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Citizens of Humanity v. Applied Underwriters, Inc.

In Citizens of Humanity v. Applied Underwriters, Inc., ___ Cal. App. 5th __ (2017), the California Court of Appeal, Second Appellate District affirmed the trial court’s denial of various defendants’ petition to compel arbitration with plaintiffs Citizens of Humanity, LLC and CM Laundry, LLC (collectively, “Plaintiffs”).

Plaintiffs purchased from the named defendants a workers’ compensation insurance package and entered into a Reinsurance Participation Agreement (“RPA”) with Applied Underwriters Captive Risk Assurance Company, Inc. (“AUCRA”), an affiliate of the other defendants. The agreement contains an arbitration provision that provides, in pertinent part, that disputes concerning the construction and enforceability of the provision are to be determined exclusively by binding arbitration. The agreement also contains a choice of law provision, stating that Nebraska law will govern without regarding to any conflict of laws. The other agreements between the parties do not contain an arbitration provision.

In February 2015, plaintiffs filed a complaint against defendants and AUCRA alleging causes of action against AUCRA for fraudulent inducement in entering into the arbitration agreement, breach of contract, and breach of the covenant of good faith and fair dealing; and against all of the defendants for fraud, false advertising, breach of fiduciary duty, professional negligence, and declaratory relief.

The parties filed competing motions to compel and to stay arbitration of their dispute. In their motion to stay the arbitration, plaintiffs argued that Nebraska law applied pursuant to the choice of law provision in the RPA and that the arbitration provision of the RPA was void under section 25-2602.01(f)(4) of the Nebraska Uniform Arbitration Act (NUAA), which prohibits arbitration of “any agreement concerning or relating to an insurance policy.” Plaintiffs further argued that the Federal Arbitration Act (9 U.S.C. §§ 1–16) (FAA) did not preempt the NUAA because another federal statute, the McCarran-Ferguson Act (15 U.S.C. §§ 1011–1015) mandates that state laws “regulating the business of insurance” preempt any federal statute not specifically related to the business of insurance and that impairs state insurance laws. (15 U.S.C. § 1012(b).) Defendants argued that the FAA governs and preempts the NUAA, and that under the RPA's broad delegation clause, any issue concerning arbitrability should be resolved by the arbitrator.

Before the hearing on defendants' motion to compel arbitration, plaintiffs dismissed AUCRA as a defendant. Plaintiffs then argued that the motion to compel arbitration should be denied because the only defendant that had signed the RPA had been dismissed. At the hearing on defendants' motion, the trial court requested supplemental briefing from the parties on a number of issues, including whether California or Nebraska law should be applied to determine whether defendants have the right to enforce the RPA's arbitration provision, whether Nebraska law bars arbitration of the parties' dispute, and whether the FAA or the McCarran-Ferguson Act applies.

In their supplemental brief, plaintiffs argued, among other things, that the McCarran-Ferguson Act displaced the FAA, that both California and Nebraska law applied to bar arbitration, and that the court, not the arbitrator, should determine the consequences of applying the McCarran-Ferguson Act. Defendants argued that the RPA's delegation clause required all questions concerning construction and enforceability of that agreement, including applicability of the NUAA, to be decided by the arbitrator, and that the FAA governed the arbitration provision, which was not displaced by the general choice of law provision.

Following a July 8, 2016 hearing, the trial court denied the motion to compel arbitration. In its written order denying the motion, the trial court first addressed the threshold question of who should decide—the court or the arbitrator—the arbitrability of the parties' dispute. The court noted that defendants' sole basis for arguing that the arbitrator rather than the court should decide this issue was the FAA and cases decided thereunder. The trial court then noted that a potential conflict existed between the FAA and the McCarran-Ferguson Act, which allows state laws enacted for the purpose of regulating the business of insurance to reverse preempt the FAA. After analyzing applicable federal case law on the reverse preemption issue, the trial court concluded that reverse preemption applied under the McCarran-Ferguson Act and that Nebraska law applied to invalidate the arbitration clause in the RPA. The trial court denied the motion to compel arbitration and this appeal followed.

The Court determined the standard of review on appeal is de novo as the denial of the petition to compel arbitration presented “a pure question of law.”

The Court then turned to the statutes at issue on appeal:

A. The NUAA

Section 25-2602.01(b) of the NUAA provides that a written agreement to arbitrate disputes between the contracting parties “is valid, enforceable, and irrevocable, except upon such grounds as exist at law or in equity for the revocation of any contract, if the provision is entered into voluntarily and willingly.” (Neb. Rev. Stat., § 25-2602.01(b).) Subsection (f)(4) of that statute, however, excepts from this provision “any agreement concerning or relating to an insurance policy,” thereby prohibiting agreements to arbitrate certain insurance-related disputes.

B. The FAA

The FAA reflects the fundamental principle that arbitration is “a matter of contract.” (Rent-A-Center, West, Inc. v. Jackson (2010) 561 U.S. 63, 67 [177 L.Ed.2d 403, 130 S.Ct. 2772] (Rent-A-Center).) Section 2 of the FAA makes arbitration agreements in contracts “involving commerce … valid, irrevocable, and enforceable” (9 U.S.C. § 2), and section 4 of the FAA provides for federal district court enforcement of such agreements. The “‘body of federal substantive law’” created by the FAA is applicable, however, in both state and federal courts. (Southland Corp. v. Keating (1984) 465 U.S. 1, 12 [79 L.Ed.2d 1, 104 S.Ct. 852].) State law therefore cannot bar enforcement of the FAA, even in the context of state law claims brought in state court. (Buckeye Check Cashing, Inc. v. Cardegna (2006) 546 U.S. 440, 445 [163 L.Ed.2d 1038, 126 S.Ct. 1204].) The FAA thus ordinarily preempts conflicting state laws that prohibit arbitration of particular types of claims. (AT&T Mobility LLC v. Concepcion (2011) 563 U.S. 333, 341 [179 L.Ed.2d 742, 131 S.Ct. 1740].)

C. McCarran-Ferguson Act

The federal McCarran-Ferguson Act provides a narrow exception to federal preemption of conflicting state laws that regulate the business of insurance. Section 1012(b) of the McCarran-Ferguson Act provides: “No 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 McCarran-Ferguson Act thus allows state law to reverse-preempt an otherwise applicable federal statute, because the McCarran-Ferguson Act does not permit an ‘Act of Congress’ to be ‘construed to invalidate, impair, or supersede’ state law unless the Act of Congress ‘specifically relates to the business of insurance.’” (Safety National Casualty Corp. v. Certain Underwriters (5th Cir. 2009) 587 F.3d 714, 720.)

The principal issues presented here are (1) whether the McCarran-Ferguson Act causes the NUAA to reverse preempt the FAA, thereby rendering the arbitration provisions of the RPA unenforceable; and (2) who—a court or an arbitrator—should decide the preemption/ enforceability issue. We address the latter of these issues first.

The Court addressed the preliminary issue of who determines arbitrability, noting there needs to be “clear and unmistakable” evidence that the parties intend to submit such issues to an arbitrator for a court to assume so. Defendants argued the RPA expresses such an intent, pointing to language in the RPA such as that “[a]ll disputes arising with respect to any provision of this Agreement” are to be submitted exclusively to binding arbitration. The Court, however, noted that these provisions needed to be viewed in context of the whole agreement – including the provision that Nebraska law governed, and the entire agreement may be potentially unenforceable – as well as the applicable statutory framework. The Court determined that, in such context, the language “is not clear and unmistakable evidence of the parties’ agreement to arbitrate disputes arising under that agreement, including disputes concerning arbitrability.” The Court also rejected defendants’ contention that Rent-A-Center (supra) precludes judicial determination of arbitrability, finding “Rent-A-Center did not involve application of the McCarran-Ferguson Act or the NUAA and is therefore distinguishable from the instant case.” The Court found the Ninth Circuit’s decision in Van Dusen v. United States District Court for the District of Arizona, 654 F.3d 838 (9th Cir. 2011) to be instructive on the question of whether the McCarran-Ferguson Act and the NUAA preempt the FAA to be a “‘question of arbitrability’ that can legally be delegated to an arbitration.” In Van Dusen, the Ninth Circuit determined that “the question of whether the FAA confers authority on the court to compel arbitration” does not fall within “questions of arbitrability.” Similarly, the First Circuit relied on Van Dusen in determining that whether the FAA confers authority on a district court to compel arbitration is not a question of arbitrability and, as such, could not legally be delegated to an arbitration. Oliveira v. New Prime, Inc. 857 F.3d 7 (1st Cir. 2017). The Court concluded “the trial court did not err by denying defendants’ motion to compel arbitration of the preemption issue and the validity of the arbitration agreement.” 

The Court next turned to the validity of the RPA, which “turns on whether the Mc-Carran Ferguson Act applies, whether section 25-2602.01(f) of the NUAA applies, and whether those two statutes together preempt the FAA.”

Courts apply a three-part test for determining whether the McCarran-Ferguson Act causes a state law to reverse preempt a federal statute: (1) whether the federal statute to be preempted specifically relates to the business of insurance, (2) whether the state law was enacted for regulating the business of insurance, and (3) whether application of the federal statute operates to invalidate, impair, or supersede the state law. [Citations.]

It is undisputed that the FAA does not regulate the business of insurance, and that application of the FAA in this case would invalidate section 25-2602.01(f) of the NUAA. The determinative inquiry is whether section 25-2602.01(f) of the NUAA was enacted for the purpose of regulating the business of insurance within the meaning of the McCarran-Ferguson Act.

The Court found guidance from the United States Supreme Court’s decision in Department of Treasury v. Fabe, 508 U.S. 491 (1993). There, the Supreme Court determined that “an Ohio statute governing the priority of claims against an insolvent insurer is a ‘law enacted . . . for the purpose of regulating the business of insurance’” for purposes of the McCarran-Ferguson Act despite contrary argument that the law was a bankruptcy law.

Applying the principles articulated in Fabe, the Nebraska Supreme Court in Kremer, supra, 788 N.W.2d 538, addressed the precise issue presented here—whether section 25-2602.01(f) of the NUAA is a state law enacted for the purpose of regulating the business of insurance within the meaning of the McCarran-Ferguson Act. The court in Kremer held that it was, and that section 25-2602.01(f) accordingly reverse preempts the FAA through application of the McCarran-Ferguson Act. (Kremer, at p. 553.) The Nebraska Supreme Court reaffirmed this principle in Speece v. Allied Professionals Ins. Co. (2014) 289 Neb. 75 [853 N.W.2d 169, 175].

Federal courts applying Fabe have likewise concluded that the FAA is reverse preempted under state laws similar to the Nebraska statute at issue here. [Citations.]

Consistent with the principles articulated in Fabe, supra, 508 U.S. 491, as applied by federal appellate courts and the Nebraska Supreme Court, we agree with the trial court's conclusion in the instant case that section 25-2602.01(f) of the NUAA is a state law enacted for the purpose of regulating the business of insurance. If the NUAA applies in the instant case, by operation of the McCarran-Ferguson Act, it reverse preempts the FAA.

The Court then addressed defendants’ claim that the RPA provision requiring Nebraska law to govern only applies to resolution of the substantive claims, and does not incorporate state law rules limiting arbitration, citing to Mastrobuono v. Shearson Lehman Hutton, Inc., 514 U.S. 52 (1995). The Court found Mastrobuono distinguishable because the distinction the Supreme Court drew was solely as a means of giving effect to two provisions that pointed to conflicting bodies of law, noting that the RPA has a single provision that “unambiguously provides” Nebraska law will govern. The Court also declined to follow the “advisory interpretation” of the NUAA by the Third Circuit Court of Appeal in South Jersey Sanitation v. Applied Underwriters Captive Risk Assurance Co., 840 F.3d 138 (3d Cir. 2016) that limited application of the NUAA to insurance policies only, finding that Court’s decision to be “inconsistent with the plain language of the statute.” The Court then rejected defendants’ argument that application of Nebraska law to this dispute “would result in impermissible ‘extraterritorial’ regulation by a state,” finding defendants’ citation in support thereof (to a decision regarding a Nebraska statute that expressly attempted to regulate the conduct of an insurer in another jurisdiction) to be inapposite. The Court found “[t]he NUAA by its terms does not seek to regulate activities carried on outside Nebraska. The NUAA applies in the instant case because the parties contractually agreed to its application.” 

The Court concluded:

The threshold issue of whether the FAA applies or is preempted by the McCarran-Ferguson Act and section 25-2602.01(f) of the NUAA was for the court, and not the arbitrator, to decide. The trial court did not err by adjudicating this gateway issue.

The trial court did not err by concluding that section 25-2602.01(f) of the NUAA is a statute that regulates the business of insurance within the meaning of the McCarran-Ferguson Act.

Application of the FAA would operate to invalidate or impair section 25-2602.01(f) of the NUAA. The trial court did not err by concluding that the McCarran-Ferguson Act applies and reverse preempts the FAA.

Section 25-2602.01(f) of the NUAA applies to the RPA and renders the arbitration provision contained in the RPA unenforceable. The trial court accordingly did not err by denying the petition to compel arbitration.

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