2005 RIL Complete

8/2/2019 2005 RIL Complete

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VOLUME 11 NUMBER 1 WINTER 2004

INSIDE:

2004 REINSURANCELAW REPORTNO ARBITRATION CLAUSE, NO ARBITRATION? NOT NECESSARILY: THE

ARBITRABILITY OF DISPUTES ARISING UNDER COLLATERAL AGREEMENTS

THE "FOLLOW THE FORTUNES" DOCTRINE: ADDRESSING A CEDENT'S

ALLOCATION AND ANNUALIZATION DECISIONS

AN ANALYSIS OF THE 2004 PROCEDURES FOR THE RESOLUTION OF

U.S. INSURANCE AND REINSURANCE DISPUTES

REINSURANCE IN THE CONTEXT OF INSURANCE COMPANY M&A

TRANSACTIONS: A PRACTICAL OVERVIEW


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The Reinsurance Law Report is published by the Insurance & Financial

Services Practice Group of Sidley Austin Brown & Wood LLP. This newsletter

reports recent developments of interest to the reinsurance industry and should

not be considered as legal advice or legal opinion on specific facts. Any views

or opinions expressed in the newsletter do not necessarily reflect the views and

opinions of Sidley Austin Brown & Wood LLP or its clients. The Insurance &

Financial Services Practice Group of Sidley Austin Brown & Wood LLP offers

comprehensive counseling, negotiation, and arbitration and litigation services

to domestic and foreign insurers, reinsurers, receivers, brokers, creditors, and

guaranty associations. Lawyers in the worldwide offices of Sidley Austin

Brown & Wood LLP are available to provide efficient and effective services for

our clients on a wide spectrum of matters, including:

Contract Drafting

Opinions On Contractual Rights and Obligations and Audit Findings

Commutations

Arbitration and Litigation

Issues Arising Out of Insurance Insolvencies

Letter of Credit Issues

Agents and Intermediaries Problems and Issues

For additional copies of the Reinsurance Law Report or for additional

information, please contact Tom Cunningham at 312.853.7594 ; fax

312.853.7036; email address: [email protected]. The articles included in

this edition of the Reinsurance Law Report will be posted on the firms website at

www.sidley.com.

The Reinsurance Law Report is published by the Insurance & Financial

Services Practice Group of Sidley Austin Brown & Wood LLP. This newsletter

reports recent developments of interest to the reinsurance industry and should

not be considered as legal advice or legal opinion on specific facts. Any views

or opinions expressed in the newsletter do not necessarily reflect the views and

opinions of Sidley Austin Brown & Wood LLP or its clients. The Insurance &

Financial Services Practice Group of Sidley Austin Brown & Wood LLP offers

comprehensive counseling, negotiation, and arbitration and litigation services

to domestic and foreign insurers, reinsurers, receivers, brokers, creditors, and

guaranty associations. Lawyers in the worldwide offices of Sidley Austin

Brown & Wood LLP are available to provide efficient and effective services for

our clients on a wide spectrum of matters, including:

Contract Drafting

Opinions On Contractual Rights and Obligations and Audit Findings

Commutations

Arbitration and Litigation

Issues Arising Out of Insurance Insolvencies

Letter of Credit Issues

Agents and Intermediaries Problems and Issues

For additional copies of the Reinsurance Law Report or for additional

information, please contact Tom Cunningham at 312.853.7594 ; fax

312.853.7036; email address: [email protected]. The articles included in

this edition of the Reinsurance Law Report will be posted on the firms website at

www.sidley.com.

The affiliated firms, Sidley Austin Brown & Wood LLP, a Delaware limited liability partnership, Sidley Austin Brown & Wood LLP, an Illinois limited liability partnership, Sidley Austin Brown & Wood

an English general partnership and Sidley Austin Brown & Wood, a New York general partnership, are referred to herein collectively as Sidley Austin Brown & Wood.


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2004 REINSURANCELAW REPORT2004 REINSURANCELAW REPORT

This Reinsurance Law Report has been prepared by Sidley Austin Brown & Wood LLP for informational purposes only and does not constitute legal advice. This information is not intended to create, and receipt of

it does not constitute, an attorney-client relationship. Readers should not act upon this without seeking professional counsel.


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NO ARBITRATION CLAUSE, NO ARBITRATION?NOT NECESSARILY: THE ARBITRABILITY OFDISPUTES ARISING UNDER COLLATERALAGREEMENTS

BY: SUSAN A. STONE, RONIE M. SCHMELZ AND

JOSHUA G. URQUHART

In today's complex reinsurance environment, many reinsurance transactions

consist of more than just a reinsurance agreement. Trust agreements, service

and administration agreements, hold harmless and indemnity agreements,

letter agreements and side agreements, and a host of other contracts can play

nearly as important a role in delineating the relationship between cedent and

reinsurer as does the reinsurance agreement. Unfortunately-but perhaps

understandably-these related agreements often do not contain all of the

contractual provisions found in the related reinsurance agreement. One oft-

omitted provision is an arbitration clause. While this oversight may seem

trivial when negotiating a comprehensive reinsurance transaction, its

omission can take on unintended significance if a dispute arises concerning

one of the collateral or related agreements and one party resists arbitration.

This issue was at the heart of two recent court decisions: National American

Ins. Co. v. SCOR Reinsurance Co., 362 F.3d 1288 (10th Cir.2004) ("NAICO")

and New Hampshire Ins. Co. v. Canali Reinsurance Co., 2004 WL 769775

(S.D.N.Y. April 12, 2004) ("NHIC"). While they reached different

conclusions on the arbitrability of a dispute arising under a collateral or

related agreement, these cases teach that a broad arbitration clause, coupled

with sufficient indicia that a dispute arising under the collateral agreement

bears a "significant relationship" to, or "touches," the related reinsurance

contract, will generally require a court to compel arbitration of disputes

arising under a collateral agreement without an arbitration clause.

This article explores the issue of arbitrability of collateral agreements,

analyzes the NAICOand NHICcases, and offers some suggestions on howparties can best seek to ensure that a dispute arising under any agreement

that is part of a broad overarching reinsurance transaction will be arbitrated.

A threshold question for any dispute between a ceding company and its

reinsurer is whether the dispute falls within the scope of a potentially

applicable arbitration clause. The enforcement of arbitration clauses in

reinsurance contracts arising from interstate commerce is governed by the

Federal Arbitration Act, 9 U.S.C. 1, et seq. Relying upon the congressional

mandate in the Federal Arbitration Act, the Supreme Court has declared that

"any doubts concerning the scope of arbitrable issues should be resolved in

favor of arbitration." Moses H.Cone Mem'l Hosp. v. Mercury Constr. Corp., 460

U.S. 1, 24-25 (1983).

Disputes may arise, however, as to whether a collateral or related agreement

is encompassed by a reinsurance contract's arbitration clause. Courts have

generally addressed this issue through a two step inquiry. First, they ascertain

whether the arbitration provision is a broad or narrow one. See, e.g., Collins

& Aikman Products Co. v. Building Systems, Inc., 58 F.3d 16, 20 (2d Cir. 1995).

Generally, a broad arbitration provision is one that "evidences the parties'

intent to have arbitration serve as the primary recourse for disputes

connected to the agreement containing the clause," Louis Dreyfus Negoce

S.A. v. Blystad Shipping & Trading Inc., 252 F.3d 218, 225 (2d Cir. 2001),

whereas a narrow arbitration clause is one "that limit[s] arbitration to specific

types of disputes." Collins, 58 F.3d at 21. If a court determines that the

In today's complex reinsuranceenvironment, many reinsurancetransactions consist of more than justa reinsurance agreement.

These cases teach that a broad

arbitration clause, coupled withsufficient indicia that a dispute arising

under the collateral agreement bearsa "significant relationship" to, or"touches," the related reinsurance

contract, will generally require acourt to compel arbitration of

disputes arising under a collateralagreement without an arbitration

clause.

The Supreme Court has declared that"any doubts concerning the scope ofarbitrable issues should be resolvedin favor of arbitration."

NO ARBITRATION CLAUSE, NO ARBITRATION? NOT NECESSARILY: THE ARBITRABILITY OF DISPUTES ARISING UNDER COLLATERALGREEMENTS

2


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arbitration provision is narrow in scope, it generally will conclude its analysis and

hold that the dispute is not arbitrable (unless, of course, the narrow arbitration

provision expressly provides otherwise). See, e.g., Gerling Global Reinsurance Co.-U.S

Branch v. Ace Property & Cas. Ins. Co., 42 Fed.Appx. 522, 523 (2d Cir. 2002); Louis

Dreyfus Negoce, 252 F.3d at 224. If, on the other hand,the arbitration clause is broad

"there arises a presumption of arbitrability," and the clause may be deemed to

encompass any dispute that is connected or related to the agreement containing the

arbitration clause. Collins, 58 F.3d at 23; accord Louis Dreyfus Negoce, 252 F.3d at 224

Even if the arbitration provision is a broad one, however, the court's analysis is notcomplete. It must next determine whether the allegedly related or collatera

agreement under which the dispute arises bears a "significant relationship" to, or

touches, the agreement containing the arbitration provision. See Personal Security &

Safety Sys., Inc. v. Motorola, Inc., 297 F.3d 388, 392-93 (5th Cir. 2002). Put another

way, the court must determine if the two agreements are, in fact, "part of the same

overall transaction." Id. at 393.

In applying this second part of the analysis, courts typically examine a number of

different factors to gauge the extent of the relationship between the two allegedly

related or collateral agreements. First, courts look to see if the agreements are

contemporary in nature. If the agreements were executed "contemporaneously by

the same parties, for the same purposes, and as part of the same transaction," then

they will be "construed together," and a broad arbitration provision in one willencompass any disputes arising out of the other. Id. Second, courts examine the

terms of the agreements to determine whether they reference one another-if so, a

broad arbitration provision in one of the agreements will be more likely to

encompass a dispute arising out of the allegedly collateral or related agreements. See

Pennzoil Exploration and Production Co.v. Ramco Energy Ltd., 139 F.3d 1061, 1068-69

(5th Cir. 1998). Third, courts explore the interdependence between the

purportedly related or collateral agreements, holding that if each such agreement is

dependent on the existence of the overall transaction in its entirety, a broad

arbitration in one agreement will encompass disputes arising out of the other. See

Neal v. Hardee's Food Sys., Inc., 918 F.2d 34 (5th Cir. 1990). Finally, courts sometimes

inquire whether the agreement containing the arbitration clause is the "keystone"

agreement to the overall transaction, holding that if it is, the provision is intended

to "reach all aspects of the parties' relationship" and thus will govern collateral

agreements which contain no arbitration provisions of their own. Neal, 918 F.2d at

37.

This multifactor analysis seems to boil down to the following: If the parties to a

transaction consisting of multiple contracts include a broad arbitration clause in any

of the agreements that play a crucial role in the overall transaction, that arbitration

provision will likely govern disputes arising out of any agreements that are part of

the transaction. In other words, when parties to a transaction evidence their intent

to arbitrate all disputes arising out of their relationship by inserting a broad

arbitration provision in an agreement that plays a critical role in the transaction, all

disputes relating to the overall transaction-including disputes arising from related or

collateral agreements-likely will be arbitrated.

A. Compelling Arbitration of Disputes Under Related Agreements:NAICO

The Tenth Circuit's decision in NAICOaptly illustrates the above analysis. In tha

case (in which the authors represented SCOR Re), NAICO and SCOR Re were

parties to a series of surety reinsurance treaties covering various payment and

performance bonds issued by NAICO. The treaties contained an arbitration clause

that provided that "[a]s a condition precedent to any right of action hereunder, any

irreconcilable dispute between the parties to this Agreement will be submitted for

decision to a board of arbitration composed of two arbitrators and an umpire."

If, on the other hand, the arbitrationclause is broad, "there arises a

presumption of arbitrability," and

the clause may be deemed toencompass any dispute that is

connected or related to theagreement containing the

arbitration clause.

This multifactor analysis seems toboil down to the following: If the

parties to a transaction consistingof multiple contracts include a

broad arbitration clause in any of

the agreements that play a crucialrole in the overall transaction, thatarbitration provision will likely

govern disputes arising out of anyagreements that are part of the

transaction.

SIDLEY AUSTIN BROWN & WOOD LLP REINSURANCE LAW REPORT


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Prior to finalizing these treaties, NAICO apparently informed SCOR Re

that its Best's credit rating or U.S.Treasury underwriting criteria would not

permit NAICO to issue certain types of bonds that it wished to reinsure

under the treaties. To permit NAICO to be eligible to write this type of

business for cession to the treaties, SCOR Re agreed to act as co-surety on

such bonds, provided that it did not become liable as a primary insurer or

co-surety. To accomplish this goal and to protect SCOR Re from assuming

any primary liability as a co-surety, the parties entered into a hold harmless

and indemnity agreement whereby they agreed that NAICO would hold

SCOR Re harmless and indemnify it for any losses suffered or obligationsincurred as a co-surety with NAICO for such bonds.

Shortly after executing these reinsurance contracts, NAICO issued two

payment and performance bonds that were specially accepted by SCOR Re

in its role as lead reinsurer on the treaties. Due to the large size of the

project, however, NAICO apparently required additional co-surety support.

SCOR Re agreed to act as co-surety as an "accommodation" to NAICO.

Accordingly, SCOR Re executed a series of bonds as co-surety and

delivered them to NAICO to be issued. Subsequently, SCOR Re's

obligation under the reinsurance treaties was terminated. Thereafter, cost

overruns resulted in losses on both bonds, and NAICO filed suit against

SCOR Re in the U.S.District Court for the Western District of Oklahoma.

In that suit, NAICO sought recovery not under the reinsurance treaties

(which contained an arbitration clause), but under SCOR Re's allegedly

"independent" co-surety agreement which contained no arbitration clause.

SCOR Re moved to dismiss the complaint and compel arbitration, arguing

that any co-surety obligation arose solely as a result of the parties' reinsurance

treaties, and that the broad arbitration clause in those treaties extended to all

disputes arising from the related co-surety agreement. NAICO replied that

the treaties' arbitration provision was expressly limited to disputes arising

under the treaties and did not apply to the separate agreement to act as co-

surety. After extensive briefing, the district court denied SCOR Re's motion

to compel arbitration.

SCOR Re appealed the decision under Section 16 of the Federal ArbitrationAct, which permits an immediate appeal of an order denying a petition to

compel arbitration. On appeal, SCOR Re emphasized that its agreement to

act as co-surety on the relevant bonds was undertaken solely in connection

with the reinsurance treaties between it and NAICO, each of which

contained a broad arbitration provision. NAICO reiterated its arguments

from below, including that the first clause of the arbitration provision-"as a

condition precedent to any right of action hereunder"-limited the scope of

the arbitration clause to disputes under the reinsurance treaties only. SCOR

Re responded that this prefatory clause was solely procedural in nature and

could not affect the substantive scope of the arbitration provision, citing a

Second Circuit opinion on the issue. See ACE Capital Re Overseas Ltd. v.

Central United Life Ins. Co., 307 F.3d 24 (2d Cir. 2002).

The Tenth Circuit agreed with SCOR Re. In reversing the lower court's

opinion and ordering the matter to arbitration, the Circuit Court first

addressed the "condition precedent" language and the issue of whether the

arbitration clause in the reinsurance treaties was broad or narrow in scope.

The court expressly endorsed the Second Circuit's holding inACE Capital,

finding that the "condition precedent" phrase was "a procedural clause that

addresses how issues are arbitrated and when judicial action may be brought

under [the reinsurance treaties], but it does not manifest an intent to limit

the scope of the parties' broad agreement to arbitrate 'any irreconcilable

dispute.'" NAICO, 362 F.3d at 1291 (citing and endorsingACE Capital).

On appeal, SCOR Re emphasized thatits agreement to act as co-surety onthe relevant bonds was undertakensolely in connection with thereinsurance treaties between it and

NAICO, each of which contained abroad arbitration provision. NAICOreiterated its arguments from below,including that the first clause of thearbitration provision-"as a conditionprecedent to any right of actionhereunder"-limited the scope of thearbitration clause to disputes underthe reinsurance treaties only.

4 NO ARBITRATION CLAUSE, NO ARBITRATION? NOT NECESSARILY: THE ARBITRABILITY OF DISPUTES ARISING UNDER COLLATERALAGREEMENTS


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Having concluded that the arbitration provision was broad in scope, the Tenth

Circuit then turned to whether the dispute arose from an agreement that was

sufficiently related to these treaties. First, it noted that the reinsurance treaties, the

agreement to act as co-surety and the hold harmless and indemnification agreement

all involved the same subject matter-the payment and performance bonds

themselves. Id. at 1291-92. Second, it cited the fact that the hold harmless and

indemnification agreement referenced both the agreement to act as co-surety and

the reinsurance treaties as further support of its decision that the arbitration

provisions in the latter would encompass disputes arising out of the former. Id. at

1291. Third, the court acknowledged the interdependent nature of the twoagreements, observing that the reinsurance treaties and the co-surety agreement

were integral and interrelated parts of one deal and that "the two agreements are

more than related; they are dependent on each other." Id. at 1291-92. Fourth, the

court addressed NAICO's fundamental argument against compelling arbitration-

that the agreement to act as co-surety did not contain an arbitration provision-by

reiterating its holding from a prior case that the absence of an arbitration provision

in a purportedly related or collateral agreement does not mean that a dispute arising

under such an agreement is not arbitrable. Id. at 1292 (citing ARW Exploration Corp

v. Aguirre, 45 F.3d 1455 (10th Cir. 1995)). Emphasizing that sophisticated ceding

companies and reinsurers represented by counsel are always free to carve out

exceptions to broad arbitration clauses contained in their reinsurance agreements

the Tenth Circuit pointedly noted that NAICO failed to do so in the present case.

Id.

Because the facts demonstrated a "significant relationship" between the reinsurance

treaties and the co-surety agreement, the court concluded that the parties had

intended to arbitrate disputes arising under the co-surety agreement. Accordingly

it reversed the trial court's decision and determined that NAICO's claims must be

arbitrated.

B. Denying Arbitration of Disputes Under Related Agreements: NHIC

A different conclusion was reached in the NHIC decision. In NHIC, the U.S

District Court for the Southern District of New York refused to compel arbitration

of a dispute arising from a trust agreement that allegedly was collateral to a

reinsurance agreement containing an arbitration provision. In that case, Canali

reinsured various vehicle service contracts issued by NHIC. The companies also

entered into a trust agreement whereby NHIC made deposits into a trust account

to ensure that sufficient proceeds were available to satisfy claims under the reinsured

contracts. At some point, Canali asserted that NHIC failed to make sufficien

deposits into the trust agreement. NHIC responded that Canali's affiliates lacked

the financial resources to permit Canali to comply with its reinsurance obligations

thus breaching the terms of the reinsurance agreement and invalidating NHIC's

obligations under the trust agreement. NHIC filed a petition to compel arbitration

In determining whether the dispute arising under the parties' trust agreement was

encompassed by the arbitration clause in the reinsurance agreement, the District

Court addressed the preliminary issue of whether the arbitration clause was broador narrow. That clause provided that "[a]ll disputes or differences arising out of the

interpretation of [the reinsurance agreement]" would be subject to arbitration. See

2004 WL 769775, at *3 (emphasis added). The NHICcourt concluded that the

clause was narrow and limited to issues concerning the interpretation of the

reinsurance agreement. Because the parties' dispute involved the interpretation of

the trust agreement and not the reinsurance agreement, the court refused to compel

arbitration of the trust agreement dispute. Id. at *4.

The court acknowledged theinterdependent nature of the two

agreements, observing that thereinsurance treaties and the co-

surety agreement were integral andinterrelated parts of one deal and

that "the two agreements are morethan related; they are dependent on

each other."

In NHIC, the U.S. District Court forthe Southern District of New Yorkrefused to compel arbitration of a

dispute arising from a trustagreement that allegedly was

collateral to a reinsuranceagreement containing an arbitration

provision.

The NHICcourt concluded that theclause was narrow and limited toissues concerning the interpretation

of the reinsurance agreement.Because the parties' dispute

involved the interpretation of thetrust agreement and not the

reinsurance agreement, the courtrefused to compel arbitration of the

trust agreement dispute.



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ConclusionThe NAICO and NHIC decisions represent two sides of the same coin.

Whether a reinsurance agreement's arbitration provision extends to allegedly

collateral or related agreements first turns on the issue of whether the clause

is narrow or broad. If the clause is narrow in scope and no specific evidence

exists as to the parties' intent that disputes arising under collateral or related

agreements would be arbitrable, as in the NHIC case, the court may

conclude that the parties did not intend to arbitrate disputes arising under

collateral or related contracts. If the clause is broad in scope, however, as in

the NAICOcase, the court must next determine whether the purportedlycollateral or related agreement and the reinsurance agreement have a

"significant relationship" with,or "touch" upon,each other such that the two

agreements were part of the same overall reinsurance transaction. If so, this

conclusion,coupled with the strong federal policy favoring arbitration, likely

will result in an order compelling arbitration.

So what does this mean for reinsurers and ceding companies? For existing

reinsurance contracts, the NAICOand NHICdecisions buttress the position

that disputes under collateral agreements are arbitrable where the related

reinsurance contract at issue contains a broad arbitration clause. Parties may

be well-served, however, to clarify this point in amendments or addenda to

these existing collateral or related agreements that are part of the same broad

reinsurance transaction.

In negotiating future reinsurance transactions, parties can incorporate

language in any collateral or related agreements to clarify that disputes

arising thereunder should be arbitrated. Alternatively, these agreements

could state that they are part of a broader transaction between the parties-for

instance, by referencing the "keystone" agreement or the parties' overall

reinsurance relationship. Even better, the parties could enter into a "global"

arbitration agreement, specifying the agreements that are part of the

transaction, and indicating that the arbitration provision in the reinsurance

agreement is intended to encompass a dispute arising out of any of the

enumerated agreements.

In sum, the NAICOand NHICdecisions highlight the potential disputesthat can arise in complex reinsurance transactions where the parties'

relationship is governed by a multitude of agreements, only some of which

contain an arbitration clause. Through planning and careful drafting,

however, parties can avoid unnecessary disputes over the intended scope of

arbitration agreements in complex reinsurance transactions involving

multiple related contracts.

The NAICOand NHICdecisionsrepresent two sides of the same coin.

So what does this mean for reinsurersand ceding companies? For existingreinsurance contracts, the NAICOandNHICdecisions buttress the positionthat disputes under collateralagreements are arbitrable where the

related reinsurance contract at issuecontains a broad arbitration clause.Parties may be well-served, however,to clarify this point in amendments oraddenda to these existing collateralor related agreements that are part ofthe same broad reinsurancetransaction.

Through planning and carefuldrafting, however, parties can avoidunnecessary disputes over theintended scope of arbitrationagreements in complex reinsurancetransactions involving multiplerelated contracts.

6 NO ARBITRATION CLAUSE, NO ARBITRATION? NOT NECESSARILY: THE ARBITRABILITY OF DISPUTES ARISING UNDER COLLATERALAGREEMENTS


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THE "FOLLOW THE FORTUNES" DOCTRINE:ADDRESSING A CEDENT'S ALLOCATIONDECISIONS

BY: DANIELJ. NEPPL

A cedent must make judgment calls when deciding whether to settle an

underlying dispute with its insured. Factors that inform a cedent's decision

include the applicable state law, the strengths and weaknesses of its coveragedefenses, and its potential exposure. All judgment calls, of course, can be

"second-guessed." Accordingly, to prevent reinsurer second-guessing,and to

encourage settlement, the "follow the fortunes" doctrine developed.1

The follow the fortunes doctrine sets forth a deferential standard for

reviewing a cedent's decisions, and it precludes a reinsurer from second-

guessing its cedent's good-faith determinations regarding the coverage under

the policy issued to the insured. Christiania General Ins.Corp. v. Great Am.Ins.

Co., 979 F.2d 268, 280 (2d Cir. 1992). Determinations that cannot be

questioned include "coverage, tactics, lawsuits, compromise, resistance or

capitulation." British Int'l Ins. Co. v. Seguros La Republica, S.A., 342 F.3d 78,

85 (2d Cir. 2003). The doctrine obligates a reinsurer to pay unless it can

show that the cedent's decision was fraudulent, made in bad faith, clearlyoutside the scope of coverage (i.e., ex gratia), or exceeded the limits of the

reinsurance contract. Christiania, 979 F.2d at 280.

Recently, the follow the fortunes doctrine has been addressed by several

courts in the context of a cedent's settlement allocation. The court in North

River Ins.Co. v. ACE Am.Reinsurance Co., 361 F.3d 134 (2d Cir.2004) ("North

River v. ACE"), held that the follow the fortunes doctrine applied to a

cedent's settlement allocation decision. Separately, in Commercial Union Ins.

Co. v. Swiss Reinsurance Am. Corp., 2003 WL 1786863 (D. Mass. Mar. 31,

2003), andAmerican Employers' Ins. Co. v. Swiss Reinsurance Am. Corp., 275 F.

Supp. 2d 29 (D. Mass. 2003) (collectively, the "Swiss Re cases"),2 the courts

held that the doctrine did not apply when the cedent's allocation of an

environmental settlement under multi-year policies exceeded the limits of

the pertinent reinsurance contracts.3 The decisions in North River v. ACE

and the Swiss Recases illustrate that the law governing reinsurance allocation

is still developing.

1. Allocation and Settlements: North River v. ACE

In North River v. ACE, the Second Circuit held that the follow the fortunes

doctrine requires a reinsurer to accept a cedent's good faith settlement

allocation decision. The cedents, North River Insurance Company and

International Insurance Company (collectively, "North River"), issued

multiple excess policies to Owens-Corning Fiberglas Corporation ("OCF")

between 1974 and 1983. Those policies were in the second, third, fourth,and fifth excess layers of OCF's coverage block. The second excess layer had

an attachment point of $26 million and afforded $50 million in per

The follow the fortunes doctrine setsforth a deferential standard forreviewing a cedent's decisions, and itprecludes a reinsurer from second-guessing its cedent's good-faithdeterminations regarding thecoverage under the policy issued tothe insured.

The decisions in North River v. ACEand the Swiss Recases illustrate thatthe law governing reinsuranceallocation is still developing.

1 Courts frequently use the phrases "follow the fortunes" and "follow the settlements"

interchangeably. See., e.g., Stonewall Ins. Co. v.Argonaut Ins. Co., 75 F. Supp. 2d 893, 897 (N.D.

Ill. 1997). "Follow the fortunes" is the general doctrine that a reinsurer pays as the cedent

pays, while "follow the settlements" is application of the doctrine when the cedent settles its

insured's claim. This article will use the phrase "follow the fortunes."

2 The cedents in both Swiss Recases have appealed to the First Circuit,which heard oral

argument on January 7, 2005.

3 Sidley Austin Brown & Wood LLP was counsel for the cedents, North River and

International Insurance Company, in North River v.ACEand is appellate counsel for the

cedents, Commercial Union and American Employers, in the Swiss Recases.



10/34

occurrence limits annually. North River provided approximately $345 million in

limits in the second excess layer,from 1974 to 1983, and approximately $330 million

in limits in OCF's third, fourth, and fifth excess layers over the same time period.

Several years after North River had paid out the policies' aggregate limits for

asbestos products claims, OCF demanded coverage for non-products asbestos

liabilities, which allegedly were not subject to the aggregate limits. North River

disputed the claim. After OCF began dispute resolution proceedings under the

Wellington Agreement, North River and OCF reached a settlement, with North

River agreeing to pay OCF $335 million for full policy buybacks of all policies,including the policies in OCF's upper layers. After settling with OCF, North River

allocated 1% of its settlement ($3.35 million) to the "buyback" portion of the

agreement,with each policy receiving a share of the buyback premium equal to its

share of the overall limits bought back. North River allocated the remaining 99%

(approximately $332 million) to its policies in the second excess layer as payment of

non-products asbestos losses, using the "rising bathtub" allocation approach, i.e., a

horizontal exhaustion allocation approach.4

North River then sought indemnification from its reinsurers, including ACE

American Reinsurance Company ("ACE"), which had facultatively reinsured the

second excess layer policies.5 North River billed ACE $49 million. ACE paid $24

million of the loss cession, but disputed the remaining $25 million. ACE did not

take issue with North River's settlement. Rather, it challenged North River'sallocation of 99% of the settlement payment to the second excess policies, arguing

that this allocation did not properly reflect the exposure analysis that led North

River to settle for $335 million. According to ACE, more of the settlement

payment should have been allocated to the higher layer policies (which ACE did

not reinsure) because the analyses that North River undertook when valuing OCF's

claim for settlement purposes ascribed significant potential exposure to all layers of

coverage, not just the lowest layer.

In addition to disputing North River's allocation, ACE also challenged North

River's claim that the deferential, follow the fortunes standard of review governed

North River's allocation decision. ACE contended that: (i) the follow the fortunes

doctrine did not apply to a cedent's settlement allocation decision; and (ii) even if

the follow the fortunes doctrine did apply, the disputed amounts fell outside the

terms of ACE's facultative certificates covering the second layer policies. North River,

361 F.3d at 140-41.

With respect to the "follow the fortunes" doctrine and allocation, ACE drew a

distinction between a cedent's settlement decisions (where cedent and reinsurer

interests are aligned and ACE conceded that "follow the fortunes" applies) and a

cedent's allocation decisions (where cedent and reinsurer interests are not

necessarily aligned and ACE argued that "follow the fortunes" should not apply).

ACE maintained that a cedent does not have discretion in characterizing what its

settlement payment represents and then allocating its payment based on that

characterization, citing toAmerican Ins.Co. v. North American Co. for Prop. & Cas. Ins.,

697 F.2d 79 (2d Cir. 1983) ("NACPAC").

The cedent in NACPACsettled a punitive damages claim against its insured, even

though the insurance policy did not cover punitive damages. The cedent argued

that the settlement was reinsured because the payment foreclosed the possibility of

With respect to the "follow thefortunes" doctrine and allocation,ACE drew a distinction between acedent's settlement decisions(where cedent and reinsurerinterests are aligned and ACEconceded that "follow the fortunes"applies) and a cedent's allocation

decisions (where cedent andreinsurer interests are notnecessarily aligned and ACE arguedthat "follow the fortunes" shouldnot apply).

4 The "rising bathtub" approach allocates losses to the lowest coverage layer first and exhausts limits in

the lower layers before reaching the higher layers - an approach akin to filling a bathtub (the coverage

block) with water. North River, 361 F.3d at 138 n.6.

5 ACE's facultative certificates contained follow the fortunes clauses,which provided that the "liability

of the Reinsurer ... shall follow that of the Company." North River, 361 F.3d at 137. The facultative

certificates also included loss settlement clauses providing that "[a]ll claims involving this reinsurance,

when settled by the Company shall be binding on the Reinsurer,which shall be bound to pay its

proportion of such settlements." Id. at 142.

THE "FOLLOW THE FORTUNES" DOCTRINE: ADDRESSING A CEDENT'S ALLOCATION DECISIONS8


11/34

a higher compensatory damages award on remand. The reinsurer refused to

pay, the cedent sued to recover,and the reinsurer prevailed. The court found

that the cedent's payment was clearly for a punitive damages award, which

was not covered by the cedent's policy to the insured.

ACE contended that North River's presentation of 99% of the $335 million

settlement payment as a payment of non-products asbestos claims in the

lowest layer of coverage only, when it really effected a buyback of hundreds

of millions of dollars in policy limits on all layers of coverage,was akin to the

cedent's presentation in NACPAC - a characterization of a settlementpayment that did not square with reality and was not entitled to deference.

The Second Circuit rejected ACE's analogy, distinguishing NACPAC

because the cedent's settlement payment in that case was for a punitive

damages award was therefore an ex gratia payment, falling outside the scope

of the cedent's coverage to its insured. In contrast, there was no suggestion

that North River's payments were outside the scope of its coverage to OCF.

The Second Circuit held that the follow the fortunes doctrine applies to

allocation decisions. According to the Court, allowing more exacting

scrutiny of a cedent's settlement allocation decision would defeat the

principal reasons for the doctrine - encouraging settlement in coverage

litigation and protecting the cedent's ability to proceed without fear of beingsecond-guessed. North River, 361 F.3d 140-41. In deferring to the cedent'

settlement allocation decision, the Second Circuit observed:

These goals are served by upholding North River's

allocation here. ACE's appeal relies for its success not only

on its theory regarding the limits of the follow-the-

settlements doctrine, but also on the specific factual

information on which it alleges North River relied in its

settlement negotiations. But it is precisely this kind of

intrusive factual inquiry into the settlement process, and

the accompanying litigation, that the deference prescribed

by the follow-the-settlements doctrine is designed to

prevent. Requiring post-settlement allocation to match

pre-settlement analyses would permit a reinsurer, and

require the courts, to intensely scrutinize the specific

factual information informing settlement negotiations,

and would undermine the certainty that the general

application of the doctrine to settlement decisions creates.

Id. at 141.

ACE also argued that it was not bound by North River's settlemen

allocation decision because North River's pre-settlement analysis showed

that it faced a "r isk of loss" in the higher layers,which ACE did not reinsure

ACE contended that North River's settlement payment extinguished thisrisk of loss because all policies were bought back, and North River should

have allocated to those upper layers a share of the settlement payment that

corresponded to the "risk of loss" North River faced in those upper layer

policies. ACE relied on North River's pre-settlement analyses of exposure

which recognized significant exposure in the upper layers of OCF's coverage

block under certain scenarios.

The Second Circuit rejected ACE's argument, emphasizing that North

River's direct policies covered "loss," not "risk of loss" (i.e., exposure), and

North River's reinsurers contracted to indemnify it only for "loss." When

North River settled, it decided what loss it was paying, obligating ACE to

Requiring post-settlement allocationto match pre-settlement analyses

would permit a reinsurer, and requirethe courts, to intensely scrutinize thespecific factual information informing

settlement negotiations, and wouldundermine the certainty that the

general application of the doctrine tosettlement decisions creates.



12/34

pay according to the terms of the reinsurance contracts and North River's loss

presentation.

The Second Circuit's treatment of the follow the fortunes doctrine in North River

v.ACEis significant because, after recognizing some distinction between settlement

decisions and allocation decisions, the Second Circuit determined that the follow

the fortunes doctrine applies to both a cedent's decision to settle and its decision

respecting how to allocate a settlement payment. Id. at 140. Echoing the rationale

first articulated by the district court in Commercial Union Ins. Co. v. Seven Provinces

Ins. Co., 9 F. Supp. 2d 49 (D. Mass. 1998), aff'd, 217 F.3d 33 (1st Cir. 2000), forapplying follow the fortunes to settlement allocation decisions, North River v. ACE

is the first federal appellate court decision discussing the standard of review for a

cedent's allocation decisions.6

II. Allocation and Multi-Year Policies: The Swiss ReCases

The Swiss Recases involved allocation issues that arise when a cedent settles claims

under multi-year policies. The cedent argued that its allocation was binding on the

reinsurer under the follow the fortunes doctrine, but the reinsurer successfully

claimed that the follow the fortunes doctrine was inapplicable because the cedent's

billing violated the reinsurance contract limits.

The following example illustrates the issues raised in the Swiss Recases.

Assume that a cedent issues its insured a three-year policy with stated limits of $5

million per occurrence. The cedent is reinsured under the following facultative

certificates:

Reinsurer Limits

Reinsurer A 50% of first $1 million each occurrence

Reinsurer B $2 million xs $1 million each occurrence

Reinsurer C $2 million xs $3 million each occurrence

The insured claims coverage for property damage liability arising out of

contamination at a hazardous waste site where the property damage occurred

continuously across all three years of the multi-year policy. After denying liabilityand litigating coverage, the cedent settles for $4.5 million.

How should the cedent allocate the $4.5 million when it bills reinsurers? If the

cedent presents the loss as a single $4.5 million occurrence, Reinsurer A pays

$500,000, Reinsurer B pays $2 million, and Reinsurer C pays $1.5 million. On the

other hand, if the cedent presents the loss as a $1.5 million occurrence in each of

the three years under the policy, Reinsurer A pays $1.5 million (3 times $500,000),

Reinsurer B pays $1.5 million (3 times ($1.5 million less $1 million retention)), and

Reinsurer C pays nothing. Thus, how the cedent presents the $4.5 million

settlement to its reinsurers will have a significant impact on what different reinsurers

are billed. And no matter what presentation the cedent chooses,one of its reinsurers

could argue for another presentation that would lower its bill.

Whether a reinsurer's challenge to the presentation would succeed depends on the

standard of review applicable to the cedent's decision. Under a follow the fortunes

standard, a cedent's good faith decision to present the loss as either a single

North River v. ACEis the firstfederal appellate court decisiondiscussing the standard of reviewfor a cedent's allocation decisions.

6 The Second Circuit's decision in North River v.ACEarguably conflicts with the district court's

decision in Travelers Cas. & Sur. Co.v. Gerling Global Reinsurance Corp., 285 F. Supp. 2d 200 (D. Conn.

2003) ("Travelers v.Gerling"), which held that a reinsurer could reject a cedent's loss presentation

because it was based on a position that the cedent had abandoned earlier in the underlying coverage

litigation. Travelers appealed that decision, also to the Second Circuit, which heard oral argument on

November 10, 2004. For an extensive discussion of the federal district court's decision in Travelers v.

Gerling, seeWilliam M. Sneed, "Travelers v. Gerling: A Non-Products Asbestos Allocation Puzzle," Sidley

Austin Brown & Wood LLP Reinsurance Law Report, Vol. 10,No. 2 (Winter 2003).



13/34

occurrence or an occurrence per year would be binding on reinsurers. To

support a follow the fortunes standard, a cedent can argue that the single

occurrence or occurrence per year decision is a coverage determination like

any other coverage determination. The cedent makes a judgment respecting

its exposure to the insured based on the cedent's policy language to the

insured, the law governing the cedent's coverage, the nature of the insured's

claim, and any other circumstances affecting the cedent's coverage to its

insured. Coverage determinations made in good faith should be binding on

the reinsurer.

In the Swiss Re cases, the cedent made that argument, justifying its

occurrence per year (or "annual") presentation of hazardous waste site

settlements based on the circumstances it faced vis--vis its insured in each

case.7 Certainly, a reinsurer can take issue with a cedent's coverage

determination. The reinsurer in the Swiss Recases did so, arguing that the

cedent's determination respecting the occurrence liability it faced under its

multi-year policies was unreasonable, especially given the weight of judicial

authority respecting whether a multi-year policy provides a single

occurrence limit or an annual occurrence limit for a continuing loss

occurrence.

If the dispute in the Swiss Re cases had been solely about the cedent's

coverage determination, then it should have been governed by the follow thefortunes doctrine, which grants significant deference to a cedent's coverage

determinations. However, at the same time it challenged the cedent's

coverage determination, the reinsurer also framed the issue differently and in

fact argued that the cedent's determination of its occurrence liability was

irrelevant. The proper issue, according to the reinsurer, was the stated limit

on the face of the reinsurance contracts - which reinsured the cedent for

"each occurrence." The reinsurer argued that the cedent's presentation o

the loss on an annual occurrence basis assumed that the reinsurance contrac

limits provided coverage for "each occurrence each year" - and that language

did not appear in the reinsurance contracts. Relying principally on the

Second Circuit's decision in Bellefonte Reinsurance Co. v. Aetna Cas. and Sur

Co., 903 F.2d 910 (2d Cir. 1990), the reinsurer argued that the cedent's billing

exceeded the reinsurance contract limits.

In Bellefonte, the cedent insured A. H. Robins Company ("Robins"), the

manufacturer of the Dalkon Shield intra-uterine device, which was the

subject of mass products liability litigation. Robins contended that the

cedent was obliged to pay defense costs incurred in defending the products

The reinsurer argued that thecedent's presentation of the loss on

an annual occurrence basis assumedthat the reinsurance contract limits

provided coverage for "eachoccurrence each year" - and that

language did not appear in thereinsurance contracts. Relying

principally on the Second Circuit'sdecision in Bellefonte ReinsuranceCo. v. Aetna Cas. and Sur. Co., 903

F.2d 910 (2d Cir. 1990), the reinsurerargued that the cedent's billing

exceeded the reinsurance contractlimits.

7The cedent in the first Swiss Recase concluded that its multi-year, occurrence-based policiewould afford coverage for an occurrence in each year because those policies were required to

be construed no more restrictively than underlying single-year occurrence-based primary

policies and multi-year occurrence-based primary policies stating that "a policy period is

comprised of three consecutive annual periods." Commercial Union, 2003 WL 1786863 at *1.

The cedent in the second Swiss Re case concluded that its multi-year, occurrence-based

policies would afford coverage for an occurrence in per year because it determined that New

Jersey allocation law would apply to the underlying coverage dispute. Under New Jersey law,

"where a per-occurrence policy has a multi-year period, and where there is a progressive

injury that spans more than one year, the injury is a separate occurrence within each of those

years." American Employers, 275 F. Supp. 2d at 33 n.14 (citing Carter-Wallace, Inc. v.Admiral Ins.

Co., 712 A.2d 1116,1121 (N.J. 1998), and Owens-Illinois, Inc. v. United Ins. Co., 650 A.2d 974,

995 (N.J. 1994)).



14/34

claims and that defense costs were in addition to (and therefore did not serve to

exhaust) the aggregate limits in the cedent's polices. The cedent disputed these

contentions. Robins filed suit, seeking a declaration that the cedent was obligated

to pay defense costs in addition to the aggregate limits. The cedent eventually

entered into a compromise settlement with Robins, whereby the policy limits were

increased, the cedent agreed to pay defense costs, and payment of defense costs

served to exhaust the increased policy limits.

The cedent's subsequent loss presentation to its facultative reinsurers included a

share of the defense costs above the aggregate limits in the policies. For instance, ifa facultative reinsurer had assumed a $1 million part of a $10 million policy (original

limits), then the cedent billed that reinsurer 10% of what the cedent paid under the

$10 million policy, which was more than $10 million under the compromise with

Robins. The cedent argued that the follow the fortunes doctrine obligated the

reinsurers to pay their share of the increased limits because its settlement with

Robins was reasonable (and therefore entitled to deference) and because the

reinsurance contracts expressly obligated reinsurers to pay a share of defense costs.8

Thus, the cedent argued that the reinsurers must indemnify it for their pro rata

shares of defense costs. The reinsurers argued that they could not be liable beyond

the limits in the reinsurance contract (i.e., $1 million for a reinsurer assuming a $1

million part of a $10 million policy).

The Second Circuit ruled for the reinsurers, holding that the follow the fortunesdoctrine could not render a reinsurer liable beyond the stated limits of the

reinsurance contract. According to the court, the follow the fortunes doctrine is

"structured so that [it] coexist[s] with, rather than supplant[s], the liability cap."

Bellefonte, 903 F.2d at 913. The court concluded that the follow the fortunes

doctrine cannot "render a reinsurer liable for an amount in excess of the bargained-

for coverage." Id.

In the Swiss Recases, the reinsurer claimed that the cedent's presentation of the loss

on an annual basis also violated the reinsurance contract limit because (in the

example set forth above) Reinsurer A could never be billed more than $500,000

under a three-year policy for a continuing loss at a single waste site. A billing on an

occurrence per year basis ($1.5 million to Reinsurer A in the example) violates the

$500,000 limit. The cedents in the Swiss Recases, by contrast, argued that Bellefonte

did not apply because: (i) the number of occurrence limits available for a waste site

loss under their multi-year policies was an issue for them to determine; and (ii) the

reinsurer was bound by their interpretations under the follow the fortunes doctrine.

According to the cedent, the reinsurance contracts did contain a limit, but how

often that limit applied was necessarily a function of the cedent's coverage to the

insured.

The courts in the Swiss Recases ruled for the reinsurer - holding that the cedent's

billing on an occurrence per year basis violated the limits of the reinsurance

contracts. In so doing, the courts accepted the reinsurer's reliance on Bellefonteand

its progeny, stating in both cases that the "reinsurer's unambiguous, bargained-for

limits of liability" contained in the facultative certificates could not be increased.Commercial Union, at *16;American Employers, 275 F. Supp. 2d at 36 n. 33 (citing

Commercial Union, at *16; Unigard Sec. Ins. Co. v. N. River Ins. Co., 4 F.3d 1049, 1071

(2d Cir. 1993); Bellefonte, 903 F.2d at 913). The district courts determined that the

The cedents in the Swiss Recases,by contrast, argued that Bellefonte

did not apply because: (i) thenumber of occurrence limitsavailable for a waste site loss undertheir multi-year policies was anissue for them to determine; and (ii)the reinsurer was bound by theirinterpretations under the follow thefortunes doctrine. According to thecedent, the reinsurance contractsdid contain a limit, but how oftenthat limit applied was necessarily afunction of the cedent's coverage tothe insured.

8 The reinsurance contracts provided in pertinent part: "All claims involving this reinsurance, when

settled by the Company, shall be binding on the Reinsurer, which shall be bound to pay its proportion

of such settlements, and in addition thereto, in the ratio that the Reinsurer's loss payment bears to the

Company's gross loss settlement, its proportion of expenses ... incurred by the Company in the

investigation and settlement of claims or suits." Bellefonte, 903 F.2d at 911 (emphasis added).



15/34

follow the fortunes doctrine was inapplicable. Presumably, therefore, under

the decisions in the Swiss Recases, even if the cedent is required to pay its

insured three occurrence limits for a continuing loss under a three-year

policy, the facultative reinsurer of the policy need only pay one limit. These

decisions have been appealed.

ConclusionThe Second Circuit's decision in North River v. ACE provides further

guidance respecting the scope of the "follow the fortunes" doctrine,

establishing that it applies to a cedent's allocation decisions, as well as itssettlement decisions. The decisions in the Swiss Re cases underscore the

continued viability of Bellefonte and the willingness of some courts to

dispense with a follow the fortunes analysis when convinced that the

cedent's billing violates the reinsurance contract limit. The Swiss Recases

currently are on appeal to the First Circuit. That court is expected to weigh

in on this important issue, and provide cedents and reinsurers with further

guidance, likely before the end of 2005.

The district courts determined thatthe follow the fortunes doctrine was

inapplicable. Presumably, therefore,under the decisions in the Swiss Recases, even if the cedent is required

to pay its insured three occurrencelimits for a continuing loss under a

three-year policy, the facultativereinsurer of the policy need only pay

one limit. These decisions have beenappealed.



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AN ANALYSIS OF THE 2004 PROCEDURES FOR THERESOLUTION OF U.S. INSURANCE ANDREINSURANCE DISPUTES

BY:ALANJ. SORKOWITZ AND NAVNEET K. DHALIWAL

In 2004, the Insurance and Reinsurance Dispute Resolution Task Force

("Task Force") issued a comprehensive revision of their seminal 1999 effort,

the "Procedures for the Resolution of U.S. Insurance and Reinsurance

Disputes." A copy of the Procedures for the Resolution of U.S. Insuranceand Reinsurance Disputes (the "Procedures") is available at

www.arbitrationtaskforce.org. The Procedures are an attempt by a group of

veteran arbitrators, insurers, and reinsurers to collect and codify best practices

for U.S. reinsurance arbitrations1. The 2004 version of the Procedures

expands upon the 1999 work in several ways. Most fundamentally, it offers

two sets of protocols: one for traditional tripartite panels consisting of two

party-appointed arbitrators and one neutral umpire, and another for all-

neutral panels. The Procedures also address several important and timely

issues, including what it means for a party-arbitrator to be "disinterested,"

replacement of an arbitrator due to death or incapacity, and streamlined

methods of document discovery. This article will briefly discuss the new

Procedures for both traditional and all-neutral arbitration panels.

Discussion

I. The Procedures as a Compilation and Refinement of Best

Practices With Traditional Panels

The Incorporation by Reference ModelThe use of arbitration to resolve reinsurance disputes is almost as old as the

idea of reinsurance itself. Over time, the standard reinsurance arbitration

clause has evolved into its present form. Generally speaking, the standard

clause prescribes mandatory arbitration of all disputes arising with respect to

the contract; provides for appointment of two party-appointed arbitrators

who then choose a neutral umpire pursuant to a stated procedure; states theplace where the hearing is to be held; prescribes the method of splitting

expenses; and characterizes the arbitration as an honorable engagement to

which the strict rules of law are not applicable. Other provisions, such as

governing law provisions, award enforcement provisions, and multiple

reinsurers provisions, are sometimes added as well.

This typical form of arbitration clause has become so familiar in the market,

and to attorneys in the field, that it is easy to forget that it is not the only

form of clause, or even the only type of clause, available. But the usual form

must be seen as embodying only one of many methods of providing for

arbitration - a method that is not necessarily the best, and certainly is not the

only, means to that end. Specifically, the standard clause provides for

arbitration by laying out, in the contract itself, a full and complete procedurefor settling differences. There is another methodology, and the Procedures

opt for it. This is the model of incorporation by reference, whereby the

contract itself contains only a simple agreement to resolve disputes by

arbitration, and a reference to externally established procedures, not recited

in full in the contract, to be employed.

The Procedures are an attempt by agroup of veteran arbitrators,insurers, and reinsurers to collectand codify best practices for U.S.reinsurance arbitrations.

AN ANALYSIS OF THE 2004 PROCEDURES FOR THE RESOLUTION OF U.S. INSURANCE AND REINSURANCE DISPUTES14

1 Task Force participants include senior members of insurance and reinsurance companies,

industry trade associations, and experienced reinsurance arbitrators.


17/34

This is the methodology employed in many other industries,2 and it has inheren

advantages. An arbitration clause incorporated by reference can be short and

concise, thus facilitating the contracting process, while the procedures themselve

can be as detailed as necessary. Indeed, arbitration procedures incorporated by

reference can be more detailed than "usual" arbitration procedures set forth in ful

in the contract, because, as a practical matter, there are limits to the amount o

procedural detail the parties will load into their contracts. Moreover, an

incorporation methodology allows the parties to adopt procedure that can be

revised over time, whereas it may not be feasible to frequently modify expres

contract language.

If the Procedures do no more than encourage the industry to consider drafting

arbitration clauses through an incorporation model, the Task Force will have

performed a significant service to the industry. But the Procedures do much more

especially in compiling and adopting industry best practices.

Best PracticesThe individual members of the Task Force are all reinsurance veterans well versed

with existing arbitration practices. As such, they are well suited to frame

compilation of the "best practices" being employed. This is precisely what they have

done. The Procedures generally prescribe rules that foster expeditious arbitration

before quality panels fully equipped to do equity between the parties.

The Procedures encourage speedy disposition of disputes in many ways, some o

which are well-known to practitioners and others which are quite innovative

These methods include:

Definition of disinterested. Accusations that an arbitrator is not

disinterested have become an all too common event. The

Procedures state clearly that all arbitrators must be "disinterested,"

but define that term in the practical sense of not being "under the

control of either party, nor shall any member of the panel have a

financial interest in the outcome of the arbitration." (Procedures,

2.3.) This simple and limited definition should eliminate thegrowing trend of challenges to party-appointed arbitrators on the

basis that they have an indirect interest in the case, such as a

familiarity with the parties or prior exposure to the underlying

issue.3

Summary disposition. The Procedures expressly grant the panel

the power to hear and determine the case via summary

disposition. (Procedures, 13.1.) This should encourage panel

members to decide matters on the papers when a full-blown

hearing is unnecessary.

If the Procedures do no more thanencourage the industry to consider

drafting arbitration clauses throughan incorporation model, the Task

Force will have performed asignificant service to the industry.

But the Procedures do much more,especially in compiling and adopting

industry best practices.


2 See, e.g.,Volt Info. Sciences, Inc. v. Board of Trustees of the Leland Stanford Jr. Univ., 489 U.S. 468 (1989),

which deals with a contract incorporating the Construction Industry Arbitration Rules promulgated

by the American Arbitration Association ("AAA"). Other industries in which contracts frequently

incorporate rules promulgated by the AAA or other independent authors include securities and real

estate.

3 An oft-discussed case on point is Sphere Drake Ins.Ltd. v.All American Life Ins. Co., 307 F.3d 617 (7th

Cir. 2002), in which a party challenged an adverse award on the basis that the other party's party-

appointed arbitrator showed "evident partiality" due to his prior business contacts with one of the

parties. The Seventh Circuit reversed the lower court's vacatur of the award,noting that "in the main,

party-appointed arbitrators are supposed to be advocates." Id. at 620.


18/34

Death or incapacity of an arbitrator. The Procedures state

that if a party-appointed arbitrator or a neutral umpire is

unable or unwilling to serve,a replacement shall be chosen

within 14 days. (Procedures, 6.8, 6.9.) This should

eliminate the harsh effect of requiring proceedings to start

"from scratch" in the event of a panel member's death or

incapacity. 4

Mandatory document disclosures. Akin to the Federal

Rules of Civil Procedure, the Procedures require a

"voluntary, prompt and informal exchange of all non-

privileged documents and other information relevant to

the dispute" prior to formal discovery. (Procedures,

11.1.) The voluntary exchange should eliminate some of

the delay inherent in the arbitration discovery process.

Streamlined proceedings. A separate set of streamlined

procedures is prescribed for cases deemed appropriate by

the parties. (Procedures, 16.) These alternativeprocedures, which provide for shorter time periods, no

discovery, and a hearing via written submission, should

result in expeditious disposition of smaller cases.

The Procedures also suggest a new process for appointing arbitration panels.

Many parties are unhappy with the "name,strike and draw" process whereby

a party may try to "stack the deck" by advancing a short list of umpire

candidates with a favorable disposition in the hopes that one will be chosen

by lots. The Procedures call for a more complicated, but hopefully more

equitable, process. Specifically, the Procedures require party-appointed

arbitrators to be appointed simultaneously within 30 days of commencement

of the arbitration. (Procedures, 6.2.) If the party-appointed arbitrators areunable to agree upon an umpire within 30 days, then each party submits a

list of eight umpire candidates. After the candidates complete umpire

questionnaires, each party strikes five candidates from the other's list, leaving

two lists of three names each. If one individual appears on both lists, he or

she is appointed umpire. If more than one individual appears on both lists,

one umpire is chosen from that set by lots. If there is no overlap between

the lists, each party ranks the six names on the lists in order of preference,

and the person with the best total numerical ranking becomes the umpire.

(See generally Procedures, 6.7.) While a detailed discussion of the merits of

this numerical protocol is beyond the scope of this article, its intent - to curb

abuses in the umpire selection process - is laudable.

The Procedures also seek to expand the pool of qualified arbitrators.

Traditional reinsurance arbitration clauses required an arbitrator candidate to

be a "current or former officer or executive of an insurance or reinsurance

company." The Procedures offer that traditional language, or alternative

language that the parties may elect to have "professionals with no less than

Akin to the Federal Rules of CivilProcedure, the Procedures require a"voluntary, prompt and informalexchange of all non-privilegeddocuments and other informationrelevant to the dispute" prior toformal discovery. (Procedures, 11.1.)The voluntary exchange shouldeliminate some of the delay inherentin the arbitration discovery process.

Many parties are unhappy with the"name, strike and draw" processwhereby a party may try to "stack thedeck" by advancing a short list of

umpire candidates with a favorabledisposition in the hopes that one willbe chosen by lots. The Procedurescall for a more complicated, buthopefully more equitable, process.

4 See Trade & Transport, Inc. v. Natural Petr. Charterers Inc., 931 F.2d 191, 194-95 (2d Cir. 1991)

(collecting authorities). The Procedures provide that if the umpire is unable or unwilling to

serve, a replacement shall be promptly appointed, and prescribe procedures for this eventuality.

A more complete treatment of the subject might have added that the resulting, reconstituted

panel is empowered to resolve the dispute, but the intent is clear and the lack of this recitation

appears harmless.



19/34

ten years of experience in or serving the insurance or reinsurance industry" act as

panel members. (Procedures, 6.2.) This expanded qualification clause would

presumably allow experienced attorneys to serve as panel members.

Finally, the Procedures contain rules designed to ensure that the panel has full power

to control the proceedings before it and make an award that fully resolves all aspects

of the dispute, in a realistic business manner:

Paragraph 14.3 sets forth the "honorable engagement"

concept long familiar in the industry, in standard language

(including the stipulation that the panel need not follow "the

strict rules of law.") The paragraph goes on, however, to set forth

language concerning the method of resolving the dispute which,

while equally familiar to practitioners, has less uniformly been

included in arbitration clauses: "In making their Award, the panel

shall apply the custom and practice of the insurance and

reinsurance industry, with a view to effecting the general purpose

of the underlying agreement which is the subject of the

arbitration." (Procedures, 14.3.)

Settling a frequently controversial issue, the Procedures give

the panel power to grant interim relief, including pre-hearing

security. (Procedures, 8.1.)

Similarly, the panel is given express authority to impose

sanctions (including costs, attorneys fees and orders of preclusion)

for failure to comply with interim rulings, or for discovery abuse.

(Procedures, 8.2.)

The parties, if all agree, are given the right to require areasoned decision of the panel. (Procedures, 15.4.)

The proceedings, hearing and award are expressly made

confidential, thus allowing the parties the freedom of expression

required for full airing of the issues without adverse repercussions

in the marketplace. (Procedures, 7.1.) Certain exceptions to

confidentiality are established, such as for judicial proceedings

relating to the award, and the list of exceptions accords with

currently prevalent practice. (Procedures, 7.2.)

A Missed Opportunity?To the extent there is room for criticism of the Procedures, the Task Force may have

devoted too much attention to compiling the best existing practices and not enough

attention to curing defects that exist even when best practices are employed. It is

no secret that the current arbitration system is plagued by too much litigation and

controversy. There are too many challenges to the neutrality of the panel, too many

parties stonewalling the process through challenges to arbitrability, too many

motions for vacatur of the award, too many discovery disputes; in short, too much

litigation at the margins of the process and too much abuse. The Procedures could

have done more to stem the litigation tide by resolving areas of uncertainty within

existing practices. Three examples typify the problem.

The Procedures also seek to expandthe pool of qualified arbitrators.

To the extent there is room forcriticism of the Procedures, the

Task Force may have devoted toomuch attention to compiling the

best existing practices and notenough attention to curing defects

that exist even when best practicesare employed.



20/34

The first relates to the definition of "neutral" as an umpire qualification. The

Procedures require the umpire to be "neutral," but the definition of that

term set forth in paragraph 2.4 - "disinterested, unbiased and impartial" - is

somewhat tautological. The Procedures do not tell us what facts must be

present to indicate an interest, bias or partiality, or what type of interests,

biases and partialities the umpire must be free of in order to qualify as

"neutral" (or, to put the matter more starkly, what interests, biases and

partialities the umpire may have yet still be deemed "neutral"). If the intent

is that an umpire must be free of any such impediment (as we must conclude

if we give the Procedures their literal meaning), this is an open invitation forparties to litigate over a potential umpire's slightest previous contacts with

the parties, their appointed arbitrators, or the potential witnesses. In the

insular world of reinsurance arbitration, it will be difficult indeed to find

umpire candidates so utterly removed from any given dispute.

The Task Force could have adopted the same definition for "neutral" as it did

for "disinterested," or a variant thereof, or a definition offering more specific

and practical guidance. By adopting the broad definition expressed in

paragraph 2.4, it has invited continued litigation over the concept of

neutrality, with concomitant delay and expense.5

A second example is the problem of disputes involving multiple reinsureds

or reinsurers under the same contract, especially where there are differinginterests among those reinsureds or reinsurers. These cases present a myriad

of procedural issues, such as whether one proceeding or multiple proceedings

should be had and who controls the nomination of the party-appointed

arbitrators. See, e.g., Connecticut Gen. Life Ins. Co. v. Sun Life Assur. Co., 210

F.3d 771 (7th Cir. 2000). The Procedures have precious little to say about

such cases, thus leaving these issues fertile for litigation.

A final example is discovery. The Procedures include only general rules

regarding discovery; they give the panel the power to order the production

of such documents "as it considers necessary for the proper resolution of the

dispute" and "such depositions as are reasonably necessary." (Procedures,

11.2-11.3.) The Task Force chose not to limit and regularize the discovery

process by adopting one or more of the specific rules that have been

proposed in recent years (e.g., to confine discovery to the contract at issue or

to limit the number and length of depositions). Perhaps this is as it should

be, in that the scope and duration of discovery must be tailored to the

circumstances of each case. But the Procedures' broad guidelines may do

little to stem the discovery disputes that occur all too often.

II. The Neutral Procedures: A Comparison with English Arbitration Law

The Task Force also prepared an alternate set of procedures for neutral

arbitration panels (the "Neutral Procedures"). Neutral panels are, of course,

a mainstay of arbitration under English law. One meaningful way in which

to analyze the Neutral Procedures, then, is by comparing them to the rules

of arbitration under the English Arbitration Act of 1996 (the "Arbitration

Act") and the arbitration rules of the A.I.D.A. Reinsurance Arbitration

Society of the UK (the "UK Rules"), which are often used to supplement

the procedures for arbitration conducted under the auspices of the

Arbitration Act. There are several useful points of comparison among the

Neutral Procedures, the Arbitration Act and the UK Rules as follows:

The Task Force also prepared analternate set of procedures for

neutral arbitration panels.

5 Paragraph 2.4 of the Procedures does contain a caveat recognizing that an umpire may be

"neutral" even if he has had "previous knowledge of or experience with respect to issues

involved in the dispute." While this language is helpful, it does not address the common

problem of a prospective umpire who has had previous contacts with the parties, their

appointed arbitrators, or the witnesses.



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Ex parte communications. The Neutral Procedures, the Arbitration Act and theUK Rules all require that arbitrators be neutral and have no ex partecommunication

with any party once the panel has been formed. These procedures differ, however

with respect to the permissibility of pre-appointment ex partecommunication. The

custom and practice under the Arbitration Act and the UK Rules is to permit a

party to have limited pre-appointment discussions with a prospective arbitrator

concerning the general nature of the dispute and the identity of the parties. The

Neutral Procedures, by contrast,prohibit even this limited pre-appointment ex part

communication. Specifically, the Neutral Procedures state that "[u]nder no

circumstances shall either Party or anyone acting on the Party's behalf engage in anycommunication with any prospective panel member that could reasonably lead such

panel member to identify the Party that initiated the proposed panel member'

selection. Ex partecommunications between the Parties and the panel in relation

to the arbitration is prohibited." (Neutral Procedures, 6.4 (emphasis added.)

Although party-appointed arbitrators may be able to surmise who appointed them

the Neutral Procedures' strict prohibition against ex parte communication may

further foster the spirit of complete neutrality.

Confidentiality. The Neutral Procedures and the UK Rules both expressly statethat arbitrations are confidential. (Neutral Procedures, 7.1; Rule 11.5, UK Rules.

English case law interpreting the Arbitration Act likewise has held that arbitration

are confidential.

Chairman Qualifications. The trend in London market practice has been towardshaving a three party tribunal, consisting of two London market individuals and a

third arbitrator or "chairman" being an experienced reinsurance lawyer. The

Neutral Procedures recognize this trend by offering that "professionals with no les

than 10 years of experience in or serving the insurance or reinsurance industry" can

qualify as an arbitrator. This would allow a reinsurance lawyer to sit as chairman

which may prove especially useful in drafting reasoned awards that withstand

appellate scrutiny.

Reasoned Awards. Both the Arbitration Act ( 52(4)) and the UK Rules (Rule16.2) require the panel to set out their reasons for the award unless the parties agree

otherwise. By contrast, the Neutral Procedures mandate a reasoned award only by

agreement of both parties. The absence of any ex parte communication or a

mandatory reasoned award may leave parties with little insight into the Panel'

reasoning after an award is issued in an arbitration conducted pursuant to the

Neutral Procedures.

Interim Relief and Pre-Hearing Security. The Arbitration Act and the NeutraProcedures both permit the panel to award interim relief as it deems necessary

(Arbitration Act, 41; Neutral Procedures, 8.2.) The UK Rules, by contrast, specify

certain powers which are not granted to the arbitration panel, including, the posting

of pre-hearing security and the payment of exemplary or punitive damages. (UK

Rules, Rule 14.)

Hold Harmless Agreements. The Arbitration Act and the UK Rules both providethat an "arbitrator is not liable for anything done or omitted in the discharge or

purported discharge of his functions as arbitrator unless...in bad faith." (ArbitrationAct at 29;UK Rules at Rule 21.2.) The Neutral Procedures, by contrast, are silen

regarding the immunity of the arbitrators. In practice, we would expect that an

arbitration panel operating under the Neutral Procedures may simply refuse to serve

unless all parties to execute a hold harmless agreement.

ConclusionThe 2004 Procedures and Neutral Procedures represent a significant step forward in

establishing best practices for both traditional arbitration panels and all-neutral

panels. Reinsurers, cedents and reinsurance intermediaries should review the

Procedures and consider whether to incorporate them, or certain of their features

into future reinsurance arbitration clauses.

The custom and practice under theArbitration Act and the UK Rules is

to permit a party to have limitedpre-appointment discussions with a

prospective arbitrator concerning

the general nature of the disputeand the identity of the parties. The

Neutral Procedures, by contrast,prohibit even this limited pre-

appointment ex partecommunication.

The absence of any ex partecommunication or a mandatory

reasoned award may leave partieswith little insight into the Panel'sreasoning after an award is issued

in an arbitration conductedpursuant to the Neutral Procedures.

The 2004 Procedures and NeutralProcedures represent a significant

step forward in establishing bestpractices for both traditional

arbitration panels and all-neutralpanels.



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REINSURANCE IN THE CONTEXT OF INSURANCECOMPANY M&A TRANSACTIONS: A PRACTICAL

OVERVIEW1

BY: MICHAEL P. GOLDMAN AND SEAN M. KEYVAN

I. IntroductionReinsurance is an integral component of the operations and financial position of

most insurance companies. At the most basic level, a ceding insurance company usesreinsurance to transfer policy-related risk to another legal entity. If structured

correctly, such cession of risk will be recognized for financial reporting purposes,

affording the ceding insurer additional capacity to expand its operations. In the

context of insurance company mergers and acquisitions, due to the role and

prominence that reinsurance can play in the financial structure of an insurance

company, an acquiring party should devote a significant level of due diligence to the

reinsurance programs of the target, as well as structure transaction documentation

to address any related legal, business and financial issues.

Separate from the ceded reinsurance programs existing within a target insurance

company, reinsurance can also be used as a tool to facilitate insurance company

acquisition transactions. In the context of a traditional stock acquisition,

reinsurance can be used as a tool to add flexibility to the structure of the

transaction, by removing lines of business that the parties desire to exclude from the

principal transaction, by providing transitional financial and operational support for

continuing operations,or by providing stop-loss protection to the acquiring party

as a substitute for certain types of indemnities and/or a purchase price adjustment.

In the ultimate sense, reinsurance can also be used as the primary vehicle for the

acquisition of specific lines of insurance business, essentially creating the

equivalent of an asset acquisition with respect to all or a portion of a target

insurance company's operations.On an ever increasing basis,acquiring parties in the

insurance industry are pursuing this mode of acquisition as a strategy to avoid

unrelated liabilities, successor liability and operational issues associated with

unwanted lines of business.

II. Reinsurance in the Context of Stock Purchase TransactionOne common form of insurance company acquisition is a stock purchase

transaction, whereby the purchaser acquires the target insurance company through

the direct or indirect acquisition of the capital stock of the insurance company.2

Although reinsurance is not the primary acquisition vehicle in a traditional stock

purchase transaction, reinsurance is, nevertheless, an important consideration in

nearly all such transactions, affecting the due diligence, structuring and

documentation aspects of the deal.

A. Reinsurance due diligence considerations in insurance companyacquisition transactions

The evaluation or "due diligence" phase of a stock purchase acquisition is perhapsthe most important aspect of the transaction. Given the relative prominence of

ceded reinsurance in the overall operations and financial structure of most target

insurance companies, a thorough review of a target insurance company should

include an evaluation of the target's overall reinsurance program.

Separate from the cededreinsurance programs existingwithin a target insurance company,reinsurance can also be used as atool to facilitate insurancecompany acquisition transactions.

20 REINSURANCE IN THE CONTEXT OF INSURANCE COMPANY M&A TRANSACTIONS: A PRACTICAL OVERVIEW

1 This article is adapted from a version that originally appeared in the Spring 2004 issue of the Journalof Reinsurance, published by the Intermediaries & Reinsurance Underwriters Association. The authorswould like to thank Bobbi Anderson,Anthony Calabrese and Claudine Chen-Young for theircontribution to this article.

2 Such an acquisition could be accomplished directly through the acquisition of the stock of thetarget insurance company, or indirectly, through the acquisition of the stock of the direct or indirectparent of the target insurance company.


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Such evaluation generally includes a review and assessment of (i) the type

of reinsurance coverage maintained and in-force with respect to the target

business, including a review of overall retention and participation levels and

limits of coverage, (ii) the adequacy of the target's reinsurance program in

relation to the target's business, (iii) the credit quality of the target

reinsurers, including a review of the credit and financial strength ratings o

the reinsurers, (iv) the target's relationship with its reinsurers, includin

investigation of any disputes and collection issues, (v) whether the target

ceded reinsurance contracts satisfy applicable statutory credit for reinsuranc

requirements, permitting the company to reduce the liability on its statutoryfinancial statement with respect to policies ceded under such reinsurance

contracts, including review of reinsurance trusts, letters of credits, etc.,3 (vi

prior ceded assumption reinsurance transactions, including an analysis of th

target's compliance with applicable regulatory requirements and an

evaluation of wheth

2005 RIL Complete

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