Appeals Court Throws Out Confidential Arbitration in Delaware

A decision by a federal appeals court has ended Delaware’s experiment with confidential arbitration.

In an opinion released Wednesday, a three-judge panel for the United States Court of Appeals for the Third Circuit upheld a lower court ruling that Delaware’s state-sponsored arbitration program violated the First Amendment.

The controversial arbitration program was established by Delaware in 2009. Delaware is the leading state for incorporations by public companies, and the five judges on Delaware’s Chancery Court specialize in business disputes. The state Legislature was worried about Delaware’s continuing pre-eminence in resolving these disputes in light of the extraordinary growth in confidential arbitration for resolving disputes.

To “preserve Delaware’s pre-eminence in offering cost-effective options for resolving disputes,” the Legislature established a business arbitration program. The program was limited to business disputes involving Delaware companies and had to involve an amount in dispute of at least $1 million.

The program was remarkable on several fronts. First, it essentially replicated the disputes you would see in Delaware’s public courts, albeit with more streamlined arbitration proceedings. Most notably, the disputes would be arbitrated by Delaware’s judges, who are prized for their knowledge and ability in adjudicating corporate law matters. Second, because it was arbitration, the deliberations and resolution would be confidential.

For the courtesy of arbitrating these disputes, Delaware would charge $6,000 a day with a $12,000 filing fee, generating revenue for the state.

The adoption of these rules was met with consternation, mostly by people outside of Delaware. Critics complained that it moved important business disputes that normally would be heard before the Chancery Court judges to a private sphere. This fear looks to the increasing use of arbitration in other areas, and the worry, real or not, that it will increase the legitimacy of arbitration to the detriment of shareholders and other stakeholders in the corporation.

This issue crystallized in the most prominent of arbitration cases to occur under the program in its short life: the arbitration involving Skyworks Solutions efforts to break its $262.5 million deal to purchase publicly traded Advanced Analgoic Technologies.

The parties sued each other over whether Skyworks was obligated to complete the deal. But because the parties had agreed to arbitration, shareholders were left in the dark as the companies battled.

Brian Quinn at the M&A Law Prof blog wrote at the time, “The problem with trying to follow a dispute like this from the outside is that nothing is public unless the parties want it to be. So, we end up getting bits and drabs of information here and there. It becomes very difficult for an observer, or the market, to get any idea what the issues are. Welcome to the world of private arbitration.”

The second main concern was that if these disputes were regularly litigated in arbitration, corporate law would be made but no one would know about it, making the life of companies and lawyers who advise them much harder.

But the experiment also had strong proponents. They argued that judges regularly participate in mediation. Moreover, parties can agree to arbitrate their disputes without these judges. Delaware wasn’t taking away cases so much as just co-opting them. Given Delaware’s important need to compete, arbitration was a natural extension of its corporate law expertise.

The Delaware Coalition for Open Government sided with the critics and sued in federal court, claiming that the arbitration statute was unconstitutional. A lower court struck down the statute in 2012 holding that these arbitration cases were essentially civil trials since the judges, place and proceedings were the same.

Accordingly, the First Amendment principle of open access applied. The statute failed because it allowed confidential proceedings.

At the time, I wrote that the decision made “logical sense:”

“It’s one thing for a dispute by two companies over a joint venture in a foreign country to arbitrate the dispute. And it makes sense for Delaware judges to be picked for this task.

But when it is a dispute that directly implicates third parties like shareholders, the arbitration provision may go a bit too far” since they provide for confidential dispute of the proceedings without knowledge of those third parties.

Delaware appealed, and on Wednesday, the federal appeals court upheld the trial court asserting that “[t]here is a long history of access to civil trials in a democratic society.”

The appellate court applied an experience and logic test to determine whether the arbitration statute was similar to court proceedings. Because these types of proceedings had traditionally been open to the public, they should remain open even if called arbitration. The court added that “the benefits of openness weigh strongly in favor of granting access to Delaware’s arbitration proceedings.”

Thus ends Delaware’s arbitration experiment.

There are still some grounds to allow Delaware to appeal to all of the judges on the circuit court, and ultimately, the Supreme Court, if it is willing to take up the case.

An appeal would not be without basis. One of the three judges in appellate court’s opinion dissented, stating that “the Court of Chancery, as a formal adjudicator of disputes, may not be able to compete with the new arbitration systems being set up in other states and countries.” The judge concluded that arbitration had never been open to the public and that Delaware therefore “did not intend to preclude the public from attending proceedings that historically have been open to the public.”

The program has not been popular in its few years of existence with less than a dozen cases decided under it. Still, this may have been because of its uncertain legality.

Despite this, Delaware is likely to appeal because it does have grounds for a case and has nothing to lose at this point. Lucky for us, we’ll be able to see the entire thing play out in public, as is our constitutional right.