Reinsurance Arbitration Decision Upheld
December, 2002
The Seventh Circuit has upheld an arbitration award in Sphere Drake Ins. Ltd. v. All American Life Ins. Co., 2002 WL 31255618 (7th Cir.), reversing a trial court decision which the Seventh Circuit identified as the only case in the last 77 years where a federal court had set aside an award because a party-appointed arbitrator on a tripartite panel, as opposed to a neutral, displayed “evident partiality” under the Federal Arbitration Act (“FAA”).
Facts
Sphere Drake’s agent, Euro International Underwriting (“EIU”), sold seven reinsurance policies to All American Life Insurance Company’s agent, Stirling Cooke Brown Reinsurance Brokers. The policies contained an arbitration clause. Sphere Drake contended that the binding authority it extended to its agent EIU was limited, and the policies were invalid because beyond its agent’s limited authorization. Further, Sphere Drake argued that All American and Stirling Cooke knew of the limitations on EIU’s binding authority. As Sphere Drake saw it, All American could not rely on principles of actual or apparent authority of EIU to issue binding policies. The upshot of its position was that no policies existed.
Sphere Drake litigated one policy and on appeal won the right to have a court, not an arbitration panel, decide the issue of whether that policy was valid. Sphere Drake Ins. Co. v. All American Ins. Co., 256 F.3d 587 (7th Cir. 2001) (court notes the potential circularity of an arbitration required by an insurance policy whose validity is at issue before the arbitrators). As to the other six policies, Sphere Drake submitted to arbitration at All American’s insistence.
The arbitration was conducted under the auspices of the Association Internationale de Droits des Assurances (“AIDA”) and its U.S. affiliate, the AIDA Reinsurance and Insurance Arbitration Society (“ARIAS”) which uses tripartite panels. Each side selected an experienced international reinsurance arbitrator and those two selected an equally well-qualified umpire or neutral.
Before the arbitration got underway, Sphere Drake’s arbitrator disclosed by letter that several years before he had served as counsel to a Bermuda subsidiary of Sphere Drake, and had recommended using his former law firm to represent that subsidiary in an arbitration involving a set of wholly unrelated issues.
In a separate disclosure, the umpire revealed that he held stock in an insurer that had made a bid to acquire All American. No one thought this financial interest, whether viewed as actual or potential, imperiled the neutrality of the umpire.
The arbitrators decided in favor of Sphere Drake on the ground that All American had disavowed its agent Stirling Cooke. This meant that when Stirling Cooke placed the reinsurance through EIU, Stirling Cooke had no authority to act on behalf of All American. Unhappy with this result, All American – having insisted on the arbitration process up to this point – went to court to overturn the arbitrators’ decision.
The trial court compelled discovery of the legal billing records of Sphere Drake’s party-appointed arbitrator regarding his prior representation of Sphere Drake’s subsidiary on the unrelated matter. The records, unlike the letter, disclosed that the Sphere Drake arbitrator billed 380 hours on the prior, unrelated legal matter. The trial court reversed the arbitration award on the basis that the Sphere Drake arbitrator’s letter did not disclose fully the extent of his involvement in the prior representation of the subsidiary and that the full facts constituted “evident partiality,” one of the few grounds for refusing to enforce an award under the FAA. See 9 U.S.C. Sec. 10(a)(2).
Analysis
The Court noted that in the main, party-appointed arbitrators are supposed to be advocates. For example, in labor arbitration a union may name as its arbitrator the business manager of the local union, and the employer its vice president for labor relations. Yet no one believes that the predictable loyalty of these designees spoils the award. This illustrates that the parties are entitled to waive the protection of Section 10(a)(2) of the FAA, just as they can waive almost any other statutory enactment. Section 10(a)(2) of the Act states the presumptive rule of impartiality, which is subject to variation by mutual consent. The Act allows a privately negotiated arbitration agreement to be enforced in accordance with its terms. To the extent that an agreement entitles parties to select interested arbitrators, Section 10(a)(2) has no role to play.
This is not a waiver case. The party-appointed arbitrators are entitled under ARIAS rules to engage in ex parte discussions with their principals until the case is taken under advisement, but they are supposed thereafter to be impartial adjudicators. Thus, the Court had to address the issue of whether Sphere Drake’s party-appointed arbitrator was disqualified because of “evident partiality” under Section 10(a)(2) due to his prior representation of a subsidiary on an unrelated matter.
The Court looked to the federal statute which disqualifies federal judges on account of prior legal work (28 U.S.C. 455(b)(2)) as a point of reference. That section disqualifies a federal judge on account of prior legal work only where the judge served as a lawyer in the matter in controversy, or practiced with a lawyer while that lawyer served in the matter in controversy, or where the judge or lawyer has been a material witness concerning the matter. As Sphere Drake’s arbitrator did not fall in any of these three categories, the Court noted that he could have served as a federal judge in the case without fear of disqualification. Moreover, even if Sphere Drake’s arbitrator had been the umpire, his prior representation of the subsidiary would not have implied “evident partiality,” said the Court.
The Seventh Circuit ruled that “evident partiality” for a party-appointed arbitrator must be limited to conduct in transgression of contractual limitations. Here, All American made no claim that the Sphere Drake arbitrator’s past violated the contractual restrictions for ARIAS arbitration. Instead, All American argued that the award had to be overturned because Sphere Drake’s arbitrator did not make a full disclosure of the extent of his involvement in the unrelated proceedings four years earlier, citing Commonwealth Coatings Corp. v. Continental Cas. Co., 393 U.S. 145, 89 S.Ct. 337, 21 L.Ed. 2d 301 (1968). However, the Seventh Circuit distinguished Commonwealth Coatings on the ground that there an award was spoiled because the umpire had a present business relationship with a party on the projects involved in the arbitration. Commonwealth Coatings did not hold that disclosure was compulsory for its own sake and its absence fatal, even if the arbitrator meets judicial standards of impartiality.
The Seventh Circuit emphasized that different standards apply for neutrals than for party-appointed arbitrators. For example, the opinion says that a federal judge “...can’t hold even a single share of a party’s stock...” In an aside, it noted that the sort of “financial entanglements” that would disqualify a judge will cause problems for a neutral under Section 10(a)(2) unless disclosure is made and the parties’ consent obtained.
The Court observed that while 28 U.S.C. 455(a) calls for disqualification of a federal judge where “his impartiality might reasonably be questioned,” this “appearance of partiality” ground of disqualification applies only to adjudication by judges, not to arbitrators. Only evident partiality, not appearances or risks, spoils an award.
Learning Point:
The tradeoff between impartiality of all three arbitrators, and securing the expertise necessary and found only in persons with substantial industry connections suggests that it is realistic to waive the protections of Section 10(a)(2) of the FAA with regard to party-appointed arbitrators. As a consequence, the umpire’s “swing vote” should be restricted by contractual provisions calling for full and complete disclosure. Efforts to overturn arbitration awards on the basis of “evident partiality” of party-appointed arbitrators will continue to fail. One must carefully consider in advance the finality of the decision in light of both the applicable rules of arbitration and the terms of any arbitration clause. If uncertainty appears, one should consider modifying the rules, the arbitration clause or both before the arbitration begins. The “evident partiality” standard of the FAA is a more difficult test for any challenger of an arbitration decision to meet than the test applicable to disqualification of federal judges due to prior legal work.
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