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February 2019: Arbitration Provisions in Agency or Brokerage Agreements

Avoiding Them if You Can or Modifying Them if You Cannot

February 2019 | Volume 31, Number 2

The danger of a riptide is that it catches you unaware because it cannot be seen; its strong cross-currents flow under the water. However, there is time between getting into the water and being swept out to sea where one starts to feel the pull of the riptide and is close enough to the shore to get out of the water.

From our perspective, that is exactly where we are in the use of arbitration provisions in agency or similar agreements. We feel the pull on our body, but our feet are still firmly planted in the sand, allowing us to have control over what we do next; and what we do next is incredibly important to our survival. By this last I mean literally because agreeing to an oppressive arbitration provision can spell doom for your agency.

The Basics

Despite its name, an “Arbitration Provision" in an agency agreement is actually not considered a “provision" at all. Rather, New York law holds it to be a separate contract from whatever it is contained in. While that seems wrong and counterintuitive, (and you would be right), understand that arbitration provisions do not follow any recognized law that you are familiar with as to the running of your businesses and/or the procurement of insurance.

Like a science fiction movie that takes place in an alternate universe where the laws of physics do not apply, arbitration provisions in New York agreements do not have to follow the law of New York, or any states' law for that matter. So draconian are these provisions that a Choice of Law provision in the agency agreement proper, unless surgically worded and incorporated in the arbitration provision itself, will NOT apply to the arbitration provision.

Know that even a basic arbitration provision will force you to have to arbitrate anything arising under the agreement, including whether or not the contract was entered into by fraud. With an arbitration provision you give up your rights to getting into court, (except and limited to challenging the validity of the arbitration provision itself), and that means you lose due process. Gone is discovery, appeals, judicial standards and review.

A new arbitration decision was handed down by the U.S. Supreme Court on January 8, 2019 in the Henry Schein case.^[1] In that case the Court reiterated that under the Federal Arbitration Act, state courts must respect the parties' decision in their contracts to delegate the arbitrability question to the arbitration panel. Questions of arbitrability will be decided by the arbitrators and not the courts. This new decision can be argued to take away the last remaining power of the State court where there is an arbitration provision.

An Example

Recently we were retained to defend the interests of an agent, (with binding authority), who had entered into an agency agreement in 2009 with a major insurance carrier. In 2017, the carrier sent the agent a letter demanding $50 million in reimbursement, calculated based on the difference between the premium collected for 130 policies issued from 2009 to 2011 allegedly in violation of the Underwriting Guidelines and what was paid in claims. The agency agreement contained an arbitration provision which, in pertinent part stated as follows:

ARBITRATION

In the event of any dispute or difference of opinion hereafter arising with respect to the rights and obligations of the parties under this Agreement, it is hereby mutually agreed that such dispute or difference of opinion shall be submitted of such dispute.
The arbiters shall consider this Agreement as an honorable engagement rather than merely as a legal obligation and they are relieved of all judicial formalities and may abstain from following the strict rules of the law.

The agreement also contained the following Choice of Law provision.

Governing Law. This Agreement shall be governed by and interpreted according to the laws of the State of New York without regard to conflicts of laws and principles that would cause the application of the laws of another jurisdiction.

While you might think that the Choice of Law provision would mean that New York law's 6-year statute of limitations would be a bar to the claims, you would be wrong. The arbitration provision, as a “separate agreement", controls the arbitration and since it states that that no particular law must be followed and grants the arbitrators the ability to “abstain from following the strict rules of law", the arbitrators can rule that all the claims were viable and there is nothing the agent could do about that. Even a court, when asked to confirm an arbitration award, cannot overturn the arbitrator's award even if they knowingly applied the wrong statute of limitations.

Furthermore, the language referring to the arbitration provision as an “honorable engagement" allows the arbitrators to fashion any remedy they want without being limited to legal remedies.

The Law – Summary

In order to give you an understanding of why and how arbitration provisions contained in contracts can cause problems, below are some examples of the draconian New York law on arbitration.

Arbitration in the First Instance

In a case called Ramos, the court stated the following general principle of how arbitration provisions are initially viewed.

“Arbitration is a favored method of dispute resolution in New York. The threshold issue of whether there is a valid agreement to arbitrate is for the courts. Once it is determined that the parties have agreed to arbitrate the subject matter in dispute, the court's role has ended and it may not address the merits of the particular claims." ^[2]

Honorable Engagement:

The “Honorable Engagement" language in the Arbitration provision referred to above is shockingly broad in that it gives almost unfettered power and discretion to the Arbitrators. In a case called First State Insurance Company, the court stated the following regarding the operation of an honorable engagement provision:

“Until today, this court has not had occasion to address the operation and effect of an honorable engagement provision in an arbitration clause. We believe that an honorable engagement provision empowers arbitrators to grant forms of relief, such as equitable remedies, not explicitly mentioned in the underlying agreement. This is a huge advantage: the prospects for successful arbitration are measurably enhanced if the arbitrators have flexibility to custom-tailor remedies to fit particular circumstances. An honorable engagement provision ensures that flexibility."^[3]

Separability of The Arbitration Provision and The Contract That It Is In

The New York Court of Appeals in the Weinrott case found that (1) an arbitration provision in a contract is to be considered a separate contract and (2) if the arbitration provision is valid, then the Arbitrators get to decide all aspects of the contract itself, including if it was entered into by fraud.^[4] (Yes, this makes no sense but it is the law.)

“As a general rule, however, under a broad arbitration provision the claim of fraud in the inducement should be determined by arbitrators."

Citing the Weinrott case, and just this past April the Court of Appeals in another case similarly said:

“The validity of an arbitration clause is determined separately from the validity of the underlying agreement. Under the doctrine of separability, 'courts are required to treat an agreement containing an arbitration clause as if there were two separate agreements—the substantive agreement between the parties, and the agreement to arbitrate.^[5]

The Challenge to the Arbitrator's Award – The Standard

It is near impossible to overturn an arbitrator's award even if they do not apply the correct law. In the New York City Transit Authority case, the court said as follows regarding this issue:

An arbitrator is charged with the interpretation and application of the agreement. Courts may vacate an arbitrator's award only on the grounds stated in CPLR 7511(b). The only such ground asserted here is that the arbitrator “exceeded his power" (CPLR 7511[b][1][iii]). Such an excess of power occurs only where the arbitrator's award violates a strong public policy, is irrational or clearly exceeds a specifically enumerated limitation on the arbitrator's power. Moreover, courts are obligated to give deference to the decision of the arbitrator. [“An arbitrator's paramount responsibility is to reach an equitable result, and the courts will not assume the role of overseers to mold the award to conform to their sense of justice"]). This is true even if the arbitrator misapplied the substantive law in the area of the contract.^[6]

This would apply to an Arbitrator not using the correct statute of limitations for the breach of contract claims or the doctrines of waiver or estoppel, with little chance of overturning that decision on motion or appeal. In the Motor Vehicle Accident Indemnification case, the court said the following regarding this issue:

“Consequently, we cannot say, as a matter of law, that the arbitrator's decision was arbitrary and capricious or unsupported by any reasonable hypothesis and, thus, the awards cannot be overturned in the courts even though under this decision, it entailed an erroneous application of the Statute of Limitations."^[7]

This was principle was also stated by the court in the Weinrott case mentioned above where the court wrote that “Arbitration awards may not be set aside for misapplication of the law."^[8]

CONCLUSION

We have witnessed the problems that arbitration provisions can cause for insurance agencies and brokerages. Based upon our experience, we cannot caution you enough. While arbitration provisions are thought to be a mechanism to avoid litigation costs, or to be used to amicably and efficiently resolve disputes, they have become something far from that. As we have cautioned in the past, the prudent insurance agency or brokerage never signs a company contract without first reading and understanding every term and condition contained in it. One of those provisions that you should be aware of and understand is the arbitration provision. On occasion insurers will modify or delete an arbitration provision based upon a request by the agency or brokerage. However, if an arbitration provision is contained in any contract that you sign, hopefully this E&O Report provides you with a better understanding of how an arbitration provision can be applied.

Submitted by:
Howard S. Kronberg, Esq.
Keidel, Weldon & Cunningham, LLP

[1] Henry Schein, Inc. v. Archer and White Sales, Inc., No. 17-1272 (U.S. Sup. Ct. Jan. 8, 2019).

[2] Ramos v. Uber Technologies, Inc., 60 Misc.3d 422 (Sup Ct. Kings County, 2018)

[3] First State Insurance Company v. National Casualty Company, 781 F.3d 7, 12 (1st Cir. 2015)

[4] Weinrott v. Carp, 32 N.Y.2d 190 (1973)

[5] 332 East 66th Street, Inc. v. Walker 59 Misc.3d 1216(A) (NY Sup Ct. 2018) N.Y. Slip Op. 50584(U)

[6] New York City Transit Authority v. Transport Workers' Union 6 N.Y.3d 332 (2005) (Internal citations omitted, and emphasis added.)

[7] Motor Vehicle Acc. Indemnification Corp. v. Aetna Cas. & Sur. Co., 89 N.Y.2d 214 (1996) (Internal citations omitted, and emphasis added.)

[8] Weinrott v. Carp, 32 N.Y.2d 190 (1973); see also NY Civil Practice Law and Rules Section 751.

Keidel, Weldon & Cunningham, LLP concentrates its practice in the defense of insurance agents and broker's errors and omissions claims and litigation, errors and omissions loss control counsel and education, insurance coverage analysis and litigation and insurance regulatory matters. Please direct any comments or questions to James C. Keidel, Esq. by mail to the main office of Keidel, Weldon & Cunningham, LLP, at 925 Westchester Avenue, Suite 400, White Plains, NY 10604, telephone at (914) 948-7000 or e-mail at jkeidel@kwcllp.com. The law firm also maintains offices in Syracuse, New York; New York City, New York; Wilton, Connecticut; Fair Lawn, New Jersey; Warwick, Rhode Island, Philadelphia, Pennsylvania, Williston, Vermont and Naples, Florida.