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Fourth Circuit: Abitration Ordered - McCarran-Ferguson Act Does Not Combine With South Carolina Law Barring Arbitration To Preempt International Convention Favoring Arbitration

by ~ Michael Aylward (Email) (Web Site)

A recent ruling by the U.S. Court of Appeals for the Fourth Circuit addresses the complex question of how federal preemption principles work where federal statutes, international treaties and principles of public policy collide. At issue in ESAB Group, Inc. v. Zurich Ins. PLC, 685 F.3d 376 (4th Cir. 2012), was whether a South Carolina statute that bars the enforcement of arbitration clauses in insurance agreements, which has been held, under McCarran-Ferguson, to “reverse preempt the application of Chapter 1 of the Federal Arbitration Act (“FAA), has similar preemptive effect with respect to foreign arbitral agreements subject to Chapter 2 of the FAA.

In ESAB Group, the Fourth Circuit joined the Fifth Circuit in holding that the sphere of state regulation protected by the McCarran-Ferguson Act is limited to domestic insurance arrangements. Put differently, state “reverse preemption of insurance under McCarran-Ferguson does not extend to foreign insurance undertakings containing arbitration clauses protected by the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (“Convention). Noting the troubling implications of allowing the views of individual states to interfere with international agreements, the Fourth Circuit reaffirmed the importance of America “speak[ing] with one voice when it comes to regulating foreign commerce, including insurance agreements.

The ESAB Group opinion includes an historical overview of both McCarran-Ferguson and the Convention. In 1944, the U.S. Supreme Court had “shock[ed] observers by holding that insurance was subject to regulation under the Commerce Clause. See U.S. v. South-Eastern Underwriters Assoc., 323 U.S. 533 (1944). Alarmed by the antitrust implications of this ruling, Congress passed the McCarran-Ferguson Act (15 U.S.C. 1101, et seq.) the following year, declaring that only the individual states had jurisdiction to regulate the insurance industry. McCarran-Ferguson is unusual in that the Supremacy Clause to the U.S. Constitution ordinarily gives predominant effect to federal law. As a result, McCarran-Ferguson is often spoken of as creating “reverse preemption" of federal law.

In 1958, a conference of the United Nations produced the International Convention on the Recognition and Enforcement of Foreign Arbitral Awards. The United States did not ratify the Convention for many years due to domestic concerns, however, notably the potential conflict between this new international treaty and the lack of any provision in the Federal Arbitration Act (9 U.S.C. 1, et seq.) for international arbitral terms. Only after the FAA was amended to include Chapter 2 dealing with foreign arbitrations did the U.S. become a signatory in 1970.

ESAB Group is a South Carolina-based manufacturer of welding equipment that was acquired by foreign entities in the late 1980s. Between 1989 and 1996, it was insured under seven global liability policies issued by Trygg-Hansa, a Swedish insurer. Five of these policies contain clauses mandating that any disputes be resolved through binding arbitration in Sweden, in accordance with Swedish law. The other two policies include Swedish choice of law provisions but omit arbitration clauses.

The obligations of ESAB’s original insurers were transferred to Zurich in 1998 through a Loss Portfolio Transfer Agreement. In 2005, Zurich transferred these obligations to ZIP, an Irish insurer.

After ESAB became ensnared in the surge of welding-fume toxic tort litigation during the past decade, disputes arose between ESAB and its liability insurers concerning the coverage available for these claims. By mid-2009, ESAB had spent over $54 million to defend these cases and another $25 million on judgments and settlements.

After ZIP declined to provide a defense to the underlying welding-fume suits, ESAB sued it and other carriers in South Carolina. ZIP removed the case to federal court and sought to invoke the protection of the Convention and the Convention Act’s grant of removal jurisdiction. ESAB disputed ZIP’s right to removal, contending that the policies did not contain valid arbitration agreements and therefore did not fall under the Convention. The South Carolina district court ruled, however, that the arbitration clauses in the 1989-93 policies were subject to arbitration. However, the court remanded to state court the insured’s dispute with respect to those policies lacking such clauses.

Although South Carolina law favors arbitration in general, S.C. Code Ann.  15-48-10(b)(4) makes plain that the general protection of arbitration agreements “does not apply to . . . insureds or beneficiaries under any insurance policy. Applying McCarran-Ferguson, South Carolina courts have ruled that this state insurance law preempts the application of Chapter 1 of the Federal Arbitration Act to arbitration agreements in domestic insurance policies. Relying on this precedent, ESAB argued that the South Carolina statute similarly “reverse preempted the application of Chapter 2 of the FAA to the ZIP foreign arbitration clauses.

Nevertheless, the South Carolina District Court adopted the view pioneered by the Fifth Circuit in Safety National Cas. Corp. v. Certain Underwriters at Lloyd’s, London, 587 F.3d 714 (5th Cir. 2009), cert. denied, 131 S. Ct. 65 (2010), concluding that, “[t]he Convention, not the Convention Act directs courts to enforce international arbitration agreements. Accordingly, because the McCarran-Ferguson Act text limits its scope to federal statutes, the Act may not disrupt the application of traditional preemption rules with respect to this international treaty.

On appeal to the Fourth Circuit, ESAB argued that the Convention is a non-self-executing treaty, that is to say one that requires implementing legislation to be given effect in domestic courts. It followed, therefore, that the Convention only has legal effect insofar as it is incorporated into its implementing legislation, the Convention Act. Noting that the Convention Act is, itself, a federal statute that does not speak directly to insurance, ESAB argued that the Convention Act should be subject to reverse preemption under the McCarran-Ferguson Act, allowing South Carolina’s public policy against arbitration clauses in insurance agreements to ‘trump the Convention.

The Fourth Circuit disagreed, adopting the view of the Fifth Circuit in Safety National, that whether or not the Convention is “self-executing," reverse preemption should not apply. In Safety National, a majority of the Fifth Circuit sitting en banc had concluded that the McCarran-Ferguson Act applied only to statutes, not treaties. It then concluded that, despite the presence of implementing legislation, it was the Convention itself, and not the Convention Act, that was being construed to supersede state law. Because the McCarran-Ferguson Act did not apply to treaties, it did not provide a basis for state law to preempt the Convention.

Similarly, the Fourth Circuit ruled that, even assuming that Chapter 2 of the Convention is “non-self-executing," the Convention Act, as implementing legislation of a treaty, does not fall within the scope of the McCarran-Ferguson Act. In keeping with U.S. Supreme Court precedent and the view of other federal courts, it concluded that the McCarran-Ferguson should be read narrowly in this context: “Where a statute touches upon foreign relations and the United States treaty obligations, we must proceed with particular care in undertaking this interpretative task."

The Fourth Circuit noted that Congress might in the future opt to exclude insurance disputes from the Convention but has not done so with the McCarran-Ferguson Act. Nor is there anything in the statute suggesting that, by enacting McCarran-Ferguson, Congress intended to delegate to the states the authority to abrogate the United States international agreements.

The Fourth Circuit concluded, therefore, that “[b]ecause the Supreme Court has made clear that McCarran-Ferguson is limited to domestic affairs, we hold that the Convention Act falls outside of its scope. Accordingly, the Fourth Circuit upheld the South Carolina District Court’s ruling assuming jurisdiction and compelling arbitration in Sweden with respect to the ESAB Group’s claims under these ZIP policies.

A concurring opinion by Judge Wilkinson observed that holding the McCarran-Ferguson Act empowered states to displace the Convention on the recognition and enforcement of foreign arbitral awards would ignore the Convention’s express statement that contracting states “shall recognize an agreement in writing under which the parties undertake to submit to arbitration as well as its direction that “The court of a Contracting State shall, at the request of one of the parties, refer the parties to arbitration.

Michael Aylward is a partner in the Boston office of Morrison Mahoney LLP. He can be reached at maylward@morrisonmahoney.com.

 2012 Morrison Mahoney LLP. All rights reserved.

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