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Wednesday, October 20, 2010

Fifth Circuit Tells District Court It Has No “Inherent Authority” To Impose Sanctions For Actions Arising Out Of An Arbitration Proceedings

By Stephen P. Groves, Sr.

In Positive Software Solutions, Inc. v. New Century Mortgage, et. al. v. Camina, ___ F.3d ___ (5th Cir. 2010) (Docket No. 09-10355, filed 13 September 2010), the United States Court of Appeals for the Fifth Circuit concluded a Federal District Court did not have the “inherent authority” to impose monetary sanctions for actions allegedly occurring during an arbitration proceeding, even though the District Court had ordered the arbitration to take place.

Positive Software Solutions sued New Century Mortgage for allegedly infringing on certain software patents associated with telemarketing software licensed to New Century. Camina, a partner in Susman Godfrey, LLP, represented New Century in a court-ordered contractual arbitration even though Positive Software opposed the proceeding.

During the arbitration Camina advised New Century on discovery issues. After an award was rendered, the District Court vacated due to an alleged undisclosed relationship between Camina and the arbitrator. In an initial appeal, the Fifth Circuit reversed the vacatur and remanded the case. After remand, New Century declared bankruptcy. Positive Software ultimately settled its dispute with New Century and, as an interesting part of the settlement, “New Century waived and assigned to Positive Software its attorney-client and work-product rights.” The District Court later ordered Susman Godfrey LLP to turn over its files to Positive Software for sanctions investigation purposes.

Positive Software subsequently moved for sanctions against Camina and other under, Rule 37, F.R.Civ.P., 28 U.S.C. § 1927 (counsel’s liability for excessive costs, expenses, and attorneys’ fees), and the District Court’s “inherent authority”. In February 2009, the District Court sanctioned Camina $10,000.00 via the District Court’s “inherent authority”.

On appeal, the Fifth Circuit recognized that a District Court had the “inherent authority” to impose sanctions in order to (a) control the litigation before it, (b) sanction conduct in direct defiance of the sanctioning court, and (c) sanction conduct which constitutes disobedience to court orders. Nevertheless, the Court of Appeals noted such “inherent authority” must only be used when essential to preserve the court’s authority.

The District Court had imposed the sanctions on Camina based upon a theory that the arbitration proceeding was an “annex” to litigation. The District Court believed, since it had ordered the arbitration to proceed, it retained the authority to impose sanctions for conduct occurring during the arbitration. The Fifth Circuit easily dismissed this theory, noting arbitration is an alternative means of dispute resolution – separate from litigation. In fact, the Court of Appeals concluded if the District Court was correct and arbitration was a mere “annex” of litigation, then the very purpose of such private (i.e.; non-judicial) ADR/arbitration would be completely undermined. Consequently, the Court of Appeals acknowledged “[p]arties agree to avoid litigation; they voluntarily surrender judicial remedies in favor of an extrajudicial process.” (Emphasis in original).

Interestingly, Positive Software argued that the sanctions were appropriate in a court-ordered arbitration, but agreed that sanctions would not have been proper had the parties voluntarily entered into the arbitration. The Fifth Circuit found this to be an unjustifiable “significant and perverse asymmetry”.

Additionally, the Court of Appeals concluded the sanctions order likely violated the Federal Arbitration Act, 9 U.S.C. §§ 1, et. seq., which significantly limits a court’s ability to interfere with an arbitration proceeding. Furthermore, the Fifth Circuit did not want a District Court to “become a roving commission to supervise private method[s] of dispute resolution and exert authority that is reserved, by statute, caselaw, and longstanding practice, to the arbitrator.”

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