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First State Ins. Co. v. National Cas. Co.

Issue Discussed: Honorable Engagement Clause

Submitted by Elizabeth V. Kniffen, Dennis Anderson

Date Promulgated: March 20, 2015

First State Ins. Co. v. Nat. Cas. Co., 781 F.3d 7 (2015)

Court: United States Court of Appeals, First Circuit

Issue Decided: In the First Circuit, what is the scope of judicial review of an arbitration award issued under an arbitration agreement that includes an honorable engagement clause?

In First State Insurance Company v. National Casualty Company, the United States Court of Appeals for the First Circuit considered – for the first time – the operation and effect of an honorable engagement provision in an arbitration clause. The court concluded that the already narrow scope of review for arbitration awards generally is even narrower under an honorable engagement clause, and that the clause empowers arbitrators to grant relief not explicitly mentioned in the underlying contracts.

First State arose from a dispute rooted in a number of reinsurance and retrocessional agreements between First State Insurance Company and New England Reinsurance Corporation (collectively, “First State”) and National Casualty Company (“National”). In August of 2011, First State demanded arbitration under eight of the agreements to resolve billing disputes and disagreements about the interpretation of certain contract provisions. The eight arbitrations were consolidated into a single proceeding.

Each of the eight contracts included an honorable engagement clause directing the arbitrators to consider each agreement as “an honorable engagement rather than merely a legal obligation” and explaining that arbitrators were “relieved of all judicial formalities and may abstain from following the strict rules of law.”

Arbitration panel decided to consider the contract interpretation issues first and issued a contract interpretation award in 2012, which established a detailed payment protocol. The arbitration panel turned its attention to the billing dispute, and issued a final arbitration award in 2013. First State sought judicial confirmation of both awards. The U.S. District Court for the District of Massachusetts confirmed the arbitration awards, and National appealed.

National argued that the arbitrators exceeded the scope of their authority by setting up a payment protocol not found in the insurance contracts. The First Circuit rejected that argument, and provided appellate guidance – for the first time ever in the First Circuit – regarding the scope of judicial review of arbitration awards pursuant to arbitration agreements that include honorable engagement clauses.

At the outset of the opinion, the court stated that the scope of review of an arbitration award is “among the narrowest in the law,” and that it is even narrower when the arbitration clause contains an honorable engagement provision. Later in the opinion, the court summarized its guidance for the lower courts of the First Circuit:

Here, the sole inquiry is whether the arbitrators even arguably construed the underlying agreements . . . . A legal error (even a serious one) in contract interpretation is, in and of itself, not a sufficient reason for a federal court to undo an arbitration award. Only if the arbitrators acted so far outside the bounds of their authority that they can be said to have dispensed their own brand of industrial justice will a court vacate the award. Put another way, as long as an arbitration award draw[s] its essence from the underlying agreement, it will withstand judicial review – and it does not matter how good, bad, or ugly the match between the contract and the terms of the award may be.

The court encouraged lower courts tasked with deciding whether an arbitration panel was arguably interpreting the underlying contract to look to the text of the arbitration award. The award in this case explained that the payment protocol at issue was, in part, “based upon the terms of the subject reinsurance agreements,” and that the panel’s inquiry pertained to National’s obligations “under the subject reinsurance agreements.” Based on this intrinsic evidence, the court concluded that it was “readily apparent . . . that the arbitrators understood the nature of their task.”

Turning its attention to the honorable engagement clause specifically, the court left no doubt that such clauses are favored in the First Circuit, describing them as a “huge advantage” to the prospects of successful arbitration. “We believe,” the court wrote, “that an honorable engagement provision empowers arbitrators to grant forms of relief, such as equitable remedies, not explicitly mentioned in the underlying agreement. This is a huge advantage: the prospects for successful arbitration are measurably enhanced if the arbitrators have flexibility to custom-tailor remedies to fit particular circumstances. An honorable engagement provision ensures that flexibility.”