“Barely Colorable Justification” May be Enough to Support an Arbitration Award based on “No More than a Guess”

Austin attorney Abigail Chacon wrote the following article for Construction News Magazine in the June 2024 issue. The article highlights the necessity for parties to provide clear, compelling evidence and well-supported expert testimony in arbitration proceedings. Read the full article below.

It is well known that an arbitrator’s final decision is not automatically subject to review by filing an appeal. In most cases, the arbitrator’s decision will be final and binding on the parties unless one of a few narrow exceptions allowing for judicial review of the decision is met. A party may request judicial review of an arbitration award when it is unclear whether an arbitrator exceeded its powers, imperfectly executed its powers, or manifestly disregarded the law.

The ‘manifest disregard of the law’ argument was the basis for the US Southern District Court of New York’s May 3, 2024, opinion regarding Mercantile Global Holdings, Inc. v. Hamilton M&A Fund arbitration award. Hamilton contended that the arbitrator’s admission that the award was based on a guess was a ‘manifest disregard of the law’ for not applying the ‘reasonable certainty’ test to the damages awarded to Mercantile.

Summary of the case:

Hamilton and Mercantile entered into several investment agreements. Under the terms of those agreements, Hamilton was to “provide funds to Mercantile… in exchange for preferred shares of Mercantile’s stock.” However, those funds were never transferred to Mercantile. Mercantile brought an arbitration claim for breach of contract against Hamilton, for which it was ultimately successful and was awarded damages.

While Mercantile was not awarded lost profits as it did not meet the ‘reasonable certainty’ standard—a legal requirement for a high degree of certainty in calculating lost profit damages—it was, however, awarded expectations damages. The arbitrator did not use the “reasonable certainty” standard in determining its expectations damages; instead, it employed an estimate based on the testimony of the experts on the case.

During Arbitration, Mercantile argued the shares were “worthless,” while Hamilton argued the shares were worth the full contract price. Neither party presented evidence as to the current market value of the shares. Rather, Mercantile’s damages expert testified that the proper way to determine the resale value of the shares would be to determine the value of a replacement investment and discount that value to account for the delay. Hamilton’s damages expert agreed with Mercantile expert’s approach but testified the discount rate Mercantile proposed was excessive.

The arbitrator treated the testimony of both damages experts as a mutually agreeable method between the parties and then proceeded to “estimate” the market value of the shares in order to deduct it from the contract price in the investment agreements. Notably, the arbitrator stated in his award that the amount he calculated from this formula “[was] no more than a guess.” Hamilton argued that, by stating the damages calculation was “no more than a guess,” the arbitrator had failed to apply the applicable “reasonable certainty” test. Upon review, the Court nevertheless denied vacatur and confirmed the arbitration award. The Court employed the “barely colorable justification” test, a standard of review in which an arbitrator’s decision is entitled to substantial deference. Opining that even though the arbitrator acknowledged that his award was ‘no more than a guess,’ he relied on it because it was ‘the only estimate offered in this case.

The Court criticized that although the parties had an adequate opportunity to provide an estimate of the shares’ market value, both parties failed to provide the arbitrator with better estimates. Thus, the arbitrator had relied upon a figure that he ‘understood to be acceptable to both sides’ damages experts, which was the most accurate estimate offered. Albeit, the only one provided by the parties.

Texas Implication:

While this ruling originates from the Southern District of New York, the ‘barely colorable justification’ test has also been cited in past Texas Arbitration Award challenges. This was evident in the 2008 case, Saipem Am., Inc. v. Wellington Underwriting Agencies, Ltd, where the U.S. Southern District Court of Texas emphasized that “an arbitrator’s decision is entitled to substantial deference, and the arbitrator need only explicate his reasoning under the contract ‘in terms that offer even a barely colorable justification for the outcome reached’ in order to withstand judicial scrutiny.” Although in this case the “barely colorable justification” was not applied to the ‘reasonable certainty’ standard for damages, it underscores the continued relevance of the ‘barely colorable justification’ in Texas and its potential expansion.

Lessons Learned:

The crucial lessons from Mercantile v. Hamilton are that arbitrators are accorded a significant amount of deference in their awards and the reasoning behind them. Therefore, it is imperative that parties present the importance of ensuring that the arbitrator is provided with the tools to award damages fairly, including alternative methods of damage calculation, to withstand scrutiny through judicial review. This case highlights the importance of ensuring that the arbitrator is provided with the tools to award damages fairly. Additionally, damage experts should exercise caution in their testimony and ensure they include the appropriate qualifications and observations when discussing other experts’ opinions.

Abigail E. Chacon

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