If you are trying to figure out a fair rent for a Saks Fifth Avenue store in San Francisco, wouldn’t it make sense to take a look at other Saks stores, including the retailer’s flagship location in New York City?

An arbitrator trying to settle a dispute between the chain and the landlord for its Bay Area location thought this was a logical way to gather some useful information. But a trial court said the arbitrator overstepped his authority, and an appellate court recently agreed. (California Union Square v. Saks & Co.)

Saks leased the 131,000 square-foot building at 384 Post St. in San Francisco in 1991, signing a 25-year lease with options for up to five 10-year renewals. In January of 2016, Saks exercised its option to renew the lease for a 10-year term starting on Feb. 1, 2017.

The lease agreement called for a “Fair Market Rent,” which it defined as “the open market rental value” of Union Square property used for “first-class retail use.” If the parties could not agree on the rent amount, they would submit the issue to arbitration, under very specific terms spelled out in the lease document.

For example, the lease said the arbitrator could consult experts, but only in the presence of both parties, who would have the right to cross-examine them.

The agreement also required what is known as “baseball arbitration,” in which each party proposes its own rent to the arbitrator, who then must select the one that is closest to the amount the arbitrator has determined is appropriate. The arbitrator cannot pick a different figure, such as a compromise amount somewhere between the two.

Saks and its landlord selected arbitrator Jan Kleczewski to resolve the dispute.

Kleczewski proposed that the scope of his work include performing “due diligence and other analysis.” Saks objected, saying the arbitrator’s analysis and decision should be based only on evidence presented by the parties. Kleczewski agreed, and submitted a revised agreement.

The arbitrator sent an email to the parties on Feb. 15, 2017, saying he would travel to Beverly Hills to look at retail stores discussed in testimony presented at the arbitration hearing, then fly to New York City to see other stores “discussed in testimony in terms of sales volume.”

The landlord proposed an annual rent of $13.9 million, while Saks said the rent should be $6.25 million. The midpoint between these two figures was about $10.1 million. Kleczewski determined that “fair market rent” was $10.9 million. Since this was greater than the midpoint of the parties’ proposals, under the principles of “baseball arbitration,” he ruled that the annual rent for the new lease would be $13.9 million.

Kleczewski went on to explain how he reached his determination. He said the Union Square store could add a restaurant to its top floor, as the Saks store on Fifth Avenue in New York had done.

He also said the San Francisco location justified a higher rent, comparing it to a Coach store in New York where the rent was $20 million per year for a much smaller space.

The landlord asked the San Francisco Superior Court to confirm the arbitrator’s award. Saks objected, saying Kleczewski had violated the arbitration agreement by conducting his own due diligence and investigation by visiting the retail stores in New York City and relying on that information in reaching his decision.

The trial court agreed with Saks. It ruled that Kleczewski had exceeded the authority given to him by the lease agreement and the parties. The court vacated the award and ordered the parties to participate in a second arbitration with a different arbitrator.

The landlord appealed, asking the Court of Appeal to direct the trial court to confirm Kleczewski’s award. That was denied, and in the second arbitration the new arbitrator found in favor of Saks. The landlord then appealed.

It argued that the trial court erred by failing to “defer to the (first) arbitrator’s reasonable reading” of the arbitration agreement, and that visiting the New York stores was within Kleczewski’s authority.

The Court of Appeal again ruled against the landlord. The appellate justices noted that because arbitration is viewed as a relatively inexpensive and speedy way to resolve disputes, arbitration awards are rarely overturned by the courts.

However, “precisely because arbitrators wield such mighty and largely unchecked power,” the justices noted, courts will set aside arbitration awards “that are the product of procedural irregularities.” That includes arbitrators acting “in a manner that is not authorized by the arbitration agreement.”

The lease placed limits on Kleczewski’s authority. When he initially proposed doing more, by performing his own due diligence, the parties objected and he agreed. His mandate was to evaluate only facts and evidence presented to him “in the presence of both parties with the full right on their part to cross-examine.”

The arbitrator’s visit to New York stores, the appellate court said, was beyond the scope of his assignment. Because he relied on that information in reaching his decision, the justices said, the arbitration must be voided.

The Court of Appeal affirmed the trial court’s order vacating the first arbitration award and confirming the second one, and awarded Saks its costs on appeal.

The takeaway here is that arbitrators have a lot of power, but they can’t go beyond what’s specified in an arbitration agreement.

By Laurie Murphy