Vital Basics v. Vertrue Incorporated

United States Court of Appeals
For the First Circuit

No. 05-2741

IN RE: VITAL BASICS INCORPORATED,

Debtor.

VITAL BASICS INCORPORATED,

Appellant,

v.

VERTRUE INCORPORATED, F/K/A MEMBERWORKS, INCORPORATED,

Appellee.

APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MAINE

[Hon. George Z. Singal, U.S. District Judge]

Before

Lipez, Circuit Judge,
Stahl, Senior Circuit Judge,
and Howard, Circuit Judge.

Russell Beck, with whom Jeffery M. Rosin and Foley & Lardner
LLP were on brief, for appellant.
Steven M. Cowley, with whom Christopher P. Silva and Edwards
Angell Palmer & Dodge LLP were on brief, for appellee.

December 29, 2006
 STAHL, Senior Circuit Judge. Appellant Vital Basics,

Inc. (VBI) asks this court to vacate an arbitration panel award in

favor of appellee Vertrue Incorporated (Vertrue),1 and instead

order payment by Vertrue to VBI. Our review of an arbitration

award is exceedingly narrow, and VBI has not presented the

compelling evidence necessary to warrant a reversal of the

arbitration panel's decision. Therefore, we affirm the district

court's confirmation of the arbitration panel's award.

I. BACKGROUND

A. The Relevant Facts

VBI markets and sells nutritional and dietary supplements

directly to consumers. Vertrue sells membership programs that

provide consumers with discounts on health care and related

services. The two companies had a long-term marketing agreement

which operated in the following manner. When a customer called VBI

to order its products, the VBI phone operator would also attempt to

enroll the customer in one of Vertrue's membership programs.

Initially, VBI received a flat fee commission for each Vertrue

membership sold, whether or not the customer subsequently cancelled

the membership and received a full or partial refund. Under this

arrangement, Vertrue bore the entire risk of loss for customers who

purchased a membership and then, during the first year, cancelled

the membership and received a refund. On June 1, 2000, the parties

1
Vertrue was formerly known as MemberWorks.

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signed a new contract that continued the per-sale commission

arrangement. Subsequently, on June 25, 2001, the parties signed an

amendment to the contract that changed the commission scheme.

Under the new agreement, instead of receiving commissions on a per-

sale basis, VBI would earn commissions in two ways: (1) for

memberships that were renewed after one year (so-called "Renewal

Commissions"); and (2) for first-year memberships, on a retention-

contingent basis.

A central point of contention between the parties before

the arbitrators was how this second type of commission was to be

earned by VBI. More precisely, the parties disagreed as to whether

VBI was to earn a commission on so-called "Paid Cancels" --

memberships that were cancelled after thirty days but before one

year, meaning the customer received a partial refund, and Vertrue

retained a partial payment. Vertrue contended that the June 25th

amendment provided a commission to VBI only for memberships that

were retained for the full one-year period; in other words, VBI

would not earn a commission if a customer either cancelled and

received a full refund (which occurred if the customer cancelled

within 30 days), or cancelled and received a partial refund (which

occurred if the customer cancelled after 30 days but before one

year). In contrast, VBI contended that the amendment granted a

commission to VBI on Vertrue's net revenue; in other words, if a

customer cancelled after 30 days but before one year, and received

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only a partial refund, VBI would still earn a commission on the

portion of the membership fee retained by Vertrue.

In order to pay VBI a retention-based commission on a

monthly basis, the companies agreed to a complex accounting formula

whereby Vertrue would make monthly payments based on an estimate of

the percentage of subscriptions that would be retained for the

entire one-year subscription period. Every three months, the

actual retention numbers would be calculated and the companies

would "true up" the commission payments to better approximate the

actual retention rate. The contract set the initial projected

retention rate at 40 percent, subject to amendment if retention

proved to deviate from this percentage. Notably, the "true up"

system did not mention Paid Cancels, nor provide a mechanism for

calculating commissions based on Paid Cancels.

In 2003, Vertrue discovered that it had significantly

overpaid advance commissions to VBI by $3.8 million, because

retention rates had plummeted to about 25 percent. Using the "true

up" system, the overpayment amount was whittled down to $2.2

million by the time the dispute went to arbitration.

At the same time that the parties were negotiating a

solution to the overadvance problem, VBI was quietly developing its

own competing membership program, called the Omega Plan. VBI

launched the competing plan in August 2003, in violation of the

contract's exclusivity clause, which barred VBI from marketing or

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selling any competing membership program. Once VBI began selling

its Omega Plan, sales of Vertrue's membership plans slowed

significantly, making it impossible for Vertrue to recover its

multi-million dollar overadvance through the "true up" process.

B. Proceedings Below

To resolve this dispute, Vertrue initiated arbitration,

as provided for in the contract. Before a three-judge arbitration

panel ("the Panel"), Vertrue alleged breach of contract, fraud, and

violation of the Connecticut Unfair Trade Practices Act ("CUTPA").

VBI asserted counterclaims for breach of contract. The Panel heard

numerous days of complex testimony and issued an award in favor of

Vertrue.

The Panel decision ordered VBI to pay Vertrue $3.5

million in compensatory damages, composed of: (a) about $2.2

million, plus interest, to cover the overadvances VBI had received;

and (b) almost $1.2 million for damages caused by VBI's breach of

the exclusivity clause. In addition, the Panel rejected VBI's

counterclaims, and held that Vertrue's obligation to pay VBI for

Renewal Commissions terminated on August 6, 2003, the date that VBI

breached the exclusivity clause of the contract. Finally, the

Panel concluded that VBI "engaged in unfair and deceptive acts and

practices" in violation of CUTPA, and ordered payment to Vertrue of

$1.3 million in punitive damages and attorney fees.

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 On May 10, 2004, after the arbitration process had

commenced, VBI became a bankrupt, thus subjecting itself to the

jurisdiction of the United States Bankruptcy Court, District of

Maine. After the arbitration panel issued its award, VBI sought

vacation of the award before the bankruptcy court, where the

parties thoroughly briefed the issues and presented oral argument.

The bankruptcy court, finding no grounds to vacate, issued an order

confirming the award. VBI appealed the bankruptcy court's

confirmation order to the United States District Court, District of

Maine, alleging several grounds for relief, including that the

Panel disregarded the law, exceeded its authority, was biased, and

failed to hear relevant evidence. The district court, having

received extensive briefs from both sides, affirmed the bankruptcy

court in all respects, holding that "the arbitration award

represents a final and definite award based upon a 'plausible'

reading of the contract between VBI and [Vertrue]." Vital Basics,

Inc. v. Vertrue Inc., 332 B.R. 491, 494 (D. Me. 2005). This appeal

followed.

II. DISCUSSION

VBI makes three arguments on appeal. First, that the

Panel's conclusion regarding Renewal Commissions violates the

express language of the contract. Second, that the Panel's holding

regarding Paid Cancels violates the express language of the

contract. And third, because Vertrue allegedly owes VBI commission

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payments for Paid Cancels but did not make those payments, that

Vertrue was the first party to breach the contract, thus nullifying

VBI's later breach of the exclusivity clause. We consider each

argument in turn below.

A. Standard of Review

It is well-settled that our review of arbitral panel

awards is exceedingly narrow. Wonderland Greyhound Park, Inc. v.

Autotote Sys., Inc., 274 F.3d 34, 35 (1st Cir. 2001). Indeed, as

we have noted before, "disputes that are committed by contract to

the arbitral process almost always are won or lost before the

arbitrator." Gupta v. Cisco Sys., Inc., 274 F.3d 1, 3 (1st Cir.

2001) (quoting Teamsters Local Union No. 42 v. Supervalu, Inc., 212

F.3d 59, 61 (1st Cir. 2000)).

When considering a district court's confirmation of an

arbitration award, we review questions of law de novo and questions

of fact for clear error. First Options Of Chicago, Inc. v. Kaplan,

514 U.S. 938, 947-48 (1995). In addition, our de novo review is

highly circumscribed. See United Paperworkers Int'l Union v.

Misco, Inc., 484 U.S. 29, 38 (1987) (confirmation of award required

where arbitrator was "even arguably construing or applying the

contract"); Gupta, 274 F.3d at 3 (confirmation required if the

interpretation is "in any way plausible, even if we think [the

arbitrator] committed serious error."). We will only disturb an

arbitration award in limited circumstances, two of which are

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relevant here. Based on the federal courts' "inherent power,"

Cytec Corp. v. DEKA Prods. Ltd. P'ship, 439 F.3d 27, 33 (1st Cir.

2006), we can vacate an award where it is contrary to the plain

language of the relevant contract, or where the arbitrator has

construed the contract "in a way that cannot possibly be described

as plausible or rational." Labor Relations Div. of Constr. Indus.

v. Int'l Bhd. of Teamsters, 29 F.3d 742, 745 (1st Cir. 1994).

In this case, the appellant argues that the Panel's award

directly violates the plain terms of the contract. Because this is

a legal claim involving contract construction, our review is de

novo.2

B. Renewal Commission

VBI first argues that the Panel's finding regarding

Renewal Commissions -- that Vertrue's obligation to pay VBI Renewal

Commissions terminated on the date VBI breached the exclusivity

2
Appellee Vertrue argues that de novo review is not warranted
because, in its view, the bankruptcy court made a factual finding
that the Panel viewed the contract as ambiguous. Therefore, argues
Vertrue, this court must use the clearly erroneous standard to
review this supposed factual finding before reaching the merits of
VBI's claim about the plain meaning of the contract. This argument
misses the mark. Even if the bankruptcy court made such a factual
finding -- a dubious assertion on its own -- VBI's claim that the
award violates the plain language of the contract would still raise
a question of law, and thus would be subject to de novo review by
this court. Labor Relations Div., 29 F.3d at 745 ("We reject
plaintiffs' contention that our review of the district court's
vacation of an arbitration award, based on an alleged impermissible
interpretation of a contract, is made under the clearly erroneous
standard. In this case, all deference is due to the arbitrator's
interpretation of the contract, not to the interpretation of the
district court.").

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clause -- violates the plain language of the contract. We

disagree.

VBI's argument here relies on the following clause

regarding Renewal Commissions:

[Vertrue] shall continue to pay VBI Commissions to which
VBI may be entitled with respect to Renewal Net
Membership Revenue after the termination or expiration of
this Agreement.

Reading this clause alone, VBI's plain language argument appears to

have some merit. However, the Panel was tasked with evaluating the

agreement as a whole, not just one isolated clause. See Blackie v.

State of Me., 75 F.3d 716, 722 (1st Cir. 1996) (rejecting contract

interpretation that "harps on isolated provisions, heedless of

context."). Consideration of Section 12A of the contract shows

that the Panel's conclusion on Renewal Commissions was an eminently

plausible reading of the agreement:

During the term of this Agreement and for so long as
[VBI] is receiving revenue as a result of the Sales of
the Programs neither [VBI] nor any of its affiliates or
subsidiaries shall purchase, market, administer, or enter
into an agreement [that violates the exclusivity clause].

The Panel was justified in concluding that the parties agreed to

condition VBI's receipt of revenue, including Renewal Commissions,

on compliance with the contract's exclusivity clause. Thus, the

Panel's conclusion regarding Renewal Commissions is not contrary to

the plain language of the contract, leaving no basis for us to

vacate the Panel's award in this respect.

C. Paid Cancels

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 VBI also argues that the plain language of the contract

contradicts the Panel's conclusion that VBI was not entitled to

commissions on Paid Cancels. To support this claim, VBI points out

that the contract required Vertrue to pay VBI advance commission

payments "with respect to First Year Net Membership Revenue," which

the contract defines as:

[A]ll revenue received by [Vertrue] . . . from Eligible
Program Members with respect to Initial Membership Years,
less refunds for Member cancellations with respect to
such Initial Membership Years.

This clause too, read in isolation, appears to support VBI's

assertion that commissions are owed to VBI on Paid Cancels, because

if a customer cancelled his membership and only received a partial

refund, Vertrue retained a partial payment, thus increasing

Vertrue's net revenue.

However, again, the Panel was interpreting the contract

as a whole, not just one clause. As Vertrue points out, the

contract's "Commissions" and "Advance" sections clearly create an

advance commission and "true up" scheme whereby commission payments

on first-time sales are based on the number of memberships that are

purchased and fully paid for, meaning they were not cancelled

during the one-year subscription period. Admittedly, the

contract's definition of First Year Net Membership Revenue appears

to conflict with the contract's advance commission and "true up"

system. Given this apparent contradiction, it was perfectly

reasonable for the Panel to conclude, based on the language and

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structure of the contract, that the parties did not contract to pay

commissions on Paid Cancels, but only on fully-paid memberships

that were retained for one year. The fact that the contract's

complex "true up" mechanism provides no formula at all for

measuring or calculating commissions based on Paid Cancels is

sufficient to justify the Panel's conclusion in this regard.

Having so determined, we can easily dispatch VBI's third

claim, that Vertrue breached the contract first by failing to make

commission payments on Paid Cancels. Because the Panel reasonably

concluded that the contract did not require payments based on Paid

Cancels, it cannot be successfully argued that Vertrue breached the

contract by failing to make those payments. Thus, we uphold the

Panel's conclusion that VBI breached the contract first by

marketing a competing product in violation of the agreement, and

leave untouched the Panel's award of damages for such breach, both

punitive and compensatory.

III. Conclusion

The Panel's award did not violate the plain language of

the parties' contract. We therefore affirm the district court's

confirmation of the arbitration panel's award. Having presented

its arguments to the arbitration panel, the bankruptcy court, the

district court, and this court, VBI must now abide by the

reasonable conclusions reached by the arbitration panel, a body

that they themselves selected to resolve disputes under the

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contract. Bull HN Info. Sys., Inc. v. Hutson, 229 F.3d 321, 330

(1st Cir. 2000) ("[I]t is the arbitrator's view of the facts and of

the meaning of the contract that [the parties] have agreed to

accept.") (quoting United Paperworkers, 484 U.S. at 37-38 (1987)).

Costs to appellee.

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