Judge gavel on american flagSome contracts, including insurance and reinsurance contracts, include provisions providing that the successful party’s damage award will include all costs of the suit or arbitration, including attorney fees. This type of clause modifies the traditional default American Rule of costs and fees, in which each litigant pays its own attorney fees, win or lose. What happens when this type of contract clause bumps up against the Federal Arbitration Act (“FAA”) and the ability of a party to petition a court to seek to vacate an arbitration award? Is the prevailing party entitled to costs and attorney fees defending the vacatur proceeding?

In a recent case, the United States Court of Appeals for the Second Circuit was asked to review a district court order confirming an arbitration award and awarding costs and attorney fees to the prevailing party. Zurich Am. Ins. Co. v. Team Tankers A.S., No. 14-4036-cv, 2016 U.S. App. LEXIS 1390 (2d Cir. Jan. 28, 2016). This case was an arbitration under a charter party agreement. The arbitrators rejected the claim of breach of the charter agreement. The shipper sought to vacate the award on various grounds and the carrier cross-petitioned to confirm the award. The district court confirmed the award and, based on language in the charter agreement, awarded costs and attorney fees to the carrier. The shipper appealed.

In reversing in part, the Second Circuit, vacated the award of costs and attorney fees. The charter party agreement provided as follows: “BREACH. Damages for breach of this Charter shall include all provable damages, and all costs of suit and attorney fees incurred in any action hereunder.” The Second Circuit found that this provision authorized a fee award against a party that breached the charter agreement as part of the non-breaching party’s damages. Here, there was no finding of a breach of the charter agreement thus no basis to award costs and attorney fees.

That seems simple, but the carrier argued that the fee award was proper because the parties agreed to be bound by the arbitration decision and that by resisting judgment on the award, the shipper breached that understanding. In rejecting this argument, the court found that while the parties agreed to arbitrate, they also agreed to confirmation of the award in any court of competent jurisdiction. Thus, the parties agreed that a federal court would have the authority to confirm the award under the standards of the FAA. By effectively incorporating FAA review into their agreement, the shipper could not be seen as breaching the contract by making permissible arguments under the FAA.

Moreover, held the court, any agreement that purports to divest the court of its statutory and common-law authority to review awards is not enforceable. Thus, a party is permitted to raise legitimate arguments allowed under Section 10 of the FAA seeking review of an arbitration award and doing so will not be considered a breach of the underlying contract.

So while parties can modify the American Rule in their contracts, they cannot preclude either party from seeking review of an arbitration award when they have effectively incorporated the FAA into their contracts.