* Ruling blocks private arbitrations overseen by sitting judge
* Delaware legal industry saw arbitration as growth area
* Court ruled 2-1 that process violated First Amendment
Oct 23 (Reuters) - Delaware's legal industry suffered a blow when a federal court found on Wednesday the state violated the U.S. Constitution with its novel system of allowing judges to arbitrate private business disputes, which critics called secret trials.
The U.S. Court of Appeals for the Third Circuit found private arbitrations overseen by a sitting judge on Delaware's highly respected Court of Chancery violated the First Amendment of the U.S. Constitution.
"Allowing public access to state-sponsored arbitrations would give stockholders and the public a better understanding of how Delaware resolves major business disputes," wrote Justice Dolores Sloviter.
The court ruled 2-1, and Judge Jane Roth wrote a dissenting opinion. Judge Julio Fuentes also wrote a concurring opinion.
A statement from Andy Pincus, an attorney for Mayer Brown who handled the state's case, said an appeal was being considered.
The 37-page ruling contained three opinions. Sloviter found the type of proceeding that Delaware established was traditionally open to the public and upheld the lower court. Fuentes took a narrower view, that only secrecy was a problem, and Roth called Delaware's system a "perfect model for commercial arbitration."
Delaware's arbitration system was shut down in 2012 by U.S. District Court Judge Mary McLaughlin, who found it essentially amounted to civil trials by another name, and that the secrecy violated the First Amendment.
Delaware's legislature unanimously adopted the system in 2009 as a way for the state's legal industry to compete with increasingly popular private arbitration for settling business disputes.
The system combined the acclaimed judges from the Chancery Court -- which recently blocked Carl Icahn's attempt to disrupt the Dell Inc buyout -- with the speed and confidentiality of arbitration.
To use the arbitration process, at least one party had to be a business and the dispute had to involve at least $1 million.
The arbitration process was entirely secret and even the existence of a case was not public. Attorneys for the Court of Chancery have said the process was used six times.
The five judges on the non-jury court were sued by the Delaware Coalition for Open Government, a group that promotes government transparency, for holding what the group said amounted to secret trials.
The group did not respond immediately to a request for comment.
While the appeals court came to the same conclusion as the U.S. District Court, it took a different route to get there.
The appeals court applied the "experience and logic" test. The justices found that because the Delaware process takes place in a courtroom, a place with a history or experience of openness, the process therefore should be open. The justices rejected the argument that they should consider the history of privacy in arbitration.
The logic test also weighed in favor of openness, with few drawbacks since the Court of Chancery already allows confidential filing of documents. "Public access would expose litigants, lawyers, and the Chancery Court judge alike to scrutiny from peers and the press," Sloviter wrote.
The court also rejected the argument that opening the arbitration would effectively kill it. They noted that the arbitration, even if public, offered expedited proceedings and customized procedures that many parties might prefer.
Pincus, who represented the Court of Chancery judges, said the dissent from Roth was encouraging.
"We feel strongly that it is important to our nation and our state to provide cost-effective options to resolve business-to-business disputes to remain competitive with other countries around the world," said Pincus.
The private arbitration process was popular in Delaware's tight-knit corporate law community and proponents hoped it would provide new legal business.
The law also required one party in the arbitration to be incorporated in Delaware. It was seen as a way to jumpstart the flagging growth in the number of businesses chartered in the state.
That growth is key to Delaware's economy. More than half of the companies in the S&P 500 stock index are incorporated in the state, often for access to its courts, and money related to chartering businesses accounts for 40 percent of the state's general revenue.
The case is Delaware Coalition for Open Government v The Honorable Leo E. Strine Jr et al, U.S. Court of Appeals for the Third Circuit, No. 12-3859