Arbitration Clause Does Not Trigger McCarran-Ferguson Reverse Preemption

On February 18, 2016, the Court of Appeals issued a decision in Matter of Monarch Consulting, Inc. v. National Union Fire Insurance Co. of Pittsburgh, PA, 2016 NY Slip Op. 01209, unanimously reversing a decision of the Appellate Division First Department and enforced arbitration agreements in a series of insurance-related cases. (We examined the First Department's decision in this dispute here.)

The First Department ruling under appeal addressed three separate actions involving California insurance regulations. In each, National Union and their insured had entered into California workers' compensation insurance policies, and had subsequently entered into "Payment Agreements" deferring payments due under the insurance policies in exchange for the insureds providing collateral. The Payment Agreements contained arbitration agreements and required any court proceeding concerning arbitration to take place in New York. California law requires any workers’ compensation insurance policy, as well as collateral agreements thereto, be filed with and approved by the California Department of Insurance, and the Payment Agreements had not been so filed. Accordingly, when disputes arose the insureds (supported by the California Department of Insurance) argued that the Payment Agreements were unenforceable, and the arbitration agreements void, because they were illegal under California law.

In two of the actions, National Union prevailed before the Supreme Court, which ordered arbitration to proceed, but the insureds prevailed in the third. The First Department consolidated the three cases and, in a 3-2 decision, ruled in favor of the insureds, declaring the arbitration agreements unenforceable.

The principal legal issue presented was how any conflict between California insurance law and the Federal Arbitration Act, which provides that arbitration agreements should be "rigorously enforced," should be resolved. Congress has long recognized that the states play an important role in regulating insurance, and to that end, the McCarran-Ferguson Act, 15 USC § 1011 et seq., was enacted. In effect, McCarran-Ferguson provides that, unless a federal statute specifically relates to insurance, it does not preempt state insurance laws (also known as McCarran-Ferguson reverse preemption). Specifically,

the McCarran-Ferguson Act applies if: (1) the federal statute in question does not specifically relate to insurance; (2) the state law at issue was enacted to regulate the business of insurance; and (3) the federal statute at issue would invalidate, impair, or supersede the state law.

The first two elements were satisfied—the FAA does not specifically relate to insurance, whereas the California law does—but the Court of Appeals held that application of the FAA did not "impair" the California law. First, the California law "did not, at relevant times, prohibit, limit, or regulate the use or form of arbitration clauses in [workers' compensation] insurance contracts." Second, "the purpose of the filing rule is to ensure that the insurance documents comply with the Insurance Code and accompanying regulation—none of which pertained to the use or form of arbitration provisions." Third, regardless of whether an arbitrator or a court considered the question of enforceability of unfiled agreements, in neither case would the question be determined by the Department of Insurance, so "application of the FAA would [not] undercut the Department's authority to review insurance agreements and incentivize violations of the filing requirements." Furthermore, the Department of Insurance could still bring its own enforcement action against National Union.

The Court of Appeals went on to decide that, because the insured's objection was that the Payment Agreements in their entirety were unenforceable, they were making "an attack on the validity of the contract, as distinct from [an attack] on the validity of the arbitration clause itself," the issue of whether the failure to file the Payment Agreements with the Department of Insurance rendered them unenforceable should be decided by the arbitrators, applying California law.

This decision is yet another example of how readily agreements to arbitrate are enforced—even where the insureds had a strong claim that their arbitration agreements violated state insurance law, and state insurance law has supremacy over contradictory federal laws, arbitration was still required.