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Case Note: First Circuit Holds That Honorable Engagement Clause “Empowers” Arbitrators to Craft Remedies

by ~ Jeffrey Gordon (Email) (Web Site)

In a matter of first impression in the First Circuit, the Court of Appeals has ruled in First State Insurance Co. v. National Casualty Co., 781 F.3d 7 (1st Cir. 2015) that an arbitration clause’s “honorable engagement” provision “empowers” arbitrators to grant remedies not expressly mentioned in the underlying reinsurance agreement. The opinion sets forth both a useful recitation of the standards constraining judicial review of arbitration awards as well as a provocative analysis of the power of arbitrators to devise equitable remedies that might not be expressly described in a contract’s arbitration clause.

Facts and Procedural History

First State and New England Re had entered into certain reinsurance and retrocessional agreements with National Casualty. After a dispute arose between the parties with respect to certain billing disputes and whether National Casualty could insist on the right to inspect First State’s files before making payment, First State demanded arbitration under eight of the agreements. In 2012, a three-arbitrator panel issued an award that established a payment protocol whereby National Casualty was obliged to issue payment once it received a billing supported by a Proof of Loss and certain Reinsurance Report(s) from First State. The panel ruled that “[s]aid payments may be made subject to an appropriate reservation of rights by [National Casualty] in instances where it has or does identify specific facts which create a reasonable question regarding coverage under the subject reinsurance agreement(s).” Id. at 9. However, National Casualty’s payment obligations could not be “conditioned upon the exercise of its right to audit or the production of additional information or documents, other than those provided by First State as described above.” Id. at 9-10.

First State filed a petition to confirm the panel’s award under the Federal Arbitration Act (FAA) in the U.S. District Court for the Southern District of New York. On National Casualty’s motion, the court transferred the case to the District of Massachusetts. National Casualty cross-petitioned to vacate the panel’s contract interpretation award. By that time, the underlying arbitration proceedings had resulted in a final award, which resolved the billing dispute between the parties. First State moved to confirm the final award in the District of Massachusetts. The court confirmed both the contract interpretation award and the final award. National Casualty appealed to the First Circuit, claiming error only with respect to the contract interpretation award. Id. at 10.

Analysis

After declining to “unravel” the “tangled skein” of issues relating to First State’s assertion that National Casualty’s cross-petition to vacate the contract interpretation award was time-barred, the First Circuit delved headlong into the merits of the case. Id. at 10. As the opinion was authored by Justice Selya, the opinion was as colorfully worded as it was densely analyzed.

From the start, the Court made clear that “defenestrating” (throwing out the window) an arbitration award is no easy task and that, in general, its authority to vacate such awards is “extremely limited.” Id. at 11. The Court observed that its inquiry should be confined to determining “whether the arbitrators ‘even arguably’ construed the underlying agreements, and thus, acted within the scope of their contractually delineated powers.” Id. The Court further noted that even a serious legal error in a contract interpretation is not enough to disturb an award. Rather, the award will be upheld so long as it “draw[s] its essence” from the underlying agreement -- no matter how “good, bad, or ugly” the match between the contract and the terms of the award. Id. “Only if the arbitrators acted so far outside the bounds of their authority that they can be said to have dispensed their ‘own brand of industrial justice’ will a court vacate the award.” Id.

The Court quickly concluded that the matter before it did not constitute one of the “rare instances in which the vacation of an arbitration award is warranted.” Id. The Court rejected National Casualty’s argument that the panel was not interpreting the reinsurance contracts when it fashioned a payment protocol that, according to National Casualty, could force National Casualty to pay billings not required by the contracts. Citing the language of the award itself, which referred to the “subject reinsurance agreements,” the Court discerned that the panel “understood the nature of their task.” Id. The Court further noted that the payment protocol tracked the plain language and general structure of loss settlement provisions in the underlying contracts. Id. at 11-12. For example, the loss settlement provisions in the underlying agreements did not reference inspection or audit rights. Id. at 12. The award maintained this separation by not linking National Casualty’s payment obligations to its right to inspect and audit First State’s records. Thus, while the Court took no position on the correctness of the arbitrators’ interpretations or conclusions, it was satisfied that the arbitrators were “arguably construing” the underlying agreements. Id.

Far more noteworthy was the Court’s treatment of National Casualty’s claim that the panel’s creation of a reservation of rights procedure was not based upon anything in the reinsurance contracts. To the contrary, the Court found that this procedure was an equitable remedy that the arbitrators were authorized to devise pursuant to the “honorable engagement” clause in the agreements, which directed “the arbitrators to consider each agreement as ‘an honorable engagement rather than merely a legal obligation’ and goes on to explain that the arbitrators are ‘relieved of all judicial formalities and may abstain from following the strict rules of law.’” Id. Based upon this language, the Court reasoned that honorable engagement clauses “empower[] arbitrators to grant forms of relief, such as equitable remedies, not explicitly mentioned in the underlying agreement.” Id. The Court further noted that honorable engagement provisions provide arbitrators with “flexibility to custom-tailor remedies to fit particular circumstances” and thus, significantly improve the likelihood of a successful arbitration. Id. The Court concluded that in crafting the reservation of rights procedure, the panel had created an equitable remedy consistent with its powers under the honorable engagement clause.

As a result, the Court affirmed the District Court’s denial of National Casualty’s cross-petition to vacate the arbitration panel’s contract interpretation award, and the Court confirmed the District Court’s order confirming that arbitration award.

This latest First Circuit opinion makes clear the difficulties that an aggrieved participant in an arbitration faces in persuading a court to vacate the award as well as the broad latitude that courts will accord the arbitrators in devising equitable remedies to resolve the parties’ dispute.

Mr. Gordon is an attorney at Zelle Hofmann Voelbel & Mason LLP. He may be reached at jgordon@zelle.com.

© 2015 Zell Hofmann Voelbel & Mason LLP. All rights reserved.

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