Introduction

One of the first questions that needs to be addressed in any reinsurance arbitration, assuming you have already reached the conclusion that a dispute is subject to arbitration (no small matter in itself), is what law will control the procedural elements of the arbitration. This question may prove very simple to resolve; or decidedly more complex. Which course the determination takes is largely dependent on how carefully the contract was drafted.

In any event, the importance of promptly and correctly resolving this governing law question cannot be underestimated. Its resolution may, under some circumstances, result in dramatically different discovery obligations. It may broadly alter the powers of your arbitrators to control discovery and provide assistance with third-party discovery. Depending on which law governs the arbitration, your time for timely filing a motion to vacate a disagreeable panel award may vary by several days and the grounds on which you may contest an award may change in very important substantive ways. In fact, in certain circumstances, your very arbitration may arguably be invalidated based on the action or inaction of your arbitrators. In sum: you really do not know what type of arbitration you will have until you have confirmed what law will govern its procedures.

Two relatively recent court decisions have underscored the importance of promptly and correctly deciding which law governs the arbitration procedure. In the Second Circuit’s recent decision in Security Ins. Co. of Hartford v. TIG Ins. Co., 360 F.3d 322 (2d Cir. 2004), the Court held that a reinsurance arbitration may be stayed pending the outcome of related litigation, based on an application of the California Code of Civil Procedure where the reinsurance agreement designated California law as controlling. This outcome is in contrast to the priority typically given to arbitration over litigation under the Federal Arbitration Act, 9 U.S.C. §1, et. seq. (the “FAA”). The application of the California Code rather than the FAA, as a very practical matter, resulted in the arbitration being stayed, rather than the litigation.

More recently, the United States Supreme Court reached a decision that re-emphasized the importance of clearly deciding which jurisdiction’s law governs your arbitration before proceeding headlong into arbitration. In Buckeye Check Cashing, Inc. v. Cardegna, et al., No. 04-1264 (U.S., Feb. 21, 2006), the Supreme Court concluded that the question of a contract’s validity is to be considered by the arbitrator in the first instance, not resolved by a court, even though the state law applicable to the contract generally would leave the issue to a court’s resolution. The Court based its decision on the view that the FAA and related federal arbitration case law preempted the application of state law and ultimately governed the dispute, even though the state court had properly exercised jurisdiction over the contract and had reached an opposite conclusion based on the application of conflicting Florida state arbitration law. In Buckeye, the arbitration agreement expressly provided that the FAA was to govern. Again, which law governed the procedure of the arbitration made a significant difference.

This article is intended to provide the reinsurance practitioner with a basic outline for and case law relevant to determining the answer to the question of which law will control the procedure of the arbitration. As always, the specific facts of the arbitration clause and the particular substantive law of the jurisdiction considering the question will vary.[1]

Begin at the Beginning: Some Basic Choices

In deciding which law will govern, you might first ask: what procedural law options are available? Focusing for the moment on just the United States jurisdictional options, the choices for governing law largely come down to either the FAA or one of the various state arbitration acts.

The FAA can be found in 9 U.S.C. §1 et. seq. and is implicated whenever interstate commerce is at issue. As a general rule, contracts of reinsurance typically involve interstate commerce and therefore trigger application of the FAA. See, e.g., Security Life Ins. Co. of Am. v. Hannover Life Reassurance Co. of Am., 167 F. Supp. 2d 1086, 1088 (D. Minn. 2001) (“Reinsurance contracts fall under the protection of the Federal Arbitration Act.”); Utica Mutual Ins. Co. v. Gulf Ins. Co., 762 N.Y.S.2d 730, 732 (N.Y. App. Div. 2003).

Notwithstanding that the FAA has often been applied, sometimes without question or serious consideration, by many a federal court, this does not mean state arbitration laws can be safely ignored. State arbitration laws may still be properly found to apply to govern the procedure of an arbitration arising from a particular reinsurance contract, even when the contract clearly involves interstate commerce. When a state’s procedural law may apply, the specific law must be carefully researched and considered. While there has been considerable effort to attempt to achieve some measure of uniformity among the various state arbitration acts, by the promulgation of the Uniform Arbitration Act and, more recently, the Revised Uniform Arbitration Act, there still remains considerable diversity among the various states. As mentioned above, these differences can have some dramatic impacts on the practical outcome of the dispute.

A Clear Choice of Procedural Law: Say What You Mean and Mean What You Say

Determining which jurisdiction’s law applies to your dispute may be as simple as reading the contract. Many modern reinsurance contracts contain a clear choice of law provision which expressly adopts a particular jurisdiction’s law to govern the arbitration procedures. When such a provision exists and is clear, the selected law will typically govern the arbitration. See, e.g, Volt Info. Sci., Inc. v. Board of Trs. Of Leland Stanford Junior Univ., 489 U.S. 468, 477 (1989) (affirming stay of arbitration as required by California state law where parties’ agreement provided that California law was to apply); Security Ins. Co. of Hartford v. TIG Ins. Co., 360 F.3d 322, 328 (2d Cir. 2004) (affirming stay of arbitration as required by California state law where agreement contained broad choice-of-law provision). Likewise, if an agreement expressly and clearly adopts the FAA, it will be likely applied. See Rodriguez v. Am. Tech., Inc., No. G034933 (Cal. Ct. App., Feb. 16, 2006) (reversing denial of motion to compel arbitration despite California state law where parties’ agreement was made pursuant to the FAA).

Federal Preemption: The Federal Empire Strikes Back

A clear choice-of-law provision, even including a clear choice of law governing procedure, is not, however, a complete guarantee that the selected jurisdiction’s law will govern the procedural aspects of the arbitration. Indeed, federal courts have many times rejected the chosen jurisdiction’s law and, instead, applied the FAA to govern the arbitration’s procedure.

This is most likely to occur when the choice of law clause is not clear about its application to the arbitration procedure. See, e.g., Certain Underwriters at Lloyd’s London v. Argonaut Ins. Co., 264 F.Supp.2d 926, 933 (N.D.Cal. 2003) (holding that a mere venue clause is not sufficient to demonstrate an intent to make a substantive choice-of-law). If there is any ambiguity about whether a choice-of-law provision also incorporates a state jurisdiction’s procedural rules of arbitration and the state’s arbitration rules restrict the availability of arbitration, courts are even more likely to find that the FAA preempts the state arbitration act consistent with the general pro-arbitration policy of the FAA. This was most recently confirmed in Hudson v. ConAgra Poultry Company, No. 06-2596 (8th Cir, April 4, 2007) (finding that clear choice-of-law provision was not sufficient to defeat application of the FAA when state law application would have resulted in tort claims not being subject to arbitration); see also Mastrobuono v. Shearson Lehman Hutton, Inc., 514 U.S. 52, 62 (1995) (holding that ambiguous choice-of-law provision only incorporated the state’s substantive law, not its procedural arbitration statute). Indeed, it should be noted that if a state law is clearly anti-arbitration, the courts are likely to find it unenforceable under the Federal Arbitration Act, even in light of a broad state choice-of-law clause. See, e.g., Ainsworth v. Allstate Ins. Co., 634 F.Supp. 52, 54 (W.D. Mo. 1985) (applying Federal Arbitration Act despite broad choice-of-law clause where state law would have made the arbitration agreement unenforceable).[2] In contrast, when there is no clear choice-of-law provision selecting either the FAA or the applicable state arbitration act and the state law is not in any manner antagonistic to arbitration but merely impacts the manner in which the arbitration will proceed or an award is reviewed, federal courts have held that the FAA will not preempt the state’s arbitration act. This was recently confirmed in Trombetta v. Raymond James Financial Services, 907 A.D. 550, 565 (Pa. Super. Ct. 2006). There the court reasoned that FAA preemption is “inappropriate when the state rule of law in question was a procedural one having no effect on the enforcement of an underlying arbitration agreement,” id. at 567, and, as a result, the FAA would not preempt unless “the Pennsylvania standards of review frustrate the underlying objectives of the FAA, as standards of review are an inherently procedural mechanism”. Id. at 569. This same analysis was followed in a very recent decision from the Western District of Virginia. Penn Virginia Oil & Gas Corporation v. CNX Gas Company, 2007 WL 593578 (W.D.Va.) (holding that absent an express provision stating which law was to be applied, FAA standards of review cannot preempt Virginia Uniform Arbitration Act standards that are more restrictive and therefore do not conflict with the underlying objectives of the FAA). In short, if there is a clear choice-of-law provision selecting a state’s substantive law, many courts have found that the FAA preempts the state arbitration act’s application if there is any conflict between the state act and the FAA. This is possibly the result regardless of whether the choice-of-law provision selecting the state arbitration act as the governing law is ambiguous or not. However, if there is no choice of law at all in the applicable agreements and the governing procedural law is left for a court’s determination, there are recent decisions supporting the view that the FAA does not preempt the application of a state’s arbitration act to govern the arbitration’s procedure, even if the state act provides more restrictive procedural requirements, as long as they do not conflict with the general pro-arbitration objectives of the FAA.

Reverse Preemption: Just When You Thought It Was Safe to Go Back Into the Water

When a contract clearly arises from interstate commerce and does not include a clear choice of law, it still may be interpreted to require a particular state’s arbitration procedure, over the FAA, even when the state procedure is inconsistent with the FAA. This result, while not common, typically is justified by application of a doctrine known as “reverse preemption.”

The McCarran-Ferguson Act was adopted to prevent generic federal statutes from preempting state statutes that regulate insurance. 15 U.S.C. §§ 1011-1015. One section of the Act specifically addresses reverse preemption (sometimes also known as “inverse preemption”):

No Act of Congress shall be construed to invalidate, impair, or supersede any law enacted by any State for the purpose of regulating the business of insurance, or which imposes a fee or tax upon such business, unless such Act specifically relates to the business of insurance . . .

15 U.S.C. § 1012(b). Relying on this language, the courts apply a three-part test to determine if a state arbitration statute would control over (or reverse preempt) the federal statute:

1) The federal statute at issue does not specifically relate to the business of insurance.

2) The state statute at issue was enacted for the purpose of regulating the business of insurance.

3) Application of the federal statute would invalidate, impair, or supersede the state statute.

See, e.g., Munich Amer. Reins. Co. v. Crawford, 141 F.3d 585, 590 (5th Cir. 1998). If all three elements are satisfied, the state statute will control, thus reverse preempting the federal statute.

As a general matter, the first and third elements are easily satisfied in cases of reinsurance arbitration.

The first element requires that the federal statute not specifically relate to the business of insurance. In reinsurance arbitrations, the federal statute that may be implicated is the Federal Arbitration Act. Universally, courts have held that the Federal Arbitration Act does not specifically relate to the business of insurance. See, e.g., Munich, 141 F.3d at 590; Stephens v. American Internat’l Ins. Co., 66 F.3d 41, 44 (2d Cir. 1995). Therefore, the first element is almost certainly satisfied.[3]

The third element requires a showing that the federal statute, if applied, would invalidate, impair, or supersede the relevant state statute. Here, the focus is often on the lack of any specific state statute. For example, in Miller v. National Fidelity Life Insurance Company, the plaintiff argued that the Federal Arbitration Act was precluded by the McCarran-Ferguson Act because Georgia had enacted statutes that regulate the business of insurance. 588 F.2d 185, 187 (5th Cir. 1979). There was no specific state statute, however, forbidding arbitration of insurance disputes. Id. Because no state statute was invalidated, impaired, or superseded, then, the Federal Arbitration Act controlled, and arbitration was required under the parties’ agreement. Id. See also Quackenbush v. Allstate Ins. Co., 121 F.3d 1372, 1381-82 (9th Cir. 1997) (affirming order to arbitrate because no state statute prohibited the arbitration of offset issues in the context of a liquidation proceeding); Bernstein v. Comm’r of Banking and Ins. of Vt, 606 F.Supp. 98, 103 (S.D.N.Y. 1984) (allowing arbitration where no state statute prohibited it even though state case law might).

The second element, then, asks whether the state statute was enacted for the purpose of regulating the business of insurance. In analyzing the state statute at issue, the United States Supreme Court has stated that statutes regulating the “business of insurance” within the meaning of McCarran-Ferguson are statutes that are aimed at protecting or regulating the relationship between an insurance company and its policyholders. SEC v. Nat’l Sec., Inc., 393 U.S. 453, 460 (1969). Courts will look at three factors to determine whether the practice that the state statute regulates falls within the “business of insurance”: 1) whether the practice has the effect of transferring or spreading the risk; 2) whether the practice is an integral part of the policy relationship between the insurer and the insured; and 3) whether the practice is limited to entities within the insurance industry. Union Labor Life Ins. Co. v. Pireno, 458 U.S. 119, 129 (1982) (summarizing and applying the criteria developed in Group Life & Health Ins. Co. v. Royal Drug Co., 440 U.S. 205 (1979)). None of these factors alone is determinative; rather, a court will examine all three in determining whether a practice falls within the “business of insurance,” and, therefore, within McCarran-Ferguson. Id. Reinsurance is likely to be considered a practice that is within the “business of insurance.” See, e.g., Stephens, 66 F.3d at 44 (“Reinsurance practices fall within this test.”).

Generally, courts have reviewed two types of statutes under McCarran-Ferguson: general arbitration statutes and statutes regulating the liquidation of insurance companies (which sometimes involve arbitration). Under either type of statute, you must determine whether a statute is aimed at protecting or regulating the relationship between an insurance company and its policyholders.

Many states have adopted statutes governing arbitration. When those statutes are general, without any specific reference to insurance, a claim for reverse preemption will usually not be supported. That is because general arbitration statutes do not specifically regulate the business of insurance, but rather regulate dispute resolution generally. See Hamilton Life Ins. Co. of N.Y. v. Republic Nat’l Life Ins. Co., 408 F.2d 606, 611 (2d Cir. 1969) (holding that the Federal Arbitration Act was not reverse preempted by the New York or Texas arbitration statutes because those statutes did not regulate the business of insurance); Ainsworth v. Allstate Ins. Co., 634 F.Supp. 52, 56 (W.D. Mo. 1985) (concluding that state common-law rule against arbitration was not within the category of laws regulating insurance).

Of the states that have adopted a uniform arbitration act, many expressly exclude contracts of insurance from their reach.[4]  Under those state laws, arbitration provisions in insurance contracts are deemed to be unenforceable. Most, however, exempt reinsurance contracts or contracts between insurance companies.[5]  Therefore, even under these more restrictive state laws, arbitration provisions in reinsurance contracts would remain enforceable. When a more specific exclusion is at issue, the McCarran-Ferguson analysis is different.

In the context of direct insurance policies, courts consistently find that a state statute that makes arbitration provisions in insurance contracts unenforceable is a statute regulating the business of insurance. See, e.g., Amer. Bankers Ins. Co. of Fla. v. Inman, 2006 WL 52273 (5th Cir.) (holding that Federal Arbitration Act was reverse preempted under McCarran-Ferguson Act in light of Mississippi statute); McKnight v. Chicago Title Ins. Co., Inc., 358 F.3d 854, 855 (11th Cir. 2004) (reverse preemption in light of Georgia statute); Standard Sec. Life Ins. Co. of N.Y. v. West, 267 F.3d 821, 824-25 (8th Cir. 2001) (reverse preemption in light of Missouri statute); Nat’l Home Ins. Co. v. King, 291 F.Supp.2d 518, 530 (E.D. Ky. 2003) (reverse preemption in light of Kentucky statute). In those instances, the Federal Arbitration Act is reverse preempted by the McCarran–Ferguson Act, and the state statute controls, thus making the arbitration provision unenforceable.

Courts have reached the same conclusion in the context of reinsurance. For example, at one time, Kansas’ arbitration statute provided that arbitration provisions were unenforceable in all contracts of insurance, including reinsurance. Mut. Reins. Bureau v. Great Plains Mut. Ins. Co., Inc., 969 F.2d 931, 932 (10th Cir. 1992). Applying the three-part test, the Tenth Circuit Court of Appeals concluded that this statute regulated the “business of insurance,” and that the “business of insurance” also includes reinsurance. Id. at 933. Therefore, under McCarran-Ferguson, the state law controlled and the arbitration clause in the reinsurance agreement was unenforceable. Id. at 934.[6]  See also Oil Ins. Ass’n v. Royal Indem. Co., 519 S.W.2d 148, 151 (Tex. Civ. App. 1975) (applying general state statute invalidating arbitration provisions in insurance contracts to a reinsurance agreement).[7]

As to liquidation statues, most courts conclude that such statutes regulate the business of insurance because they offer the policyholder the protection of an orderly liquidation. [8]  United States Dept. of Treasury v. Fabe, 508 U.S. 491, 505-06 (1993); Munich, 141 F.3d at 592; Stephens, 66 F.3d at 44-45. If the liquidation statute expressly prohibits arbitration, a court is likely to conclude that McCarran-Ferguson saves the state statute from preemption by the Federal Arbitration Act. See, e.g., Stephens, 66 F.3d at 44 (applying Kentucky Liquidation Act that voided arbitration provisions in insurance contracts once the insurance company is in liquidation). In those instances, the arbitration provision will be overtaken by litigation.

The liquidation statute need not expressly prohibit arbitration, however. If, for example, it provides that all matters involving an insurance company in liquidation must be consolidated in one court, this may be a state statute that reverse preempts the Federal Arbitration Act. See Davister Corp. v. United Rep. Life Ins. Co., 152 F.3d 1277, 1281 (10th Cir. 1998) (applying reverse preemption so that Utah statute controlled). Or, if the state liquidation statute provides exclusive original jurisdiction in the state court, the arbitration provision may be invalid. See Munich, 141 F.3d at 596 (applying reverse preemption so that Oklahoma statute controlled). But, there are also several recent decisions which reject the reasoning of the Davister and Munich courts and do not allow arbitration provisions to be voided. See In Re Liquidation of Integrity Ins. Co., 2006 WL 2795343 (N.J. Super., Oct. 2, 2006); Suter v. Munich Reins. Co., 233 F.3d 150, 152-54 (3d Cir. 2000); Amsouth Bank v. Dale, 386 F. 3d 763, 780-83 (6th Cir. 2004); Northwestern Corp. v. National Union Fire Ins. Co. of Pittsburgh, 321 B.R. 120, 121 (Bankr. D. Del. 2005); Costle v. Fremont Indem. Co., 839 F. Supp. 265 (D. Vt. 1993)

Conclusion

It is critically important, if for no other reason than to know what deadlines may apply to your arbitration, to confirm which laws govern the procedure of the arbitration. This resolution may be simply answered by a clear and broadly-worded choice of law clause that plainly describes an election by the contracting parties of a particular jurisdiction’s arbitration laws. In such a case, it is merely important for you to educate yourself of the particulars of that jurisdiction’s arbitration act.

If the contract is not so clear, further effort must be undertaken to carefully and properly resolve the issue of which law will govern the arbitration and describe the procedure to be followed. This paper describes in a general manner some of the important elements of this consideration.

[1] Opinions expressed in this paper are not necessarily those of Larson • King, LLP or its clients. This paper is based on materials originally prepared for the Mealey’s Fundamentals of Reinsurance Litigation and Arbitration Conference, March 23 & 24, 2006.

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[2] While Ainsworth is still technically good law, it is unclear whether it would continue to be followed after Volt. Nevertheless, courts highly disfavor state statutes that prohibit arbitration completely. See, e.g., Allied-Bruce Terminix Cos., Inc. v. Dobson, 513 U.S. 265 (1995) (refusing to apply state arbitration statute that would have invalidated arbitration provision under a broad interpretation of “interstate commerce”); see also, Hudson v. ConAgra.

[3] An example of a federal statute that specifically relates to the business of insurance is the Federal Crop Insurance Act. 7. U.S.C. § 1501 et seq. Because that statute, which mandates arbitration, specifically relates to the business of insurance, the McCarran-Ferguson Act does not apply. In re 2000 Sugar Beet Crop Ins. Litig., 228 F.Supp.2d 992, 997 (D.Minn. 2002); IGF Ins. Co. v. Hat Creek P’ship, 76 S.W.3d 859, 864 (Ark. 2002). Therefore, in cases arising under the Federal Crop Insurance Act, the Federal Arbitration Act continues to preempt any contrary state law. Id.

[4] Specifically, Arkansas, Georgia, Kansas, Kentucky, Missouri, Montana, Nebraska, South Carolina, South Dakota, and Vermont all have arbitration statutes that exclude insurance contracts. Maine and Mississippi both exclude policies of automobile liability under their uninsured motorist coverage statutes, and Rhode Island excludes policies of primary insurance; presumably, these statutes would not affect contracts of reinsurance.

[5] Kansas, Kentucky, Missouri, and Nebraska specifically provide that their arbitration statutes apply to contracts of reinsurance. Georgia, Montana, and South Dakota have arbitration statutes that apply to contracts between insurance companies, presumably including reinsurance contracts. This leaves only Arkansas, South Carolina, and Vermont that would arguably invalidate arbitration provisions in reinsurance agreements.

[6] Since Mutual Reinsurance was decided, Kansas has amended its arbitration statute to provide that reinsurance contracts are not to be considered as contracts of insurance. K.S.A. § 5-401. In fact, this is consistent with the position taken by most states that exclude insurance contracts from their arbitration statutes, but expressly exempt reinsurance contracts from that exclusion. See supra note 5 and accompanying text.

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[7] Like Kansas, Texas has since revised its arbitration act: Texas no longer excludes insurance contracts. Tex. Civ. Prac. & Rem. § 171.002.

[8] In one case, the court allowed arbitration, concluding that Colorado’s liquidation statute did not regulate the “business of insurance” under McCarran-Ferguson. Phillips v. Lincoln Nat’l Health & Cas. Ins. Co., 774 F.Supp. 1297, 1300 (D. Colo. 1991). The case, however, contains no explanation of the court’s reasoning and actually cites to the dissent of one of the leading cases on the definition of “business of insurance,” U.S. Dept. of Treasury v. Fabe, 508 U.S. 491 (1993).

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