U.S. Life Ins. Co. v. Insurance Commissioner of California

Issue Discussed: Judicial Review/Manifest Disregard

Submitted by Eric A. Haab, Jonathan R. Glusman

Date Promulgated: November 28, 2005

Issues addressed: Grounds for vacating awards; jurisdiction of federal court; Eleventh Amendment immunity for receivers

The United States Court of Appeals for the Ninth Circuit, in an unpublished decision, recently upheld an arbitral award reducing a reinsurer’s liability under a reinsurance agreement, saying it did not exhibit “manifest disregard of the law” and was not “irrational.” The Ninth Circuit further held that such an award did not offend the public policy of California favoring disclosure in reinsurance transactions. The district court did not lack jurisdiction to entertain a petition to vacate the award, even though the reinsurer previously had sought assistance from the state court to lift the injunction arising from the cedent’s insolvency. Finally, the Ninth Circuit held that the Eleventh Amendment was no bar to suing an insurance commissioner in his capacity as receiver of an insolvent insurer.

U.S. Life initiated arbitration against Superior National Insurance Group (SNIG) accusing SNIG and other insurers (Cedents) of nondisclosure in the placement of reinsurance on policies valued at over $1 billion. According to U.S. Life, SNIG knew but did not disclose that its subsidiary that issued the reinsured policies was under-reserved by between $100 million and $300 million.

During the course of the arbitration, SNIG was declared insolvent. The Insurance Commissioner of California took control of SNIG’s assets, and a California state court issued a stay of proceedings against the company. U.S. Life requested an order in state court to lift the stay with respect to its ongoing arbitration with SNIG, which was granted in November 2000. The arbitration thus proceeded to its conclusion. Ultimately, the arbitration panel denied U.S. Life’s claim for rescission, but “reformed” the contract, saying that “Cedents should have acted in a more open and forthright manner,” and reduced the liabilities ceded to U.S. life by 10 percent. U.S. Life moved to vacate the award in the District Court for the Central District of California. That petition was denied, and U.S. Life appealed the denial to the Ninth Circuit.

U.S. Life had petitioned the district court to set aside the award on grounds that the panel exceeded its powers and that the award exhibited “manifest disregard of law” and was “completely irrational.” It also claimed that the finding that “Cedents should have acted in a more open and forthright manner” was the equivalent of a finding of concealment, thus mandating an award of rescission. The Ninth Circuit agreed with the district court that the Panel’s words fell short of a finding of concealment. Even if the Panel had found concealment, however, the arbitration clause contained “honorable engagement” language and permitted the arbitrators to “abstain from following the strict rules of law.” This language gave the arbitrators wide latitude which, combined with the court’s narrow scope to review arbitral awards, preventing a finding of “manifest disregard of law.” The Ninth Circuit also found that the award could not be “completely irrational,” noting that the panel’s award reflected the “low end of the estimated reserve shortfall.”

U.S. Life also argued that the arbitration award violated California’s public policy “to promote full disclosure in reinsurance transactions.” The Ninth Circuit recognized that policy, but said that it also had to consider California’s strong public policy in favor of arbitration. The Ninth Circuit said courts must “indulge every intendment to give effect” to arbitral awards. Moreover, California public policy was served by an award granting relief “likely … in excess of $100 million” for nondisclosure short of concealment.

In opposing the petition to vacate, the Insurance Commissioner argued that the district court lacked jurisdiction to review the award for three reasons. First, the Commissioner argued, U.S. Life was bound to litigate in state court because it had “voluntarily invoked state court jurisdiction.” Second, the state court’s general stay of proceedings against the cedent prevented the petition from being heard in federal court. Finally, the Commissioner claimed immunity under the Eleventh Amendment, which bars lawsuits against states.

The Ninth Circuit disagreed with the Commissioner on all three jurisdictional arguments. The Ninth Circuit noted that U.S. Life had invoked state court jurisdiction merely for the purpose of lifting the stay and had not asked the state court to review the award. Even if U.S. Life had asked the court to review the award, the federal court would not have needed to abstain from hearing the case. The Ninth Circuit noted that the state court’s order said that the stay of proceedings “shall not deprive U.S. Life of any of its rights or remedies in connection with the Arbitration,” and a petition for review of the award was one such right. Finally, the Eleventh Amendment does not bar suit against a state entity when it is sued only in its representative capacity as receiver of an insolvent insurer.

* Mr. Haab is the managing partner of Lovells’ Chicago office. Mr. Glusman is an associate in Lovells’ Chicago office. Their practices involve a wide array of reinsurance matters, including insurer insolvencies and disputes with cross border and international dimensions.