‘Honorable Engagement Clauses’ Give Arbitrators Broad Discretion

By Don R. Sampen, published, Chicago Daily Law Bulletin, October 5, 2021

The 7th U.S. Circuit Court of Appeals recently upheld arbitration orders in a dispute between an insurer and reinsurer, and in the process explained the rules applicable to judicial review of such orders.

The case is Continental Casualty Co. v. Certain Underwriters at Lloyds of London, 2021 U.S. App. Lexis 25184 (7th Cir. Aug. 23). The insurer, Continental, was represented by Sidley Austin LLP of Chicago. Day Pitney of Boston represented Underwriters.

Continental entered into a series of treaty reinsurance contracts with Underwriters beginning in the late 1960s through the late 1970s. They continued in effect for several decades. The risks ceded were subject to a $1 million risk retention by Continental as the cedent.

For some 40 years, pursuant to an “aggregate extension clause,” Continental calculated the retention amount on an annual basis, both for losses contained within a single year and multi-year losses. This meant that Underwriters would indemnify Continental in the aggregate, for any given policy year, amounts that exceeded the treaties’ annual retention amount.

Beginning in 2010, however, Continental outsourced its claims handling to Resolute Management Inc., a third-party administrator. Resolute took the position that for a multi-year loss, only one retention amount needed to be paid. This change resulted in higher demands for payment from Underwriters.

Underwriters objected and sought arbitration of the dispute pursuant to the parties’ pertinent arbitration clauses. Those clauses, referred to as “honorable engagement clauses,” gave the three-person panel of insurance industry experts unusually broad discretion in interpreting contract obligations and remedies.

The clauses expressly permitted the arbitrators to do away with judicial formalities and interpret the agreement “not as merely a legal obligation,” but with “a view to effecting the general purpose” of the contractual arrangement.

Following a hearing, the panel issued a final award that found that Continental’s new methodology on aggregation was contrary to the parties’ agreement. The award further stated that Underwriters had paid “the full amount due” with respect to specific insured accounts and precluded Continental from “re-presenting” bills for those accounts.

Continental regarded the award unclear regarding future billings on certain accounts and asked for clarification. In response, the panel issued an “Interim Order No. 3” stating that Underwriters had fully discharged its “past, present and future obligations” on three accounts regarding asbestos products losses.

Dissatisfied again, Continental moved for reconsideration, arguing that this order constituted a sanction in that it barred future bills on the identified accounts. The panel denied the motion.

Continental then filed suit in district court seeking confirmation of the initial final award but the vacatur of the two subsequent orders on the ground that the arbitrators exceeded their powers. The district court confirmed everything, and Continental took this appeal.

Analysis

In an opinion by Judge Diane P. Wood, the 7th Circuit affirmed. She initially reviewed the scope of review applicable to an arbitration award. In accordance with the Federal Arbitration Act, 9 U.S.C. Sec. 1, et seq., she said the court must find a violation of the agreement to arbitrate before it could set aside the award.

Thus, the question was not whether the arbitrators erred in interpreting the contract, but only “whether they interpreted the contract.” Only if “there is no possible interpretive route to the award may a noncontractual basis be inferred and the award set aside.” The court’s review therefore is exceedingly narrow.

Wood went on to observe that, in her view, the arbitration panel’s original final award was unclear whether Continental could submit future billings to Underwriters arising from new events. Thus, Continental’s request for reconsideration was justified.

The Interim Order No. 3, however, eliminated any doubt about future billings, at least with respect to the three accounts mentioned and regarding asbestos product losses. Thus the question was whether the arbitrators had the power to address future billings.

In addressing that question, Wood observed that other circuits had interpreted honorable engagement clauses as providing for particularly wide discretion over remedies. In this case, moreover, the arbitrators may have considered it their obligation to wrap up the case in an efficient way by announcing the effect of their award on future billings.

It was also possible, wrote Wood, that although the record was silent as to why the arbitrators cut off coverage for just the three accounts mentioned, they may have been persuaded that no such further claims were likely to come along.

In any event, Wood found possible an “interpretive route” to the two orders being challenged by Continental. And given the narrow scope of review, the arbitrators could not be said to have strayed beyond the boundaries of their authority.

The court therefore affirmed the arbitration awards in favor of Underwriters.

Key Points

• Only when an arbitrator strays from interpretation and application of the parties’ agreement will an arbitration award be found unenforceable. A court thus reviews an award “with a very light hand.”

• “Honorable engagement” arbitration clauses give arbitrators particularly wide discretion over remedies.