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Practice Note:
Can Arbitration Panels Retain Their Own Experts?

by ~ Alexander G. Henlin (Email) (Web Site)

An Expert Dilemma: Arbitrators & Independent Experts in Reinsurance Disputes

Rare is the reinsurance arbitration proceeding that does not feature an expert. Parties routinely employ consultants to vet their case theories or steer their questioning by examining reams of data. Many will introduce expert reports or, if the matter goes to formal hearing, bring their experts to testify before the panel. But what happens when the panel needs more guidance? Can the panel itself employ independent experts to offer advice about the case? Would that act deprive the parties of the procedural and substantive rights they bargained for as part of the arbitration clause in their reinsurance agreement?

These were some of the questions before the Ninth Circuit in United States Life Insurance Company v. Superior National Insurance Company, 591 F.3d 1167 (9th Cir. 2010). A unanimous panel held that a reinsurance arbitration award would not be set aside, where the panel had employed independent experts to help it sort through a complex case, and the panel afforded the parties an opportunity to question the experts about their qualifications and conclusions.

Factual Background

Five California insurance carriers contracted with U.S. Life to reinsure their workersĀ compensation risks between May 1, 1998, and January 1, 2003. The reinsurance contract contained an arbitration provision. The five ceding carriers later declared bankruptcy.

On November 29, 1999, U.S. Life demanded arbitration. It claimed that the five carriers had misrepresented their reserves when the reinsurance agreement was being underwritten, entitling U.S. Life to rescission or reformation. U.S. Life also asserted that it was entitled to damages for the five carriersĀ bad-faith performance. The ceding carriers agreed to arbitration and asserted counter-claims, demanding a ruling that the reinsurance contract was valid and that U.S. Life was obligated to perform.

A three-member panel, consisting of two party-appointed arbitrators and a neutral umpire, bifurcated the proceedings. In the first phase, the panel considered U.S. Lifeís rescission and reformation claims. After conducting formal hearings, the panel ruled that there was no basis to grant rescission; but it did reform the reinsurance contract, reducing U.S. Lifeís obligation to 90% of the promised coverage. U.S. Life unsuccessfully sought to set aside the award.

In the second phase, the panel considered whether the five carriers had improperly handled the claims they submitted to U.S. Life, resulting in bills in excess of the amounts due under the reinsurance agreement. Rather than review each of the approximately 99,000 claims submitted, the parties agreed to use a much smaller sample. Experts for both the ceding carriers and U.S. Life prepared detailed reports.

Following thirteen days of hearings, in March 2005, the panel announced to the parties that it was unable to reach a decision about the quality of the five carriersĀ claims handling and U.S. Lifeís reinsurance obligations. To rectify the problem, the panel announced that it would retain two independent workersĀ compensation claims experts to review the agreed-upon sample. The panel unanimously agreed to employ the following process: (1) the panelís experts would review 162 of the 500 claim files comprising the sample; (2) the reviewers would meet with the panel members ex parte for three days, and no transcript would be prepared; (3) the panelís experts would provide their conclusions in writing to the panel; (4) the parties could submit briefs in response to the panelís expertsĀ conclusions; (5) the parties would then have five hours each to question the panelís experts, in formal hearing, about their qualifications and conclusions, but not the ex parte meeting; and (6) the parties could submit post-hearing briefs to the panel.

On December 6, 2006, the panel issued its second-phase findings. It found that all amounts billed by the five ceding carriers to U.S. Life were properly due and imposed a remedy that further required U.S. Life to disgorge its investment earnings on all money due under the reinsurance agreement.

U.S. Life filed another action to vacate the panelís findings. The district court denied U.S. Lifeís petition, leading to the appeal to the Ninth Circuit.

Discussion

The entire opinion is too lengthy to discuss in detail here, and the interested reader is directed to the full ruling for a treatment of other challenges to the arbitration award. One of the grounds upon which U.S. Life sought to void the arbitration award, though, was alleged misconduct and prejudicial behavior on the part of the panel. U.S. Life contended that, by closing the meeting of the panel with the reviewers, the panel refused to hear material evidence about the ceding carriersĀ claim-handling practices.

The Ninth Circuit found that, while not routine, the panelís decision to employ its own neutral experts and then have ex parte meetings with them fell within the scope of the panelís authority to set rules of procedure. Accordingly, the arbitration panel did not commit actionable misconduct, as would be required to vacate an award under 9 U.S.C. Ā 10(a)(3). The court concluded that the panelís refusal to let the parties participate in or question the neutral experts about the ex parte meeting did not constitute a refusal to hear evidence that was ďpertinent and material.Ā It was only after the panel listened to, and considered, the partiesĀ expert opinions and other evidence that the arbitrators sought additional information from its own experts; and the panel designed a process that allowed the parties to review and critique the neutral expertsĀ conclusions.

The Ninth Circuit then proceeded to distinguish U.S. Lifeís case from others where there had been panel misconduct. This was not a case, the court said, like one in which the arbitrator misled a party into believing that certain evidence had been admitted, but then ruled against that party on grounds that it had failed to present the evidence in dispute. Nor was it like another case, where the arbitration decision had been rendered before each party had been allowed to complete the presentation of its proof. Here, the panelís process provided extensive due process and fell within the arbitratorsĀ ďwide discretionĀ to fashion the rules under which the presentation of evidence would be allowed.

The court then proceeded to consider U.S. Lifeís alternative argument: that the arbitration award should be set aside because the panel had not permitted U.S. Life to respond to evidence that the neutral experts presented against it. This, U.S. Life contended, amounted to prejudicial misbehavior by the panel and required vacatur of the award. U.S. Life placed particular reliance on the Fifth Circuitís holding in Totem Marine Tug & Barge v. North American Towing, 607 F.2d 649 (5th Cir. 1979), which stated that arbitrators could ďnot conduct ex parte hearings or receive evidence except in the presence of each other and of the parties, unless otherwise stipulated.Ā

The Ninth Circuit distinguished Totem Marine. In the Fifth Circuit case, the court wrote, the arbitrators had contacted one party to obtain a damages figure and then did not allow the other party to respond. What was objectionable there was that the ex parte contact was with a party to the arbitration. The court found dispositive the fact that the ex parte contact that formed the basis for U.S. Lifeís complaint was with neutral experts, not a party. Because both parties were aware of the ex parte contact, because the experts could be challenged in subsequent hearings and briefs, and because it was a three-person arbitration panel rather than just one person, the Ninth Circuit found that the risk of prejudicial misbehavior had been mitigated.

In short, according to the court, perhaps U.S. Life ďdid not enjoy a perfect hearing; but it did receive a fair hearing.Ā Even U.S. Lifeís party-appointed arbitrator had endorsed the procedure used to arrive at the final award. Finding no misconduct, the arbitration award stood.

* * *

There are any number of ways to read the Ninth Circuitís decision. Some will see it as a pragmatic end to a reinsurance dispute that had dragged on for over ten years. Others will see it as setting up a circuit split that will ultimately require resolution by the Supreme Court. Still others will view it as instruction to take care in the selection of party-appointed arbitrators, because the ones in this dispute were still unable to resolve questions about the meaning of a reinsurance agreement after thirteen days of formal hearings and unknown amounts of briefing.

One additional lesson to be drawn from U.S. Life is that the parties to a reinsurance arbitration would do well to agree to arbitration procedure well before the arbitrators are even selected. While perhaps unorthodox in the reinsurance context, what the panel did here does not seem all that different from what property practitioners have come to expect from appraisal panels. Parties should be careful, though: they just might get what they asked for, and be required to wade through voluminous data themselves Ā which has its own implications for the continued relevance of a supposedly cost-effective and expedient means of resolving disputes.

Alex Henlin can be reached at ahenlin@eapdlaw.com.
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