Swift Industries, Inc. v. Botany Industries, Inc.

Issue Discussed: Security

Submitted by Thomas J. Kinney, Michael T. Carolan*

Date Promulgated: August 14, 1972

Swift Industries, Inc. v. Botany Industries, Inc., 466 F.2d 1125 (3rd Cir. 1972)

Court: United States Court of Appeals, Third Circuit

Issues Decided: Whether an award of prospective cash damages or a surety bond in anticipation of potential loss exceeded the scope of the arbitrator’s authority or was in manifest disregard of the terms of the parties’ agreement; whether an award of attorneys’ fees and court costs exceeded the scope of the arbitrator’s authority or was in manifest disregard of the terms of the parties’ agreement.

In Swift Industries, Inc. v. Botany Industries, Inc., the Third Circuit overturned an arbitrator’s award of prospective cash damages (or a surety bond) to secure a prospective but as of yet unfounded liability.  In doing so the court also affirmed the arbitrator’s decision to award costs and attorneys’ fees.

The Arbitration                                                                                 

This case arose from a stock exchange between Botany Industries, Inc. (“Botany”) and Swift Industries, Inc. (“Swift”), in which Botany conveyed ownership of two subsidiary corporations to Swift in exchange for shares of Swift.  As a condition of that transfer, Botany agreed to indemnify Swift for “all losses, liabilities and expenses incurred or suffered by [the subsidiaries] or Swift” arising from the transfer.

Shortly after the exchange, the parties learned that the subsidiary corporations were each potentially jointly and severally liable for over $6 million in retrospective federal taxes and interest.  While Swift and the subsidiaries (along with several entities who, while not a party to this dispute, were also allegedly jointly and severally liable for the tax deficiency) set about challenging the assessment, they also immediately informed Botany that it was responsible for the liabilities under the terms of their agreement.  Botany, however, disclaimed liability and the matter was submitted to arbitration.

Following a full hearing, the arbitrator entered an award: (1) finding that Botany was liable to Swift for any federal taxes either of the subsidiaries were required to pay; (2) ordering that Botany should deliver to Swift either $6 million cash or a surety bond to protect Swift and the subsidiaries against the tax liability as finally determined; and (3) ordering Botany to reimburse Swift for $100,000 in costs and attorneys’ fees associated with the arbitration.

Botany immediately challenged this order before the U.S. District Court for the Western District of Pennsylvania.  The District Court upheld the finding of liability and the order for attorneys’ fees but vacated the order to pay prospective damages/a surety bond.  Botany and Swift subsequently filed cross-appeals with the U.S. Court of Appeals for the Third Circuit.

The Appellate Court Opinion

With respect to the prospective award/surety bond issue, the Third Circuit began by noting that neither the terms of the parties’ agreement, nor the terms of the Federal Arbitration Act (as incorporated therein), contemplated a surety bond as a remedy in the event of breach or as the means of making an aggrieved party whole.  The court further noted that the agreement only provided for the payment of cash for all losses, liabilities, and expenses actually incurred by Swift or the subsidiaries, and that, since Swift and the subsidiaries’ challenge to the assessment was still ongoing, neither Swift nor the subsidiaries had suffered actual loss or incurred actual liability. Next, the court noted the absence of any provisions in the parties’ agreement which would secure either party against breaches of warranty by the other, explaining that such provisions “are frequent in agreements of this type,” and that it could not “assume their absence was accidental.”  Thus, the court found that the arbitrator did not have the authority to order a cash bond to cover a liability that had not yet materialized and that the order was in manifest disregard of the parties’ agreement.

The court also upheld Botany’s challenge on the basis that, even assuming the arbitrator had the authority, the award was “completely irrational” because, under a sharing agreement among the subsidiaries, the maximum prospective liability for the two subsidiaries was $1.5 million.  As the court framed it, an award of $6 million in cash or surety bond to guard against a prospective $1.5 million loss could not be rational.

With respect to the arbitrator’s award of costs and attorneys’ fees, the court explained that, in contrast to the tax deficiency claim, Swift had already “incurred or suffered” the cost of its attorneys’ fees.  The court also noted that the parties’ agreement expressly provided for the reimbursement of attorneys’ fees and costs associated with an arbitration.  Thus, the court found it was reasonable for the arbitrator to conclude that Swift’s right to reimbursement for counsel fees had accrued, and affirmed confirmation of that portion of the award.

* Thomas J. Kinney and Michael T. Carolan are associate and partner, respectively, in the Insurance & Reinsurance group of Crowell & Moring LLP. They each represent cedents and reinsurers in disputes involving a broad spectrum of issues.