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Meadows Indem. Co., Ltd. v. Arkwright Mut. Ins. Co.

Issue Discussed: Security

Submitted by Michael T. Carolan*

Date Promulgated: September 30, 1996

 

Meadows Indem. Co., Ltd. v. Arkwright Mut. Ins. Co., No. MISC. 88-0600, 1996 WL 55713 (E.D. Pa. Sept. 30, 1996)

Court: U.S. District Court for the Eastern District of Pennsylvania

Issue Decided: Whether an arbitration panel’s pre-hearing order requiring reinsurer to obtain a $1.5 million irrevocable letter of credit exceeded the panel’s powers.

 

In Meadows Indem. Co., Ltd. v. Arkwright Mut. Ins. Co., the U.S. District Court for the Eastern District of Pennsylvania affirmed an arbitration panel’s pre-hearing order requiring the reinsurer to secure a $1.5 million irrevocable letter of credit, holding that the arbitration panel was within its powers to order the pre-hearing security, which was rationally derived from the terms of the treaty and a reasonable method for protecting the cedent’s stake in the controversy.

The Arbitration

In 1979, Meadows Indemnity Company (“Meadows”) issued a Professional Reinsurance Department Quota Share Treaty (the “Treaty”) to Philadelphia Manufacturers Mutual Insurance Company, a predecessor-in-interest to Arkwright Mutual Insurance Company (“Arkwright”).  Under the Treaty, Arkwright ceded six percent of its net liabilities under its insurance contracts.  Arkwright also agreed to periodically forward Meadows a statement with its reserves, including case reserves and incurred but not reported (“IBNR”) reserves.  In turn, the Treaty required Meadows to obtain a clean irrevocable letter of credit equal to Meadows’ proportion of Arkwright’s reserves.

By 1994, however, Meadows’ deficiency under the letter of credit was $1,405,766.16.  Because Arkwright’s reserves had increased significantly and Meadows believed there was a discrepancy in its IBNR reserves, Meadows requested that Arkwright provide data supporting its posted reserves.  Arkwright did not provide the requested documents.

On November 23, 1994, Arkwright demanded arbitration against Meadows.  The arbitration panel held its organizational meeting on November 6, 1995.  Meadows sought to assert its right to review the financial records regarding Arkwright’s reserves.  Arkwright, stating that it had “heard industry rumors” that Meadows’ financial condition was perilous, asked the panel to order Meadows to post an immediate letter of credit for security before the arbitration hearing went forward.  Meadows opposed the request, arguing that the panel did not have the power to order pre-hearing security.

After hearing argument from both parties, the panel decided it would not rule on Arkwright’s pre-hearing security request until the panel received a report from an independent auditor as to the correctness of Arkwright’s reserve figures.  On December 15, 1995, the auditor issued its findings.  On December 19, 1995, the panel granted Arkwright’s request and ordered Meadows to post pre-hearing security in the amount of $1.5 million by obtaining an irrevocable letter of credit drawn in favor of Arkwright before year-end.

On December 29, 1995, Meadows filed a motion with the U.S. District Court for the Eastern District seeking to vacate the panel’s award of pre-hearing security, asserting that the panel had exceeded its powers in making the award.  On January 16, 1996, Arkwright cross-moved for confirmation of the award.

The District Court Opinion

The two-prong standard applied by the district court was 1) whether “the form of the relief awarded . . . can be rationally derived either from the agreement between the parties or from the parties’ submissions to the arbitrators” and 2) “whether the terms of the award are rational.”

Ultimately, the court confirmed the arbitration panel’s award of pre-hearing security.

First, the court found that the arbitrators rationally derived their award from the Treaty.  Specifically, the court pointed to the fact that the Treaty “requires Meadows to deliver Arkwright an irrevocable letter of credit in an amount equal to Meadows’ proportion of Arkwright’s reserves.”  The court also pointed out that the Treaty required the parties to submit to arbitration “any dispute or difference of opinion . . . arising with respect to the contract” and that the arbitration provision contained an “honorable engagement” clause.  In the court’s view, because the agreement granted the arbitrators “broad powers without limiting those powers in any way,” the parties necessarily “empowered the arbitrators to award relief in any reasonable form or at any stage in the proceeding.”

Second, the court found that the arbitrators “chose a reasonable method to protect Arkwright’s stake in the controversy” and that the award “was not disproportionate.”  The court noted that although the arbitration panel “did not reveal why” it awarded pre-hearing security, it “may have concluded” that if Meadows did not post substantial pre-hearing security, the impact of the arbitration or the entire Treaty would be in serious doubt.

Finally, the court distinguished the opinion by the U.S. Court of Appeals for the Third Circuit in Swift Indus., Inc. v. Botany Indus., Inc., 446 F.2d 1125 (3d Cir. 1972) and explained its disagreement with Recyclers Ins. Group, Ltd. v. Insurance Co. of N. Am., No. 91-503, 1192 WL 150662 (E.D. Pa. June 15, 1992).

The court distinguished Swift in several ways.  First, unlike the Treaty, which required Meadows to post a letter of credit equal to Arkwright’s reserves, Swift involved a stock exchange agreement that did not mention security of any time.  Second, the arbitration demand in Swift was limited to declaratory relief, whereas Arkwright’s arbitration demand included a specific request for pre-hearing security.  Third, in Swift the award of pre-hearing security was “an innovation created in the mind of the arbitrator alone,” a very different situation, in the court’s view, than deciding “an issue that had been submitted to the panel by one of the parties and had been argued at the organizational meeting.”

With respect to the Recyclers case, the court explained its difference of opinion rests on whether an agreement must explicitly empower the arbitration panel must to order pre-hearing security.  In the court’s view, the answer was no.  Rather, it believed that “as a general rule, and provided the parties have not agreed otherwise, an arbitration panel may impose awards on the parties that are not specifically stated in the contract giving rise to the arbitrators’ powers.”

 

* Michael T. Carolan is a partner in the Insurance & Reinsurance group of Crowell & Moring LLP. He represents cedents and reinsurers in disputes involving a broad spectrum of issues.