PUBLISHED

UNITED STATES COURT OF APPEALS

FOR THE FOURTH CIRCUIT

GALLUS INVESTMENTS, L.P.,

Plaintiff-Appellee,

v.

PUDGIE'S FAMOUS CHICKEN, LIMITED,

Defendant-Appellant,

No. 97-1706

and

PUDGIE'S CHICKEN, INCORPORATED;

STEVEN M. WASSERMAN; HENRY A.

GUINN; MIKE J. BEARSS,

Defendants.

Appeal from the United States District Court

for the Eastern District of Virginia, at Alexandria.

Albert V. Bryan, Jr., Senior District Judge.

(CA-95-890-A)

Argued: October 28, 1997

Decided: January 13, 1998

Before WILKINS and MICHAEL, Circuit Judges, and

CAMPBELL, Senior Circuit Judge of the United States Court of

Appeals for the First Circuit, sitting by designation.

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Affirmed by published opinion. Senior Judge Campbell wrote the

opinion, in which Judge Wilkins and Judge Michael joined.

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COUNSEL

ARGUED: Stanley Steven Zinner, GREEN & ZINNER, P.C., White

Plains, New York, for Appellant. Michael Lee Sturm, WILEY, REIN
& FIELDING, Washington, D.C., for Appellee. ON BRIEF: Thomas

W. Queen, WILEY, REIN & FIELDING, Washington, D.C., for

Appellee.

_________________________________________________________________

OPINION

CAMPBELL, Senior Circuit Judge:

Pudgie's Famous Chicken, Ltd., appeals from the district court's

confirmation of an arbitration panel's award to Gallus Investments,

L.P. As basis for this appeal, Pudgie's challenges the arbitration

panel's consideration of evidence allegedly forming part of a settlement offer that Pudgie's made to Gallus during the litigation. The

admission of this evidence was improper, according to Pudgie's,

because the parties' franchise agreement specified the applicability of

New York law, and New York law generally bars the admission of

settlement offers. Moreover, according to Pudgie's, the admission of

this evidence denied it a fundamentally fair hearing. Disagreeing, we

affirm.

I. Background

The facts are largely undisputed. This case arose from a failed business venture between Defendant-Appellant Pudgie's Famous

Chicken, Inc. ("Pudgie's"), a franchiser of take-out chicken restaurants, and Gallus Investments, L.P. ("Gallus"). Gallus and Pudgie's

signed a franchise agreement that allowed Gallus to develop Pudgie's

restaurants in several Virginia counties. That agreement contained

two clauses at issue here: an arbitration clause and a choice-of-law

clause specifying that the contract was governed by New York law.

The arbitration clause covered "any dispute with respect to either

this Agreement or the adequacy of either party's performance thereunder," and stated that "arbitration shall be conducted in accordance

with the rules promulgated by the American Arbitration Association."

The AAA's Commercial Arbitration Rule 31 provided that "[t]he parties . . . shall produce such evidence as the arbitrator may deem necessary to an understanding and determination of the dispute," and that

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"[t]he arbitrator shall be the judge of the relevance and materiality of

the evidence offered, and conformity to legal rules of evidence shall

not be necessary."

When the venture failed, Gallus brought the instant diversity-ofcitizenship action against Pudgie's. Gallus alleged that Pudgie's and

its officers, also defendants here, had misrepresented the success of

past Pudgie's franchises. Such misrepresentations were actionable

under the New York Franchise Sales Act, N.Y. Gen. Bus. Law §§ 687

& 691. Pursuant to the franchise agreement, the district court referred

the case to arbitration.

On the sixteenth day of the eighteen-day arbitration, Gallus proffered the evidence that is at issue here. The documents in question

were letters exchanged between the parties' lawyers showing that

Pudgie's offered to pay back the $750,000 in expenses that Gallus had

expended on the franchise agreement. Some of these letters were

marked "Submitted for Settlement Discussion Purposes Only." Over

Pudgie's objection, the all-attorney arbitration panel received the documents. Gallus then introduced several other documents providing its

version of the $750,000 offer.

The panel decided in favor of Gallus, awarding it a total of

$1,706,704 in compensatory damages and attorneys' fees. The district

court confirmed the arbitration award, and this appeal followed.

II. Discussion

In the district court and in this appeal, Pudgie's argues that the

panel committed a serious error by considering the evidence of settlement offers. Pudgie's first contends that the panel was bound to follow New York's rules of evidence barring the admissibility of

settlement offers, in which event, Pudgie's says, the documents in

question would not have been admitted.

However, while the franchise agreement's choice-of-law clause

specified New York law, the agreement's arbitration clause is equally

clear that conformity to legal rules of evidence was unnecessary. The

plain language of the agreement provided that disputes between the

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parties would be arbitrated in accordance with AAA rules, and those

rules expressly provided that the arbitrators need not apply judicial

rules of evidence.

Despite the arbitration clause's plain language, Pudgie's contends

that to ignore the New York evidence rule would vitiate the parties'

contractual choice of New York law. However, to force the panel to

apply New York's (or any other) evidentiary rules would be to reject

the parties' agreement that legal evidentiary rules need not be followed. Fortunately, there is no necessary conflict between the choiceof-law provision and the arbitration clause. The two clauses can easily

be reconciled if interpreted to mean that New York law governs the

parties' contractual rights and duties, and that the panel is free not to

apply legal rules of evidence from any jurisdiction, New York or elsewhere. Such a reading gives effect to the arbitration clause while in

no way undermining the choice-of-law provision.

Our reading is consistent with the Supreme Court's approach in

Mastrobuono v. Shearson Lehman Hutton, Inc., 514 U.S. 52 (1995).

There, the Court considered a contract that, like the one between Pudgie's and Gallus, provided for both arbitration and the parties' choice

of law. The Mastrobuono Court upheld the arbitration panel's award

of punitive damages despite the fact that the state law prescribed by

the contract's choice-of-law provision did not provide for punitive

damages (and even though the arbitration clause itself was also silent

on the subject of punitive damages). As the Court explained, "the

choice of law provision covers the rights and duties of the parties,

while the arbitration clause covers arbitration." 514 U.S. at 64. Here,

the admissibility of settlement offers falls even more plainly on the

"arbitration" side, as it is a subject controlled by evidentiary rules

expressly exempted from enforcement under the arbitration clause.

We hold, therefore, that the parties' choice-of-law agreement did not

preclude the panel from receiving and considering the evidence in

question.

Pudgie's insists, nonetheless, that the arbitrators' willingness to tolerate the use of evidence of settlement negotiations violated its right

to have a fundamentally fair arbitration, requiring a reversal on that

separate ground alone. We do not agree.

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As an initial matter, the legal basis of Pudgie's claim is not perfectly clear. Judicial review of an arbitration award is limited to the

grounds set out in § 10(a) of the Federal Arbitration Act, 9 U.S.C.

§ 10(a) (providing for vacatur of award based on, inter alia, "fraud,"

"corruption," "evident partiality," and"misconduct" on the part of the

arbitrators, and "[w]here the arbitrators exceeded their powers"),

and scrutiny for whether the award evinces a "manifest disregard"

of applicable law, Wilko v. Swan, 346 U.S. 427, 436-37 (1953),

overruled on other grounds, Rodriguez de Quijas v. Shearson/

American Express, Inc., 490 U.S. 477 (1989). Instead of specifying

one of these accepted grounds for vacatur, Pudgie's has chosen to

style its argument in terms of its right to a "fundamentally fair hearing" and "due process." We do not take these terms to connote a constitutional claim, as the arbitrators were not state actors for purposes

of the Fifth or Fourteenth Amendments. Rather, we read Pudgie's

argument to imply that the arbitrators, by admitting evidence of settlement offers, violated one or more unnamed provision of § 10(a),

resulting in a lack of "fundamental fairness" and "due process." Without greater specificity, this argument is more rhetorical than real. Still,

even assuming without deciding that, in some other imagined context,

an arbitrator's blatant use of settlement-offer evidence might be so

fundamentally unfair as to violate § 10, we find no such violation

here.

In the instant case, the arbitrators at no time broadly rejected the

policy against utilization of settlement evidence. Rather they narrowly

justified receipt of the documents in question because of their relevance to Gallus's claim to have mitigated damages by, among other

things, entering into negotiations with Pudgie's. The arbitrators

believed this limited use was not inconsistent with the principles forbidding the introduction of settlement evidence to establish liability.

Like judges in a bench trial, the arbitrators were presumably capable

of confining their use of evidence to the limited purpose for which

received. In any case, whether the arbitrators were right or wrong

under strict legal evidentiary standards, the use of these materials, in

the manner and context that appears, was plainly not"fundamentally

unfair," much less was it a violation of § 10. Accord, Bowles Fin.

Group, Inc. v. Stifel Nicolaus & Co., 22 F.3d 1010, 1013-14 (10th Cir.

1994) (rejecting fundamental-unfairness challenge to arbitrators' consideration of settlement offers).

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Finally, Pudgie's contends that if it becomes common knowledge

that arbitrators may feel free to consider settlement offers, this will

have a chilling effect on settlement negotiations in other cases, undermining one of the rationales for using alternative dispute resolution.

Especially given the limited use made here of these materials, this

contention seems obviously extreme. From what appears, the arbitrators had no intention of sabotaging the general rule, meaning to utilize

the documents only for a purpose believed to be consistent with it.

But even if they were mistaken, and have somehow widened the door

to use of such evidence, with unfortunate implications, any danger is

better corrected by arbitration associations and private parties than by

courts. Rules and contracts can be revised to restrict the use of settlement materials should those persons or groups directly concerned

with arbitrations decide that there is a reoccurring problem.*

AFFIRMED

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*Again, the legal basis for Pudgie's policy argument is unclear. Courts

have long refused to enforce contracts that contravene public policy, but

there is no "broad judicial power to set aside arbitration award as against

public policy." United Paperworkers Int'l Union v. Misco, Inc., 484 U.S.

29, 43 (1987). The Supreme Court has explained that vacatur of an award

on public policy grounds must be based on "explicit conflict with other

`laws and legal precedents' rather than an assessment of `general considerations of supposed public interests.'" Id. (quoting W.R. Grace & Co.

v. Rubber Workers, 461 U.S. 757, 766 (1983)). Since, as we have already

concluded, the panel followed all the laws applicable under the parties'

agreement, this line of argument is unavailing.

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