Expert Commentary

Exclusive Arbitral Authority Dangers in Reinsurance Contracts

Arbitration clauses in reinsurance contracts, like many commercial contracts, often contain explicit references to an arbitral forum or set of rules before which or under which any dispute must be arbitrated. Sometimes arbitration clauses also specify the arbitrator or umpire appointing authority should there be an impasse in appointing an arbitrator or umpire.


Reinsurance
December 2016

There is nothing wrong with—and much to applaud about—specifying details like these in the arbitration clause. Lack of specificity or precision in language used in reinsurance contracts has caused many a reinsurance dispute. But there is a flipside to over-specificity in an arbitration clause. Sometimes the reference to the arbitral forum or a set of rules or an appointing authority is exclusive and includes no alternative procedure or flexibility. This may leave the parties without the ability to move forward with the arbitration or with the arbitration award vacated.

Exclusivity Provisions

Exclusivity provisions in arbitration clauses have resulted in some interesting case law over the years. Why, you may ask? Because when parties specify an exclusive arbitral forum to conduct the arbitration and that forum no longer exists, a dispute is likely to arise if one party does not wish to arbitrate or compromise. Where a set of rules to govern the arbitration is stated explicitly in the arbitration clause and those rules are outdated and superseded—or never existed—a dispute may arise.

Where the exclusive appointing authority is nonexistent or refuses to make the appointment, a dispute likely will arise. Because reinsurance arbitration, like all commercial arbitration, is a creature of contract, the courts may not read into the contract the amendments needed when exclusivity exists in the arbitration clause without a safety valve.

Arbitration Clauses with Exclusive Provisions

It cannot be overemphasized that an arbitration provision in a reinsurance contract should be drafted without any ambiguities and should make clear how the arbitration panel is to be selected, the criteria for the arbitrators, and other factors to allow the process to move forward swiftly and efficiently. If the parties wish to specify an arbitral forum or a set of arbitration rules or an appointing authority, they should expressly draft for the application of that forum or those rules in the arbitration clause.

For example, a simple arbitration clause referring to a set of arbitration rules may look like this.

Any dispute or claim arising out of or relating to this Agreement, including its formation and validity, shall be referred to arbitration. The arbitration shall be conducted in accordance with the ARIAS•U.S. Neutral Panel Rules for the Resolution of U.S. Insurance and Reinsurance Disputes.

The clear implication here is that the arbitration will proceed under the currently existing version of those rules. If a clause gets too specific, like "Arbitration shall be based on the Procedures for the Resolution of U.S. Insurance and Reinsurance Disputes (September 1999)," a dispute may arise about whether the 1999 rules have to be used in 2016. Moreover, if the arbitration clause refers to an organization's set of rules and that organization has not promulgated any arbitration rules, a problem arises.

The same issue arises if an arbitral forum or appointing authority is exclusive. Below are two examples of an appointment methodology.

If the two arbitrators are unable to agree upon the third arbitrator within thirty (30) days of their appointment, the parties shall appoint the third arbitrator in accordance with the ARIAS•U.S. Umpire Selection Procedure.

 

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If the two (2) arbitrators fail to agree upon the appointment of an umpire within thirty (30) days after notification of the appointment of the second arbitrator, within ten (10) days thereof, the two (2) arbitrators shall request ARIAS•U.S. ("ARIAS") to apply its procedures to appoint a third arbitrator for the arbitration with the qualifications set forth above in this Article. If the use of ARIAS procedures fails to name an umpire, either party may apply to the court named below to appoint an umpire with the above required qualifications.

In the first example, the ARIAS•U.S. appointment procedure is exclusive. The word "shall" makes it so. Should the procedure no longer work, this could cause a problem. In the second example, the ARIAS•U.S. appointment procedure is not exclusive because even though the word "shall" is used, the arbitration clause allows the parties to go to court if the appointment procedure does not work.

In cases where the appointing authority is not the court, where state arbitration laws or the Federal Arbitration Act (FAA) have specific provisions directing the court to select an arbitrator if there is an impasse, issues can arise. For example, if the arbitration clause selects the insurance commissioner in a specific state or the president of ARIAS•U.S. as the appointing authority, there is no guarantee (and certainly no requirement) that both would accept that responsibility and appoint the arbitrator.

Specificity is great, but if the forum or authority no longer exists, or the authority declines to become involved, the parties may lose their agreed-upon right to arbitrate.

What Happens When the Arbitration Forum No Longer Exists?

Sometimes the arbitration forum no longer exists and the party receiving the demand for arbitration argues that the arbitration provision is invalid, given the lack of the forum's existence. This issue was addressed by a New York federal court in 1999, where the specific arbitration forum no longer existed, but the parent organization did exist and was still involved in administering arbitrations. Constitution Reins. Corp. v. Republic W. Ins. Co., 1999 U.S. Dist. LEXIS 2651 (S.D.N.Y. Mar. 9, 1999).

Here, even though the court agreed that the specific arbitration forum under an arbitration clause in a reinsurance agreement no longer existed and that the forum was exclusive, the court refused to read the arbitration clause so narrowly as to cause arbitration to fail. The court looked to the public policy favoring arbitration and also noted that the parent organization was designated as the appointing authority as a basis to order the arbitration to go forward under the administration of the parent organization. Query what would have happened if the parent organization did not exist or was not an arbitral forum or was not named as the appointing authority?

What Happens When the Appointing Authority Does Not Exist?

Where the appointing authority is exclusive but does not exist, any award issued by the arbitrator not appointed as required by the arbitration clause in the contract may be vacated. This situation happened in a complex arbitration dispute in PoolRe Ins. Corp. v. Organizational Strategies, Inc., 783 F.3d 256 (5th Cir. Tex. 2015). The dispute involved a captive insurance program.

The contracts between the manager and the principal company required American Arbitration Association (AAA) arbitration, while the contracts between the reinsurer and the captive insurance companies required International Chamber of Commerce arbitration. Moreover, the reinsurance agreements required that the arbitration take place in Anguilla and that the arbitrator be selected by the Anguilla, British West Indies Director of Insurance.

A dispute arose over the premiums being paid, and the principal company sought an audit. After the company's request for accounting changes was rebuffed, the agreements were cancelled and arbitration was filed. A further dispute arose over whether deposits were properly refunded under the reinsurance agreements. The arbitration demand was forwarded to a dispute resolution professional who appointed himself as arbitrator. He also became the arbitrator under the reinsurance agreements when the director of the Anguilla Financial Services Commission advised the reinsurer that there was no Anguilla Director of Insurance.

Despite objections and the joinder of the reinsurer in the arbitration, the arbitrator, under AAA rules, retained jurisdiction. After other procedural scrambling and court proceedings, the arbitrator ultimately issued an award in favor of the reinsurer and its manager. The award was challenged and the district court vacated the award, holding that the arbitrator exceeded his authority.

In affirming, the circuit court noted the difference in appointment authority and in the governing rules under the different categories of contracts. The court also noted that the arbitrator could not have been appointed by the authority required under the reinsurance agreements because that person did not exist. Nevertheless, the court found that an arbitration award made by an arbitrator not appointed under the required method must be vacated.

The court outlined the procedure for resolving the problem of a nonexistent appointing authority; Section 5 of the FAA. Under Section 5, the district court can appoint an arbitrator if there is a lapse in the naming of the arbitrator. Here, the mechanical breakdown in the arbitrator selection process that occurs when the appointing authority does not exist is the kind of lapse that can be addressed by an application for appointment under Section 5. But in this case, naming an existing and available appointing authority in the first place would have avoided at least part of the problem.

Exclusivity May Void the Arbitration Clause

A recent example of what could go wrong was before the United States Court of Appeals for the Second Circuit in a non-reinsurance case. In Moss v. First Premier Bank, 835 F.3d 260 (2d Cir. N.Y. 2016), which was a payday lender dispute, the loan application had an arbitration clause specifying that all disputes were subject to arbitration under the Code of Procedure of the National Arbitration Forum (NAF) in effect at that time. After the borrower brought a class action, the lender sought to compel arbitration. When the district court ordered the parties to arbitrate, the borrower sent a notice of intent to arbitrate to NAF. NAF, however, responded that because of a consent judgment concerning consumer arbitrations, it could not accept the arbitration. The borrower then returned to federal court and moved to vacate the order compelling arbitration. The district court granted the motion.

In affirming the district court, the Second Circuit focused on the language of the arbitration clause. The court noted that the clause did not address how the parties should proceed in the event that NAF was unable to accept the dispute. Citing an earlier case, Gutfreund v. Weiner (In re Salomon Inc. Shareholders' Derivative Litig.), 68 F.3d 554 (2d Cir. N.Y. 1995), the court held that the parties' agreement to arbitrate evinced an intent to designate an exclusive arbitral forum; arbitration before NAF. Because of this mandatory language, said the court, and the absence of any indication that the parties would assent to arbitration before a substitute, the order compelling arbitration was properly vacated.

The dispositive factor was whether the arbitral forum was exclusive. Where it is exclusive, the court held that Section 5 of the FAA could not be used to circumvent the parties' designation of an exclusive arbitral forum by compelling arbitration before a substitute. In other words, if you pick an exclusive forum and that forum is not available or refuses to accept the case, your dispute gets resolved in court.

The Second Circuit also noted a difference in opinion among the circuits on this issue, so at some point, the U.S. Supreme Court may weigh in. But for now, in the Second Circuit, if you designate an arbitral forum as the exclusive entity to hear the dispute, you are bound by that choice. And if that forum is not available, then you stay in court.

Conclusion

Where an arbitration provision names an arbitral authority, appointing authority, or set of rules as the exclusive mechanism for an arbitration under the contract, the arbitration may not go forward or the award may be vacated if that exclusive entity or set of rules does not exist or refuses to act. Care must be taken in specifying these items in an arbitration clause, and some flexibility should be considered if an overly specific exclusive provision is used.


Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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