In National Union Fire Insurance Co. v. Source One Staffing, LLC, the Supreme Court of New York County was asked to consider the interrelationship of three statutes: the McCarran-Ferguson Act (15 U.S.C. § 1101 et seq.), the Federal Arbitration Act (“FAA”) (9 U.S.C. § 1 et seq.), and the California Insurance Code (Cal. Ins. Code § 11658).  National Union has sought to compel arbitration under the FAA of a dispute involving a “Payment Agreement” entered into in connection with workers compensation insurance coverage provided to Source One Staffing, LLC (“Source One”).  In its preliminary ruling, we believe the Court improperly denied National Union’s motion to compel arbitration in a manner that raises serious impairment of contracts concerns on an industry-wide scale.  The Court granted National Union leave to replead, and National Union filed its amended pleadings on September 1.

The Payment Agreement is a credit agreement between Source One and National Union that permits Source One to defer a portion of its premium and reimbursement obligations arising under the policies.  It is separate from the policy and addresses collateral to secure those deferred payment obligation, sets forth the timing of those payments, specifies terms of default, and critically, provides for arbitration of disputes under the Payment Agreement.  As such, it is a separate agreement, outside of the scope of the workers compensation insurance policy.  These kinds of agreements are customarily entered into between large, sophisticated commercial insureds or public entities and workers compensation insurers.  In this case the parties specifically agreed that payment disputes under the Payment Agreement are subject to binding arbitration in a location to be mutually determined and, further, any questions regarding the arbitrability of a dispute must be brought in a court of competent jurisdiction in New York County, New York.

On July 27, 2011 the Court issued a preliminary ruling concerning National Union’s Motion to Compel Arbitration.  The preliminary ruling denied the motion to compel arbitration, but granted National Union leave to replead its petition to compel arbitration of its payment dispute with Source One to demonstrate that the Payment Agreement and its 2004 Addendum are not “policies or components of policies within the meaning of the California Insurance Code” which should have been filed with the California Department of Insurance (the “CDI”).  Source One has argued that, because the Payment Agreement was not filed with and approved by the CDI, its arbitration and forum selection provisions are unenforceable.

In its preliminary ruling, the Court made a finding that McCarran-Ferguson may permit the California Insurance Code to preempt the FAA.  However, as noted in National Union’s amended petition to compel arbitration, the Court’s preliminary ruling denying arbitration overlooked binding law establishing that McCarran-Ferguson does not permit the California Insurance Code to preempt the FAA in this instance.

Specifically, the Court’s preliminary ruling misapplied governing law when it concluded that National Union had not “shown how mandating arbitration would not invalidate, impair or supersede the [California Insurance] Code.”  Where a state has not enacted a prohibition of the arbitration of insurance disputes, McCarran-Ferguson does not authorize a state insurance code’s reverse preemption of the FAA.  California has not enacted such a prohibition.  In fact, California and other courts have specifically enforced arbitration provisions in similar cases.  Further, the California legislature has recently passed Senate Bill 684, a bill recognizing and affirming that workers compensation carriers may use arbitration as a method of dispute resolution.  The legislation confirms that insurers are entitled to negotiate choice of law and forum selection provisions in relation to such arbitration provisions and in no way seeks to prevent arbitration of disputes.  The Court need look no further than the language of Subsections (f) and (h) of Section 1 of the legislation:

(f) In an effort to save time and costs, and because of the uncertainty of litigation, workers’ compensation carriers and employers may freely and voluntarily use types of dispute resolution, including arbitration, to resolve disputes.


(h) Employers and workers’ compensation carriers should be freely able to negotiate and voluntarily agree to the terms of dispute resolution, including arbitration, without undermining the protections afforded to California employers under California law.  (Emphasis added.)

Finally, in its preliminary ruling, the Court failed to consider that not every agreement relating to an insurance policy needs to be filed with state regulatory bodies.  On its face the Payment Agreement is not a policy or endorsement under the definitions provided pursuant to the California Insurance Code.  In consideration of those definitions, the workers’ compensation policies issued to Source One exclusively determine and govern National Union’s obligation to indemnify Source One for benefits payable to injured workers under California’s workers’ compensation laws.  Further, Source One’s premium obligations are dictated by each policy’s Large Risk Ratings Plan endorsement.  The Payment Agreement has no role in coverage or cost of coverage determinations and thus cannot be considered a policy or endorsement under the California Insurance Code.

The Court’s preliminary ruling raises substantial concerns regarding parties’ ability to negotiate the terms of a contract as they see fit.  The parties chose binding arbitration as the sole method for the resolution of disputes under the Payment Agreement.  The FAA establishes a national policy favoring arbitration where parties specifically contract for that method of dispute resolution.  Because California’s insurance regulatory scheme does not prohibit arbitration, McCarran-Ferguson does not permit California law to preempt the FAA.

A copy of National Union’s amended petition and supporting memorandum can be found here.