main image

ReliaStar Life Insurance Co. v. EMC National Life Co.: Critical Analysis of an Important Reinsurance Arbitration Decision

April 28th, 2009 Arbitrability, Authority of Arbitrators, Awards, Life Reinsurance, New York Court of Appeals, United States Court of Appeals for the Second Circuit 3 Comments » By Philip J. Loree Jr.

Introduction

We recently reported on ReliaStar Life Ins. Co. v. EMC National Life Co., ___ F.3d ___, ___ (2009) (Raggi, J.) (blogged here), in which the United States Court of Appeals for the Second Circuit held that an arbitration panel was authorized to award under the bad faith exception to the American Rule attorney and arbitrator fees to a ceding company in a case where the parties had agreed that “[e]ach party shall bear the expense of its own arbitrator.  .  .  and related outside attorneys’ fees, and shall jointly and equally bear with the other party the expenses of the third arbitrator.”  This post takes a critical look at ReliaStar.  

The Second Circuit is one of the most influential and respected  Circuit Courts of Appeal in the United States, yet on occasion even this prestigious court renders a decision that is open to question.  ReliaStar is one of those decisions.  The majority opinion lost sight of what the parties agreed about the arbitrators’ power to award attorney fees.  Rather than adhere to the plain meaning of the parties’ agreement as required by New York  law, the Court construed an unambiguous limitation on arbitral authority to mean something other than what it said. 

No doubt that the Court believed that its decision would encourage resort to arbitration by construing arbitral authority broadly.  But the Court would have done a far better job encouraging resort to arbitration had it simply enforced the parties’ agreement as written.  One of the most attractive features of arbitration is that parties get to dictate how they want their dispute decided, including, among other things, how best to allocate the costs, fees and expenses of deciding it.   But that feature falls by the wayside if courts cannot be relied upon to enforce arbitration agreements as written. 

Discussion 

Background

The question before the Court was one of arbitrability:  Did the arbitrators have the power to award attorneys fees for EMC’s alleged bad faith conduct in the arbitration?  It turned on what the contract had to say about attorney fees.  State law governed the interpretation of the arbitration clause, including the question of whether it was reasonably susceptible to more than one interpretation.  See First Options of Chicago, Inc. v. Kaplan, 514 U.S. 938,  944 (1995); Mastrobuono v. Shearson Lehman Hutton, Inc., 514 U.S. 52, 62-63 & n.9 (1995).  If the clause was ambiguous under applicable state law, then federal law required that the ambiguity in its scope be resolved in favor of arbitration.   See 514 U.S. at 62.

The parties agreed that New York law, “and to the extent applicable the Federal Arbitration Act,”  would “govern the interpretation and application” of their agreement.  For many years the New York Court of Appeals (New York’s highest court) has adhered to what is known as the “plain meaning” rule of contract interpretation.  The theory behind the plain meaning rule is that the most persuasive indication of what the parties intended their written contract to mean is embodied in the words, phrases and sentences they used.    

Here is what the New York Court of Appeals has to say about the plain meaning rule:        

A familiar and eminently sensible proposition of law is that, when parties set down their agreement in a clear, complete document, their writing should as a rule be enforced according to its terms.  Evidence outside the four corners of the document as to what was really intended but unstated or misstated is generally inadmissible to add to or vary the writing.  That rule imparts stability to commercial transactions by safeguarding against fraudulent claims, perjury, death of witnesses.  .  .  infirmity of memory .  .  . [and] the fear that the jury will improperly evaluate the extrinsic evidence.  .  .  . 

W.W.W. Associates, Inc. v. Giancontieri, 77 N.Y.2d 157, 162-63 (1990) (citations and quotations omitted).   

The key phrase that the ReliaStar Court had to analyze stated “[e]ach party shall bear the expense of its own arbitrator.  .  .  and related outside attorneys’ fees, and shall jointly and equally bear with the other party the expenses of the third arbitrator”   (the “Fee and Expense Provision”).   Under the plain meaning rule, there is no reasonable interpretation of this unqualified provision, but that: 

  1. Each party “bears the expense of its own arbitrator. . .fees”;
  2. Each party “bears the expense of its own. . . outside attorneys’ fees”; and
  3. Each party “shall jointly and equally bear with the other party the expenses of the third arbitrator.”

There are no qualifications or exceptions stated in these simple risk allocation rules and they are not susceptible to construction.   As the dissent observed, the Fee & Expense Provision is “no more susceptible to construction than is Article II, Section I of the U.S. Constitution which provides that no person shall be eligible to be President ‘who shall not have attained to the Age of thirty five years.'”  Slip op. at 17. 

When the majority considered what the parties intended by the plain and unambiguous words they used, they focused not on the said, but the unsaid.   According to the majority, the Fee and Expense provision “simply states the general American Rule that each party will bear its own attorney fees and extends that principle to apply also to the fee of the arbitrator selected by each party.”  Slip op. at 11.  The Court found that the provision said nothing about how fees were to be allocated in the event a party acted in bad faith and it interpreted this understandable silence to mean that the parties intended to incorporate into their contract the bad faith exception to the American Rule applicable in federal courts. 

Analysis

The Court’s reasoning and findings cannot withstand scrutiny under New York rules of contract interpretation.  First, the Court should have determined whether or not the Fee & Expense Provision was ambiguous as written, without regard to its supposed purpose or the reason for its inclusion.  The provision might have been agreed upon for any number of reasons, and even if there were extrinsic evidence of what the parties’ intended, that evidence would be irrelevant.  The only relevant consideration was what the parties said.  The majority’s speculation about what the parties meant or intended but did not say was besides the point where, as here, the language they used was clear and unqualified.   

Second, the Court violated New York contract interpretation rules by determining that the parties’ failure to address fee shifting in the event of bad faith effectively created an ambiguity in the Fee & Expense Provision.  To ascertain whether a contract is ambiguous, courts are required by New York law to focus on what is said, not what is omitted:     

An omission or mistake in a contract does not constitute an ambiguity [and].  . . the question of  whether an ambiguity exists must be ascertained from the face of an agreement without regard to extrinsic evidence.

Reiss v. Financial Performance Corp., 97 N.Y.2d 195, 199 (2001) (citations and quotations omitted).   

The Fee & Expense Provision is unqualified; by its terms it applies whether or not one of the parties acted in bad faith.  Expressly stating that the parties intended the rule against fee shifting to apply where a party acted in bad faith would not have broadened the provision’s scope or made it any clearer than it already was.  Having already used unqualified language, there was simply no reason the drafters would or should have believed that it was necessary to say more to ensure that the arbitrators would not be permitted to shift fees under any circumstances.  

Third, the Court violated New York contract interpretation rules by effectively adding a “bad faith exception” to the unqualified Fee & Expense Provision.  New York law generally forbids courts from adding implied terms to the parties’ contract under the guise of interpretation or construction:   

Even where a [contractual] contingency has been omitted, we will not necessarily imply a term since courts may not by construction add or excise terms, nor distort the meaning of those used and thereby make a new contract for the parties under the guise of interpreting the writing. 

Reiss, 97 N.Y.2d at 199 (citations and quotations omitted).   While implying a term may be appropriate under certain limited circumstances, New York courts “will not imply a term where the circumstances surrounding the formation of the contract indicate that the parties, when the contract was made, must have foreseen the contingency at issue and the agreement can be enforced according to its terms.”  97 N.Y.2d at 199. 

There was no dispute that the parties knew or should have known at the time of drafting that a party might arbitrate in bad faith.  That is one of the risks parties undertake when they agree to arbitrate and they can choose to allocate that risk as they see fit.  The Court’s reasoning assumed the parties were aware that there was a possibility the other might not arbitrate in good faith.  One of the key predicates for the Court’s decision was that the Fee & Expense Provision was simply a restatement of the American Rule and that “bad faith was a well-recognized exception to the American Rule.  .  .  .”  Slip op. at 13. 

There was likewise no legitimate dispute that the Fee & Expense Provision could be enforced as written.   The provision was clear and unambiguous and all it required the parties to do was bear their own attorney and party-appointed arbitrator fees, and split the umpire’s fee, irrespective of the outcome of the dispute, and irrespective of whether one party alleged the other arbitrated in bad faith.   

In any event, even if New York rules of contract interpretation and construction allowed the Court to look behind the plain meaning of the Fee & Expense Provision to ascertain the parties’ intent, the Court looked askew.   The Court assumed, without explanation, that the Fee & Expense Provision was intended to incorporate the federal version of the American Rule, including the bad faith exception to that federal rule.  But the parties agreed their contract would be interpreted according to New York Law, and the American Rule as articulated by the New York courts does not feature a bad faith exception:  “attorney’s fees are incidents of litigation and a prevailing party may not collect them from the loser unless an award is authorized by agreement between the parties, statute or court rule.”   Hooper Associates, Ltd. v. AGS Computers, Inc., 74 N.Y.2d 487, 491 (1989).     While there is a New York court rule authorizing courts to award attorney fees against a party that litigates in bad faith, that rule does not purport to authorize arbitrators to award attorney fees for bad faith.  The only statute even arguably applicable is Section 7513 of  New York’s Civil Practice Law and Rules, which establishes a presumption that arbitrators do not have the authority to award attorney fees unless the parties otherwise agree.  See New York Civ. Prac. L. & R. 7513Synergy Gas Co. v. Sasso, 853 F.2d 59, 65 (2d Cir. 1988),

Finally, the breadth of the arbitration clause did not create an ambiguity when read together with the Fee & Expense Provision.  New York rules of contract interpretation provide that specific contract provisions trump general ones.  See, generally, Katz v. Feinberg, 290 F.3d 95, 96 (2d Cir. 2002) (per curiam).  The arbitration clause’s broad grant of authority was a general provision, which made no reference whatsoever to attorney fees, arbitrator fees, or any other form of relief.  By contrast, the Fee & Expense Provision specifically and unambiguously dealt with the subject of attorney and arbitrator fees.  Just as an insurance policy’s broad grant of coverage is subject to an unambiguous exclusion, so is an arbitration clause’s broad grant of authority subject to a specific, unambiguous provision limiting that authority. 

It seems to us that the majority of the ReliaStar Court may have been motivated more by a desired result than by applicable law and the parties’ agreement.  Given that the preeminent purpose of the Federal Arbitration Act is to enforce the parties’ arbitration agreement as written, ReliaStar may be one of those rare Second Circuit decisions that warrant rehearing and reversal en banc.

         

Tags: , , , , , , , , , , , , , , ,

3 Responses to “ReliaStar Life Insurance Co. v. EMC National Life Co.: Critical Analysis of an Important Reinsurance Arbitration Decision”

  1. […] and construction, which the parties expressly agreed would apply.  You can find our critique here, and a report on the case […]

  2. […] Global Arbitration Review, July 13, 2009. Also, read Phillip J. Loree, Jr. summary here, critique here, and recent mention of the case […]

  3. […] Life Co.: Critical Analysis of an Important Reinsurance Arbitration Decision,”  available here.  On July 13, 2009 the London-based  Global Arbitration Review published an interesting article […]