Arbitration—Archived Article
October 2004
Arbitration requirements, found either within the basic D&O policy form or as an attached endorsement, may appear innocuous but can contain onerous language. Such clauses can be troublesome, especially where binding arbitration is made a mandatory provision of the policy. For more information, refer to “Mandatory Arbitration Clauses in Insurance Contracts Stirs Controversy, located in the Appendix section.
Arbitration ordinarily means a proceeding voluntarily undertaken by parties who want a dispute resolved on the merits of the case by an impartial decision maker, whose decision the parties agree to accept as final and binding. Arbitration usually imports a procedure that is speedy, economical and bears equally on insured and insurer. While arbitration is favored by many courts as a means of relieving overburdened calendars, it often favors the insurer and can still prove expensive.
The following sample mandatory binding arbitration clause is from a National Union policy endorsement.
In consideration of the premium charged, it is hereby understood and agreed that this Policy shall be deemed to have been executed in the State of New York and any interpretation of the policy relating to the construction, validity and performance of the Policy shall be made in accordance with the laws of the state of New York .
It is further understood and agreed that all disputes which arise under or in connection with this policy, including any determination of the amount of loss, shall be submitted to the American Arbitration Association under and in accordance with its then prevailing commercial arbitration rules. The arbitration will be held in New York, New York, U.S.A. The award rendered by the arbitrator(s) shall be final and binding upon the parties and judgment thereon may be entered in any court having jurisdiction thereof.
National Union Arbitration Endosement
It should be noted that when coverage disputes are submitted for arbitration, the arbitrators may not follow the traditional rule that ambiguities of the policy language are construed in favor of the insured. The arbitrators also may choose to ignore the doctrine of the insured's reasonable expectations, which has been adopted by the court systems of several states to protect purchasers with limited insurance knowledge. When the doctrine is applied, the insured may be able to recover loss—even though a policy unambiguously excludes coverage—if the insured's expectations of coverage are found to be objectively reasonable.
By agreeing to arbitrate, either voluntarily or through a policy requirement to do so, the insured gives up a valuable right — the opportunity to seek a judicial resolution of the dispute as guaranteed by the Seventh Amendment right of due process. In most cases arbitration does not allow appeal, there is no discovery and arbitrators usually lack the resources to conduct any meaningful case research. An arbitrator's decision is not generally reviewable for errors of fact or of law even though such error may result in substantial injustice to the insured. In the sense that insureds benefit from consistency and certainty in the law, mandatory arbitration requirements in insurance contracts may actually be counterproductive.
The ACE D&O policy contains, in part, the following wording in a condition entitled ARBITRATION:
(a) Any dispute, controversy or claim arising out of or relating to this POLICY, or the breach, termination of invalidity thereof shall be finally and fully determined in London, England under the provisions of the Arbitration Acts of 1950, 1975 and 1979, and/or any statutory modifications or amendments thereto…
(c) This POLICY, and any dispute, controversy or claim arising out of or relating to this POLICY, shall be governed by and construed and enforced in accordance with the internal laws of the State of New York, except insofar as such laws: (I) may prohibit payment hereunder in respect of punitive damages; (ii) pertain to the procurement, issuance, delivery, renewal, nonrenewal or cancellation of policies of insurance or the regulation under New York Insurance Law, or regulations issued by the Insurance Department of the State of New York pursuant thereto, applying to insurers doing insurance business within the State of New York or as respects risks or insureds situated in the State of New York, or (iii) are inconsistent with any provisions of this POLICY.
ACE 02 (05-96)
The above language emphasizes one of the most important problems in arbitration of insurance policy coverage disputes: that the conditions and conduct of arbitration affect how the policy shall be interpreted, sometimes to the detriment of the insured.
An arbitration requirement can also be restrictive when policy interpretation is to follow the laws of a specific jurisdiction. For example, the courts of some states, such as New York, have favored the insurer as respects advancement-of-loss disputes. Resolving an advancement dispute where New York interpretation is a condition of the policy may stack the deck against the insured, effectively preordaining the outcome in favor of the insurer.
In most instances arbitration clauses dictate the forum and situs of dispute resolution. These can also be restrictive. The first of the above examples requires submission of disputes to the American Arbitration Association and the arbitration to be held in New York. It also provides for any interpretation of the policy to be in accordance with New York law. In contrast, the second example above mandates that arbitration be conducted in London, England. When a policy requires arbitration to be held in a foreign country, such as England or Bermuda, severe logistic problems can arise and prevent the insured from even raising a dispute. It is questionable whether many insureds will be familiar enough with foreign arbitration practices to determine the impact of such arbitration requirements.
The limitations inherent in arbitration may be sufficient reason to avoid policies with mandatory arbitration provisions or to negotiate such clauses out of the policy. In the absence of arbitration requirements, the insurer and insured still could agree to submit a coverage dispute to arbitration, and some insurers may provide mandatory arbitration language through endorsement when requested.
While most policy forms are silent regarding mandatory binding arbitration, a few policies contain language requiring certain types of disputes to be resolved by the insured(s) and insurer using their best efforts.
With respect to (i) Defense Costs joint incurred by, (ii) any joint settlement made by, and/or (iii) any adjudicated judgment of joint and several liability against the Company and any Director or Officer, in connection with any Claim other than a Securities Claim, the Company and the Director(s) or Officer(s) and the Insurer agree to use their best efforts to determine a fair and proper allocation of the amounts as between the Company and the Director(s) or Officer(s) and the Insurer, taking into account the relative legal and financial exposures of and the relative benefits obtained by the Directors and Officers and the Company. In the event that a determination as to the amount of Defense Costs be (sic) advanced under the policy cannot be agreed upon, then the Insurer shall advance such Defense Costs which the Insurer states to be fair and proper until a different amount shall be agreed upon to determined pursuant to the provisions of this policy and applicable law.
National Union 62335 (5/95)
Such language addresses problems associated with allocating loss between insured and uninsured parties, which frequently occurs when the corporation and individual insureds have been named as codefendants in some action. While both parties may be jointly defended by counsel, expenses allocated to the defense of the corporation generally are not covered by the D&O policy unless the policy provides coverage for direct actions against the corporate entity. The allocation of loss between parties often is tricky business, and disputes are common.
Care should be exercised when evaluating arbitration clauses. Too often these important policy conditions are overlooked or their restrictive features misunderstood. Policies that contain unfavorable or restrictive mandatory arbitration clauses should be avoided whenever possible.