Garamendi v. California Compensation Insurance Company

Issue Discussed: Judicial Review/Manifest Disregard

Submitted by Paul Janaskie, Jante Santos

Date Promulgated: January 20, 2006

Issue Addressed: Vacating an Arbitration Award due to Improper Granting of Set-Off?

The California Court of Appeals, in an unpublished decision, vacated an arbitration award in its entirety and required the parties to hold another arbitration proceeding. The court held that the award improperly granted a setoff in violation of a court order, and it held that under the California Insurance Code a cedent is entitled to the return of its entire premium upon rescission of a reinsurance treaty.

Background

Insurance Corporation of Hannover, Scandinavian Reinsurance Company, Ltd., and Odyssey Reinsurance Corporation (collectively, “Reinsurers”) entered into a reinsurance treaty with Business Insurance Group, which included several insurance company affiliates (“Reinsureds”). The treaty provided for $37.5 million excess layer reinsurance in exchange for 50 percent of the premium.

Several of the Reinsureds became insolvent, a conservator was appointed, and proceedings were instituted to liquidate the Reinsureds’ assets. During the course of the liquidation proceedings, the liquidation court issued an order prohibiting the parties from “exercising any right of setoff.”

Thereafter, the Reinsurers filed suit against the Reinsureds, seeking rescission of the reinsurance contract and seeking damages based on alleged material misrepresentations and fraudulent concealment. The Reinsurers moved to arbitrate their affirmative claims against the Reinsureds. The liquidation court granted the motion, but ordered that “[n]o payment of any award or judgment obtained against . . . any of the [Reinsureds] . . . shall be paid in whole or in part out of any assets of the estates of any of these liquidating [Reinsureds] . . . .”

The arbitration panel issued a final award in which it rescinded the reinsurance treaty from its inception and declared the treaty void ab initio. The arbitration panel ordered that the Reinsurers pay the Reinsureds the amount of $2.5 million, which included the return of the premium with interest. The Reinsureds sought vacatur based on the fact that the amount of premium paid was at least $7 million, and the $2.5 million final award amount reflected a setoff.

Reinsureds Entitled to Return of Entire Premium

As an initial matter, the appellate court held that rescission of the contract from its inception required the return of the whole premium. The court determined that the California Insurance Code mandated this result because the Code provides for the return of the whole premium “if the insurer has not been exposed to any risk of loss.”

Arbitration Award Constituted a Setoff That Exceeded Arbitration Panel’s Authority

The appellate court then held that the arbitration award constituted a setoff because it was undisputed that the premium paid was at least $7 million, and the shortfall was a setoff in favor of the Reinsurers who sought recovery of tort damages. The court reasoned that the shortfall was attributable to tort damages such as fraud, costs, and expenses that the Reinsurers sought against the Reinsureds in the same arbitration proceeding. Thus, the court concluded that issuance of the $2.5 million award, on its face, reflected a setoff against the whole premium due the Reinsureds, which violated the liquidation court’s order and exceeded the authority of the arbitrators. Thus, the appellate court found that the award should be vacated.

Court Requires New Arbitration Proceeding

Finally, the appellate court found that the award was incapable of correction since, on its face, it failed to specify the nature and amount of the relief granted. Because the final award did not attribute any amount to the premium or interest, the court required that the entire award be vacated in its entirety and a new arbitration proceeding be initiated.

* Mr. Janaskie is a partner and Ms. Santos is an associate in the Insurance and Reinsurance Practice Group of Hunton & Williams LLP. They represent cedents and reinsurers in a wide range of reinsurance and insurance coverage matters.