Cytyc Corporation v. Deka Products

United States Court of Appeals
For the First Circuit

No. 05-2371

CYTYC CORPORATION,

Plaintiff, Appellant,

v.

DEKA PRODUCTS LIMITED PARTNERSHIP,

Defendant, Appellee.

APPEAL FROM THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF MASSACHUSETTS

[Hon. William G. Young, U.S. District Judge]

Before

Selya, Lynch and Lipez, Circuit Judges.

Matthew M. Wolf, with whom Marc A. Cohn, Howrey LLP, Lisa
J. Pirozzolo, Steven P. Lehotsky, and Wilmer Cutler Pickering Hale
and Dorr LLP were on brief, for appellant.
Lee Carl Bromberg, with whom Eric Paul Belt and Bromberg &
Sunstein LLP were on brief, for appellee.

March 1, 2006
 SELYA, Circuit Judge. Judicial review of arbitration

awards is extremely narrow. As a result, "disputes that are

committed by contract to the arbitral process almost always are won

or lost before the arbitrator." Teamsters Local Union No. 42 v.

Supervalu, Inc., 212 F.3d 59, 61 (1st Cir. 2000). This case is no

exception to that general rule. Because the losing party,

appellant Cytyc Corporation (Cytyc), has failed to establish any

legally cognizable basis for setting aside the arbitrators' award,

we uphold the district court's order granting the confirmation

motion filed by the prevailing party, appellee DEKA Products

Limited Partnership (DEKA).

I. BACKGROUND

Cytyc manufactures and sells a cervical cancer screening

system. DEKA operates a commercial research and development

laboratory. In the late 1980s, Cytyc endeavored to improve the

accuracy of the traditional Pap smear test — a test that relies on

technicians to prepare a microscope slide from each cervical cell

sample and then review the specimen for irregularities. Due to

human error, this methodology yields a relatively high incidence of

false negatives. Cytyc proposed to solve that problem by using a

computer imager to prescreen the slide specimens.

During the developmental phase of this project, Cytyc

encountered a potentially insuperable obstacle: its imaging

technology could accurately screen a thin, uniform layer of cells,

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but the slide specimens prepared by human technicians were often

disuniform. Desirous of obtaining standardized slide specimens,

Cytyc retained DEKA to create an automated process for transferring

cells from a test sample onto a slide.

DEKA successfully developed such a process (the ThinPrep

system). This system consists of two components. The first is the

ThinPrep processor — a machine that transfers the cells onto the

slide. The processor utilizes technology patented by DEKA prior to

its association with Cytyc. This body of knowledge is known as

fluid management system (FMS) technology. The second component of

the ThinPrep system is a set of four disposable accessories: a

microscope slide, a sample collection device manufactured by a

third party, a vial of Cytyc's patented preservative solution, and

a filter cylinder invented specifically for use in the ThinPrep

system. While the ThinPrep system employs a number of products and

processes, its sine qua non is the FMS technology.

In March of 1993, Cytyc and DEKA entered into a licensing

agreement (the Agreement) relative to the ThinPrep system. The

Agreement recited that DEKA, by means of the FMS technology, had

developed a "method and apparatus . . . to facilitate the

preparation of slides for medical and laboratory purposes" and

wished to license the FMS technology to Cytyc for use in the

ThinPrep system. In exchange for this license, Cytyc agreed to pay

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DEKA a royalty "equal to One Percent . . . of the Net Sales of

Products or Improvements" covered by the Agreement.

By its terms, the Agreement divided royalty-bearing

"Products" into two categories: "Product Hardware" and "Product

Disposables." "Product Hardware" meant, in effect, the ThinPrep

processor (we do not dwell on this, as there is no dispute between

the parties concerning royalty payments related to hardware).

"Product Disposables" comprised "any filter cylinder or similar

disposable provided such disposable utilizes the Cytyc Technology,

the FMS Technology or both." The Agreement noted somewhat

cryptically that the term "Product Disposable[s] presently includes

[the filter cylinder]."

Although the ThinPrep system functioned well, Cytyc

struggled to perfect its imaging technology. Finally, it began to

market the ThinPrep system without the computer imager. At some

point, Cytyc developed a special microscope slide for use in the

ThinPrep system and started to sell it, along with the other three

disposable accessories, in a single bundle called the ThinPrep kit.

The ThinPrep kit became a rousing commercial success, and Cytyc

emerged as a leader in the market for cervical cancer screening

systems.

For some period of time, Cytyc made quarterly royalty

payments to DEKA pursuant to the Agreement. In November of 2001,

however, Cytyc notified DEKA of its belief that, for an earlier

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three-year period, it had calculated DEKA's royalties too

generously. In staking out this position, Cytyc posited that the

Agreement entitled DEKA to royalties only on sales of the filter

cylinder and not on sales of the other three disposable accessories

included in the ThinPrep kit. Cytyc further informed DEKA that,

consistent with this reading of the Agreement, it had computed the

royalties referable to filter cylinder sales in accordance with the

relative cost of the kit components (the relative cost ratio

method). DEKA disputed both Cytyc's overpayment claim and its

method for figuring royalties. In DEKA's view, the Agreement

required Cytyc to pay a flat one percent royalty on net sales of

all disposable accessories.

The parties attempted on at least two occasions to

resolve their differences. At one such meeting, Cytyc's chief

financial officer threatened that if DEKA continued to resist

Cytyc's royalty calculation method, he would "manipulate" the cost

data and suppress future royalties.

The Agreement gave DEKA the right to commission an

independent audit of Cytyc's books should questions arise about the

amount of royalty payments due. When the parties' negotiations

stalled, DEKA exercised this prerogative. The final audit report

covered the period from January of 1996 through September of 2002.

The auditors described Cytyc's relative cost ratio method of

calculating royalties as "unusual and uncommon" and found that,

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even under this unorthodox approach, Cytyc had underpaid DEKA. The

auditors further concluded that if the Agreement required the

payment of royalties on the net sales of all disposable accessories

contained in the ThinPrep kits, the amount of the underpayment

would exceed $4,000,000 for the audit period alone.

The Agreement stipulated that disputes between the

parties would be subject to binding arbitration. Armed with the

audit report, DEKA served a demand for arbitration. It claimed,

inter alia, that Cytyc had breached the Agreement by failing to pay

royalties on the net sales of all the disposable accessories or,

alternatively, by allocating royalties referable to the filter

cylinder based on the relative cost ratio method.

A three-member arbitration panel held an evidentiary

hearing that focused on the interpretation of the term "Product

Disposables" and the appropriate method for calculating DEKA's

royalties. The parties' positions were in sharp contrast. On the

one hand, DEKA maintained that the term "Product Disposables"

included any and all disposable accessories that used the Cytyc or

FMS technology in the creation of a sample slide (a reading that,

in effect, mandated the payment of royalties with respect to sales

of all four disposable accessories bundled in the ThinPrep kit).

DEKA also asserted that royalties should be gauged by the net

sales, rather than the relative costs, of the kit components. On

the other hand, Cytyc argued that the term "Product Disposables"

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covered only the filter cylinder, not the other three disposable

accessories bundled in the ThinPrep kit, and that royalties should

be computed by using the relative cost ratio method.

To bolster its position, Cytyc proffered two kinds of

adscititious evidence. The first was a set of three letters

between the parties, exchanged prior to the execution of the

Agreement, which purported to document an intent to exclude sales

of Cytyc's preservative solution from DEKA's royalty base. The

second comprised testimonial and documentary evidence suggesting

that, over a period of years, Cytyc had disclosed its use of the

relative cost ratio method to DEKA without eliciting any objection.

Shortly after the conclusion of the hearing, one of the

arbitrators died. In March of 2005, the remaining two arbitrators

issued a partial final award (the PFA). The Agreement provided

that New Hampshire law would be controlling and, in the PFA, the

arbitrators ruled that the New Hampshire statute of limitations

barred DEKA's breach of contract claim for periods prior to

November 17, 2000. As to subsequent periods, the linchpin of the

arbitrators' decision was a finding that:

FMS Technology is a system; it is not a
specific product. It is the operation of a
system on certain components. In this
particular situation the components are the
four units . . . : the filter, the collection
device, the vial and the slide. . . . [T]hese
units . . . are worthless by themselves, but
when put together and governed by this
patented system, the FMS technology, [they]
become[] enormously valuable.

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The arbitrators coupled this finding with two other findings: that

the FMS technology was the "key" component of the ThinPrep system

and that the four disposable accessories were "integrated by design

and function in order to work."

After making these findings, the arbitrators addressed

the contested contractual provision:

The phrase "or similar disposable provided
such disposable utilizes the Cytyc Technology,
the FMS Technology or both" cannot be read to
be restricted to only the filter. The very
next sentence, which reads "Product
Disposable[s] presently includes [the filter
cylinder]," must mean that the term
"Disposables" includes the other disposables
in the Kit and any improvements or
modifications.

In line with this parsing of the Agreement's text, the arbitrators

determined that Cytyc's relative cost ratio method for figuring

royalties was "contrary to the [A]greement" and that "the parties

never intended that royalties would be paid on parts of the Kit

rather tha[n] the Kit as a whole." Based on these serial

determinations and the plain language of the Agreement, the

arbitrators concluded that the term "Product Disposables" covered

all four of the disposable accessories bundled in the ThinPrep kit

and, accordingly, that the Agreement entitled DEKA to royalties on

the proceeds derived from the net sales of the kits.

Although the PFA resolved the central issues in dispute,

the panel believed that it could not make an accurate calculation

of DEKA's damages on the record as it stood. Consequently, the

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arbitrators ordered the parties to submit proposed damage

computations within twenty-five days and authorized them to

supplement the record to the extent necessary to buttress these

computations.

The parties submitted widely disparate damage estimates.

In large part, that disparity arose because Cytyc claimed a right

to offset DEKA's royalties by deducting commissions allegedly paid

on the sales of ThinPrep products, whereas DEKA argued that, in the

language of the Agreement, Cytyc was entitled to deduct only those

commissions that were "actually stated on a customer invoice."

In their ensuing final award, the arbitrators once again

sided with DEKA. They found that "[t]he only customer invoices in

the record are devoid of any . . . statement of commissions."

Largely for that reason, the arbitrators' final award set DEKA's

damages in the amount of $7,524,168, plus interest of $563,645 —

amounts that pretty much tracked what the panel characterized as

the "persuasive" calculations made by DEKA's accountants. The

arbitrators also ordered Cytyc to bear the expenses of both the

audit and the arbitration, and to reimburse DEKA $1,000,000 for

attorneys' fees and costs.

Having lost at virtually every turn, Cytyc asked the

district court to vacate the arbitral award. DEKA cross-moved for

confirmation of the award. Ruling ore sponte, the district court

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rejected Cytyc's importunings and granted DEKA's motion. This

timely appeal followed.

II. DISCUSSION

On appeal, Cytyc asseverates that the arbitrators (i)

neglected to interpret the Agreement or, alternatively, devised an

interpretation that was unfounded in reason and fact (and, thus,

that failed to draw its essence from the Agreement); (ii)

manifestly disregarded applicable New Hampshire law; and (iii)

refused to consider material evidence referable to the issue of

damages.1 After limning the applicable standard of review, we

address each of these asseverations.

A. Standard of Review.

In an action to vacate or confirm an arbitral award, we

typically review the district court's decision de novo.2 See,

e.g., Supervalu, 212 F.3d at 65. The authority of a federal court

to disturb an arbitration award is tightly circumscribed. While

1
In its opening brief, Cytyc hinted at additional challenges
based on the untimely death of the third panel member, the interest
calculation, and the award of attorneys' fees. Because Cytyc
failed to develop these embryonic arguments, we treat them as
stillborn. See United States v. Zannino, 895 F.2d 1, 17 (1st Cir.
1990) (explaining that "issues adverted to in a perfunctory manner,
unaccompanied by some effort at developed argumentation, are deemed
waived").
2
The standard of review may be more nuanced where the district
court has conducted an evidentiary hearing and made findings of
fact. See First Options of Chi., Inc. v. Kaplan, 514 U.S. 938,
947-48 (1995). The district court made no such findings in this
case.

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the award must "draw its essence from the contract" that underlies

the arbitration proceeding, courts will deem that benchmark

achieved as long as the arbitrators are "even arguably construing

or applying the contract and acting within the scope of [their]

authority." United Paperworkers Int'l Union v. Misco, Inc., 484

U.S. 29, 38 (1987). That a reviewing court is convinced that the

arbitrators committed error — even serious error — does not justify

setting aside the arbitral decision. Id. This remains true

whether the arbitrators' apparent error concerns a matter of law or

a matter of fact. Advest, Inc. v. McCarthy, 914 F.2d 6, 8 (1st

Cir. 1990).

None of this means, however, that arbitral awards are

utterly impregnable. Although courts "do not sit to hear claims of

factual or legal error by an arbitrator as an appellate court does

in reviewing decisions of lower courts," Misco, 484 U.S. at 38,

there are nevertheless a few exceptions to the general rule that

arbitrators have the last word. One set of exceptions is codified

in the Federal Arbitration Act (FAA). The operative provision,

section 10(a) of the FAA,3 authorizes vacatur only in cases of

3
The FAA authorizes a federal court to vacate an arbitral
award:

(1) Where the award was procured by
corruption, fraud, or undue means.
(2) Where there was evident partiality or
corruption in the arbitrators, or either of
them.
(3) Where the arbitrators were guilty of

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"specified misconduct or misbehavior on the arbitrators' part,

actions in excess of arbitral powers, or failures to consummate the

award." Advest, 914 F.2d at 8.

A second set of exceptions flows from the federal courts'

inherent power to vacate arbitral awards. See id. This authority

is very narrow. One manifestation of it, usually (but not

exclusively) associated with labor arbitration, arises when an award

contravenes the plain language of the applicable contract. See Bull

HN Info. Sys., Inc. v. Hutson, 229 F.3d 321, 330-31 (1st Cir. 2000)

(recognizing the applicability of this principle outside the labor

context). Another manifestation arises in those rare cases in which

it is clear from the record that the arbitrators cavalierly

disregarded applicable law. Advest, 914 F.2d at 9.

At the expense of carting coal to Newcastle, let us make

one thing perfectly clear. Despite the existence of these

misconduct in refusing to postpone the
hearing, upon sufficient cause shown, or in
refusing to hear evidence pertinent and
material to the controversy; or of any other
misbehavior by which the rights of any party
have been prejudiced.
(4) Where the arbitrators exceeded their
powers, or so imperfectly executed them that a
mutual, final, and definite award upon the
subject matter submitted was not made.

9 U.S.C. § 10(a). An additional provision of the FAA, 9 U.S.C. §
11, allows a federal court to correct "evident" and "material"
arithmetic or descriptive errors in arbitral awards. Cytyc has not
invoked section 11 here.

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exceptions, great deference remains the general mode of approach to

judicial review of arbitral awards. Id. at 8.

B. The Merits.

Against this backdrop, we turn to Cytyc's asseverational

array.

1. Misinterpretation of the Agreement. Cytyc's most

bruited contention is that the panel neglected to offer any

interpretation of the text of the Agreement or, alternatively, that

the panel's interpretation of the term "Product Disposables" is

unfounded in reason and fact (and thus, in either event, that the

arbitral award fails to draw its essence from the Agreement). If

either part of that binary charge were correct, vacation would be

an appropriate remedy. See Misco, 484 U.S. at 38. Cytyc, however,

has failed to carry its heavy burden of substantiating the charge.

Cytyc's claim that the panel neglected to interpret the

Agreement is jejune. We must uphold the arbitrators' decision as

long as they were even "arguably" construing the Agreement. Id.

That standard is abundantly satisfied here. The panel's decision

(portions of which are quoted above) makes manifest that the

arbitrators pondered the pertinent language of the Agreement and

construed that language in accordance with the parties' discernible

intent. That is contract interpretation, pure and simple. See

Robbins v. Salem Radiology, 764 A.2d 885, 887 (N.H. 2000) (holding

that, in reviewing a contract, a court must give the language "the

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interpretation that best reflects the parties' intentions" at the

time of contracting).

Cytyc's more robust claim is that the arbitrators'

interpretation of the Agreement was flawed. Even under the highly

deferential standard that constrains judicial review of arbitral

awards, the moving party may establish entitlement to vacation of

an arbitral award on a persuasive showing that the arbitrators'

interpretation is contrary to the plain language of the contract.

Bull HN Info. Sys., 229 F.3d at 330-31; Advest, 914 F.2d at 9. This

configuration requires the movant to demonstrate that the award is

"(1) unfounded in reason and fact; (2) based on reasoning so

palpably faulty that no judge, or group of judges, ever could

conceivably have made such a ruling; or (3) mistakenly based on a

crucial assumption that is concededly a non-fact." Advest, 914 F.2d

at 8-9 (citations and internal quotation marks omitted).

In this case, the plain language of the Agreement, when

coupled with the arbitrators' factual findings, easily sustains the

interpretation upon which the award rests. The Agreement defines

"Product Disposables" as "any filter cylinder or similar disposable

provided such disposable utilizes the Cytyc Technology, the FMS

Technology or both." In what necessarily amounted to an explication

of this provision, the panel supportably found that the FMS

technology pervades the entire ThinPrep system and that the four

disposable accessories are "systematically integrated" into that

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system "by design and function." With certain exceptions (none

relevant here), we are duty-bound to give effect to an arbitrator's

findings of fact. Mercy Hosp., Inc. v. Mass. Nurses Ass'n, 429 F.3d

338, 344 (1st Cir. 2005). Doing so, we hold that the panel's

finding that the term "any similar disposable [which] utilizes the

Cytyc [or] FMS Technology" captures all the disposable accessories

in the ThinPrep kit was not plainly erroneous, much less so

unfounded in reason and fact as to justify judicial correction.

Cytyc's contrary argument relies heavily on

correspondence which, it maintains, establishes the parties' shared

intention to include only sales of filter cylinders in DEKA's

royalty base. These letters cannot carry the weight that Cytyc

loads upon them.

In the first place, the arbitrators' interpretation —

with or without the letters — does not appear to be strained or

chimercial. By its terms, the Agreement did not exclude any

disposable accessory from the definition of "Product Disposables"

and DEKA presented evidence that, early in the parties' course of

dealing, Cytyc included the sales of all the disposable accessories

in DEKA's royalty base.

Moreover, the letters, even if taken at face value, are

far from dispositive. This is especially so since DEKA adduced

evidence that any informal agreement to exclude sales of the

preservative solution from the royalty base only covered sales of

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the solution unrelated to the ThinPrep system. This proof comported

with documentation indicating that, at the time the parties executed

the Agreement, Cytyc had not decided whether to sell the filter

cylinder individually or in combination with the other disposable

accessories.

In the second place, Cytyc asks us to draw an inference,

based on nothing more than the panel's omission of any direct

reference, that the arbitrators neglected to consider the letters.

This is whistling past the graveyard. Arbitrators are not required

to provide particularized reasons for their decisions. See Raytheon

Co. v. Automated Bus. Sys., Inc., 882 F.2d 6, 8 (1st Cir. 1989).

It follows that an arbitrator's failure to comment upon a specific

piece of evidence cannot support an inference that he failed to

consider it. See Nat'l Cas. Co. v. First State Ins. Group, 430 F.3d

492, 498-99 (1st Cir. 2005).

Third, and finally, the parties exchanged the

correspondence in question months before the execution of the

Agreement. When signed, the Agreement itself not only omitted any

mention of excluding sales of Cytyc's preservative solution from

DEKA's royalty base but also contained an integration clause.4 Under

4
The clause provided in relevant part:

This Agreement constitutes the entire
understanding of the parties with respect to
the subject matter hereof and supersedes all
prior understandings and writings relating
thereto.

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such circumstances, the arbitrators were not compelled to use the

letters to vary the apparent meaning of the Agreement. Cf. Richey

v. Leighton, 632 A.2d 1215, 1217 (N.H. 1993) (holding that even

where a contract is not completely integrated, "parol evidence is

admissible only to prove unexpressed terms that are not inconsistent

with the writing").

Refined to bare essence, Cytyc's argument reduces to a

frontal attack on the merits of the arbitral award. Such an attack

is easily repulsed. It was the province of the arbitrators to

scrutinize the language of the Agreement, weigh the conflicting

evidence of the parties' intentions, and determine the dimensions of

DEKA's royalty base. See Major League Baseball Players Ass'n v.

Garvey, 532 U.S. 504, 509-10 (2001). Cytyc has advanced no sound

justification for us to tamper with the arbitrators' resolution of

those issues.

2. Manifest Disregard of the Law. An arbitrator, of

course, cannot intentionally flout the law. See First Options of

Chi., Inc. v. Kaplan, 514 U.S. 938, 942 (1995); Advest, 914 F.2d at

9. In its second assignment of arbitral error, Cytyc tries to

repackage its misinterpretation claim as a manifest disregard of the

law claim. It begins by citing evidence that, for a period of

years, DEKA never objected to Cytyc's calculation of royalties in

accordance with the relative cost ratio method. It then points to

a New Hampshire statute providing that, with respect to contract

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interpretation, "any course of performance accepted or acquiesced in

without objection shall be relevant to determine the meaning of the

agreement." N.H. Rev. Stat. Ann. § 382-A:2-208(1). With this

foundation in place, it blithely asserts that the panel must have

disregarded the statute. This assertion lacks force.

A party seeking to establish manifest disregard of the law

sufficient to warrant setting aside an arbitral award must

demonstrate that the arbitrators appreciated the existence and

applicability of a controlling legal rule but intentionally decided

not to apply it. Advest, 914 F.2d at 10. This tenet demands "some

showing in the record, other than the result obtained, that the

arbitrators knew the law and expressly disregarded it." Id.

(citation and internal quotation marks omitted).5

The record in this case contains no evidence that the

panel appreciated the applicability of the New Hampshire statute and

willfully ignored it. Indeed, it is hopelessly unclear whether this

provision, which appears in New Hampshire's version of Article 2 of

the Uniform Commercial Code, governs agreements to license patented

intellectual property. See N.H. Rev. Stat. Ann. § 382-A:2-102

5
In George Watts & Son v. Tiffany & Co., 248 F.3d 577 (7th
Cir. 2001), the Seventh Circuit held that the manifest disregard of
the law exception has been restricted to cases in which the
arbitral award either requires the parties to violate the law or
"does not adhere to the legal principles specified by contract, and
hence [is] unenforceable under § (10)(a)(4)" of the FAA. Id. at
581 (citing E. Assoc'd Coal Corp. v. UMW, Dist. 17, 531 U.S. 57
(2000)). We need not decide today whether the exception has been
limited to that extent.

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(stating that "this Article applies to transactions in goods").

Given these deficiencies in Cytyc's proffer, the arbitral award

cannot be said to have been rendered in manifest disregard of the

law.

3. Failure to Consider Material Evidence. In a last-

ditch effort to salvage its appeal, Cytyc takes issue with the

arbitrators' refusal to discount DEKA's damage award by the amount

of commissions allegedly paid on the sales of ThinPrep products.

Specifically, Cytyc avers that the panel failed to allow it to

introduce material evidence anent the deductibility of these

commissions and, thus, that the award must fail under 9 U.S.C. §

10(a)(3) (authorizing vacatur when arbitrators are "guilty of

misconduct . . . in refusing to hear evidence pertinent and material

to the controversy").

Cytyc's argument is vecordious. Notwithstanding ample

opportunity during the evidentiary hearing and before the issuance

of the PFA, Cytyc failed to produce any evidence relating to the

payment or deductibility of sales commissions. To cinch matters,

the panel afforded the parties a twenty-five day window after

announcing the PFA within which to augment the record with evidence

pertaining to the computation of damages. During that period, DEKA

specifically requested Cytyc to furnish "appropriate documentation"

substantiating its supposed payment of commissions and warned that

it would ask the arbitrators to disallow any commission not

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"actually stated on a customer invoice by Cytyc or [its]

affiliates," as required by the Agreement.

Cytyc spurned the opportunity afforded by the arbitrators

and turned a deaf ear to DEKA's warning; it produced neither a

single invoice reflecting a commission nor a shred of evidence

concerning the propriety of deducting unstated commissions. Given

these missed opportunities, Cytyc cannot now be heard to complain

that the panel followed the letter of the Agreement, refused to

consider non-existent extrinsic evidence, and rejected Cytyc's

damage computation. Arbitrators are, after all, not expected to be

mind readers.6

III. CONCLUSION

We need go no further. For the reasons elucidated above,

we hold that Cytyc has failed to identify any legally cognizable

basis for vacating the arbitral award. Accordingly, we uphold the

district court's order of confirmation.

Affirmed.

6
To be sure, Cytyc did make a motion for reconsideration after
the arbitrators handed down their final award. In that motion, it
promised to present expert evidence bolstering its theory of
deductibility. This was clearly too little and too late, and we
cannot fault the arbitrators for summarily denying the motion.

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