Published in Law 360 (July 8, 2019)
The United States Constitution, a U.S. treaty, two federal statutes, a state statute, and a commercial contract walk into a bar. The federal statutes are arguing. The Constitution, the treaty, one of the federal statutes, and the state statute are arguing. The treaty and the other federal statute are arguing. And the contract and the state statute are arguing. In what order does the bartender serve them? Which one does the bartender serve first?
From time to time, an insurance policy’s arbitration clause will run into the thresher-sharp conflict between (a) the U.S. Constitution’s Supremacy Clause (art. VI, cl. 2), which gives federal laws and international treaties preemptive authority over conflicting state law, and (b) the McCarran-Ferguson Act, which gives state insurance law reverse preemptive authority over federal statutes that interfere with state regulation of the insurance business. Who “wins”? It depends.
Most often, when a state insurance law provision conflicts with the Federal Arbitration Act (“FAA”), there may be reverse preemption due to McCarran-Ferguson. But the judicial decisions have been inconsistent. It may depend upon the precise laws that are said to be in conflict and on the precise procedural issue at bar.
Furthermore, the Federal Courts of Appeals are split regarding whether a non-self-executing arbitration-related U.S. treaty – e.g., the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the “New York Convention”) – and/or its implementing legislation can be reverse preempted pursuant to McCarran-Ferguson. There is not much disagreement that the New York Convention itself cannot be reverse preempted; there is considerable disagreement regarding whether U.S. legislation implementing the New York Convention – i.e., FAA ch. 2, 9 U.S.C. §§ 201, et seq. – can be reverse preempted; and there is significant case-wise disagreement regarding whether the terms of the treaty or the terms of the implementing legislation are even being addressed.
And if all of that uncertainty were not enough, enter the wildcard – a contractual “conformity to statute” term in an insurance policy, providing that any policy provision that is inconsistent with state law is automatically deemed amended to conform to state law. How does the preemption-reverse preemption analysis play out in that case?
The Fifth Circuit took up that question recently in McDonnel Group LLC v. Great Lakes Ins. SE, 923 F.3d 427, 2019 U.S. App. LEXIS 14177 (5th Cir. May 13, 2019). It held that Federal law preemption prevailed. But, inevitably, not all would agree.
McCarran-Ferguson Reverse Preemption
The McCarran-Ferguson Act provides that
“[n]o Act of Congress shall be construed to invalidate, impair or supersede any law enacted by any State for the purpose of regulating the business of insurance . . . unless such Act specifically relates to the business of insurance.” 15 U.S.C § 1012(b).
The U.S. Supreme Court has held that a state law is shielded from federal preemption by McCarran-Ferguson if the state law regulates the insurance business according to the following criteria: (1) it has the effect of transferring or spreading a policyholder’s risk; (2) the practice it affects is “an integral part of the policy relationship between the insurer and the insured;” and (3) that practice is “limited to entities within the insurance industry.” See Pilot Life Ins. Co. v. Dedeaux, 481 U.S. 41, 48-49 (1987).
Moreover, McCarran-Ferguson arguably enables such state laws to reverse preempt the FAA if: (1) the FAA does not specifically relate to the business of insurance; (2) the state law invalidating the arbitration agreement in an insurance contract was enacted to regulate the business of insurance; and (3) the FAA would “invalidate, impair, or supersede” that state law. See also Humana Inc. v. Forsyth, 525 U.S. 299, 307 (1999).
Generally, a narrowly framed state statute that in effect prohibits arbitration of insurance coverage disputes would reverse preempt a conflicting federal statute by reason of McCarran-Ferguson. Among the 50 states, (a) 24 apparently have no statute or regulation prohibiting or restricting the use of arbitration provisions in insurance contracts; (b) 16 have statutes that prohibit enforcement of arbitration clauses in insurance contracts; (c) 7 have laws or courts that restrict the application of arbitration clauses within insurance contracts; and (d) 3 have regulations restricting arbitration with respect to insurance contracts. Notably, arbitration of covered disputes is not in effect prohibited under the laws of many large states, including New York, California, Texas, New Jersey, Ohio, and Illinois.
A number of federal courts, including the Fifth, Eighth, Tenth, and Eleventh Circuit Courts of Appeal, have held that McCarran-Ferguson enables pertinent state law to reverse preempt the provisions of FAA ch. 1, 9 U.S.C. §§ 1, et seq., which is not directly related to any international treaty. FAA ch. 2 is another matter, however.
The McCarran-Ferguson Analysis vis-à-vis the New York Convention
In the recent Fifth Circuit case, McDonnel Group (“MG”) bought a builder’s risk insurance policy from some U.K. insurance companies concerning a construction project in New Orleans. In 2017, the property suffered water damage, and MG submitted a claim that the insurers rejected. 2019 U.S. App. LEXIS 14177 at *2. MG commenced suit in Federal District Court seeking declaratory relief and money damages, and the insurers moved to dismiss, relying on the policy’s arbitration clause. (The agreement provided for arbitration of disputes in New York under AAA International Arbitration Rules. Id. at *3.)
The policy also contained a “conformity to statute” provision:
“In the event any terms of this Policy are in conflict with the statutes of the jurisdiction where the Insured Property is located [in this case, Louisiana], such terms are amended to conform to such statutes.” Id. at *3.
La. Rev. Stat. Ann. § 22:868(A)(2) in effect invalidates arbitration agreements in insurance contracts that cover property located in the state. 2019 U.S. App. LEXIS 14177 at *4.
The insured thereupon argued that the policy’s arbitration provision conflicted with La. Rev. Stat. Ann. § 22:868(A)(2), and therefore must be deemed amended to conform to the statute in accordance with the policy’s “conformity” provision. That is, enforce the contractual term first. Once that was done, the argument went, there was no arbitration agreement in the insurance policy left to consider, the New York Convention and the FAA became irrelevant, and there was no need for any preemption analysis. See, id. at *3-*4.
But the District Court’s analysis of the priorities among the relevant legal factors went in the opposite direction. It held that the New York Convention preempts the pertinent Louisiana statute. Moreover, McCarran-Ferguson was not a factor because it preempts federal statutes, whereas a treaty like the New York Convention is not an “Act of Congress” and therefore would not be affected. And finally, addressing the wildcard contract provision, because the state statute was preempted, “no conflict existed between the policy and state laws so as to trigger the conformity provision of the policy.” Id. at *4. Thus the policy’s arbitration clause remained valid and enforceable, and the District Court dismissed the suit in favor of arbitration.
Upon de novo review, and with the allegations in the complaint assumed to be true and viewed in the light most favorable to the plaintiff, id. at *5, the Fifth Circuit considered the terms of the insurance policy in question, the FAA, the apparently conflicting Louisiana statute, the McCarran-Ferguson Act, the New York Convention, and the Supremacy Clause of the U.S. Constitution.
Under the New York Convention, when there is an applicable agreement to arbitrate, N.Y. Convention art. II(1), courts of a signatory nation like the U.S. must “at the request of one of the parties, refer the parties to arbitration, unless it finds that the . . . [arbitration] agreement is null and void, inoperative or incapable of being performed.” Id. art. II(3).
The Fifth Circuit had previously held that McCarran-Ferguson does not reverse-preempt the New York Convention or its implementing legislation (FAA ch. 2, 9 U.S.C. §§ 201, et seq.) because the Convention was not an “Act of Congress.” 2019 U.S. App. LEXIS 14177 at *8, citing Safety Nat. Cas. Corp. v. Certain Underwriters at Lloyd’s, 587 F.3d 714, 725 (5th Cir. 2009). The Court furthermore opined, consistent with the Safety National decision, see 587 F.3d at 722-26, that McCarran-Ferguson does not reverse preempt a treaty “whether the treaty is self-executing or requires implementing legislation.” 2019 U.S. App. LEXIS 14177 at *8. Moreover, the Court opined that legal agreements for arbitration “fall” under the Convention, rather than under the implementing Congressional legislation. Id.
Thus, the Fifth Circuit determined, the provisions of the New York Convention and of its implementing legislation)are not reverse preempted by state law under the authority of McCarran-Ferguson. Id. at *9.
That analysis was consistent with that of the Fourth Circuit in ESAB Group, Inc. v. Zurich Ins. PLC, 685 F.3d 376 (4th Cir. 2012), and inconsistent with that of the Second and Eighth Circuits in Stephens v. American International Ins. Co., 66 F.3d 41 (2d Cir. 1995) and Transit Casualty Co. v. Certain Underwriters at Lloyd’s, 119 F.3d 619 (8th Cir. 1997), respectively.
In the ESAB Group case, the Fourth Circuit was motivated by the principle that states did not have authority to in effect nullify treaty agreements made by the United States, opining that “Congress did not intend for the McCarran-Ferguson Act to permit state law to vitiate [the U.S.’s] international agreements. . . .” 685 F.3d at 389, citing Am. Ins. Ass’n. v. Garamendi, 539 U.S. 396, 428 (2003). Hence, the Fourth Circuit held that “Supreme Court precedent dictates that McCarran-Ferguson is limited to legislation within the domestic realm.” Id. at 388. The Court furthermore held that treaty-implementing legislation like FAA ch. 2 was not subject to reverse preemption either. Id. at 388, 390. Consequently, the Court held, a South Carolina law invalidating arbitration agreements in insurance policies would not reverse preempt either ch. 2 of the FAA or the New York Convention, and the insurance companies could sustain their removal of an insured’s suit to a federal court and there have the suit dismissed in favor of arbitration in Sweden.
On the other hand, the Second Circuit, in Stephens v. American International Ins. Co., 66 F.3d 41 (2d Cir. 1995), considering that the New York Convention was not self-executing, found that implementing legislation – FAA ch. 2 (an Act of Congress) – could be reverse preempted by Kentucky law, see id. at 45. But see also, Stephens v. Nat’l Distillers & Chem. Corp., 69 F.3d 1226 (2d Cir. 1995)(re FSIA). (It did not consider whether McCarran-Ferguson could be interpreted to affect the U.S. treaty terms themselves.)
That latter analysis was more recently adopted within the Eighth Circuit again in Foresite Energy LLC v. Certain London Market Ins. Cos., 2018 U.S. Dist. LEXIS 69423 (E.D. Mo., Apr. 25, 2018). In Foresite Energy, the question arose in the context of a motion to remand litigation to state court after it had been removed to federal court on the basis of 9 U.S.C. § 205, part of the implementing legislation in FAA ch. 2. The insurance policies in question provided for arbitration of disputes in London. However, the governing law of the policies was that of Missouri, which has a statute in effect prohibiting arbitration of disputes between insurers and policyholders. See Mo. Rev. Stat. § 435.350 (2010). The New York Convention arguably applied, given that the insurers were alien companies, but the bases for the removal (and of the federal court’s subject matter jurisdiction) were in the implementing legislation – i.e., ch. 2 of the FAA – rather than in the Convention itself. The court apparently viewed that federal legislation as interfering with Missouri state law regulating the business of insurance – i.e., the arbitration prohibition – and therefore found that McCarran-Ferguson applied to enable Missouri’s anti-arbitration statute to reverse preempt FAA §§ 205 and 203.
The “Conformity to Statute” Wildcard
But in the McDonnel Group case, even if Louisiana state law prohibiting arbitration were arguably subject to preemption by reason of the New York Convention, wasn’t the insurance policy’s arbitration agreement nonetheless in effect nullified ab initio by the policy’s own “conformity” provision? (Egg before chicken?) If so, then the preemption and reverse preemption analyses were mooted.
On appeal, the pertinent issue was whether “the contractual agreement to conform to state statutes appl[ies] when the conflicting state statute has been held as a matter of law to have been preempted by the [New York] Convention.” 2019 U.S. App. LEXIS 14177 at *4-*5. The Court’s answer was “no.”
The Fifth Circuit’s logic prioritized giving effect to the Convention, rather than giving effect to the contractual “conformity” provision. That is, (a) the state statute was preempted by the New York Convention, (b) reverse preemption vis-à-vis a treaty (or its implementing legislation) was not permitted, and (c) the state law therefore became irrelevant. Hence, there was no conflict between the insurance policy arbitration clause and the inoperative (superseded) state statute, and the contractual conformity provision was not triggered. Id. at *10.
Does this same analysis get applied in a Circuit that distinguishes between the New York Convention and its implementing legislation (ch. 2 of the FAA) for purposes of a reverse preemption analysis? Perhaps not. There, the analysis might consider (i) preemption of the state statute by ch. 2 of the FAA, then (ii) reverse preemption by reason of McCarran-Ferguson, and then, if necessary, (iii) the effect of the insurance policy’s conformity-to-statute provision. Or vice versa.
So, regarding the priority of enforcement of all of the competing legal factors, the chicken comes first. Or is it the egg?