The Arbitration Trap

November 5, 2012

For decades now, your company has reinsured a substantial portion of its risk under reinsurance contracts (treaties) negotiated by executives who retired long ago. But just a few years ago, your reinsurer – now in run-off and no longer looking for your business – changed several of its long-standing positions as to liability under the treaty and then commenced an arbitration to recoup millions of dollars in claims it had previously paid. Today, after your company incurred heavy discovery costs and attorneys’ fees, and many of your employees and former employees were deposed to testify at a multi-week hearing, the dispute has been submitted for decision to a three-person arbitration panel. Each party appointed one of the panel’s arbitrators, but by agreement, the umpire was selected from a list the reinsurer provided after it won an odd-even guess on the closing price of a major stock index.

The situation is stark. The financial fortunes of your company will turn upon the sole judgment of a long-retired reinsurance executive who now makes his money as a full-time umpire selected by reinsurers. And when he decides this case, your company will have no possibility of appeal whatsoever, absent some unlikely egregious misconduct.

Rather than lamenting, you should be considering how to avoid such a scenario in the future. Because, even as the umpire is deciding your dispute, a team within your company is negotiating another reinsurance treaty focusing on premium rates, scope of coverage and numerous other “business” terms. But they are likely to trade away your company’s ability to enforce those terms by agreeing to include an arbitration provision that invariably favors the reinsurer.

Your company does not have to agree to an arbitration provision and should not do so unless it receives some value for doing so. Traditional justifications for arbitration no longer warrant including such a provision.

Instead of an arbitration clause, include a provision selecting the venue and waiving a jury.

Don’t believe the canard that arbitration is necessarily less costly than litigation. Arbitration panels are reluctant to limit discovery unless the parties agree to do so, and oppressive discovery tactics are a tool your reinsurer can use to inflict cost and extract a settlement. It’s the insurer that maintains the majority of potentially responsive documents in a reinsurance dispute, and they may have to be gathered from numerous corners of a vast business enterprise. If the reinsurer is in run-off, it is likely to have even fewer documents, and thus has even less incentive to limit discovery. Today it is not uncommon to produce millions of documents in an arbitration proceeding, and your company will have to pay for them to be gathered, processed and reviewed.

It’s a misconception that arbitration is necessarily faster than litigation. An astonishingly small number of arbitrators and umpires serve on a majority of reinsurance arbitration panels. Reconciling their crowded schedules can result in hearing dates set far in the future. The burden of discovery is likely to ensure that the dispute is not resolved any more quickly. In addition to paying costs of discovery, your company will pay for its separate arbitrator and half of the umpire’s time.

Another misconception is that outcomes in arbitration are likely to be as just as in litigation. Recent court decisions establish that there is almost no way to overturn an arbitration decision based on bias absent egregious circumstances. Even if the umpire completely misunderstands and misapplies the law, or unjustifiably disregards your sound legal positions, remedy is unlikely because he does not have to disclose his reasoning.

Finally, there is an alternative that works. Instead of including an arbitration clause, include a provision selecting the venue and waiving a jury. That way, a judge will decide the dispute based on the facts and the law. If knowledge of industry custom and practice is necessary to decide the case, you can present such evidence through an expert. If the judge makes an erroneous ruling of law, your company has the right to appeal it. And your company won’t have to pay separately for the judge to hear and decide the case. If the judge believes the case should be settled quickly, the parties will be ordered to mediation.

About Daniel McNeel Lane Jr.

McNeel Lane Jr. is a partner at Akin Gump Strauss Hauer & Feld LLP. His practice represents insurers in class action litigation, reinsurance arbitration proceedings and other disputes. Email: Nlane@akingump.com. Phone: 210-281-7070.

From This Issue

Insurance Journal West November 5, 2012
November 5, 2012
Insurance Journal West Magazine

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