Delaware Arbitration Procedure Ruled Unconstitutional

04 September 2012 Publication

Legal News Alert: Litigation

On August 30, 2012, U.S. District Court Judge McLaughlin of the U.S. District Court for the Eastern District of Pennsylvania, sitting by designation for the U.S. District Court for the District of Delaware, ruled 10 Del. Code § 349 and Court of Chancery Rules 96-98, which established a confidential arbitration procedure, are unconstitutional in violation of the First Amendment. Delaware Coalition for Open Gov’t v. Hon. Leo E. Strine, Jr., et al, C.A. No. 1:11-1015, 2012 U.S. Dist. LEXIS 123980 (D. Del. Aug. 30, 2012).

To briefly recap, in April 2009, the Delaware State Legislature passed 10 Del. Code § 349, granting to the Delaware Court of Chancery “the power to arbitrate business disputes when the parties request a member of the Court of Chancery … to arbitrate a dispute.” The Legislature’s rationale in enacting this law was “to preserve Delaware’s pre-eminence in offering cost-effective options for resolving disputes, particularly those involving commercial, corporate, and technology matters.” Del. H. R. No. 49 (2009).

In order to participate in an arbitration proceeding, the parties needed to consent to do so, either before a dispute arose between them, or when they submitted the dispute to arbitration. 10 Del. Code § 349(a). At least one of the parties was required to be a business entity, and one party (which could be the same party) was required to be a citizen of the State of Delaware. 10 Del. Code § 347(a)(2), (3). If monetary damages were sought, the amount in controversy was required to be more than $1 million. Moreover, consumers, defined as individuals who purchased or leased merchandise for personal use, were not eligible for the arbitration procedure. 10 Del. Code § 347 (a)(4); 6 Del. Code § 2731(1).

To administer the arbitration proceedings, the Court of Chancery adopted rules detailing the specific procedures to be followed. A petition would first be filed with the Register in Chancery, and the Chancellor would appoint a Chancery Court judge to preside. Within 10 days, a preliminary conference would be had and then as soon as practicable, a preliminary hearing would be scheduled. An arbitration hearing was required to occur approximately 90 days after the filing of the petition.

While the Court of Chancery Rules governing discovery applied to the arbitration, the parties and the arbitrator could agree to different rules. An arbitration decision could be appealed to the Delaware Supreme Court to vacate, stay, or enforce the arbitrator’s award, but the award could be vacated only if there was a showing of fraud, corruption, or misconduct on the part of the arbitrator, or if the arbitrator exceeded his powers or failed to make an award.

Both the law enacting the arbitration procedure and the Court of Chancery Rules required that the proceedings be confidential. Specifically, the relevant provision of the Delaware Code provides: “Arbitration proceedings shall be considered confidential and not of public record until such time, if any, as the proceedings are the subject of an appeal. In the case of an appeal, the record shall be filed by the parties with the Supreme Court in accordance with its rules … .” 10 Del. Code § 349(b). It was the confidential nature of the arbitration proceedings that was challenged by the Delaware Coalition for Open Government.

In assessing these provisions, the Federal District Court first detailed the history of the application of the First Amendment to criminal trials, under which the government was prevented from denying public access to historically open government proceedings. Del. Coalition, 2012 U.S. Dist. LEXIS 123980, at *12-14. After acknowledging that the U.S. Supreme Court has never addressed the public’s right of access to civil proceedings, Judge McLaughlin noted that every Court of Appeals that has considered the issue has held that there is a right of access to civil trials. The rationale is that the “[o]penness of civil trials promotes the integrity of the courts and the perception of fairness essential to their legitimacy. Public dissemination of the facts of a civil trial can encourage those with information to come forward, and public attention can discourage witnesses from perjury.” Id. at *16.

Against this backdrop, the Court turned to Delaware’s arbitration procedure. The Court first examined whether “Delaware had implemented a form of commercial arbitration … or has it created a procedure ‘sufficiently like a trial’” such that there was a right of public access. Id. at *19. The Court determined that it was the latter, as “the parties submit their dispute to a sitting judge acting pursuant to state authority, paid by the state, and using state personnel and facilities; the judge finds facts, applies the relevant law, determines the obligations of the parties; and the judge then issues an enforceable order.” Id. at *28.

Indeed, one of the factors that made Delaware’s arbitration procedure appealing — the fact that the arbitrator would be a Chancery Court judge — appeared to be the key factor that resulted in the Court finding that the arbitration procedure was in substance a trial. The Court acknowledged that the Alternative Dispute Resolution Act, which creates court-annexed arbitration in the federal court system, appeared to allow magistrate judges to serve as arbitrators, but the Court could not find any evidence of that actually occurring. Id. at *26. After noting the differences between arbitrators and judges, the Court concluded that “[a] judge bears a special responsibility to serve the public interest. That obligation, and the public role of that job, is undermined when a judge acts as an arbitrator bound only by the parties’ agreement.” Id. at *27.

The Court also rejected the argument that the fact that the parties to an arbitration could agree to procedures to facilitate faster discovery and resolution of the dispute distinguished the arbitration proceeding from a trial, finding that parties to a civil litigation could agree to similar procedures. Id. at *29.

Having found that the Delaware arbitration procedure was in substance a civil trial proceeding, it was then a seemingly foregone conclusion that the Court would determine that the public has a right of access to the proceedings. Of course, it is not the case that all civil trial proceedings, whether held in the Court of Chancery or elsewhere, are fully open to the public. Many commercial cases involve a party’s confidential information. Consequently, filings in those cases may not be public, and portions of such trials may exclude the public. Indeed, the Court acknowledged in a footnote that the First Amendment’s right of access is not absolute and that protected proceedings may be closed to the public, but noted that “[t]his part of the First Amendment analysis is not addressed by the parties or considered by the Court.” Id. at *19 n. 7.

In its ruling, the Court found that the “public benefits of openness are not outweighed by the defendants’ speculation that such openness will drive parties to use alternative non-public fora to resolve their disputes. Even if the procedure fell into disuse, the judiciary as a whole is strengthened by the public knowledge that its courthouses are open and judicial officers are not adjudicating in secret.” Id. at *30. Hence, the Court ruled that the public’s right of access applies to the arbitration procedure created by the Delaware Legislature, and the portions of that law and the corresponding Chancery Court rules that render such proceedings confidential violate that right. Id. at *31.

While only a few matters had been submitted to Delaware’s arbitration procedure (according to court officials, only six thus far), many practitioners, both in and outside of Delaware, had counseled clients to consider selecting the Delaware arbitration procedure as a form of alternative dispute resolution in their agreements. In addition, parties involved in litigation in the Court of Chancery regularly considered converting their cases to arbitration proceedings to enable them to retain the experience of a Court of Chancery judge while enjoying a more streamlined, confidential procedure.

The Court of Chancery has indicated that it will appeal the District Court’s decision. Until the issue has been definitively resolved, parties who have identified the Delaware arbitration procedure as a dispute-resolution mechanism may wish to revisit the ramifications of that selection.

Legal News Alert is part of our ongoing commitment to providing up-to-the-minute information about pressing concerns or industry issues affecting our clients and our colleagues. If you have any questions about this update or would like to discuss this topic further, please contact your Foley attorney or the following:

Roger A. Lane
Boston, Massachusetts

Courtney Worcester
Senior Counsel
Boston, Massachusetts