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    Recent Caselaw Illuminates the Limits of the Federal Arbitration Act’s Reach to Insurance Contracts

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    Courts are more and more likely to enforce an arbitration clause, but not necessarily the ones in an insurance contract. The U.S. Supreme Court has held the Federal Arbitration Act (“FAA”) to override state common law and statutes that would obstruct enforcement of an arbitration clause. AT&T Mobility LLC v. Concepcion, 131 S. Ct. 1740 (2011); Marmet Health Care Center, Inc. v. Brown, 132 S. Ct. 1201 (2012). On July 15, the Ninth Circuit Court of Appeals found that the FAA similarly overrode Montana’s common law against enforcing an arbitration clause when it appeared in a contract of adhesion and is deemed not within the parties’ reasonable expectations. See here for the Ninth Circuit’s opinion in Mortensen v. Bresnan Communications, LLC, No. 11-35823 (9th Cir. July 15, 2013).

    But three days earlier in Scott v. Louisville Bedding Co., the Kentucky Court of Appeals ruled that the FAA does not override a Kentucky statute held to limit arbitration clauses in insurance contracts. Under the Kentucky Uniform Arbitration Act, a written arbitration clause is “valid, enforceable and irrevocable,” but by its own terms the Kentucky Act “does not apply to: . . . Insurance contracts.” Hugh Scott, as president of United Re AG, signed a trust agreement the Louisville Bedding Co. The Bedding Co. sued, claiming that Mr. Scott was supposed to purchase insurance for its benefit, and Mr. Scott moved to compel arbitration pursuant to the trust agreement’s arbitration clause. Deeming the trust agreement an insurance contract, the trial court denied Mr. Scott’s motion, and the Court of Appeals affirmed.

    The appellate court treated the Kentucky Act as banning arbitration clauses in insurance contracts, a point we shall revisit. The FAA mandates that a written arbitration clause “shall be valid, irrevocable, and enforceable” without any disclaimer for insurance contracts, and the U.S. Supreme Court has ruled the FAA to override conflicting state laws because federal law is supreme. So why did the Kentucky court fail to follow suit? Because of the federal McCarran-Ferguson Act. This other federal statute requires 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,” and Kentucky’s purported ban on arbitration clauses in insurance contracts seems to serve the purpose of regulating the business of insurance. The Kentucky court’s ruling is consistent with most courts, which commonly interpret the McCarran-Ferguson Act to deem the FAA “reverse preempted” by state law banning insurance contracts’ arbitration clauses.

    The court left an important point unexplained: how does the Kentucky Act ban insurance contracts’ arbitration clauses? On its face, these clauses are not enforceable under the Kentucky Act, but it does not expressly ban them. They still should be enforceable under the FAA, which, after all, a state court can invoke. Mr. Scott and the Bedding Co.’s contract easily falls within interstate commerce, as Mr. Scott conducted his business from Texas. It may well have been that the Kentucky Act does not ban insurance contracts’ arbitrations clauses at all.

    Be that as it may, the McCarran-Ferguson Act presents an interesting dichotomy between American insurers and foreign insurers seeking to enforce their insurance contracts’ arbitration clauses. Whereas the FAA is the general device for a party to use to enforce an arbitration clause, that device for a foreign party to use is the New York Convention, a treaty among the United States and nearly 150 other countries. Circuits have split on the McCarran-Ferguson Act’s effect on the Convention. The Second Circuit has ruled that the McCarran-Ferguson Act reverse preempts the Convention, hence courts in that jurisdiction would enforce state law bans on insurance contracts’ arbitration clauses. Stephens v. Am. Int’l Ins. Co., 66 F.3d 41 (2d Cir. 1995). In contrast, the Fourth and Fifth Circuits have ruled that it does not. Therefore courts there would ignore the state law bans and instead enforce the arbitration clauses if one party to the contract is a foreigner. ESAP Group v. Zurich Ins. PLC, 685 F.3d 376 (4th Cir. 2012); Safety Nat’l Cas. Corp. v. Certain Underwriters at Lloyd’s, London, 587 F.3d 714, 720 (5th Cir. 2009) (en banc). The McCarran-Ferguson Act should not let a state set the Convention aside and refuse to enforce a foreign insurer’s arbitration clause, as doing so permits each state to conduct its own foreign policy, undermines the trustworthiness of the American side of the bargain struck in the Convention, and invites other countries to treat American insurers the same way. Further, American insurers should not stand in American courts on worse footing than their foreign competitors would. Courts should re-examine whether bans of insurance contracts’ arbitration clauses are indeed “for the purpose of regulating the business of insurance,” which always has been a squishy, indeterminate concept.

    The opinion of the Kentucky Court of Appeals in Scott v. Louisville Bedding Co., No. 2012-ca-252 (Ky. July 12, 2013) can be found here.

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