Fifth Circuit Affirms Vacatur After Arbitrator Exceeded His Authority

The United States Court of Appeals for the Fifth Circuit has held an arbitrator exceeded his authority when he reformed a multi-million dollar contract between two companies.  In Hebbronville Lone Star Rentals, LLC v. Sunbelt Rentals Industrial Services, LLC, No. 17-50613 (5th Cir. August 6, 2018), an equipment rental company, Lone Star, sold its assets, contracts, and customer lists to Sunbelt for $25 million plus three subsequent contingent payments based on a formula that considered Sunbelt’s revenue derived from former Lone Star customers.  The purchase contract included an arbitration provision.

According to the parties’ contract, Lone Star was not entitled to a contingent payment if Sunbelt received less than 90 percent of the revenue Lone Star previously received from its former customers during a specified period prior to the close of the first payout period.  Following the end of the first payment period, a dispute arose between Lone Star and Sunbelt regarding whether certain companies constituted former Lone Star customers for purposes of calculating of the first contingent payment.  As a result, the two companies engaged an accounting firm and submitted their disagreement to arbitration based on the terms of the purchase contract.

An arbitrator initially agreed that the amount due to Lone Star should be adjusted upward based on the amount of revenue Sunbelt received from Lone Star’s former customers.  Interestingly, however, the arbitrator also decided the two companies made a mutual mistake regarding the preacquisition revenue threshold used to calculate the contingent payment and reformed the parties’ signed contract.  Following the reformation, Lone Star failed to meet the 90 percent threshold specified in the purchase contract and received no contingent payment.

Next, Lone Star filed a lawsuit in the Western District of Texas seeking to “(1) to confirm the part of the arbitration award that agreed with its revenue adjustment, but (2) to vacate the reformation of the contract which resulted in the new threshold.”  A magistrate judge agreed with Lone Star and the district court confirmed the revenue adjustment.  The federal court also vacated the arbitrator’s reformation of the parties’ contract because the arbitrator exceeded his authority.  In response, Sunbelt filed an appeal with the United States Court of Appeals for the Fifth Circuit.

On appeal, the Fifth Circuit first said:

Whatever the outcome of this appeal, someone will decide the question of mutual mistake. If we affirm the district court and vacate the arbitrator’s reformation, Sunbelt has filed a counterclaim in district court asking it to decide whether the parties made a mutual mistake. So this appeal involves only the issue of who will decide, not what will be decided. But the question of who decides—which we often see in the form of a choice between a federal or state court, a federal court in one district versus another, or this question of an arbitrator or a court—can be as hotly disputed as the merits of a case. That is the case here.

After that, the appellate court pointed out that whether a question is one for an arbitrator to decide “is a matter of contract.”  The court then examined the language of the parties’ arbitration provision, which was included in Section 3.5 of the purchase contract, before stating it was “limited to a ‘dispute over Seller’s proposed adjustments’ to the Revenue Calculation.”  The Court of Appeals continued:

Various features of this clause show it is limited to the first part of what the arbitrator did: resolving the parties’ dispute about the Revenue Calculation. First, Section 3.5 refers only to the revenue calculation, it says nothing about the threshold amount. Unlike the revenue calculation, which as a future event was one the parties anticipated might be disputed, the threshold amount is an exact figure defined earlier in the agreement and thus not contemplated for reexamination. Even with respect to the Revenue Calculation, Section 3.5 does not allow for full-scale reconstruction. The arbitrator is to resolve only “any remaining dispute over Seller’s proposed adjustments to a Revenue Calculation” (emphasis added). Because only Lone Star’s disagreement with Sunbelt’s Revenue Calculation can give rise to a Section 3.5 arbitration, Sunbelt surely could not have used that clause to seek arbitration of its reformation claim had the parties agreed on revenue. We do not see why that door is opened because Lone Star disputed the revenue calculation.

The court also looked to how other Circuit Courts ruled in similar cases before concluding the parties’ arbitral agreement was narrow and limited in scope to include “only a ‘dispute over Seller’s proposed adjustments to a Revenue Calculation.’”

Finally, the Fifth Circuit Court of Appeals dismissed Sunbelt’s remaining arguments claiming the arbitrator’s reformation of the parties’ contract was permitted before ultimately holding:

Because the parties did not agree in either the asset purchase agreement or the engagement letter to have the arbitrator decide reformation, a court must decide that issue. The judgment of the district court is AFFIRMED and the case is REMANDED for consideration of the mutual mistake claim.

H/T to Arbitration Nation for alerting us to this case.

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