Reverse Preemption Is Alive And Well In Washington State

Larry P. Schiffer | Squire Patton Boggs

Most reinsurance contracts have binding arbitration provisions. The Federal Arbitration Act (FAA) sets out a national policy in favor of arbitration. Yet, there are states that expressly preclude arbitration provisions in insurance contracts. Does that apply to reinsurance contracts?

In Washington Cities Insurance Authority v. Ironshore Indemnity, Inc., No. 2:19-cv-0054-RAJ, 2020 U.S. Dist. LEXIS 39633 (W.D. Wash. Mar. 6, 2020), a public entities association organized for the purse of self-insuring risks and jointly purchasing insurance and reinsurance, purchased a reinsurance agreement that included an arbitration provision. A dispute arose concerning the settlement of a police misconduct lawsuit, which the cedent presented to the reinsurer for payment. The cedent commenced an action because of the reinsurer’s denial. The reinsurer moved to compel arbitration and the cedent moved to establish that the arbitration clause was void.

Washington, it turns out, is one of several minority states that have express provisions in their insurance laws that prohibit arbitration provisions in insurance agreements. RCW § 48.18.200 expressly provides that insurance contracts delivered or issued for delivery in Washington cannot contain a provision depriving the courts “of the jurisdiction of action against the insurer.” As the court noted, although the FAA would normally preempt a conflicting state law under the Supremacy Clause of the US Constitution, the McCarran-Ferguson Act creates a system of reverse preemption for state insurance law. The court cited examples of cases that hold, and noted that the parties did not appear to dispute, that under the McCarran-Ferguson Act, RCW § 48.18.200 preempts Chapter I of the FAA.

The court then articulated the dispute before it: (1) does reinsurance qualify as insurance and (2) does the anti-arbitration provision apply to reinsurance agreements where the reinsurance was purchased by a joint self-insurance program. The court concluded that the answer to both questions was yes.

The court examined the definition of insurance under Washington law, RCW § 48.01.040, and concluded that “reinsurance” comes within the definition of “insurance.” The court noted that both are contracts where one undertakes to indemnify the other or pay a specified amount upon determinable contingencies. The court found no basis to find that the reinsurance agreement did not fall within the definition of insurance. Moreover, the court noted that nothing in the statute’s text expressly excluded reinsurance and that a review of other sections showed that the legislature knew how to specifically exempt certain types of insurance from the section and to carve reinsurance out of other sections.

The court also concluded that the statute governing the joint self-insurance program that created the cedent did not contain any language saving arbitration provisions in reinsurance contracts purchased by the cedent. Although the statute suggested that the legislature authorized the cedent to purchase their own reinsurance, the statute did not reference arbitration provisions or authorize the inclusion of arbitration provisions in those contracts. The court refused to read into the statute that which the legislature omitted.

The court concluded that there was nothing in the statutory language or the relevant case law to support the reinsurer’s arguments and the motion to compel arbitration was denied.

You Cannot Arbitrate Claims Not Covered By The Arbitration Agreement

David Adelstein | Florida Construction Legal Updates

Regardless of the type of contract you are dealing with, “[a]rbitration provisions are contractual in nature, and therefore, construction of such provisions and the contracts in which they appear is a matter of contract interpretation.”  Wiener v. Taylor Morrison Services, Inc., 44 Fla. L. Weekly D3012f (Fla. 1st DCA 2019).   This means if you want to preserve your right to arbitrate claims you want to make sure your contract unambiguously expresses this right.  Taking this one step further, if you want to make sure an arbitrator, and not the court, determines whether the claim is arbitrable if a dispute arises, you want to make sure that right is expressly contained in the arbitration provision.

For example, in Wiener, a homeowner sued a home-builder for violation of the building code – a fairly common claim in a construction defect action.  The homeowner’s claim dealt with a violation of building code  as to exterior stucco deficiencies.   The home-builder moved to compel the lawsuit to arbitration based on a structural warranty it provided to the homeowner that contained an arbitration provision.   The structural warranty, however, was limited and did not apply to non-load-bearing elements which, per the warranty, were not deemed to have the potential for a major structural defect (e.g., a structural defect to load-bearing elements that would cause the home to be unsafe or inhabitable).  The trial court compelled the dispute to arbitration pursuant to the arbitration provision in the structural warranty.

But, the First District Court of Appeal held the trial court was wrong to compel the dispute to arbitration.  Why?  The homeowner did not sue the home-builder for a breach of the structural warranty.  Even if the homeowner was trying to navigate around the structural warranty, the warranty was limited in nature and would NOT apply to a claim dealing with defective stucco, which is not a load-bearing issue, to say the least.  See Wiener, supra (“[C]onsidering the plain meaning of the structural warranty agreement, the [plaintiff’s] complaint does not raise claims subject to arbitration under that agreement.”).  The home-builder could not have its cake and eat it too — it could not exclude claims from the warranty and then try to arbitrate those very excluded claims per an arbitration provision in the warranty.

Here, the issue of whether the claim was arbitrable (subject to arbitration), was decided by the court, as it typically is.  The arbitrability of a claim is typically a question for the court.  Wiener, supra. This does not mean that it needs to be that way.   Parties can clearly include in their arbitration provision that the determination of the arbitrability of a claim is a determination for an arbitrator, and not the court.

The Legal Framework for Insurance Disputes in USA

Summer Craig and Susannah S. Geltman | Simpson Thacher & Bartlett

All questions

The legal framework

i Sources of insurance law and regulation

The regulation of insurance in the US is primarily performed by the states. In 1945, the US Congress passed the McCarran-Ferguson Act, which provides that ‘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 . . . unless such Act specifically relates to the business of insurance.’ Under the McCarran-Ferguson Act, federal law preempts state insurance law only if it specifically relates to ‘the business of insurance’.

The law of insurance in the US generally falls into one of two broad categories: (1) the regulation of entities that participate in the business of insurance; and (2) the regulation of the policyholder–insurer relationship. State law pertaining to the regulation of entities is generally comprised of statutes enacted by state legislatures and administrative regulations issued by state agencies, such as departments of insurance.

Each state also has statutory and common law applicable to the policyholder–insurer relationship. State statutes address a range of topics, including, among others, the disclosure obligations of the parties to an insurance contract, the nature of a policyholder’s notice obligations and the circumstances in which a victim of tortious conduct may sue a tortfeasor’s insurer directly. State common law is an important source of law for resolving disputes between policyholder and insurer. Practitioners must carefully assess potentially applicable law at the outset of a dispute, as insurance law (whether common law or statutory) varies by jurisdiction.

ii Insurable risk

In the US, the validity of an insurance contract ordinarily is premised on the existence of an insurable interest in the subject of the contract. An insurable interest may be defined as any lawful and substantial economic interest in the safety or preservation of the subject of the insurance free from loss, destruction or pecuniary damage. The insurable interest doctrine was first adopted by courts and has since been codified in state statutes. The purpose of the insurable interest requirement, as articulated by courts and commentators, is to discourage wagering and the destruction of life and property and avoid economic waste.

iii Fora and dispute resolution mechanics

Litigation of insurance disputes

The US judicial system is comprised of two separate court systems. The US itself has a system comprised of federal courts and each of the 50 states has its own system comprised of state courts. Although there are important differences between federal and state courts, they share some key characteristics. Each judicial system has trial courts in which cases are originally filed and tried, a smaller number of intermediate appellate courts that hear appeals from the trial courts and a single appellate court of final review.

Unlike state courts, which include courts of general jurisdiction that can address most kinds of cases, federal courts principally have jurisdiction over two types of civil cases. First, federal courts may hear cases arising out of the US Constitution, federal laws or treaties. Second, federal courts may address cases that fall under the federal ‘diversity’ statute, which generally authorises courts to hear controversies between citizens of different US states and controversies between citizens of the US and citizens of a foreign state. For diversity jurisdiction to exist, there must be ‘complete’ diversity between litigants (i.e., no plaintiff shares a state of citizenship with any defendant) and the ‘amount in controversy’ must exceed US$75,000.

Most insurance disputes are litigated in the first instance in federal or state trial courts. Federal courts commonly exercise jurisdiction over insurance disputes under the diversity statute. In this context, an insurance company, like any other corporation, is deemed to be a citizen of both the state in which it is incorporated and the state in which it has its principal place of business.

An insurance action that is originally filed in state court may be ‘removed’ to federal court based on diversity of citizenship of the litigants. In the absence of diversity of citizenship or some other basis of federal court jurisdiction, insurance disputes are litigated in state courts. The venue is typically determined by the place of injury or residence of the parties, or may be dictated by a forum selection clause in the governing insurance contract. The law applied to the dispute may likewise be dictated by a choice-of-law clause in the insurance contract or, in the absence of such a clause, determined by a court based on relevant choice-of-law principles.

Arbitration of insurance disputes

Some insurance contracts contain arbitration clauses, which are usually strictly enforced. The Federal Arbitration Act (FAA) and similar state statutes empower courts to enforce arbitration agreements by compelling the parties to arbitrate. If an insurance contract contains a broadly worded arbitration clause, virtually every dispute related to or arising out of the contract typically may be resolved by arbitrators rather than a court of law.

While all US states recognise the validity and enforceability of arbitration agreements in general, some states have made a statutory exception for arbitration clauses in insurance contracts. Complex legal issues may arise when an insurance contract obligates parties to arbitrate but applicable state statutory law prohibits the arbitration of insurance-related disputes. Although state laws that prohibit arbitration are generally preempted by the FAA, by virtue of the Supremacy Clause in the US Constitution, state anti-insurance arbitration statutes may be saved from preemption by the McCarran-Ferguson Act. As noted, the McCarran-Ferguson Act provides that state laws enacted ‘for the purpose of regulating the business of insurance’ do not yield to conflicting federal statutes unless a federal statute specifically relates to the business of insurance. Because the FAA does not specifically relate to insurance, courts have held that the FAA may be ‘reverse preempted’ by a state anti-insurance arbitration statute if the state statute has the purpose of regulating the business of insurance. As discussed in Section IV, courts are split regarding whether the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention), an international treaty that mandates the enforcement of arbitration agreements, may be reverse preempted pursuant to the McCarran-Ferguson Act.

Where an insurance dispute is resolved through arbitration, the resulting award is generally considered to be binding, although there are grounds to vacate or modify an award under the FAA, similar state statutes and the New York Convention. The FAA describes four limited circumstances in which an arbitration award may be vacated by a court: (1) where the award was procured by corruption, fraud or undue means; (2) where there was evident partiality or corruption in the arbitrators; (3) where the arbitrators were guilty of misconduct in refusing to postpone the hearing, upon sufficient cause shown or in refusing to hear evidence pertinent and material to the controversy; or if by any other misbehaviour the rights of any party have been prejudiced; or (4) where the arbitrators exceeded their powers or so imperfectly executed them that a mutual, final and definite award upon the subject matter submitted was not made. One area of legal uncertainty is whether a court may vacate an award based on an arbitrator’s ‘manifest disregard’ of the law. Although the manifest disregard standard is not listed in the FAA, some courts have ruled that an award may be vacated on this basis.

Ensuring Efficient Arbitration of Construction Disputes Involving Mechanic’s Liens

Robert G. Campbell and Trevor B. Potter | Construction Executive

There may be tension between the enforcement of statutory mechanic’s lien claims when a contractual dispute resolution provision calls for arbitration. Once the parties are in arbitration, it may not be clear whether the arbitrator has authority to make factual determinations regarding amount and validity of mechanic’s liens, and whether courts are bound by these determinations. This uncertainty stems from the fact that in most states a mechanic’s lien can only be enforced by a court of competent jurisdiction. Indeed, many mechanic’s liens statutes define foreclosure as a “judicial process,” and courts generally have exclusive jurisdiction to issue orders foreclosing on real property1.  

The risk for contractors and owners is that they will spend time and money re-litigating factual issues related to proving elements of a mechanic’s lien claim, including the proper lien amount, timeliness and other prerequisites. Without a clear understanding of what issues and elements are arbitrable, the parties run the risk that an arbitrator will rule on certain elements only to find out during post-arbitration lien foreclosure proceedings that the arbitrator lacked authority to make determinations on those elements. Questions therefore arise whether a court will enforce the arbitrator’s determinations and whether the parties must relitigate mechanic’s lien issues creating a further risk of inconsistent rulings. 

These risks can be minimized through arbitration provisions which address these issues, express requests in arbitration demands and by ensuring that arbitration awards contain explicit determinations of mechanic’s liens issues.

The resolution of any mechanic’s lien claim requires factual determinations regarding the amount and validity of a lien. The appropriate amount of a mechanic’s lien is generally the same as the contract balance owed2.  Since construction disputes usually involve breach of contract claims for unpaid amounts, arbitrators will necessarily determine the contract balance owed to a lien claimant during arbitration. It is therefore efficient for arbitrators to determine the appropriate amount of mechanic’s lien claims. 

Lien “validity” refers to whether a lien claimant strictly complied with state law requirements to perfect its mechanic’s lien. Some of those prerequisites include:

  • providing timely pre-lien notice (in California this is referred to as a Preliminary Notice) and post-recordation notice of the lien in proper form with all required information;
  • proper service of the pre-lien notice on all required persons;
  • timely recording of the lien; and 
  • timely filing of a lawsuit to foreclose on the lien. 

As with the amount of mechanic’s liens, much of the evidence relevant to lien validity, including the date work commenced, the date of notice, the project completion date and the timing of any lien foreclosure actions, etc. will likely be presented at arbitration. Since arbitrators typically consider significant evidence relevant to the amount and validity of mechanic’s liens in the normal course of a construction arbitration, it is efficient and proper for arbitrators to determine these elements in arbitration. 

In order to reduce the uncertainty regarding the arbitrator’s authority to make factual determinations regarding the amount and validity of mechanic’s liens, parties should first ensure that the arbitration provision in their construction agreements is broadly worded to encompass “all disputes” related to the project. The scope of arbitrator authority in the AIA A201 General Conditions is tied to the resolution of “Claims”, which include “…any demand or assertion by one of the parties seeking, as a matter of right, payment of money, a change in the Contract Time, or other relief with respect to the terms of the Contract…[and] other disputes and matters in question between the Owner and Contractor arising out of or relating to the Contract.” 

This language arguably empowers the arbitrator to determine the amount and validity of mechanic’s liens, but on its own, it may be insufficient to resolve uncertainty with respect to the arbitrator’s authority. To remedy this, Parties should consider including language in their arbitration provisions which expressly states “To the fullest extent permitted by law, the arbitrator shall determine factual issues concerning the amount and validity of any mechanic’s lien claims asserted by the parties3.”  This language clarifies the parties’ intent for the arbitrator to make factual determinations related to mechanic’s liens in arbitration, and provides courts with a justification to enforce these determinations in a subsequent foreclosure proceeding. 

Addressing uncertainty regarding the arbitrator’s authority to make factual determinations regarding the amount and validity of mechanic’s liens is an important step, but there are other practical steps owners and contractors should take to ensure courts accept and enforce those determinations. 

First, parties should expressly request determinations concerning the validity and amount of mechanic’s liens in their arbitration demands and responsive submissions. If the arbitrator has apparent contractual authority to determine the amount and validity of mechanic’s liens, but the parties do not expressly request these determinations from the arbitrator, the arbitration award may not contain them and issues may later arise in the trial court when proceedings ensue to foreclose on the lien. The parties may be forced to relitigate them in a subsequent lien foreclosure action. 

Second, if the award does not include the requested factual determinations concerning the amount and validity of mechanic’s liens, the parties should move to correct/modify the arbitration award immediately. Courts are very deferential to arbitration awards as a matter of public policy, but the parties must ensure that the award contains all of the mechanic’s lien determinations requested from the arbitrator in order for a court to enforce them. Following these recommendations will minimize the risk of having to relitigate mechanic’s lien issues in post-arbitration lien foreclosure proceedings. 

To be sure, there are aspects of arbitrating mechanic’s lien claims that remain problematic. Since arbitration is a creature of contract, non-parties to the arbitration agreement cannot be compelled to participate in arbitration and may justifiably argue they are not bound by arbitrator determinations. This problem crops up in lien foreclosure proceedings where the priority of the lien vis-à-vis junior liens and other interests in the property will be determined by the court. There is little parties can do to eliminate this phenomenon given that foreclosure of mechanic’s liens and lien priority, as noted above, is typically within the exclusive province of the courts.

Nevertheless, uncertainty regarding the scope of arbitrator authority to determine factual issues concerning the amount and validity of mechanic’s liens and the potential inefficiency associated with that uncertainty can be minimized through express language in arbitration provisions, explicit requests for a determination of these issues in arbitration demands and ensuring that arbitration awards include the requested determinations. Litigating a mechanic’s lien once is painful enough, litigating it twice should be avoided as much as possible.

Who Gets To Decide Whether Class Arbitration Is Available? It Just Might Be The Arbitrator

Philip Mohr | Womble Bond Dickinson

Where an agreement provides that “any dispute… arising out of the agreement” would be settled by binding arbitration in accordance with “the Rules of the American Arbitration Association,” such language provides “clear and unmistakable evidence” of the parties’ agreement to delegate certain substantive issues—like the availability of class arbitration—to the arbitrator. Rickenbaugh v. Power Home Solar, LLC, 2019 NCBC 79 (J. Bledsoe). As such, when agreements incorporate AAA’s Rules, the Business Court will compel arbitration but leave it to the arbitrator to determine whether class wide arbitration is available.

Plaintiffs are North Carolina homeowners. Defendant Power Home Solar, LLC (“Power Home”), a nation-wide solar installation company, contacted Plaintiffs to discuss Power Home’s “standard energy savings package.” Power Home’s representative allegedly promised Plaintiffs savings in excess of 90% on their energy bills if they purchased its energy package. Based upon these representations, Plaintiffs entered into an agreement with Power Home to purchase the energy package and have it installed (“Agreement”). The Agreement contained an arbitration provision that stated, “[A]ny dispute arising out of …any aspect of this agreement…shall be settled by binding arbitration in accordance with the Construction Industry Rules of the American Arbitration Association…” Power Home installed the energy package, but Plaintiffs did not experience the drop in energy bills they were expecting. Plaintiffs filed a putative class action against Power Home in Mecklenburg County Superior Court on behalf of themselves and other Power Home customers. Power Home filed a motion to dismiss or, in the alternative, to compel bilateral arbitration (thereby effectively precluding class-wide arbitration). In its Motion, Power Home argued that the Agreement clearly required Plaintiffs to arbitrate their claims and, because the Agreement had no clear language permitting class wide arbitration, the Court should determine whether Plaintiffs could maintain a class wide arbitration. Plaintiffs disagreed and contended, at a minimum, the inclusion of AAA’s Rules meant that the arbitrator, and not the Court, had to decide whether the Agreement allowed for class wide arbitration.

In its decision, the Business Court compelled Plaintiffs to arbitrate, but agreed with Plaintiffs that the arbitrator—and not the Court—would decide whether class wide arbitration was permitted. While a court typically decides questions of “substantive arbitrability” (e.g., whether the parties are bound by a given arbitration clause, whether the arbitration clause applies to a particular type of controversy, etc.), the Business Court recognized that the parties can delegate “substantive arbitrability” questions to the arbitrator so long as there is “clear and unmistakable evidence” of an agreement to so delegate. Because AAA’s Construction Rules empower the arbitrator to determine the “scope” of the arbitration agreement, the Business Court followed numerous federal court decisions and held the Agreement’s incorporation of AAA’s Rules provided “clear and unmistakable evidence” that Plaintiffs and Power Home had delegated the issue of the arbitrability of their personal claims to the arbitrator. (Opinion, ¶¶21,31,32). However, the Business Court also recognized whether the inclusion of AAA’s Rules constituted “clear and unmistakable evidence” that the parties’ had agreed to delegate the question of class wide arbitration to the arbitrator was an issue that had divided federal circuit courts and had not been definitively answered by the U.S. Supreme Court. (Id., ¶¶25,27,28). Acknowledging the “fundamental difference” between class arbitration and bilateral arbitration, as well as the potential due process concerns for allowing an arbitrator to determine the existence of a class (Id., ¶¶23,27), the Business Court nonetheless sided with those federal circuit courts that have concluded the incorporation of AAA’s Rules constitutes “clear and unmistakable evidence” to delegate the question of class wide arbitration to the arbitrator. (Id., ¶33). As a result, the arbitrator—and not the Business Court—would determine the availability of class wide arbitration. (Id., ¶34).

Based upon this decision, a business which incorporates any of the Rules of the American Arbitration Association into its arbitration agreements should understand that it is agreeing that an arbitrator—and not a judge—will decide whether an agreement permits class wide arbitration and, correspondingly, whether a class can be certified, whether a class action can be maintained, etc. All such decisions will be made with limited opportunity for judicial review. In order to avoid such a result, a business would be well served to provided explicit language in its arbitration agreements that requires any issue about the availability of class wide arbitration to remain with the court.

Additional legal points from this decision:

  • Although the agreement at issue in this case involved AAA’s Construction Rules, the same language involving the expansive “scope” of the arbitrator’s power that is contained in the Construction Rules (and which the Business Court relied on in reaching its decision that “clear and unmistakable evidence” existed) is the same language used in AAA’s Commercial Arbitration Rules and AAA’s Consumer Arbitration Rules. See American Arbitration Association Commercial Arbitration Rules and Mediation Procedures, §R-7(a); American Arbitration Association Consumer Arbitration Rules, §R-14(a). As such, the Business Court’s reasoning would likely apply regardless of which AAA Rules are employed.
  • Although the rules for AAA do not contain class arbitration procedures, class arbitration procedures are provided for in AAA’s Supplementary Rules for Class Arbitration which, by their own terms, are incorporated into “any of the rules of [AAA] where a party submits a dispute to arbitration…” (Opinion, ¶31).