Pitfalls in Moving to All-Neutral Reinsurance Arbitration Panels[dagger]

I.

INTRODUCTION

This article considers whether it would be desirable, as a general proposition, to use all-neutral panels in reinsurance disputes that are submitted to arbitration. I suggest that moving to all-neutral panels may in some important respects work to the detriment of the parties to reinsurance arbitrations.

It is not my intent in this article to suggest that there are no conceivable benefits to the all-neutral model. Anthony Lanzone's article in this same issue sets forth many of the concerns that have led some observers to conclude that an all-neutral panel is preferable to the tripartite model typically used in reinsurance arbitration in the United States. 1 For an opposing view see an article written by fellow FDCC member Vincent Vitkowsky.2 Attorneys counseling clients who are interested in the possibility of agreeing to an all-neutral panel will certainly want to review with those clients the points in favor of all-neutral panels contained in the Lanzone article. At the same time, however, attorneys will want to ensure that the potential pitfalls of all-neutral panels are understood and carefully considered before a final decision is made.

II

BACKGROUND: THE PRESENT SYSTEM

While there is no universal practice, it is usual for reinsurance contracts specifying arbitration as the mechanism for dispute resolution to provide for so-called tripartite arbitration panels.3 Each party appoints an arbitrator, and those two arbitrators then select an umpire. In some instances, the umpire is appointed by a court, an institution such as the American Arbitration Association or ARIAS-U.S., or an individual holding a specified office or position such as, for example, the Commissioner of Insurance for a specified jurisdiction.

It has long been accepted in United States arbitration jurisprudence that "party-designated arbitrators are not and cannot be 'neutral', [sic] at least in the sense that the third arbitrator or a judge is."4 The Code of Ethics thus permits party-appointed arbitrators to be disposed to the party appointing them. The Code also permits party-appointed arbitrators to consult with the appointing party about the acceptability of persons being considered for the neutral third arbitrator role and to consult about any other aspect of the case provided disclosure of the intent to have such communication is first made to the other arbitrators and the parties. As a practical matter, the parties to reinsurance arbitrations typically agree that ex parte communication can occur with party-appointed arbitrators, without disclosure, up to a specified stage in the proceedings.5 The ARIAS Practical Guide suggests cutting off ex parte communications at (a) the Organizational Meeting; (b) the end of discovery; (c) the filing of pre-hearing briefs; or (d) commencement of the hearing. In the author's experience, it is customary to adopt the end of discovery or the filing of prehearing briefs as the cutoff point. It is relatively unusual to adopt either the organizational meeting or the commencement of the hearing.

Legislation governing the arbitration process generally reflects the lack of a neutrality requirement for all arbitrators. Section 12(a)(2) of the Uniform Arbitration Act ("UAA"), as adopted by the Conference of Commissioners on Uniform State Laws in 1955 and subsequently enacted by most states, provides that arbitration awards can be vacated for "evident partiality" on the part of a neutral arbitrator only.6

The Revised Uniform Arbitration Act ("RUAA"), adopted by the Conference of Commissioners in 2000, preserves the distinction between neutral and non-neutral arbitrators. section ll(b) provides, "An individual who has a known, direct, and material interest in the outcome of the arbitration proceeding or a known, existing, and substantial relationship with a party may not serve as an arbitrator required by an agreement to be neutral."7 This leaves such an individual free to serve as a non-neutral arbitrator. section 23(a)(2)(A) provides for vacatur of awards for evident partiality on the part of an arbitrator appointed as a neutral arbitrator only.8

In contrast, the Federal Arbitration Act ("FAA"),9 does not distinguish explicitly between neutral and non-neutral arbitrators.10 Nonetheless, courts applying the FAA have adopted very different standards for the conduct of party-appointed, non-neutral arbitrators as contrasted with neutral arbitrators. In Sphere Drake Insurance Ltd. v. All-American Life Insurance Co.,11 the Court of Appeals for the Seventh Circuit observed of the decision under review that "[a]s far as we can see, this is the first time since the Federal Arbitration Act was enacted in 1925 that a federal court has set aside an award because a party-appointed arbitrator on a tripartite panel, as opposed to a neutral, displayed 'evident partiality.'"12 Having made that observation, the court proceeded to reverse the decision below, removing the one exception it had found to the general rule.

It may be seen even from this relatively brief summary that a movement to all-neutral panels in United States reinsurance arbitration would entail a dramatic change from the status quo. I am not persuaded that the present system would be improved by such a change. In addition, an all-neutral system contains some disadvantages compared with the present procedure. Three major pitfalls are addressed below.

A. Pitfall #1: Loss of Access to the Arbitrator 's Expertise

Reinsurance arbitration clauses typically require that the arbitrators be active in or retired from the insurance or reinsurance business. Even when no such qualification requirement is imposed, it is rare in practice for parties to reinsurance disputes to appoint as arbitrators or nominate as neutral arbitrators or umpires individuals with no background in insurance or reinsurance whatever.

It is evident from the background summary above that party-appointed arbitrators in a tripartite system such as that customarily employed for reinsurance disputes typically interact extensively with the parties appointing them throughout much of the arbitration. Replacing the present tripartite system with a system of all-neutral panels would almost certainly eliminate such communication. This is problematic because one of the primary reasons for resolving disputes through arbitration is to ensure that the decision makers are familiar with the industry in which the dispute arises and are thus able to apply their accumulated knowledge and expertise to the resolution of that dispute. As the Sphere Drake court explained:

The more experience the panel has, and the smaller the number of repeat players, the more likely it is that the panel will contain some actual or potential friends, counselors, or business rivals of the parties. Yet all participants may think the expertise-impartiality tradeoff worthwhile; the Arbitration Act does not fasten on every industry the model of the disinterested generalist judge.13

Advocates of the all-neutral system may respond that arbitrators may bring their expertise to bear on the dispute presented with or without ex parte contacts with their appointing parties. Yes, but it is not quite that simple. In formulating its case in practice, the appointing party often benefits considerably from the ability to consult directly with its appointed arbitrator. At the outset, such consultations may even have the effect of preventing arbitrations from taking place that are doomed from the start. If a prospective arbitrator advises a party that he or she cannot comfortably or effectively advocate that party's position in panel deliberations, the party may rethink its position and be more open to settlement of the dispute. After all, if a prospective arbitrator who is respected by the would-be appointing party finds that party's position unpersuasive, it is likely that at least one other member of the tripartite panel will be similarly unpersuaded.

Even if generally disposed favorably toward the appointing party's position, an arbitrator can provide invaluable advice on what types of documentary and other evidence will be most persuasive to a panel of experts whose decision is expected to be informed by their knowledge of custom and practice in reinsurance. This input can be very useful to counsel in deciding what specific arguments to put forth and which alternative approaches to emphasize in presenting the client's case. While the value of such consultations is most obvious when a party's counsel is relatively inexperienced in reinsurance matters, seasoned counsel also benefit from this kind of discussion and are better able to serve the client as a result.

The appointed arbitrator, as well as the appointing party and its counsel, can also benefit from these consultations. The ability to confer candidly and confidentially about the merits of the dispute better equips the appointed arbitrator to perform effectively the role of advocate on the panel.14

B. Pitfall #2: Loss of an Advocate on the Panel

As noted in the Sphere Drake decision, "party-appointed arbitrators are supposed to be advocates."15 The same decision goes on, however, to state that once the case is taken under advisement, party-appointed arbitrators are supposed to be "impartial adjudicators."16 In practice, this means that the party-appointed arbitrator is expected to take responsibility for ensuring that the appointing party's position is fully understood and considered by the panel as a whole, but at the end of the day is expected to vote his or her conscience.

The presence of an advocate on the panel - at least to the extent of ensuring meaningful consideration of the appointing party's position - is very important in guaranteeing a fair process. As a practical matter, arbitration awards cannot generally be vacated under United States law for mistakes of fact or errors in judgment.17

Thus, in the vast majority of cases, the only "shot" a party to a reinsurance arbitration has is before the arbitration panel. In contrast to litigation, there is no meaningful ability to have even serious errors in the decisionmaking process reviewed and corrected. Are parties truly well served by retaining the arbitration process, with its extremely limited scope for judicial review, while relinquishing the ability to have an advocate doing his or her best to ensure that their positions are given a fair shake in the panel's deliberative process?

C. Pitfall #3: Loss of Access to Information on the Reasons for the Panel's Decision

In United States reinsurance arbitrations, it is rare for the panel to issue a so-called "reasoned decision" setting forth the rationale for the award made by the panel. The ARIAS Practical Guide goes so far as to state that "the United States custom and practice is that arbitration Panels, unless requested otherwise, do not issue written explanations of the basis of their award."18 While the Guide encourages panels to provide reasoned awards if both parties request them, many ARIAS-certified arbitrators make no secret of their disinclination to issue such awards, and some have even stated that they will refuse to serve on a panel if a request for such an award is made.

Most parties are interested in having at least some idea of the reasons for the panel's decision, so that they can be guided by those reasons in future disputes or transactions. Absent such guidance in the award itself, a party's appointed arbitrator is likely to be the only available source of information. Communications regarding the bases for the award are, however, more limited than other types of ex parte communication. Specifically, there is broad agreement that even in a tripartite system the panel's deliberations should not be disclosed by the appointed arbitrators to their appointing parties.19

In practice, however, many arbitrators find it possible to convey to their appointing parties the general reasons for the ultimate award without breaching the confidentiality expected by the other panel members as to the specifics of the deliberative process. In fact, the ARIAS Code directs arbitrators to consider whether it is appropriate for the parties to be given some informal explanation of the reasons for the award. While the ARIAS Code notes the possibility that this informal explanation can come from either the appointed arbitrators or the umpire, the appointed arbitrator, with his or her greater understanding of the appointing party's case, is likely in the best position to provide a meaningful understanding of why that case did or did not prevail. If nothing else, the appointed arbitrator should be able to share with the appointing party what aspects of that party's case the individual arbitrator found persuasive or otherwise.

III.

CONCLUSION

It is suggested that the old saw, "If it ain't broke, don't fix it" may be applicable to the debate over moving to all-neutral panels. Inherent in that saying are two possibilities: (1) the present situation may not be seriously in need of repair; or (2) the repair under consideration may make the situation worse, not better. While few would suggest the present system is perfect, it is not as clear as the proponents of all-neutral panels would have it that the problems with that system stem from use of the tripartite as opposed to the all-neutral model. And, as suggested in this article, the proposed cure may bring pitfalls that outweigh any benefits.

[dagger] Submitted by the author on behalf of the FDCC Alternative Dispute Resolution section.

1 see Anthony M. Lanzone, Impartial, Independent, Neutral Arbitrators v. Non-Neutral Party Appointed Advocates, 54 FED'N DEF, & CORP. COUNS. Q. 381 (2004).

2 see Vincent Vitkowski, The Value of Party-Appointed "Non-Neutral" Arbitrators, ARIAS-U.S. Quarterly, Vol. 1, No. 3/4, 4th Quarter 1995.

3 see generally ARIAS-U.S., Practical Guide to Reinsurance Arbitration Procedure ("ARIAS Practical Guide "), Chapter II, available at http://www.arias-us.org/index.cfm?a=39.

4 Astoria Med. Group v. Health Ins. Plan of Greater N.Y., 182 N.E.2d 85, 87 (N.Y. 1962). The Code of Ethics for Arbitrators in Commercial Disputes ("ABA-AAA Code of Ethics"), available at http://www.adr.org, which has been approved and recommended by special committees of the American Arbitration Association and the American Bar Association, respectively, adopts the presumption that party-appointed arbitrators in a tripartite arrangement are non-neutral.

5 See supra note 3, Chapter III, § 3.9.

6 UAA available at http://www.law.upenn.edU/bll/ulc/fnact99/l920_69/uaa55.htm.

7 RUAA § ll(b), available at www.law.upenn.edu/bll/ulc/uanba/arbitratl213.htm.

8 Id. at § 23(a)(2)(A). Additional information is available from http://www.nccusl.org.

9 9 U.S.C. § 1-16(2004).

10 See id. § 10(a)(2) (award subject to vacatur "where there was evident partiality or corruption in the arbitrators, or either of them").

11 307 K3d 617 (7th Cir. 2002)

12 Id. at 620.

13 Id.

14 See infra ILB.

15 Sphere Drake, 307 F.3d at 620.

16 Id.

17 see, e.g., Michigan Mut. Ins. Co. v. Unigard sec. Ins. Co., 44 F.3d 826, 832-33 (9th Cir. 1995) (declining to vacate award relieving reinsurers of future contractual obligations which was more favorable than rescission they had requested due to lack of any requirement to return premium); Employers Ins. of Wausau v. Certain Underwriters at Lloyd's London, 552 N.W.2d 420, 425-26 (Wis. Ct. App. 1996) (award of amount in excess of contract limits absent explanation not subject to vacatur).

18 See supra note 3, ARIAS Practical Guide, Chapter V, § 5.4, comment A.

19 see ARIAS-U.S., Code of Conduct ("ARIAS Code"), Canon VI, Comment 3 (improper to "inform anyone concerning the contents of the deliberations of the arbitrators"); see supra note 3, ARIAS Practical Guide, Chapter III, § 3.9, comment C ("Unless the Panel specifically decides otherwise, Panel members should not disclose panel discussions to the parties"). see also supra note 4, ABA-AAA Code of Ethics Canon VI (C).

Kathryn P. Broderick is a founding partner in the law firm of Broderick, Stirn & Regan in Washington, D. C. She is a member of the District of Columbia and Virginia Bars, the U.S. Supreme Court Bar, and the Bars of several federal appellate and district courts. Ms. Broderick is also a member of the American Bar Association (Litigation and Tort & Insurance Practice sections); ARIAS-U.S.; the Defense Research Institute; and the Federation of Defense & Corporate Counsel (past Reinsurance section Chair and current ADR section Vice Chair). She obtained her undergraduate degree summa cum laude from Trinity College at Duke University, and graduated with highest honors from the National Law Center at George Washington University. Ms. Broderick was a member of Phi Beta Kappa and the Order of the Coif, and served as a member and then as Notes Editor of THE GEORGE WASHINGTON LAW REVIEW.

Copyright Federation of Defense & Corporate Counsel, Inc. Summer 2004
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