on this question.

In fact, it appears that EMC, in the appeal, fired off all its ammunition at an entirely different issue - whether the arbitrator was correct in finding that he had the power to decide upon punitive damages in light of the fact the issue was not clearly designated and that the arbitration agreement prohibited them.

The language of the agreement stated “borrower and lender expressly waive any right to claim [punitive damages] to the fullest extent permitted by law.” The arbitrator had concluded, and the court here agreed, that Missouri law does not permit a party to exonerate itself from future liability for intentional torts or gross negligence. This prohibits attempts to obtain an advance waiver of a punitive damages claim. The real question in this case was whether Missouri law applied.

The Federal Arbitration Act does permit parties to incorporate terms into arbitration agreements that are contrary to state law. The court, therefore, averred that it was possible that if the agreement was governed exclusively by the FAA, the waiver of punitive damages would have been lawful. [It did not expressly so hold, however.] Nevertheless, the court concluded that the arbitration agreement opted for Missouri law to apply. Watch carefully now, this gets tricky:

Frist, the agreement stated that “to the extent allowed by applicable law, any Claim . . . shall be resolved by binding arbitration in accordance with (1) the Federal Arbitration Act, . . . (2) the Expedited Procedures of the Commercial Arbitration Rules of the American Arbitration Association . . . and (3) this Agreement. The agreement then defines “applicable laws” as the law of the state where the property is located. The court concluded that this meant that the substantive laws of Missouri apply while operating in the framework of the FAA and AAA rules. Therefore, since the parties said that punitive damages could be waived only to the extent permitted by applicable law, and Missouri law prohibited such waiver, the waiver was invalid.

The court went on to conclude that the arbitrator’s conclusion that in any event the waiver of punitive damages was ambiguous was not irrational.. But the court didn’t track the arbitrator’s reasoning as to ambiguity. Instead, the court noted that the reference to Missouri law, noted above, created ambiguity as to whether the parties really intended to overrule Missouri law as to punitive damages.

Finally, the court concluded that the $6 million award was not so irrational as to amount to a “manifest disregard of the law.” Again, it emphasized the great degree of discretion to be afforded the arbitrator’s judgment in such cases.

Comment 1: This is a really tricky analytic question, apparently arising from the fact that the parties provided for waiver of punitive damages only “to the extent permitted by law.” Missouri law didn’t permit such waiver. Although the FAA says that parties can override local law, it doesn’t appear that this particular provision did so. One assumes that the reasoning set forth in this opinion would have rendered enforceable a statement that said: “The parties agree that no punitive damages can be awarded, notwithstanding any law to the contrary other than the FAA.” Perhaps, though, there was some legal reason that the lender felt uncomfortable drafting such language into its form agreement. Maybe it will feel less uncomfortable about that in the future.

Comment 2: Although, due to some recent postings, some readers have accused the editor of being a “lender hater,” the editor doesn’t view himself that way, and the editor goes on record for the position that punitive damages were an inappropriate response to the reported lender conduct in this case. First, the lender had a legal right to take possession. Second, any secured lender ought to be permitted to take reasonable steps to protect security property from the elements - which is apparently all that happened here. Third, even if the lender was mistaken as to its rights - what happened here was hardly $6 million worth of outrageous.

Comment 3: On the other hand, the editor does not believe that form documents committing consumers to binding arbitration are fair or desirable public policy. Thus, the editor is pleased that a lender invoking such a clause got heisted on its own petard.