Reliance v. Raybestos

Issue Discussed: Judicial Review/Manifest Disregard

Submitted by Michael T. Walsh, Polina Shklyanoy Schultz

Date Promulgated: January 24, 2007

Issue Decided: An arbitration panel is not required to apply state substantive law in contract interpretation if not so required by the parties’ arbitration agreement or the rules of the AAA.

Reliance v. Raybestos is not a newcomer to the courts. It first appeared in the Southern District of Indiana in 1997 when Reliance Insurance Company instituted a declaratory judgment action against Raybestos to determine if coverage was available for the alleged environmental contamination of property located adjacent to the Raybestos manufacturing facility in Crawfordsville, Indiana. After several years of litigation, Raybestos filed for bankruptcy, which led to the filing of third-party complaints against its other insurers to recover the costs of the environmental cleanup of the property. Some of the other insurers moved the court to stay the action and compel arbitration under Sections 3 and 4 of the Federal Arbitration Act (“FAA”) which stated, in pertinent part:

Should any dispute arise out of or related to this endorsement and contract of insurance which cannot be resolved in the normal course of business with respect to the validity or interpretation of this insurance contract… the matter or matters upon [which] this agreement cannot be reached shall be settled by arbitration in accordance with the rules of the American Arbitration Association…

The District Court denied the motions to stay and compel arbitration, but on appeal, the Seventh Circuit Court of Appeals reversed and directed the parties to arbitrate “in accordance with the Rules of the American Arbitration Association (“AAA”) and Federal Arbitration Act.”

Raybestos filed a Demand for Arbitration to be pursuant to Indiana law. By this point, Raybestos had settled with all but one of its insurers, Westchester, who objected to Raybestos’ Demand. Pursuant to Indiana law, the absolute pollution exclusion of the Westchester policy would be considered ambiguous and thus unenforceable to bar claims arising out of a government-mandated environmental clean-up. The Panel, however, was aware that Indiana law was anathema to the law of every other jurisdiction that had tried this issue. In their decision, the Panel noted that

Indiana is the only jurisdiction, of the 48 that have ruled on this issue, that has declared the pollution exclusion ambiguous and, as a matter of law, unenforceable to bar claims arising out of a government-mandated environmental clean up.

After each party filed its motion for Summary Determination, the Panel, comprised of three former judges, agreed with Westchester, finding that “there is nothing in the arbitration provision or in any other policies that compels the application of the substantive law of any particular jurisdiction.” Applying Seventh Circuit case law, the Panel held that it was free to interpret the insurance contract according to its collective best judgment and ultimately determined that the absolute pollution exclusion in the Westchester insurance policy barred Raybestos’ claim.

Raybestos then appealed the Panel’s decision to the Southern District of Indiana in the instant litigation. In order for the Southern District of Indiana to overturn an arbitration ruling, Raybestos would have to show, in pertinent part, that the Panel exceeded its powers or that the arbitration award was in manifest disregard of the law. See Butler Mfg. v. United Steelworkers of Am., 336 F.3d 629, 632 (7th Cir. 2003), Wise v. Wachovia Securities, 450 F.3d 265, 268 (7th Cir. 2006), 9 U.S.C. §10. Raybestos argued exactly that, i.e. the Panel, which was aware of the Indiana interpretation of the absolute pollution exclusion, “manifestly disregarded the law” and/or “exceeded their powers under 9 U.S.C. §10(4),” by not applying state substantive law in their contract interpretation, thereby necessitating vacatur of their decision. Heath Services Management Corp. v. Hughes, 975 F.2d 1253, 1267 (7th Cir. 1992).

The Southern District of Indiana, however, looked to the arbitration agreement itself and the rules of the AAA to determine the scope of the Panel’s powers. The Southern District of Indiana found that neither the agreement nor the rules required the Panel to apply substantive law, and both allowed an arbitrator fairly free reign “in the formulation of remedies.” Bavarti v. Josephthal, Lyons & Ross, 28 F.3d 704, 710 (7th Cir. 1994). Therefore, under Seventh Circuit case law, the Panel was free to interpret the contract any way it deemed fit. Thus, as long as the Panel interpreted the absolute pollution exclusion without exceeding its powers, (even if the interpretation is “incorrect or even wacky”), the Southern District of Indiana must uphold the Panel’s award. See Wise, 450 F.3d at 269. Accordingly, the Southern District of Indiana found that the Panel’s interpretation of Westchester’s absolute pollution exclusion as barring Raybestos’ claims to be conclusive and binding.

Lastly, Raybestos argued that the arbitrators’ award should be vacated as violative of Indiana public policy, since Indiana courts specifically held that certain pollution exclusions contained in insurance policies were ambiguous and unenforceable. The Southern District of Indiana, however, found that as public policy did not play a role in the outcome of those previous decisions, Raybestos failed in identifying a well-defined and dominant public policy, and therefore none could be violated by the Panel’s ruling. Chicago Fire Fighters Union Local No. 2 v. City of Chicago, 751 N.E.2d 1169 (Ill.App. 2001).