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Failure to Analyze Dispute Resolution Provisions Results in Vacated Arbitration Award
by Krista Hallberg Kapp1
When design, construction and other related agreements include inconsistent dispute resolution provisions, parties face myriad risks if a dispute arises. These risks include inconsistent results, differing burdens of proof, varying evidentiary rules and others. A recent federal court decision from outside of the construction context provides a sobering lesson on just how costly inconsistent dispute resolution provisions can be. In that case, PoolRe Insurance Corp., et al. v. Organizational Strategies, Inc., et al., 14-C-20433, 2015 WL 1566633 (Apr. 7, 2015), the U.S. Court of Appeals for the Fifth Circuit upheld the district court’s decision to vacate an arbitration award for two reasons: (1) the arbitrator was not selected according to the method specified by the contract; and (2) the arbitrator did not apply the arbitration rules specified by the contract’s forum selection clause. This costly outcome resulted directly from the inconsistent and poorly-drafted dispute resolution provisions.
Background
Organizational Strategies, Inc. (“OSI”), a professional services firm, was interested in exploring captive insurance options (a captive insurance company is created for the purpose of insuring its owner). Capstone, a group of entities that provides administrative services for captive insurance companies, discussed captive insurance options with OSI. Following these discussions, Capstone’s legal advisors, The Feldman Law Firm (“The Firm”), sent OSI an Engagement Letter, which OSI executed.
The Engagement Letter contained two attachments: the Firm’s Billing Guidelines and the Services Agreement. The attachments contained clauses pertaining to arbitration and disputes. The Billing Guidelines contained an arbitration clause requiring arbitration pursuant to the Commercial Arbitration Rules of the American Arbitration Association (“AAA Rules”). The Billing Guidelines also included a clause that stated that the issue of “arbitrability shall…be decided by the arbitrator, and not by any other person.”
The Services Agreement contained an arbitration, venue and jurisdiction clause requiring arbitration, venue and jurisdiction in Delaware for all disputes other than “Article V disputes and certain fee disputes.”
Following execution of the Engagement Letter, three captive insurance companies (the “Captives”) were formed, which would underwrite alternative-risk programs for OSI. Once the Captives were formed, PoolRe Insurance Corp. (“PoolRe”) issued a series of insurance policies to OSI. PoolRe also entered into its own reinsurance agreements with each of the three Captives (“Reinsurance Agreements”).
The Reinsurance Agreements between PoolRe and the Captives contained an arbitration clause with three requirements: (1) the application of International Chamber of Commerce (ICC) arbitration rules; (2) that arbitration take place in the Territory of Anguilla, B.W.I.; and (3) that the arbitrator be selected by the Anguilla, B.W.I. Director of Insurance.
The Ramos Arbitration
Disputes arose between OSI, Capstone, the Firm, and eventually PoolRe. Capstone filed an arbitration demand against OSI with Conflict Resolution Systems, PLLC (“CRS”), a Texas-based company. Dion Ramos (“Ramos”) of CRS appointed himself arbitrator. When OSI first appeared in the Ramos arbitration, it objected to Ramos’ authority and moved to dismiss the arbitration based on the Services Agreement’s venue clause. PoolRe and the Firm intervened in the Ramos arbitration. PoolRe specifically joined for the purpose of requesting that Ramos appoint an Anguilla-based arbitrator, per the Reinsurance Agreements.
Ramos, applying AAA rules, found that he had jurisdiction over Capstone’s claims pursuant to the Billing Guidelines. He also found that he had jurisdiction over PoolRe’s claims and that PoolRe waived its right to arbitration in Anguilla by intervening.
The Delaware Proceedings
Soon after the Ramos arbitration began, OSI and the Captives sued Capstone in Delaware (the “OSI and Captive Dispute”). OSI and the Captives did not name PoolRe in its suit. In response, Capstone filed a motion to dismiss claiming the Billing Guidelines required that the arbitrability of the OSI and Captive Dispute be decided by the arbitrator — in this case, Ramos.
The court found, based on the language in the Billing Guidelines and Services Agreement that the OSI and Captive Dispute (not involving an Article V or fee dispute) was to be resolved by arbitration in Delaware. Following the ruling, OSI initiated arbitration proceedings in Delaware, and on OSI’s motion, the court compelled Capstone to join the OSI arbitration. Capstone appealed the order, but the Third Circuit affirmed.
Meanwhile, in Texas
Ramos determined that OSI breached its contracts with Capstone, PoolRe, and the Firm, and denied all of OSI’s counterclaims.
Following Ramos’s ruling, PoolRe filed a petition to confirm the award with the Texas district court. The Texas district court found that Ramos exceeded his authority by both exercising jurisdiction over and applying AAA rules to the dispute between PoolRe and the Captives. The court found that this “tainted the entire process” and vacated the award. Capstone and PoolRe appealed the district court’s decision.
The Fifth Circuit Appeal
The Fifth Circuit affirmed the district court’s holding that Ramos exceeded his authority and thus properly vacated the award. The court explained that under the Federal Arbitration Act (“FAA”), district courts may vacate arbitration awards in limited circumstances, including where arbitrators exceed their powers. See 9 U.S.C. § 10(a)(4).
The Reinsurance Agreements between PoolRe and the Captives required ICC arbitration before an arbitrator selected by the Anguilla, B.W.I. Director of Insurance. Despite the fact that no such official existed, the court emphasized that parties are generally free to structure their arbitration agreements as they see fit. By disregarding the provision designating who would select the arbitrator, Ramos disregarded an integral part of the agreement between PoolRe and the Captives. As demonstrated here, the consequences of not following the arbitration agreement method are severe: “arbitration awards made by arbitrators not appointed under the method provided in the parties’ contract must be vacated.” PoolRe at *5 (emphasis added).
While it was impossible to appoint an arbitrator in accordance with the Reinsurance Agreements because no Anguilla Director of Insurance existed, the FAA provides a solution. Under Section 5 of the FAA, a party may move the district court to appoint an arbitrator if “for any reason there [is] a lapse in the naming of an arbitrator. 9 U.S.C. § 5. “Lapse” is defined as “a lapse in time in the naming of an arbitrator or in the filling of a vacancy on a panel of arbitrators, or some other mechanical breakdown in the arbitrator selection process.” In short, the parties should have gone to the court before proceeding with Ramos.
Ramos made one other critical mistake. He acted contrary to the Reinsurance Agreements’ clause requiring that all disputes be decided under ICC rules and be submitted for binding, final, non-appealable arbitration to the ICC. The court emphasized that the forum and rules the parties choose are an essential part of the agreement. In PoolRe, Ramos applied AAA rules to parties who negotiated for ICC rules.
Finally, the Fifth Circuit discussed why the district court did not err when it vacated the entire award — an admittedly harsh result. The other recipients of the award argued that even if Ramos improperly arbitrated the dispute between PoolRe and the Captives, the district court should have only vacated the award in part (i.e., only vacate the award as to PoolRe). The Fifth Circuit disagreed noting that the district court found that the missteps in arbitration “tainted the entire process” and that the FAA allows district courts to enter an order vacating an arbitration award if the arbitrators exceed their powers. 9 U.S.C. § 10(a)(4).
Conclusion
As a result of inconsistent, poorly drafted and unenforceable arbitration agreements, the parties in PoolRe participated in two separate arbitrations (one of which the Fifth Circuit vacated), two district court cases and two appeals. The parties participated in needless and expensive litigation that could have been avoided with careful drafting and analysis.
The holding in PoolRe teaches a few important lessons. First, courts will enforce arbitration provisions in contracts as written so it is essential to read arbitration provisions carefully prior to executing an agreement. Second, if there is any doubt or objection about the propriety of an arbitrator or the arbitrator selection process, the FAA provides an avenue for solving the dilemma (go to the district court) to avoid costly and time-consuming litigation down the road. Third, consolidating arbitrations (i.e. by having a party intervene or join) can be especially problematic when the arbitration agreements involve different rules and forums. And finally, it never hurts to make sure that the arbitrator-selection process is actually viable before signing an agreement.
PoolRe’s word to the wise for construction industry professionals: check the dispute resolution provision in your contract to confirm that it is harmonious with other relevant contracts on the same project to avoid the convoluted and expensive disputes in the PooleRe case.
1The author acknowledges the contribution of Sierra Sterling of Laurie & Brennan, LLP to this article.