M. Diane Koken, Insurance Commissioner of the Commonwealth of Pennsylvania, as Liquidator of American Integrity Insurance Co. v. Cologne Reinsurance (Barbados) Ltd.

Issue Discussed: Judicial Review/Manifest Disregard

Submitted by Michele L. Jacobson, Andrew S. Lewner

Date Promulgated: August 23, 2006

Issue Addressed: Whether an Arbitration Award Should Be Vacated for Manifest Disregard of the Law

In Koken v. Cologne Reinsurance (Barbados) Ltd., the District Court for the Middle District of Pennsylvania vacated, in part, an arbitration award because the Court found that a portion of the award had been rendered in manifest disregard of the law.

The underlying dispute between the parties centered upon two separate agreements: a Coinsurance Agreement and a Stop Loss Agreement. Koken sought recovery from Cologne under the Coinsurance Agreement, and Cologne sought to offset against that recovery amounts due to Cologne under the Stop Loss Agreement. With respect to the Stop Loss Agreement, Koken contended that that agreement had terminated on July 25, 1993, thirty days after an order was entered placing American Integrity Insurance Company (“American Integrity”) into liquidation.

At the inception of the case in 1999, Koken disputed the validity and enforceability of the arbitration agreement between the parties. The District Court for the Middle District of Pennsylvania compelled the parties to arbitrate. The arbitration originally convened on May 11, 2001, but due to an unrelated circumstance, the umpire withdrew and the arbitration was discontinued. On March 11, 2004, arbitration was convened before a new panel, which bifurcated the hearing into two phases: liability and damages.

After a two-day hearing on the issue of liability, on July 22, 2004, the arbitration panel (the “Panel”) entered an award (the “Award”) which, inter alia,provided as follows:

1. Under 40 P.S. § 221.32, the Liquidator’s claim against Cologne under the Coinsurance Agreement is subject to offset under the Stop Loss Agreement. The exceptions to setoff in the statute do not apply to the facts of this case.

2. The Stop Loss Agreement did not terminate as of July 25, 1993 pursuant to 40 P.S. § 221.21.

The Award also required the parties to confer as to damages and to jointly report the results to the Panel. On March 17, 2006, the Panel issued its final award (the “Final Award”) which, in pertinent part, reiterated the relief set forth in the Award.

Cologne moved to confirm the Final Award under the Convention on the Enforcement and Recognition of Foreign Arbitral Awards (the “Convention”), claiming that confirmation was proper because none of the grounds for refusing confirmation enumerated in the Convention were present. Koken opposed Cologne’s motion to confirm and filed a motion to vacate the arbitration award. Koken claimed that vacatur was appropriate because one of the enumerated grounds for refusal provided in the Convention – the unenforceability of the agreement to arbitrate – existed. Koken further argued that vacatur was appropriate because the Final Award was rendered in manifest disregard of the law.

With respect to Koken’s claim that the agreement to arbitrate was unenforceable, Koken raised three distinct claims. First, Koken argued that the arbitration agreement cannot be enforced against the Liquidator. Secondly, she argued that the FAA is “reverse pre-empted by the McCarran-Ferguson Act.” Third, Koken contended that since the time when the Court originally ruled on the issue of arbitrability, the case law in Pennsylvania had changed.

The Court disagreed with Koken’s contention that the agreement to arbitrate was unenforceable. Specifically, the Court rejected the claim that the arbitration agreement could not be enforced against the Liquidator, because the Court held that “the Liquidator stands in the shoes of the insolvent insurer and is bound by the insurer’s contractual agreements.” Equally, the Court rejected the contention that the FAA was specifically pre-empted by the McCarran-Ferguson Act, relying on the Third Circuit’s decision in Grode v. Mutual Fire, Marine and Island Ins. Co., 8 F.3d 953 (3d Cir. 1993). Finally, after reviewing each of the cases cited by Koken, the Court concluded that the law on arbitrability had not changed since the time that Koken originally raised each of these same arguments in 1999. As such, the Court held that the agreement to arbitrate was valid and enforceable against Koken.

On the issue of manifest disregard, Koken argued that the Panel’s Final Award ignored two governing Pennsylvania statutes. Specifically, while the Panel ruled that the Stop Loss Agreement did not terminate 30 days after the liquidation order pertaining to American Integrity was entered, Koken contended that 40 P.S. § 221.21 explicitly terminates the insurance liability of an insolvent insurer 30 days after entry of a liquidation order. Koken further argued that because the Coinsurance Agreement had the effect of increasing American Integrity’s surplus, it should have been considered a capital contribution, and thus not subject to setoff, as dictated by 40 P.S. § 221.32(b)(3). Koken contended that the Panel’s failure to apply these two statutes was a manifest disregard of the law, and that such a finding was supported by the fact that the Panel did not issue a reasoned award.

Discussing the standard for vacatur of an arbitral award, the Court explained that such an award may be vacated “where the arbitrator’s decision evidences a manifest disregard for the law rather than an erroneous interpretation of the law . . . A Court can vacate an arbitration award under the manifest disregard standard if it finds that . . . (1) the arbitrators knew of a governing legal principal yet refused to apply it or ignored it altogether, and (2) the law ignored by the arbitrators was well defined, explicit, and clearly applicable to the case.” The Court also noted that while the manifest disregard standard for vacatur is not contained in the Convention, “the Convention specifically contemplates that the state in which, or under the law of which, the award is made, will be free to set aside or modify an award in accordance with its domestic arbitral law and its full panoply of express and implied grants for relief.”

Setoff

40 P.S. § 221.32(a) provides that “mutual debts or mutual credits between the insurer and another person in connection with any action or proceeding under this article shall be setoff and the balance only shall be allowed or paid, except as provided in subsection (b).” In pertinent part, subsection (b)(3) provides that “No setoff or counterclaim shall be allowed in favor of any person where . . . (3) the obligation of the person is to pay an assessment levied against the member or subscribers of the insurer, or to pay a balance upon a subscription to the capital stock of the insurer, or is in any other way in the nature of a capital contribution.” Koken argued that, because the agreement between Cologne and American Integrity increased American Integrity’s surplus, it was “in the nature of a capital contribution,” and, therefore, not subject to set-off. The Court disagreed with Koken’s position, explaining that, since the language of subsection (b)(3) cited by Koken had never been interpreted by any Pennsylvania Court, state or federal, “the only argument possible” is that “the arbitration panel erroneously interpreted the law.” The Court held that “an erroneous interpretation by the arbitration panel does not warrant a finding of manifest disregard.” The Court, therefore, refused to vacate the Final Award on this ground.

Continuation of the Stop Loss Agreement

On the issue of the termination of the Stop Loss Agreement thirty days after American Integrity was placed into liquidation, however, the Court held that the arbitration panel manifestly disregarded 40 P.S. § 221.21. In pertinent part, 40 P.S. § 221.21 provides that “[a]ll insurances in effect at the time of issuance [of] an order of liquidation shall continue in force only with respect to the risks in effect, at that time (i) for a period of thirty days from the date of entry of the liquidation order.” Based upon this language, Koken argued that the Stop Loss Agreement terminated on July 25, 1993 (30 days after the order placing American Integrity into liquidation).

Cologne opposed this position by arguing that 40 P.S. § 221.21 only applied to direct insurance, and that the Panel, therefore, did not manifestly disregard that statute. In support of this contention, Cologne cited to the NAIC model law, which specifically exempts reinsurance from the analogous provision to 40 P.S. § 221.21. The Court rejected Cologne’s position, however, and held that “the panel’s decision as to the continuation of coverage is in manifest disregard of the law. Contrary to the set-off statute, which is open to interpretation, 40 P.S. § 221.21 is quite clear. The legislature chose to adopt language different then that in the NAIC model law. If the legislature had wanted to exclude reinsurance from the statute, it could have.” Thus, the Court concluded that the Panel manifestly disregarded 40 P.S. § 221.21, and granted Koken partial vacatur of the Final Award on this point.

Lack of a Reasoned Award

Koken also argued that the lack of a reasoned award, coupled with the length of time that it took the Panel to render its award, further evidenced manifest disregard of the law. While the Court noted that it had already found that the Panel manifestly disregarded 40 P.S. § 221.21, this argument was unpersuasive with respect to the setoff claim. The Court premised this holding on the fact that the transcript of the proceeding did not demonstrate that the parties had agreed to a reasoned award. Moreover, the Court noted that no case had ever held that a delay in rendering an arbitration award evidences manifest disregard.

* Michele L. Jacobson is a partner in the litigation department of Stroock & Stroock & Lavan, L.L.P., concentrating her practice on insurance and reinsurance litigation and arbitration. Ms. Jacobson has represented ceding companies, reinsurers, retrocessionaires, liquidators and intermediaries in a vast array of matters in state and federal courts, as well as before arbitration Panels throughout the country.

Andrew S. Lewner is an associate in the litigation department of Stroock & Stroock & Lavan, L.L.P., concentrating on insurance and reinsurance litigation and arbitration. Mr. Lewner has represented ceding companies, reinsurers and retrocessionaires in a wide range of matters.