Stephens v. American International Insurance

Citation: 66 F.3d 41Docket: No. 1516, Docket 94-9143

Court: Court of Appeals for the Second Circuit; September 14, 1995; Federal Appellate Court

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The Kentucky Insurers Rehabilitation and Liquidation Law's anti-arbitration provision is deemed to regulate the business of insurance, thus preserving it from preemption by the Federal Arbitration Act (FAA) under the McCarran-Ferguson Act. Consequently, the Liquidator cannot be compelled to arbitrate, resulting in the reversal of the Southern District of New York's order compelling arbitration. Delta America Re Insurance Company, a Kentucky-chartered reinsurance firm, was declared insolvent in 1985, leading to the appointment of a Liquidator under the Kentucky Liquidation Act. The Liquidator filed a suit against various Cedents seeking recovery of owed premiums and enforcement of future payment obligations. The Cedents, however, claimed a right to set off these premiums against losses owed to them by Delta, which the Liquidator contended was prohibited under the Kentucky Liquidation Act. The dispute involved various arbitration clauses in reinsurance contracts, with some Cedents seeking to compel arbitration under the FAA. The Liquidator opposed these motions, citing a statutory prohibition against compelling arbitration in delinquency proceedings as outlined in Ky. Rev. Stat. Ann. 304.33-010(6).

The Liquidator contended that the Kentucky Liquidation Act's section invalidates the arbitration clauses pertinent to the case. Conversely, the Cedents argued that the Federal Arbitration Act (FAA) preempts this section. The Liquidator maintained that the FAA is inapplicable due to the McCarran-Ferguson Act, which preserves state regulations related to insurance from federal preemption, asserting that the FAA does not pertain to insurance. The District Court ruled that the Liquidation Act's anti-arbitration provision was not intended to protect policyholders and thus does not fall under the purview of insurance regulation that would exempt it from FAA preemption, leading to the court's decision to compel arbitration.

The Court granted the Liquidator permission to appeal the interlocutory order compelling arbitration, invoking jurisdiction under 28 U.S.C. 1292(b). The discussion highlighted that generally, arbitration clauses are enforceable under the FAA, which would preempt conflicting state laws unless a specific exception applies. The McCarran-Ferguson Act creates an exception for state laws aimed at regulating the insurance business, stipulating that federal laws cannot invalidate such state laws unless they specifically relate to insurance.

The Liquidator argued that the Kentucky Liquidation Act qualifies as a law regulating insurance; however, the Cedents countered that the District Court correctly found the anti-arbitration provision does not protect policyholders, thus failing to regulate insurance as defined by judicial precedent. The Supreme Court’s three-part test for determining what constitutes the "business of insurance" includes whether a practice transfers policyholder risk, is integral to the insurer-insured relationship, and is limited to the insurance industry. Reinsurance practices meet all three criteria. The remaining issue is whether the Kentucky Liquidation Act was enacted to regulate insurance under the McCarran-Ferguson framework.

In Fabe, the Supreme Court established that for state laws to qualify as regulations of the business of insurance under the McCarran-Ferguson Act, they must be aimed at protecting or regulating the relationship between insurers and insured parties. The Court emphasized that the core of the business of insurance includes the interactions and contracts between insurance companies and their policyholders. The Kentucky Liquidation Act specifically addresses the liquidation of insurance companies and renders arbitration clauses unenforceable during this process, thus regulating the performance of insurance contracts in cases of insolvency. 

The Cedents argue that the Act's anti-arbitration provision does not protect policyholders but instead undermines their right to arbitration, claiming it is not shielded from federal preemption by McCarran-Ferguson. However, this interpretation of 'protection' is deemed too narrow. The Fabe decision indicates that laws aimed at adjusting or controlling the business of insurance inherently regulate the relationship between policyholders and insurers. The Kentucky Liquidation Act serves to protect policyholders by ensuring an orderly liquidation process for insolvent insurers, with the anti-arbitration provision being a component of this regulatory framework.

The District Court did not examine the foreign reinsurers' arguments pertaining to international agreements and the Convention because it found the anti-arbitration provision was not enacted to protect policyholders and thus not preserved by McCarran-Ferguson. British Aviation and RECO contend that, as foreign entities, the Convention mandates arbitration for their claims, irrespective of the Liquidation Act's status concerning domestic Cedents.

The argument presented asserts that the Convention should override the Kentucky Liquidation Act under the Supremacy Clause. However, this is refuted based on the Convention's non-self-executing nature, which necessitates an Act of Congress for implementation as per 9 U.S.C. 201-208 (1994). Treaties are fundamentally contracts between nations, not legislative acts, and do not automatically achieve their intended effects without execution by the sovereign powers involved. The U.S. Constitution recognizes treaties as law, equivalent to legislative acts only when they operate independently of legislative provisions. When a treaty requires specific actions from the parties, it is a political matter that necessitates legislative action for judicial enforcement, as established in Foster v. Neilson.

Furthermore, the McCarran-Ferguson Act specifies that no federal law should be interpreted to supersede laws regulating the insurance business. Consequently, the implementing legislation does not preempt the Kentucky Liquidation Act, which regulates insurance and protects policyholders. Therefore, the Kentucky Liquidation Act remains valid and is not overridden by the Federal Arbitration Act. As a result, the Liquidator cannot be forced to arbitrate, leading to the reversal of the District Court's order. Additionally, although Reinsurance Corporation of New York (RECO) is subject to the Convention and is pursuing arbitration, it is doing so under a different jurisdiction in New York. The Court addressed previous cases interpreting the "business of insurance" within the context of the McCarran-Ferguson Act, which is relevant to the current case.