Expert Commentary

Who's on First? Conflicting Arbitration and Service-of-Suit Clauses

There is an old saying: "The more things change, the more they stay the same." This cheesy adage is certainly true in cases where reinsurance agreements contain both an arbitration clause and a service-of-suit clause.


Reinsurance
March 2011

The courts have dealt with this issue and have generally agreed that the service-of-suit clause does not override the arbitration clause. We briefly discussed this issue in our September 2000 Expert Commentary. Yet, disputes over this apparent conflict continue to arise, and all reinsurance contract wordings have not caught up with the easy fixes that are available.

The Conflicting Clauses

The conflict issue arises where the typical command of the arbitration clause, that all disputes shall be resolved by arbitration, runs head on into the service-of-suit clause, by which the reinsurer agrees to be subject to the jurisdiction of any competent court. This conflict occurs in certain direct insurance contracts with non-U.S. insurers as well.

While there is no standard reinsurance arbitration clause, a typical clause will have language similar to the following:

Any dispute or other matter in question between the Company and the Reinsurer arising out of, or relating to, the formation, interpretation, performance, or breach of this Contract, whether such dispute arises before or after termination of this Contract, shall be settled by arbitration.

Brokers & Reinsurance Markets Association (BRMA) 6A. Standing alone, there is no ambiguity or conflict. Every dispute between the ceding insurer and the reinsurer must go to arbitration.

Now let's add a service-of-suit clause to the same contract:

It is agreed that in the event of the failure of the Reinsurer hereon to pay any amount claimed to be due hereunder, the Reinsurer hereon, at the request of the Company, will submit to the jurisdiction of a court of competent jurisdiction within the United States. Nothing in this Article constitutes or should be understood to constitute a waiver of the Reinsurer's rights to commence an action in any court of competent jurisdiction in the United States, to remove an action to a United States District Court, or to seek a transfer of a case to another court as permitted by the laws of the United States or of any state in the United States. It is further agreed that service of process in such suit may be made upon (Name and Address), and that in any suit instituted, the Reinsurer will abide by the final decision of such court or of any appellate court in the event of an appeal.

BRMA 49A. The service-of-suit clause is typically applicable only to reinsurers (or insurers) outside the United States and/or not authorized in the ceding insurer's state of domicile. The clause generally says this at the beginning. Most states' insurance regulations require a clause like this in a reinsurance agreement between a ceding insurer and an unauthorized alien reinsurer as a condition for the ceding insurer to take credit on its annual statement for the reinsurance provided.

The Conflict

It should be pretty obvious how these two clauses conflict where the reinsurer is from outside the United States or is otherwise unauthorized. Are disputes over the failure to pay a claim subject to the arbitration clause, or must they be brought in court under the service-of-suit clause?

A ceding insurer in a dispute with an unauthorized reinsurer certainly has a good textual argument for why it should be permitted to litigate its dispute. The clause only applies to non-U.S. and unauthorized reinsurers and was put in place to protect domestic ceding insurers from reinsurers that refuse to pay claims after gladly accepting reinsurance premiums. Being able to haul the unauthorized reinsurer into court and subjecting that reinsurer to the jurisdictional protections and enforcement capabilities of that court seems to be the intent behind the clause. This argument has even more strength where the arbitration clause is narrow in scope.

The counterargument is also obvious. The United States has a national policy in favor of arbitration. Most states have a similar policy. Where a contract contains a mandatory arbitration clause, it must prevail over a jurisdictional clause, and the two clauses must be read in harmony. How? The service-of-suit clause is there to allow the parties to use the courts so designated to enforce the arbitration provisions of the reinsurance contract and enforce any arbitration award issued without having to fight a jurisdictional battle. This counterargument finds even greater strength in jurisdictions that have amended their regulations requiring unauthorized alien reinsurers to agree to submit to local court jurisdiction in the reinsurance agreement to specifically state that this provision does not override an agreement to arbitrate. (See, e.g., 11 N.Y.C.R.R. § 125.4(f)(3)(ix)(a).)

The Courts Weigh in

Most courts hold that an arbitration clause and a service-of-suit clause are to be read as being compatible with one another. Essentially, these courts hold that an arbitration clause takes precedence over a service-of-suit clause and that a service-of-suit clause provides an auxiliary role to the arbitration clause.

In Boghos v. Certain Underwriters at Lloyd's of London, 115 P.3d 68 (Cal. 2005), a direct insurance case, the arbitration clause stated, "[n]otwithstanding any other item set forth herein, the parties hereby agree that any dispute which arises shall be settled in Binding Arbitration." The insurance contract also contained a service-of-suit clause providing that the insurer would submit to the jurisdiction of a U.S. court in the event of a failure of the insurer to pay an amount due under the insurance contract. Even though the dispute involved the insurer's failure to pay a claim, the court still held that the dispute must be submitted to arbitration. According to the court, the phrase "notwithstanding any other item set forth herein" clearly indicated that the parties wished to submit all disputes to arbitration, even if another provision could arguably lead to a different result if read in isolation.

The Boghos holding and reasoning were followed by a California federal court in NS Holdings LLC v. Am. Inter'l Grp. Inc., No. SACV 10–1132 DOC (JEMx), 2010 WL 4718895 (C.D. Cal. Nov. 15, 2010), another direct insurance case. The NS Holdings court rejected an attempt to distinguish Boghos because the "notwithstanding" language was absent. The court found that the Boghos court "simply noted that the 'notwithstanding' clause lent additional support to the court's decision ... " The court resolved the dispute by holding that the service-of-suit clause merely required the insurers to submit to the jurisdiction of any court in the United States "in actions to compel arbitration or to enforce arbitration awards."

Similar facts were present in Security Life Ins. Co. v. Hannover Life Reassurance Co. of Am., 167 F. Supp. 2d 1086 (D. Minn. 2001). The arbitration provision was extremely broad and provided that arbitration was the "sole remedy for disputes arising under" the agreement. The service-of-suit clause applied in the event of a "failure of the Reinsurer ... to pay any amount claimed" under the agreement. The court stated: "The fact that the service of suit clause specifies that it applies to a 'failure to pay any amount claimed' does not exempt these specific claims from broad arbitration agreements." The court reasoned that the purpose of service-of-suit clauses was to ensure that jurisdiction over the parties can be obtained. The court stated that the two provisions were to be read in harmony with one another. That is, the service-of-suit provision would come into play in order to compel arbitration or enforce an arbitration award. (See also Credit Gen. Ins. Co. v. John Hancock Mut. Life Ins. Co., No. 1:99 VC 02690, 2000 U.S. Dist. LEXIS 9003 (N.D. Ohio May 30, 2000).)

In Gaffer Ins. Co. v. Discover Reins. Co., 936 A.2d 1109 (Pa. Super. 2007), the court held that the service-of-suit clause did not prevail over the arbitration clause even though the service-of-suit clause provided that "[n]othing in the Article constitutes ... a waiver of [Gaffer's] rights to commence an action in any court of competent jurisdiction in the United States ... " The court reasoned that contracts should be interpreted so as to give effect to every provision. The claim that the service-of-suit clause replaced arbitration as the mandatory dispute resolution mechanism would render the arbitration provision superfluous. Instead, the court held that the arbitration clause and the service-of-suit clause can be read as being compatible with one another. That is, parties to a reinsurance contract can mandate arbitration to resolve disputes while also relying on the courts in order to file actions to compel arbitration or to enforce arbitration awards.

Other courts, however, have held that the inclusion of a service-of-suit clause in a reinsurance agreement may affect the scope of the arbitration clause. These cases generally involved situations where the arbitration clause was narrow and not broad. For example, in New Hampshire Ins. Co. v. Canali Reins. Co., No. 03 Civ. 8889LTSDCF, 2004 WL 769775 (S.D.N.Y. Apr. 12, 2004), the court found that the presence of a service-of-suit clause may serve as evidence that the parties intended the arbitration clause to be read narrowly. In New Hampshire Ins., the service-of-suit clause provided that disputes over amounts due under the agreement would be litigated. The court held that the inclusion of the clause demonstrated that the parties contemplated issues that would not be arbitrated if a dispute arose. According to the court, this was evidence that the arbitration clause was not to be given an all-encompassing interpretation. This is a minority view, although the specific facts of a case and the wording chosen by the parties may lead to this result on occasion.

Contractual Fixes

The contractual fix used by many reinsurance counterparties in their reinsurance contracts is to expressly state that the service-of-suit clause does not override or otherwise affect the parties' right to arbitrate under the arbitration clause. This is consistent with the current New York regulation, which specifically states that the provision "does not override an agreement between the ceding insurer and the unauthorized alien assuming insurer to arbitrate." (See 11 N.Y.C.R.R. § 125.4(f)(3)(ix)(a).) There are, of course, many ways to say this. Below is one example:

This Article will not be read to conflict with or override the obligations of the parties to arbitrate their disputes as provided for in the Arbitration Article. This Article is intended as an aid to compelling arbitration or enforcing such arbitration or arbitral award, not as an alternative to the Arbitration Article for resolving disputes arising out of this Contract.

BRMA 49G. Obviously, this does not help with older reinsurance agreements that are no longer subject to amendment.

Conclusion

Like many things, disputes continue to arise over issues that many courts have resolved, often because new parties come to the issue for the first time, and not every court in every state has addressed every issue. Clever parties and advocates will continue to press what appear to be new arguments on old issues because it is in their business interest to do so. So, it is not surprising to see new cases involving the purported conflict between the arbitration clause and the service-of-suit clause in reinsurance contracts. While new contracts can avoid the issue with clear wording, disputes will continue under contracts with older wording. Fresh eyes keep seeing a basis for dispute on this issue. Most courts, however, have made it clear that arbitration comes first, and no real conflict exists.


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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