Federal Arbitration Act Does Not Apply to California Insurance Law Requiring Arbitration Agreements to be Filed With State

On September 11, 2014, the First Department issued a decision in Matter of Monarch Consulting, Inc. v. National Union Fire Ins. Co. of Pittsburgh, PA., 2014 NY Slip Op. 06158, addressing the interplay between the Federal Arbitration Act's preemption of state rules invalidating arbitration agreements and the McCarran-Ferguson Act, 15 U.S.C. § 1011, which prevents federal statutes from preempting state laws "regulating the business of insurance," unless the statute "specifically relates to the business of insurance."

In Matter of Monarch Consulting, an insurance carrier sought to enforce arbitration provisions in payment agreements collateral to workers' compensation insurance policies. The policyholders argued that the arbitration provisions were unenforceable because the payment agreements had not been filed with the California Division of Insurance, as required by California law. Ordinarily, notwithstanding state laws to the contrary, the Federal Arbitration Act requires that disputes concerning the validity of a contract containing an arbitration provision (as opposed to a challenge to the validity of the arbitration clause alone) are to be decided by the arbitrators in the first instance, rather than the courts. In this case, the analysis was complicated by the McCarran-Ferguson Act, which, in an effort to preserve the supremacy of the states in regulating the insurance industry, establishes a rule of "reverse preemption": i.e., that no federal statute "shall be construed to invalidate, impair or supersede any law by any State for the purpose of regulating the business of insurance," unless the federal statute "specifically relates to the business of insurance." The First Department held that "applying the FAA to mandate arbitration in this case would, in fact, invalidate, impair, or supersede the California Insurance Code. Therefore, the McCarran-Ferguson Act prevents the FAA from preempting the Code." The Court explained:

As noted above, the McCarran-Ferguson Act was an attempt to assure that the activities of insurance companies in dealing with their policyholders would remain subject to state regulation. Courts have established a four-part test to determine whether the McCarran-Ferguson Act precludes application of a federal statute (in this case, the FAA). Under this test, a federal statute is precluded if: (1) the statute does not specifically relate to the business of insurance; (2) the acts challenged under the statute constitute the business of insurance; (3) the state has enacted laws regulating the challenged acts; and (4) the state laws would be invalidated, impaired, or superseded by application of the federal statute.

First of all, the FAA does not specifically regulate the business of insurance, and an act specifically relating to the business of insurance is the only type of federal legislation that can preempt state insurance law under McCarran-Ferguson. Furthermore, application of the FAA would modify California law because it would mandate arbitration even though National Union did not, as required by California law, file the payment agreements, and the payment agreements, in turn, contained the arbitration clauses.

* * *

While the California Insurance Code § 11658 does not provide any prohibition against arbitration, enforcing the arbitration clause in this case would nonetheless undermine the goals of California law relating to workers' compensation insurance by enforcing the arbitration provision in a payment agreement that National Union failed to file. Indeed, the filing requirements are a fundamental underpinning for California's regulation of workers' compensation insurance, and those filing requirements are intended largely to permit review of arbitration provisions — provisions, as we noted above, with which the CDI has stated that it is particularly concerned.

(Internal quotations, elision and citations omitted.)

Justice Gische dissented in an opinion joined by Justice Manzanet-Daniels. The dissenters concluded that application of the FAA to require arbitration did not "impair" California insurance law, and therefore "the arbitrators, and not the court, should decide the gateway issue of whether the Payment Agreements containing the arbitration clauses are enforceable":

Neither California Insurance Code § 11658, nor any other provision of the California Workers' Compensation Laws, provide an express or implied prohibition against arbitration in insurance disputes. . . .

Relatedly, arbitration does not impair the California legal requirement that workers' compensation insurance policies must be filed, thereby providing the Commissioner of Insurance with an opportunity to review the policies, because California law does not restrict the power of an arbitrator to address whether the Payment Agreements in these cases were required to be filed, and if so, what the consequences for the failure to file the agreements would be.

(Citations omitted).

Matter of Monarch Consulting is second recent First Department Decision on commercial arbitration that is likely headed to the Court of Appeals, given the 2-justice dissent at the First Department. On August 25, we blogged about the Court's decision in In re Flintlock Construction Services, LLC v. Weiss, NY Slip Op 05818, which held (by a 3-2 vote) that a choice of law provision providing that the parties' agreement was to be "construed and enforced" in accordance with New York law was not sufficient to invoke the state's public policy against the imposition of punitive damages in a private arbitration, and therefore, the issue of punitive damages could be submitted to the arbitrators. We will continue to follow both of these cases.