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Massachusetts High Court Rules That Federal Arbitration Act Applies to Contracts Involving Interstate Commerce

by ~ Alexander Henlin (Email) (Web Site)

In a decision that has implications for reinsurance, the Massachusetts Supreme Judicial Court last week decided that the Federal Arbitration Act preempts the Massachusetts Arbitration Act where the relevant contract involves interstate commerce. The decision is McInnes v. LPL Financial, LLC, et al., No. SJC-11356 (Aug. 12, 2013), and is available at the court’s website.

The facts of the case are fairly straightforward. In September 2011, the plaintiff sued LPL Financial and its agent in the Massachusetts Superior Court for fraud, intentional misrepresentation, breach of fiduciary duty, violations of the Massachusetts Uniform Securities Act, violations of the Massachusetts Consumer Protection Act (“Chapter 93A”), and intentional infliction of emotional distress. The suit arose out of financial advice given to the plaintiff, in which she alleged that she was induced to purchase a variable universal life insurance policy with a face value of $2 million, for which she paid premiums totalling over $330,000 from July 1998 through July 2006. At all relevant times, the plaintiff had a fixed annual income of approximately $30,000. Unbeknownst to the plaintiff, in 2000, LPL’s agent had established an irrevocable trust in the plaintiff’s name, and identified himself as both the owner and the trustee of the life insurance policy.

With the lawsuit in state court, LPL and its agent moved for an order under the Massachusetts Arbitration Act (Mass. Gen. L. c. 251 s. 2 et seq.), staying litigation and compelling arbitration, on grounds that the plaintiff had agreed to arbitrate all of her claims. The court denied the motion, citing Massachusetts case law holding that arbitration agreements could not be enforced with respect to Chapter 93A claims, and further finding that all of the other claims in the lawsuit were “inexorably intertwined” with the Chapter 93A claim, such that it would be impractical to separate them. A subsequent motion under the Federal Arbitration Act was denied, too, because of the Superior Court’s conclusion that there were open questions about whether the arbitration agreement even existed, and whether it had been procured by fraud.

On appeal, the Massachusetts Supreme Judicial Court held that, where the underlying contract affects interstate commerce, the arbitration agreement is governed by the Federal Arbitration Act, and the substantive law to be applied is federal. Under the Federal Arbitration Act (unlike its Massachusetts counterpart), the judge is required to sever the arbitration clause from the remainder of the contract, and determine the validity of the arbitration provision by itself. The Massachusetts high court declared that nothing in the Federal Arbitration Act suggested an intent to preserve state-law rules that stand as an obstacle to the Federal Arbitration Act’s objectives; and it further held that, when state law prohibits outright the arbitration of a particular type of claim, “the analysis is straightforward: The conflicting rule is displaced by the” Federal Arbitration Act. Accordingly, the court reversed the Superior Court, stayed the litigation, and directed the issuance of orders compelling arbitration.

Reinsurers, in particular, should take note of the Supreme Judicial Court’s decision. For some time, there has been at least the possibility of an argument that, in Massachusetts, arbitration could not be compelled in the context of an unfair claim practices suit – because the suit would lie, in part, under Chapter 93A. The McInnes decision puts that argument to rest in cases where the insurance contract involves interstate commerce – which, as a practical matter, most reinsurance contracts will. Thus, where a reinsurance contract contains an arbitration clause, cedents and reinsurers alike can have greater certainty that federal law will apply should either side seek relief from the courts.

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