CHIRON v ORTHO 9915064 Arbitrator NOT court, must determine the preclusive effect of a prior arbitration award on a subsequent arbitration.

 

 

 
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CHIRON v ORTHO, 9915064

U.S. 9th Circuit Court of Appeals

CHIRON v ORTHO
9915064

CHIRON CORPORATION, a Delaware
corporation,
No. 99-15064
Plaintiff-Appellee,
D.C. No.
v.
CV-98-00639-SI
ORTHO DIAGNOSTIC SYSTEMS, INC., a
OPINION
New Jersey corporation,
Defendant-Appellant.

Appeal from the United States District Court
for the Northern District of California
Susan Illston, District Judge, Presiding

Argued and Submitted
February 7, 2000--San Francisco, California

Filed March 28, 2000

Before: Procter Hug, Jr., Chief Judge, Dorothy W. Nelson,
and M. Margaret McKeown, Circuit Judges.

Opinion by Judge McKeown

_________________________________________________________________

COUNSEL

Samuel R. Miller, Folger Levin & Kahn, San Francisco, Cali-
fornia; Harold P. Weinberger and Gregory A. Horowitz,
Kramer Levin Naftalis & Frankel, New York, New York, for
the defendant-appellant.

Daniel H. Bookin and Patricia Schmiege, O'Melveny &
Myers, San Francisco, California, for the plaintiff-appellee.

_________________________________________________________________

OPINION

McKEOWN, Circuit Judge:

This case requires us to decide whether the res judicata
effect of a prior arbitration award on a subsequent arbitration
is an issue to be determined by an arbitrator or by the court.
We are not presented with a disagreement over whether the
parties agreed to arbitrate. They clearly did, and the dispute
falls squarely within their broad arbitration agreement.
Rather, the issue before us is who should adjudicate the pre-
clusive effect of a res judicata defense. Because res judicata
is a legal defense that is necessarily intertwined with the mer-
its, we join the Second Circuit in holding that this is a matter
for the arbitrator. See National Union Fire Ins. Co. v. Belco
Petroleum Corp., 88 F.3d 129 (2d Cir. 1996). Our holding is
consistent with the strong federal policy favoring arbitration,
see Dean Witter Reynolds Inc. v. Byrd, 
470 U.S. 213
 (1985),
and with the Federal Arbitration Act, 9 U.S.C. S 1 et seq. We
have jurisdiction under 28 U.S.C. S 1291 and 9 U.S.C.
S 16(a)(3), see Cook v. Erbey, 2000 WL 263381 (9th Cir.
March 10, 1999), and we affirm.

BACKGROUND

In the late 1980s, Chiron Corporation, a biotechnology
company, successfully developed and patented a blood test
used to detect a previously unidentified form of hepatitis, the
hepatitis C virus ("HCV"). Chiron also made significant
strides in the development of AIDS-related blood tests,
obtaining certain patents in that field. In 1989, Chiron and
Ortho Diagnostic Systems, a wholly owned subsidiary of
Johnson & Johnson, combined forces to undertake a joint
business arrangement -- a 50 year collaboration -- aimed at
developing, marketing, and selling Chiron's HCV and AIDS
tests.

The parties memorialized the terms of this joint undertak-
ing in a written agreement (the "Agreement"). Under the
Agreement, Chiron assumed primary responsibility for
research and manufacturing while Ortho assumed an exclu-
sive license to the technology and primary responsibility for
product development, distribution, marketing, and sales. The
parties agreed to share equally all proceeds from the sale of
the tests. All budgetary and strategic decisions were vested in
a Supervisory Board comprised of three representatives from
each company. In the event of a Board deadlock, the Agree-
ment authorized Ortho to set the budget and strategic plan in
its discretion for the succeeding year. Chiron and Ortho
agreed to arbitrate "any dispute, controversy or claim arising
out of or relating to" the Agreement.

In 1994 a dispute arose, ultimately leading Ortho to invoke
the arbitration provision. The dispute stemmed from the par-
ties' decision to expand the venture's marketing and sales
efforts to diagnostic testing. The business initially focused its
marketing efforts on blood screening, which refers to the
series of tests routinely performed at blood banks on every
unit of donated blood to protect the integrity of the blood sup-
ply. Diagnostic testing, on the other hand, refers to tests
ordered by a physician to determine whether an individual
carries a particular virus. Unlike blood screening, diagnostic
testing is usually conducted in laboratories using specialized
equipment designed to accept a large number of blood sam-
ples and perform specified tests on each sample. Entry into
the diagnostic testing market thus required the business to
customize its AIDS and HCV tests for use on the diagnostic
machines, otherwise known as "random access instruments."
Through a series of unrelated transactions, Chiron and Ortho
each secured ownership rights to competing random access
instruments and, consequently, each company developed a
strong interest in customizing the AIDS and HCV tests for use
on its respective machine.

In setting the business's plan and budget for 1995, the
Supervisory Board deadlocked as to which random access
machine or machines the joint arrangement would focus its
sales efforts. Per the terms of the Agreement, Ortho adopted
a strategic plan and budget that authorized the venture to cus-
tomize the blood tests for use only on Ortho's Vitros machine,
effectively precluding use of the tests on Chiron's Centaur
machine. When Chiron announced its intention to market the
tests for use on its Centaur machine, Ortho objected, claiming
that Chiron was prohibited from independently selling, mar-
keting, or licensing the AIDS and HCV tests outside the joint
arrangement.

To arbitrate their dispute, the parties chose former federal
district judge Joseph W. Morris, who issued his arbitration
decision in April 1997. He determined that in light of the
deadlock, the express terms of the Agreement gave Ortho the
right to establish the budget and strategic plan for the succes-
sive year. He further concluded that Ortho's decision to limit
the sale of the tests to the Vitros machine was permitted so
long as Ortho continued to share all profits with Chiron. The
arbitration award "constitute[d] a full and complete resolution
of all claims and counterclaims submitted or urged by either
party in this Arbitration," and was "final and binding upon the
parties."

Following Judge Morris's decision, Chiron submitted a
new proposal to Ortho that involved amending both the then-
current 1997 and the 1998 strategic plans and budgets to
allow the joint business access to the Centaur. Although Chi-
ron maintained that such an amendment would serve the par-
ties' stated intent by maximizing the business's profits, Ortho
rejected Chiron's proposal without submitting it to all mem-
bers of the Supervisory Board. Chiron viewed Ortho's rejec-
tion as violating certain sections of the Agreement that
address the parties' intent -- to maximize both the profits of
each company as well as the commercial potential of the
AIDS and HCV test technology -- and that spell out the
Supervisory Board's duty to approve amendments to the plan
and budget "from time to time." Chiron sought a second arbi-
tration proceeding to resolve the disagreement. Ortho, how-
ever, refused on the ground that the new claims raised by
Chiron were the same as the claims presented to Judge Morris
and were thus precluded from further arbitration under the
doctrine of res judicata.

Chiron filed a declaratory judgment action seeking an order
compelling arbitration and later moved for such an order
under S 4 of the Federal Arbitration Act ("FAA" or "Act").
Ortho filed a cross-motion for summary judgment on the
ground that the earlier arbitration award operated as res judi-
cata to all claims Chiron sought to raise in a second arbitra-
tion proceeding. Ortho also sought an order confirming the
earlier arbitration award under S 9 of the FAA. Applying fed-
eral law, the district court concluded that Ortho's res judicata
defense was itself an arbitrable issue within the scope of the
parties' agreement to arbitrate. The Court without reaching
the merits of Ortho's objection therefore granted Chiron's
motion to compel arbitration and denied Ortho's motion for
summary judgment. The court also granted Ortho's motion to
confirm the arbitration award. This appeal stems from Ortho's
timely appeal of the district court's grant of Chiron's motion
to compel arbitration.

ANALYSIS

We review de novo the district court's decision to compel
arbitration. See Quackenbush v. Allstate Ins. Co., 121 F.3d
1372, 1380 (9th Cir. 1997). We begin our analysis by recog-
nizing that an agreement to arbitrate is a matter of contract:
"it is a way to resolve those disputes--but only those disputes
--that the parties have agreed to submit to arbitration." First
Options of Chicago, Inc. v. Kaplan, 
514 U.S. 938, 943
  (1995).
As with any other contract dispute, we first look to the
express terms which in this case require Chiron and Ortho to
arbitrate "[a]ny dispute, controversy or claim arising out of or
relating to the validity, construction, enforceability or perfor-
mance" of the Agreement. The Agreement sets forth specific
procedures that govern the initiation of an arbitration proceed-
ing and the manner in which it is conducted, and provides that
the resulting decision "shall be final and not appealable."
These express terms unambiguously reflect the parties intent
both to arbitrate disputes arising from the joint business and
to be bound by the arbitration decisions that resolve such dis-
putes. It is against this backdrop that we turn to the governing
provisions of the Act.

I. Federal Arbitration Act

[1] Because the Agreement is "a contract evidencing a
transaction involving commerce," it is subject to the FAA. 9
U.S.C. S 2. The FAA provides that any arbitration agreement
within its scope "shall be valid, irrevocable, and enforceable,"
id., and permits a party "aggrieved by the alleged . . . refusal
of another to arbitrate" to petition any federal district court for
an order compelling arbitration in the manner provided for in
the agreement. Id. at S 4. By its terms, the Act "leaves no
place for the exercise of discretion by a district court, but
instead mandates that district courts shall direct the parties to
proceed to arbitration on issues as to which an arbitration
agreement has been signed." Dean Witter Reynolds Inc. v.
Byrd, 
470 U.S. 213, 218
  (1985). The court's role under the
Act is therefore limited to determining (1) whether a valid
agreement to arbitrate exists and, if it does, (2) whether the
agreement encompasses the dispute at issue. See 9 U.S.C. S 4;
Simula, Inc. v. Antoliv, Inc., 175 F.3d 716, 719-20 (9th Cir.
1999); see also Republic of Nicaragua v. Standard Fruit Co.,
937 F.2d 469, 477-78 (9th Cir. 1991). If the response is affir-
mative on both counts, then the Act requires the court to
enforce the arbitration agreement in accordance with its
terms.

A. Governing Law

[2] As a threshold matter, Ortho claims that the district
court erred in concluding that federal law governs, pointing to
the Agreement's choice-of-law provision that provides "[t]his
agreement shall be construed and interpreted according to the
laws of the State of New Jersey." The Supreme Court rejected
a similar argument in Mastrobuono v. Shearson Lehman Hut-
ton, Inc., 
514 U.S. 52
 (1995), holding that the parties' inclu-
sion of a choice-of-law clause in the arbitration agreement
does not incorporate state decisional law pertaining to the
allocation of power between courts and arbitrators; rather, at
most the clauses read together create an ambiguity that must
be construed in favor of arbitration. Id. at 62. "We think the
best way to harmonize the choice-of-law provision with the
arbitration provision is to read [the former] to encompass sub-
stantive principles that [state] courts would apply, but not to
include special rules limiting the authority of arbitrators[,]"
notwithstanding otherwise-applicable federal law. Id. at 63-
64.

Ortho argues that the governing law issue is resolved by the
Supreme Court's analysis in Volt Info. Sciences, Inc. v. Board
of Trustees of the Leland Stanford Junior Univ., 
489 U.S. 468

(1989), rather than by Mastrobuono. This reliance is mis-
placed. In Volt, the Court declined to review the merits of the
state court's determination that the parties' choice-of-law pro-
vision was intended to encompass both the state's substantive
law as well as its rules of arbitration. Guided by Mastrobu-
ono, we have rejected the very argument that Ortho makes
here:

       Unlike the Volt Court, which declined to review a
       state court's interpretation of a private contract, we
       must interpret the Development Agreement between
       Wolsey and Foodmaker. In Mastrobuono, the
       Supreme Court distinguished Volt as follows:

       ". . . In Volt, however, we did not interpret
       the contract de novo. Instead, we deferred
       to the California court's construction of its
       own state law. In the present case, by con-
       trast, we review a federal court's interpreta-
       tion of this contract . . . ."

       Mastrobuono, 
514 U.S. at 60
 n.4. Thus, in interpret-
       ing the Development Agreement, we are bound by
       Mastrobuono, not by Volt. Because Mastrobuono
       dictates that general choice-of-law clauses do not
       incorporate state rules that govern the allocation of
       authority between courts and arbitrators, the district
       court erred in applying [the California rule] to deny
       Foodmaker's motion to compel arbitration.

Wolsey, Ltd. v. Foodmaker, Inc., 144 F.3d 1205, 1212-13 (9th
Cir. 1998). In light of Mastrobuono and Wolsey, the district
court correctly found that the federal law of arbitrability under
the FAA governs the allocation of authority between courts
and arbitrators.

B. Arbitrability of the Dispute

[3] Because the parties do not challenge the validity of the
Agreement, the FAA restricts our review to deciding only
whether the dispute is arbitrable, that is, whether it falls
within the scope of the parties' agreement to arbitrate. In so
doing, we must be cognizant of the Act's federal policy favor-
ing arbitration agreements:

       The Arbitration Act establishes that, as a matter of
       federal law, any doubts concerning the scope of arbi-
       trable issues should be resolved in favor of arbitra-
       tion, whether the problem at hand is the construction
       of the contract language itself or an allegation of
       waiver, delay, or a like defense to arbitrability.

Moses H. Cone Mem'l Hosp. v. Mercury Constr. Corp., 460
U.S. 1, 24-25 (1983). Accordingly, "[o]ur role is strictly lim-
ited to determining arbitrability and enforcing agreements to
arbitrate, leaving the merits of the claim and any defenses to
the arbitrator." Republic of Nicaragua, 937 F.2d at 478.

[4] The record here leaves little doubt that the dispute is
subject to arbitration, and Ortho does not seriously challenge
this point. The parties' arbitration clause is broad and far
reaching: "Any dispute, controversy or claim arising out of or
relating to the validity, construction, enforceability or perfor-
mance of this Agreement shall be settled by binding Alternate
Dispute Resolution ("ADR") in the manner described below."
In general terms, the current dispute centers on whether Ortho
violated certain provisions of the joint agreement or the
implied covenant of good faith and fair dealing by allegedly
refusing to consider the proposed amendment to the 1997 and
1998 plans and budgets. Resolution of the dispute would
require an analysis of the specific provisions of the Agree-
ment as well as an evaluation of evidence relating to the
alleged breach. The dispute unquestionably arises out of or
relates "to the construction, enforceability or performance" of
the Agreement and therefore falls within the parties' agree-
ment to arbitrate. Accordingly, as the FAA "leaves no place
for the exercise of discretion by a district court .. . . [,]" the
district court was correct in finding that the dispute is arbitra-
ble. Dean Witter, 
470 U.S. at 218
.

II. Arbitrability of Res Judicata Defense

[5] Recognizing that the dispute itself is subject to arbitra-
tion, Ortho attempts to shift the debate by arguing that, unlike
a determination on the merits of a claim, the defense of res
judicata is not arbitrable. Whether Ortho's res judicata objec-
tion to Chiron's claims is itself arbitrable also raises the sepa-
rate issue of who determines the preclusive effect of an earlier
arbitration award, the court or the arbitrator. Chiron counters
that a res judicata defense goes to the merits of the dispute
and is thus arbitrable under the broad terms of the parties'
arbitration agreement. Ortho, on the other hand, points out
that the district court entered judgment upon the arbitration
award as provided for by S 9 of the Act. Relying on cases
from other circuits, Ortho argues that because courts generally
determine the preclusive effect of a court judgment on a sub-
sequent court proceeding, the court rather than an arbitrator
should reach the merits of its res judicata objection. We
address each argument in turn.

[6] The simplest answer to Ortho's argument is to look
once again at the parties' agreement, which requires arbitra-
tion of "any" dispute. Nowhere is the defense of res judicata
treated differently or singled out for exclusion. Rather,
Ortho's argument to treat res judicata as a special case
appears premised on the notion that the court will make a bet-
ter decision than the arbitrator or that it is somehow unfair to
leave this issue to an arbitrator. We need not go down that
path. Ortho already opted to arbitrate all disputes arising
under the Agreement and this election was not a casual one,
evidenced by not only an unambiguous arbitration clause, but
also by the negotiated, detailed, and extensive procedures for
alternate dispute resolution that were included in the joint
business agreement.

[7] The question of whether Ortho's res judicata defense to
arbitration is itself an arbitrable issue is bound up with the
question of who should make such a determination. Although
we have not had previous occasion to consider this issue, we
find the Second Circuit's analysis persuasive: a res judicata
objection based on a prior arbitration proceeding is a legal
defense that, in turn, is a component of the dispute on the
merits and must be considered by the arbitrator, not the court.
See National Union Fire Ins. Co. v. Belco Petroleum Corp.,
88 F.3d 129 (2d Cir. 1996); see also John Hancock Mutual
Life Ins. Co. v. Olick, 151 F.3d 132 (3d Cir. 1998) (holding
res judicata objection based on prior arbitration is issue to be
arbitrated under National Association of Securities Dealers
arbitration procedures).

In the case before the Second Circuit, Belco objected to
National Union's petition to compel arbitration on grounds
similar to those raised by Ortho, namely that the preclusive
effect of a prior arbitration award must be determined by the
court, not the arbitrator. Belco argued that its preclusion
defense did not require an interpretation of the arbitration
agreement and thus fell outside the scope of "arbitrable"
issues. The court disagreed:

       The preclusion issue is not . . . a disagreement over
       "whether [the parties] agreed to arbitrate the merits"
       of their dispute. Belco's claim of preclusion is a
       legal defense to National Union's claim. As such, it
       is itself a component of the dispute on the merits.
       Belco's attempt to characterize the preclusion issue
       as not related to the merits is unavailing. It is as
       much related to the merits as such affirmative
       defenses as a time limit in the arbitration agreement
       or laches, which are assigned to an arbitrator under
       a broad arbitration clause similar to the one [here].

Belco, 88 F.3d at 135-36 (citations omitted).

Belco is directly on point -- it addresses who determines
the effect of a prior arbitration award on a subsequent demand
for arbitration. Ortho's reminder that the doctrine of res judi-
cata serves to avoid future litigation of the same dispute side-
steps the issue of who decides the res judicata issue in these
circumstances. Ortho's further suggestion that sending the
matter to arbitration is somehow unfair because it will be liti-
gating the same matter twice assumes that Ortho is correct in
its comparison of the claims between the first arbitration and
this one. This bootstrap approach does not further the debate
of who should determine res judicata and, in any event, we
need not address this issue as it falls within a merits analysis
that is subject to arbitration under the parties' agreement.

Ortho urges us to ignore the Belco rationale and, alterna-
tively, look to other provisions of the FAA to support its posi-
tion that the court should reach the merits of its res judicata
defense. Pursuant to Ortho's request, the district court entered
judgment upon the arbitration award under S 13 of the FAA.
Citing cases from other circuits,1 Ortho argues that because
S 13 treats an arbitration judgment the same as a court judg-
ment, the court should determine its preclusive effect.

By its terms, the Agreement provides that "[a]ny judgment
upon the award rendered by the neutral may be entered in any
court having jurisdiction thereof." The FAA, in turn, permits
any party to an arbitration to petition the court for an order
confirming the award. See 9 U.S.C. S 9. The resultant judg-
ment "shall have the same force and effect, in all respects, as,
and be subject to all the provisions of law relating to, a judg-
ment in an action." 9 U.S.C. S 13. Relying on the language of
the statute, Ortho argues that we must treat the district court's
confirmation of the arbitration award as if it were a judgment
rendered in a judicial proceeding. This approach, however,
begs the question because the statute says nothing about
which forum or who determines the effect of the judgment.
Moreover, it obscures the fact that while a judgment entered
upon a confirmed arbitration award has the same force and
effect under the FAA as a court judgment for enforcement
purposes, it is not wholly parallel to a court judgment for all
purposes.

Indeed, there are fundamental differences between con-
firmed arbitration awards and judgments arising from a judi-
cial proceeding. Absent an objection on one of the narrow
grounds set forth in sections 10 or 11,2  the Act requires the
court to enter judgment upon a confirmed arbitration award,
without reviewing either the merits of the award or the legal
basis upon which it was reached. A judgment upon a decision
or order rendered by the court at the conclusion of a judicial
proceeding, by contrast, confirms the merits of that decision.
Along the same lines, a judgment under S 13 of the FAA is
not subject to Federal Rules of Civil Procedure 59 or 60
whereas a judgment arising from a judicial proceeding is sub-
ject to reopening and challenge under those rules. 3 And,
unless the provisions of the parties' agreement provides to the
contrary, there is no right under the FAA to appeal the merits
of a confirmed arbitration award. In sum, a judgment upon a
confirmed arbitration award is qualitatively different from a
judgment in a court proceeding, even though the judgment is
recognized under the FAA for enforcement purposes.

Even were we to accept Ortho's position that S 13 requires
us to treat a confirmed arbitration award as a court judgment
for all purposes, the primary cases on which Ortho relies are
distinguishable in that both involved the court determining the
res judicata effect of its own prior judgment on a subsequent
arbitration proceeding. See In re Y&A Group Sec. Litig., 38
F.3d 380 (8th Cir. 1994); Kelley v. Merrill Lynch, Pierce,
Fenner & Smith, Inc., 985 F.2d 1067 (11th Cir. 1993). In In
re Y&A, for example, the Eighth Circuit premised its holding
on the court's inherent authority to defend its own judgments
as res judicata, a power the court found to include the author-
ity to enjoin or stay subsequent arbitration proceedings: "[t]he
district court, and not the arbitration panel, is the best inter-
preter of its own judgment." In re Y&A Group , 38 F.3d at
383. The Eleventh Circuit similarly relied on this rationale,
noting that "[c]ourts should not have to stand by while parties
re-assert claims that have already been resolved. " Kelly, 985
F.2d at 1069. This justification rests on the presumption that
the court issuing the original decision is best equipped to
determine what was considered and decided in that decision
and thus what is or is not precluded by that decision. The pol-
icy underlying these decisions is not served in this case, how-
ever, when the district court merely confirmed the decision
issued by another entity, the arbitrator, and was not uniquely
qualified to ascertain its scope and preclusive effect. Nor do
these cases take into consideration the FAA's policy limiting
the role of the court once arbitrability is determined.
Like the agreement in Belco, Chiron and Ortho's arbitration
agreement is undeniably broad. Ortho's res judicata defense
to a subsequent arbitration proceeding necessarily involves an
inquiry into Chiron's underlying claims. As with other affir-
mative defenses4 such as laches and statute of limitations, we
agree with the Second Circuit that a res judicata defense is a
"component" of the merits of the dispute and is thus an arbi-
trable issue.

CONCLUSION

The court's role under the Federal Arbitration Act is lim-
ited to enforcing the agreement to arbitrate between Chiron
and Ortho. Their broad arbitration clause binds them to arbi-
trate "any dispute, controversy or claim arising out of or relat-
ing to" the Agreement. Because Ortho's res judicata objection
to Chiron's petition to compel arbitration is intertwined with
the merits of the dispute, it too falls within the scope of the
agreement to arbitrate. Accordingly, we AFFIRM the district
court's order to compel arbitration.
_______________________________________________________________

FOOTNOTES

1 See In re Y&A Group Sec. Litig. , 38 F.3d 380 (8th Cir. 1994); Kelley
v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 985 F.2d 1067 (11th Cir.
1993); Miller Brewing Co. v. Fort Worth Distrib. Co., Inc., 781 F.2d 494
(5th Cir. 1986); see also Miller v. Runyon, 77 F.3d 189, 193-94 (7th Cir.
1996) (discussing issue and collecting cases).
2 Sections 10 and 11 permit a district court to vacate or modify an arbi-
tration award under limited circumstances unrelated to the merits. For
example, a court may vacate an award procured by corruption, fraud or
undue means or rendered by a partial or corrupt arbitrator. See 9 U.S.C.
S 10(a)(1), (2). Also, a court may modify an award to correct an obvious
material miscalculation of figures or an imperfection in matter of form not
affecting the merits. See 9 U.S.C. S 11(a), (c).
3 Rules 59 and 60 permit a court to reconsider and amend its own judg-
ments in certain situations. Rule 59 authorizes the court to amend a judg-ment in the context of a motion for new trial, whereas Rule 60 governs
amendments that arise from clerical mistakes or from the court's decision
to relieve a party from a judgment on one of several specified grounds.
4 For guidance in characterizing res judicata and other defenses, we look
to Rule 8(c) of the Federal Rules of Civil Procedure, which requires par-
ties to affirmatively plead a res judicata defense, as well as eighteen other
enumerated defenses and a catch-all provision, including estoppel, laches,
and statute of limitations.

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