That was the question in CLMS Management Services Limited Partnership, et al v. Certain Underwriters at Lloyd, et al, a case recently decided by the United States Court of Appeals for the Ninth Circuit.
Arbitration is an alternative to litigation. Instead of running to court, parties agree to submit their dispute to one or more independent arbitrators, who render a decision after a hearing. The decision of the arbitrators is final and can be enforced in court.
There are a number of advantages to arbitration. It is generally more efficient and timely than a lawsuit. Arbitration can often take place in months, rather than years. More importantly, arbitration can be less expensive. An arbitration agreement can limit discovery, which is often the most expensive part of litigation. In addition, damages can be limited to actual damages and can exclude other types of damages, like punitive and trebled damages, that enhance the risk of litigation.
There are also disadvantages to litigation, especially from a plaintiff’s perspective. A party to an arbitration agreement waives its right to a jury trial. A good plaintiff’s attorney can play to the jury’s emotions and often can get a better result for her client. In addition, an arbitration agreement may prohibit an award of attorneys’ fees, as well as class arbitration. This may make arbitration prohibitively expensive for a single plaintiff.
It is for these reasons that large companies often insert arbitration provisions in their contracts. Whether you know it or not, you probably agreed to arbitrate disputes with your cable or internet provider. You probably also agreed to arbitrate disputes with your credit card company. Arbitration provisions are prevalent in the consumer economy.
This brings us to the CLMS Management case.
The plaintiffs in the case were the owner and manager of a townhouse complex in Texas. In 2017, Hurricane Harvey caused approximately $5,660,000 in damages to the complex. The plaintiffs filed a claim under an insurance policy that had been procured through the defendants. The defendants adjusted the claim and said that the deductible under the policy was $3,660,000. The plaintiffs, on the other hand, claimed that the deductible was only $360,000. This was obviously a big deal!
The plaintiffs filed a lawsuit in federal district court in the state of Washington. While the insured property was located in Texas, the plaintiffs were Washington entities and the policy had been delivered in Washington. All parties agreed that Washington was the proper venue for the lawsuit, and that the federal district court had jurisdiction, since one of the defendants, Certain Underwriters at Lloyd, was a foreign entity.
The defendants responded to the lawsuit by filing a motion to compel arbitration. The district court granted the motion and ordered arbitration. The plaintiffs appealed to the Appeals Court, and this decision resulted.
An insurance policy is a contract and is subject to the same rules of interpretation as any contract. If a provision in an insurance policy is ambiguous, it will generally be interpreted in favor of the insured. However, where the policy is clear and unambiguous, it will be given its ordinary meaning. The policy in this case had a clear and unambiguous arbitration provision:
All matters in difference between the Insured and the Companies (hereinafter referred to as “the parties”) in relation to this insurance, including its formation and validity, and whether arising during or after the period of this insurance, shall be referred to an Arbitration Tribunal in the matter hereinafter set out . . .
So, why did plaintiffs appeal?
The interpretation of a contract, including an insurance policy, is generally subject to state law. And, in Washington, a binding arbitration provision in an insurance policy is unenforceable.
Wash. Rev. Code § 48.18.200 provides:
(1) . . . [N]o insurance contract delivered or issued for delivery in this state and covering subjects located, resident, or to be performed in this state, shall contain any condition, stipulation, or agreement . . .
(b) depriving the courts of this state of the jurisdiction of action against the insurer . . .
(2) Any such condition, stipulation, or agreement in violation of this section shall be void, but such voiding shall not affect the validity of the other provisions of the contract.
So, clearly, the policy’s arbitration provision was unenforceable and the Appeals Court ruled in favor of the plaintiffs. Right? Wrong!
The Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the “Convention”) is a multinational treaty developed by the United Nations in 1958. It provides, in relevant part, that:
1. Each Contracting State shall recognize an agreement in writing under which the parties undertake to submit to arbitration all or any differences which have arisen or which may arise between them in respect of a defined legal relationship, whether contractual or not, concerning a subject matter capable of settlement by arbitration.
The United States agreed to the terms of the Convention in 1970, when Congress amended an existing provision of the US Code to provide that the Convention “shall be enforced in United States courts in accordance with this chapter.”
So, Washington law prohibits arbitration provisions in insurance contracts, but an international treaty signed by the United States requires that such provisions be enforced. How was the conflict resolved?
Article VI of the United States Constitution provides that:
This Constitution, and the laws of the United States which shall be made in pursuance thereof; and all treaties made, or which shall be made, under the authority of the United States, shall be the supreme law of the land; and the judges in every state shall be bound thereby, anything in the Constitution or laws of any State to the contrary notwithstanding.
This is what is generally referred to as the Supremacy Clause, and it provides that, where federal and state law conflict, federal law prevails. In other words, federal law preempts state law – unless it doesn’t.
In 1945, Congress enacted the McCarran-Ferguson Act in response to a Supreme Court decision that held that insurance is interstate commerce and can be regulated by the federal government. Prior to that Supreme Court decision, insurance had generally been thought to be within the exclusive purview of the States. In the McCarran-Ferguson Act, Congress provided 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, or which imposes a fee or tax upon such business, unless such Act specifically relates to the business of insurance . . .
This is what is referred to as “reverse-preemption”. While in the ordinary course, federal law preempts state law, when it comes to the business of insurance, state law preempts federal law.
So, the question is which law governed in the CLMS Management case – the international treaty requiring the recognition of arbitration provisions or the Washington law prohibiting arbitration provisions in insurance contracts?
For reasons beyond the scope of this article, the Court found that the Convention was not the result of an “Act of Congress”. Since the “reverse-preemption” provisions of the McCarran-Ferguson Act apply only to “Acts of Congress”, the Convention was not “reverse-preempted” by the Washington statute. Instead, the Washington law was preempted by the Convention by virtue of the Supremacy Clause of the US Constitution.
Accordingly, the Appeals Court affirmed the decision of the district court and ordered the parties to proceed to arbitration. Whether the deductible under the policy was $360,000 or $3,660,000 will have to wait for another day.
We began by asking whether an insurance company can require an insured to arbitrate a policy dispute. The answer is that it depends upon the law of the state where the policy is delivered. Under normal circumstances – i.e., not involving an international treaty, if state law prohibits arbitration, then an arbitration provision in a policy will be unenforceable. If state law is silent, then an arbitration provision will be given effect.