Part I: PoolRe Introduction and Background
Introduction
Arbitration offers rough justice on the merits. Arbitrators have broad discretion not only in deciding the dispute but in fashioning remedies. Skilled, experienced and responsible arbitrators can cut through all sorts of legal and contractual “red tape” to resolve a dispute, applying just enough gloss on the law and the contract to make things work in a businesslike fashion while remaining true to the “essence of the agreement.” Applied just so, that kind of rough justice is sometimes exactly what the parties need to make their agreement work, and in some cases, preserve (or even improve) their commercial relationship going forward. And it is not something that Court adjudication necessarily—or even ordinarily—can achieve.
But rough justice does not govern whether the parties agreed to arbitrate, who’s bound by an arbitration agreement and whether the parties agreed to delegate authority to a particular arbitrator or to follow a particular method of arbitrator selection as set forth in the parties’ agreement. Those questions are governed principally by state contract law and—particularly when multiple agreements and multiple parties are involved, or the question concerns whether an arbitrator was validly appointed—they frequently must be decided by courts, even if some or all of the parties have clearly and unmistakably agreed to submit arbitrability questions to arbitration.
Details, Details. . .
Details always matter, but they are all the more important when a dispute will presumably be decided under state contract law rules and principles by a decision maker whose decisions—unlike those of an arbitrator—are often subject to independent review by an appellate court. Courts generally do not (or at least are not supposed to) substitute rough justice, pragmatism or equity in place of contract law, which is not always so flexible. The casebooks are littered with examples where doing so might arguably have achieved a more desirable outcome but doing so could not be squared with contract rules and principals in a way that befitted higher-court precedent and the circumstances apparently did not warrant departure from precedent.
The U.S. Court of Appeals for the Fifth Circuit’s decision in PoolRe Ins. Corp. v. Organizational Strategies, Inc., No. 14-20433, slip op. (5th Cir. April 7, 2015), is a case where the parties apparently lost sight of some important details in their apparent haste to do a deal that unfortunately went sour. Then, an arbitrator appointed under one of the contracts compounded the problem by making an award that could not even arguably be squared with the clear terms of one of the contracts’ arbitration agreements.
The parties that were probably best positioned to ensure that the arbitration agreements in the various service-provider and reinsurance contracts probably lost the most, and perhaps to some extent at least, there’s some poetic justice to that. They claimed the clients breached their service contracts, the clients said the service providers breached the contracts and independent legal duties and the arbitrator ruled in favor of the service providers. The district court, as we’ll see, properly vacated the award and the Fifth Circuit affirmed. Now the parties are essentially back at square one, albeit much worse for the wear in terms of legal expenses and protracted delay.
The facts and procedural history of the case is somewhat complex, but critically important. Not only do they drive the outcome but they read like a primer on what not to do when attempting to devise a cost-effective arbitration program for disputes that may involve multiple parties and interrelated and interdependent contracts. And they demonstrate pretty starkly some of the consequences that parties can suffer when: (a) they do not properly structure their agreement; and (b) end up with an arbitrator who is not be as savvy as he or she might otherwise be about scope of authority (or simply makes a bad call about it).
We do not mean to suggest that the Arbitrator in this case was in any way incompetent or otherwise blameworthy. To err is human, and even if the arbitrator had made the best permissible decision possible under the circumstances, the parties would still be exposed to the consequences of having not properly structured their arbitration agreements. The arbitrator’s missteps certainly exacerbated the problem, but such things are foreseeable risks that the parties could have managed by, for example, agreeing to an arbitration agreement that was drafted in simple, unambiguous terms governing what is supposed to happen in the event of a multi-contract, multi-party dispute like the one at issue. Such disputes were foreseeable, as they are in any relatively complex transaction involving multiple parties and multiple interrelated contracts.
The mess that is described in the balance of this post could have been avoided had some or all of the parties: (a) understood that their dispute resolution system needed the attention of a skilled and experienced arbitration lawyer; and (b) were willing to invest the modest sum needed to make that possible. Apparently the parties did not appreciate the risks they faced or, if they did, they made a conscious decision to ignore them, perhaps finding it preferable to avoid paying a few extra thousand dollars up front, roll the dice and hope that all would turn out well (and certainly not as it did).
Perhaps one might wonder what the odds were that an underlying dispute like the one at issue would arise. Nobody knows the precise answer, of course, but we’d have to say there was a meaningful risk in view of the nature and structure of the transaction. And given the rather obvious and dramatic disparity between the two arbitration agreements, the risk that Federal Arbitration Act enforcement proceedings would be necessary was likewise meaningful and fairly easy to foresee.
Suppose the risk was 1 in 6—that is, there was approximately a 17% chance that the parties would spend hundreds of thousands of dollars and spend at least an additional year or more embroiled in Federal Arbitration Act enforcement litigation centered on issues collateral to the merits. If we’re talking about a single round roll of a single die, with the idea being to avoid one possible outcome (represented by a whole number ranging from one to six), then that’s about as minimal a risk as could be measured (since there are only six possible outcomes). It also happens to be the same risk one would accept were one to play a round of Russian Roulette with a six-round revolver and a single bullet.
The point is that it is not just a matter of assessing the odds; severity of potential outcomes obviously drives risk assessment and management decisions as well. Most responsible corporate officers and directors aren’t going to take on a Russian-Roulette type risk (i.e., a “bet-the-company” risk) unless they have no choice, and if they must take the risk, they do what they reasonably can to minimize the odds the undesirable outcome will materialize and to mitigate any loss incurred if it does.
Here, the outcome that could have been avoided was very costly—though presumably not a death knell for either party— whereas the cost of substantially decreasing the likelihood of that outcome would probably have been less than a percentage point of the loss.
What would you have done?
The PoolRe Parties and Contracts
The PoolRe dispute concerned captive-insurance-company formation and administration services a group of business entities we’ll refer to them collectively as the “Capstone Entities”—undertook to provide to Organizational Strategies, Inc. (“OSI”), a professional-services firm. The Capstone Entities are: (a) Capstone Associated Services, Limited; (b) Capstone Associated Services (Wyoming) L.P.; and (c) Capstone Insurance Management, Limited.
The services the Capstone Entities provided to OSI included setting up a captive insurance program (the “Captive Program”), which featured three captive insurance companies (the “Captives”). The Feldman Law Firm, L.L.P. (“the Feldman Firm”) provided legal services relating to Captive Program. The Feldman Firm’s name partner had ownership interests in the Capstone Entities.
The Feldman Firm also had ownership interests in PoolRe Insurance Corporation (“PoolRe”), an offshore insurer organized under the laws of Anguilla, British West Indies (“B.W.I.”), presumably for the purposes of providing offshore reinsurance to captive insurance companies set up and administered by the Capstone Entities. PoolRe provided reinsurance to the Captives.
Nicolette and William Hendricks manage OSI and it was they who met with the Capstone Entities to discuss OSI’s captive insurance program. Once the parties decided to proceed with the work, the Feldman Firm sent OSI an engagement letter (the “Engagement Agreement”) which attached and incorporated by reference the Feldman Firm’s “Billing Guidelines,” which contained a broad arbitration agreement that called for American Arbitration Association administered arbitration. The arbitration agreement also clearly and unmistakably delegated arbitrability issues to the arbitrator.
The Capstone Entities were also parties to the Engagement Agreement, and that agreement thus addressed not only the terms and conditions of the legal relationship between the Feldman Firm and OSI, but also that between OSI and the Capstone Entities. In addition to the Feldman Firm Billing Guidelines discussed above, the Engagement Agreement also attached a Services Agreement between the Capstone Entities and OSI, which was to be executed (and apparently was) once the Captives were formed.
As respects most disputes, the Service Agreement provided that “venue and jurisdiction shall be in Delaware.” It featured an integration clause that said “[t]o the extent of any conflict between the terms and provisions of this Agreement and the Engagement Letter, this Agreement
exclusively shall control.” PoolRe was not a party to any of the agreements between OSI and the Feldman Firm and Capstone Entities.
The Engagement Agreement had a multi-year term and contemplated the formation and administration of the three Captives, which would, in the Court’s words, “underwrite alternative-risk programs for OSI.” Slip op. at 3. We suspect that the Court used “alternative risk” as shorthand for “alternative risk transfer” (a/k/a “ART”)—a way of transferring risk through various types of structured transactions that usually combine: (a) traditional insurance risk transfer; with (b) the financing of risk by way of various types of financial instruments, vehicles and structures.
The Capstone Entities performed their end of the bargain from the Engagement Agreement’s inception in June 2011 through early 2012, i.e., for roughly six months. The Captives were established, the Capstone Entities arranged reinsurance of each Captives through PoolRe, PoolRe entered into a separate reinsurance agreement with each Captive and the Captives issued policies to OSI. Each of PoolRe’s three reinsurance contracts had an identical arbitration clause, which required International Chamber of Commerce (ICC) arbitration that would “take place in the Territory of Anguilla, B.W.I.”
An annual audit OSI conducted precipitated disputes between the parties. OSI believed that it had overpaid insurance premium. It demanded that the Capstone Entities revise certain accounting information, but the Capstone Entities would not. OSI terminated the Engagement Agreement, PoolRe cancelled the reinsurance contracts and a dispute arose about whether PoolRe discharged its obligation to refund deposit premium. The Feldman Firm ceased further work for OSI, at least pending dispute resolution.
The Texas Arbitration Proceeding Begins. . .
In March 2013 the Capstone Entities demanded arbitration against OSI for breach of contract. Apparently as set forth in Engagement Agreement’s arbitration agreement, the arbitration demand was sent to Dion Ramos of Conflict Resolution Systems, PLLC (“CRS”) in Houston, Texas. Mr. Ramos “appointed himself arbitrator.” Slip op. at 4.
The Reinsurance Contracts’ arbitration agreements specify that “the Anguilla, B.W.I. Director of Insurance” was to select the arbitrator. But the Anguilla Financial Services Commission’s director (the “FSC Director”) informed Pool Re in writing that Anguilla did not have a “Director of Insurance.” The FSC Director, however, purported to designate CRS “to select ‘any such independent arbitrators and to administer related arbitration proceedings.'” Slip op. at 4 (quoting FSC Director’s letter). The FSC Director’s letter said nothing about the Reinsurance Contracts’ ICC arbitration requirement.
On April 15, 2013 OSI appeared at the arbitration and objected to the arbitrator’s authority. It moved to dismiss the arbitration based on the Delaware venue clause in the Services Agreement. Presumably also under a reservation of rights, OSI counterclaimed against the Capstone Entities, asserting that the Feldman Firm’s name partner owned and controlled the Capstone Entities and PoolRe. The common ownership and control, said OSI, created a conflict of interest in violation of applicable rules of professional responsibility governing the Feldman Firm’s attorneys.
On April 22, the Feldman Firm and PoolRe purported to intervene in the arbitration. PoolRe did so “for the limited purpose of having [the Arbitrator] appoint an Anguilla-based arbitrator.” A week later the Arbitrator made and published by email a ruling on jurisdiction that applied AAA rules and decreed he had jurisdiction over: (a) the Capstone Entities’ claims based on the arbitration agreement in the Engagement Agreement; and (b) PoolRe’s claims under the arbitration agreements in the Reinsurance Contracts. The ruling also concluded that PoolRe had waived its right to arbitrate in Aguilla by seeking to intervene in the Texas-based arbitration.
OSI wisely objected to the ruling, and noted that the ruling with respect to the PoolRe-related claims effectively negated the parties’ agreement to an ICC-administered arbitration. And after that the arbitrator denied OSI’s motion to dismiss.
The Parallel Delaware Proceedings
Ill-designed dispute resolution systems can proliferate multi-jurisdictional Federal Arbitration Act satellite litigation. When that happens, arbitration almost always becomes exponentially more expensive and time-consuming than litigation. And that’s exactly what happened here.
OSI, and its newly acquired Captives, commenced an action in Delaware Chancery Court against the Capstone Entities, claiming that the premiums was required to pay to the Captives were allegedly too high. Capstone removed the case to federal court, and moved to dismiss on the ground that the Arbitrator had to decide the dispute, including questions of arbitrability. OSI contended that the dispute was not covered by a valid arbitration clause, presumably on the ground that the Service Agreement—which contained no arbitration agreement and provided for “jurisdiction” in Delaware—expressly trumped the Engagement Agreement’s Arbitration Agreement.
The Delaware District Court granted the motion to dismiss, ruling that the parties unambiguously intended that the Delaware jurisdiction clause meant that the arbitration agreement in the Billing Guidelines section of the Engagement Agreement continued to govern, except that any arbitration (or arbitration enforcement proceedings) would take place in Delaware. It thus dismissed that action, and OSI demanded arbitration in Delaware. When the Capstone Entities refused to arbitrate, OSI returned to the Delaware District Court and requested an order compelling arbitration, which the court granted.
The Capstone Entities appealed to the U.S. Court of Appeals for the Third Circuit the District Court’s earlier ruling on the interpretation of the arbitration agreement, but the Third Circuit affirmed. See Organizational Strategies, Inc. v. Feldman Law Firm LLP, No. 141704, slip op. (3rd Cir. Mar. 20, 2015).
Meanwhile, Back in Texas. . .
Just as FAA enforcement proceedings began to proliferate, so too did the arbitration proceedings. In June 2013, three days before the first merits arbitration hearing, the Capstone Entities demanded arbitration of a claim that OSI breached Article V of the Services Agreement, which concerned the Capstone Entities intellectual property rights. The Arbitrator deferred that claim pending the upcoming arbitration hearing.
On July 9, after the first merits hearing, the Arbitrator made an award in favor of the Capstone Entities and PoolRe, which found: (a) OSI materially breached its contracts with the Capstone Entities, Pool Re and the Feldman Firm; (b) the Feldman Firm was not guilty of professional negligence or breach of fiduciary duty; (c) PoolRe was properly joined; and (d) the Capstone Entities, the Feldman Firm and PoolRe were entitled to a total of $451,244.44 in “attorney’s fees, expenses and costs,” which were “to be divided among themselves as they see fit.” The Arbitrator denied OSI relief on its counterclaims.
PoolRe petitioned to confirm the Award in the U.S. District Court for the Southern District of Texas, and included in its motion a request that OSI be compelled to arbitrate the Article V claims set forth in the Capstone Entities’ second arbitration demand (the “Phase II Claims”) The Delaware District Court had not yet ruled on the matters before it and OSI thus sought a temporary stay of the briefing and consideration of the petition to confirm.
On July 29, 2013 the Texas district court stayed the petition to confirm pending the Delaware district court’s resolution of the matters before it, finding that the Delaware action was first filed. Construing the Billing Guideline’s arbitration agreemeent with the terms of the Services Agreement, the Texas district court held that “‘the parties intended to carve out disputes under Article V from the broad grant of arbitrability in the previous agreements among the parties.'” Slip op. at 6-7.
In August 2013 the Capstone Entities and the Feldman Firm joined in PoolRe’s petition to confirm. OSI moved to lift the stay and for an order vacating the award. When the court lifted the stay, OSI responded to the petition to confirm.
The Texas District Court Decision Vacating the First Arbitration Award and Denying the Motion to Compel Arbitration of the Phase II Claims
In February 2014 the Delaware district court issued its ruling granting the Capstone Entities’ motion to dismiss, and on March 31, 2014, the Texas district court granted OSI’s motion to vacate the Award. The district court held that the Arbitrator “exceeded his authority by exercising jurisdiction over and applying the AAA rules to the disputes between Pool Re and the Captives.” “Because this,” said the district court, “‘tainted the entire process’ the [district] court vacated the award and denied the motion to confirm.” Slip op. at 7. The Court denied the motion to compel arbitration of the Phase II Claims “because the live arbitration demand requested relief on the first, and now vacated, award.” Slip op. at 7. The Fifth Circuit appeal followed.
And as we’ll discuss in Part II of this post, the Fifth Circuit affirmed the district court’s decision in all respects.
Photo Acknowledgements:
All photos used in the text portion of this post are licensed from Yay Images and are subject to copyright protection under applicable law. Text has been added to images 2, 12 and 13 (counting from top to bottom). Hover your mouse pointer over any image to view the Yay Images abbreviation of the photographer’s name.
Tags: AAA Commercial Rules, Alternative Risk Transfer, American Arbitration Association, Arbitration Agreement Drafting, Arbitration Agreement Structure, Arbitration Lawyers, Arbitrator Selection Provisions, ART, Bleak House Risk, Captive Insurance, Captive Insurance Programs, Captive Insurers, FAA Satellite Litigation, International Chamber of Commerce, Managing Arbitration Risk, Multi-Contract Disputes, Multi-Party Disputes, Offshore Reinsurance, Proliferation of Arbitration and Litigation Proceedings, Questions of Arbitrability, Reinsurance of Captive, Reinsurance of Captives, Remedial Powers of Arbitrators, Rough Justice, U.S. Court of Appeals for the Fifth Circuit
