Nielsen Contracting, Inc. v. Applied Underwriters, Inc.
In Nielsen Contracting, Inc. v. Applied Underwriters, Inc., 22 Cal. App. 5th 1096 (2018), the Fourth District Court of Appeal affirmed the trial court’s denial of a motion to compel arbitration and stay litigation filed by defendant Applied Underwriters, Inc. (“Applied”), seeking to compel arbitration of a workers compensation dispute pursuant to an arbitration provision in a Reinsurance Participation Agreement (“RPA”).
Nielsen Contracting, Inc. (“Nielsen”) signed a “Request to Bind” with Applied for its patented workers’ compensation program known as “EquityComp.” Under the agreement, California Insurance Company (“CIC”), a subsidiary of Applied, issued Nielsen a guaranteed-cost workers’ compensation policy. The Request to Bind also required Nielsen to sign the RPA with Applied Underwriters Captive Risk Assurance Company, Inc. (“AUCRA”), another of Applied’s subsidiaries. Nielsen and AUCRA signed the RPA in December 2012, with a three-year term.
The RPA modified and supplanted many of the terms in the CIC policy, including adding an arbitration provision which provided, in relevant part:
“(A) It is the express intention of the parties to resolve any disputes arising under this Agreement without resort to litigation in order to protect the confidentiality of their relationship and their respective business and affairs. Any dispute or controversy … arising out of or related to this Agreement shall be fully determined in the British Virgin Islands under the provisions of the American Arbitration Association.
“(B) All disputes between the parties relating in any way to (1) the execution and delivery, construction or enforceability of this Agreement, (2) the management or operations of the Company, or (3) any other breach or claimed breach of this Agreement or the transactions contemplated herein shall be … finally determined exclusively by binding arbitration in accordance with the procedures provided herein. … [¶] … [¶]
In June 2016, the California Insurance Commissioner issued an administrative decision in a case involving a different insured, Shasta Linen Supply, Inc., who had challenged the same EquityComp insurance program offered by Applied, AUCRA, and CIC (collectively, “Defendants”). The Commissioner found that the RPA was unlawful and void as a matter of law for several reasons, including that it had not been filed and approved by the Department of Insurance (“Department”) before it was issued. The Commissioner also determined that the governing administrative regulations required workers’ compensation insurers to obtain approvals for any “side agreements,” including any arbitration provisions differing from the dispute resolution provisions contained in a previously approved insurance policy. Two months later, the Department entered into a stipulated cease and desist order with Defendants, by which they stated that they disagreed with the administrative decision, but acknowledged its precedential effect under Government Code section 11425.60(b), and agreed that they would not issue any new RPAs or renew any existing RPA unless the policy was filed with and approved by the Department.
In January 2017, Nielsen sued Defendants, seeking a declaration that the RPA was void and its provisions unconscionable, as well as damages for Defendants’ misrepresentations and breach of the implied covenant of good faith and fair dealing. Nielsen alleged that the RPA was an adhesion contract with unconscionable terms, it was written and structured to purposely mislead Nielsen and intentionally circumvent California insurance laws, and it was an illegal contract because it was not filed with or approved by the Department.
In response to the complaint, AUCRA moved to compel arbitration pursuant to the RPA’s arbitration provision. AUCRA argued that paragraph (B) requiring arbitration of disputes concerning “enforceability of this Agreement” constituted a delegation clause that gave the arbitrator exclusive authority to determine the enforceability of the agreement. Alternatively, AUCRA argued that, if the court was permitted to rule on the arbitrability issues, the arbitration clause was valid and enforceable.
Nielsen opposed the motion to compel, arguing that the delegation clause was severable from the RPA and the arbitration clause, and the court must first resolve its specific challenge to the enforceability of the delegation clause. The trial court denied Defendants’ motion to compel, finding that it had authority to decide the enforceability of the delegation clause because Nielsen had specifically asserted that “‘both the delegation provision and the arbitration provision are illegal and unenforceable separate and apart from the evident unenforceability of the entire RPA, albeit for the same reason, i.e., failure to file with, and obtain approval from, the Insurance Commissioner.’” The trial court held that neither the delegation clause nor the arbitration provision were enforceable.
On appeal, the Fourth District Court of Appeal affirmed, finding that the trial court properly decided the enforceability of the delegation clause, and that neither the delegation clause nor the arbitration provision were enforceable.
The parties agreed that the delegation clause expressed a clear intent to delegate the issue of enforceability of the arbitration clause to the arbitrator, but that applicable law required the court to rule on specific challenges to the enforceability of delegation clauses before compelling a matter to arbitration. They disagreed as to whether Nielsen had raised an adequate challenge to the delegation clause, such that judicial resolution of the challenge was required.
The appellate court first examined the United States Supreme Court’s decision in Rent-A-Center, W., Inc. v. Jackson, 561 U.S. 63 (2010), which addressed the issue of whether the court or the arbitrator rules on a challenge to the enforceability of a delegation clause under the Federal Arbitration Act (“FAA”), as the parties agreed that the RPA was governed by the FAA.
The high court began this analysis by confirming that a delegation clause—nested within the larger arbitration agreement—must be viewed as an independent (“severable”) contract. (Id. at pp. 70–71.) Thus, the court held that as with any independent contract, the court must resolve specific challenges to the delegation clause that are proper under section 2 of the FAA, i.e., any “‘generally applicable contract defenses.’” (Rent-A-Center, at pp. 68, 71.) “If a party challenges the validity under [FAA] § 2 of the precise agreement to arbitrate at issue, the federal court must consider the challenge before ordering compliance with” the delegation clause. (Id. at p. 64.) Otherwise, courts would be treating the delegation clause on a ground that would “‘elevate it over other forms of contract,’” which is not permitted under the FAA. (Rent-A-Center, at p. 71.)
But—consistent with its severability reasoning—the Rent-A-Center court made clear this rule requiring judicial consideration of contractual defenses to the enforceability of the delegation clause is triggered only if the challenge is “directed specifically to the agreement to arbitrate.” (Rent-A-Center, supra, 561 U.S. at p. 71.) Thus, an argument that the arbitration agreement or the underlying contract is unenforceable is not sufficient to trigger the court's obligation to resolve contentions regarding the enforceability of a severable delegation clause. (Id. at pp. 71–76.)
The facts of Rent-A-Center illustrate this principle. There, the plaintiff filed an employment discrimination suit against his former employer. (Rent-A-Center, supra, 561 U.S. at p. 65.) The employer responded by seeking arbitration based on an arbitration agreement that was separate from the underlying employment contract and contained a delegation clause. (Id.at pp. 65–66.) The employee opposed the motion, arguing the arbitration agreement was unconscionable. (Id. at p. 66.) But the employee challenged only the validity of the arbitration contract and never “even mention[ed] the delegation provision.” (Id. at p. 72.) On this record, the United States Supreme Court found the arbitrator, and not the court, was to consider the enforceability of the delegation clause because the employee had not challenged the delegation provision. (Id. at pp. 72–76.) The court reasoned that the delegation clause must be viewed as a separate agreement nested within the arbitration agreement, and unless the clause is directly challenged, the arbitrator must resolve all of the disputed issues. (Ibid.)
Following Rent-A-Center, California courts have recognized that a court is the appropriate entity to resolve challenges to a delegation clause nested in an arbitration clause when a specific contract challenge is made to the delegation clause.
The appellate court determined that Nielsen had expressly raised challenges to the delegation clause:
In opposing the motion to compel, Nielsen argued the delegation clause was unenforceable because it constituted a material change to CIC's filed insurance policy (which contained no arbitration clause or delegation clause), and the RPA's delegation clause constituted an endorsement or collateral agreement that was required to be filed with the Insurance Department to be lawful and enforceable. Defendants countered by arguing California law does not require a delegation clause to be approved by the Insurance Department, and an unfiled arbitration provision and delegation clause remain lawful and enforceable. These issues relate specifically to the enforceability of the delegation clause, and thus under Rent-A-Center these issues are for the court to resolve.
Relying on Rent-A-Center, defendants contend a court may rule on the enforceability of the delegation clause only if the plaintiff's challenge to the delegation clause is different from the plaintiff's challenge to the entire contract or to the entire arbitration agreement. This argument is not supported by Rent-A-Center's holding or logic. The high court's determination that a court should generally resolve specific state law contractual defenses to delegation clauses was based on its view that delegation clauses are separate and severable from the remainder of the arbitration agreement and the FAA requires that arbitration provisions be enforced in the same manner as other types of contractual provisions. (Rent-A-Center, supra, 561 U.S. at pp. 67, 70–71 [under the FAA courts must “place arbitration agreements on an equal footing with other contracts”].) If we were to accept defendants' argument that courts are precluded from ruling on specific contract defenses to a delegation clause merely because the same defense is also brought to invalidate other related contractual provisions, we would be treating delegation clauses differently than other contractual clauses, a determination that would be inconsistent with the FAA, as interpreted by the United States Supreme Court.
The appellate court also rejected Defendants’ argument that Nielsen’s challenge was insufficient because it was directed at both the delegation clause and the arbitration agreement as a whole:
Rent-A-Center's discussion of the type of challenge that might have triggered court review supports our conclusion. In explaining that the plaintiff's unconscionability challenge specifically concerned only the validity of the contract as a whole, rather than the delegation provision, the high court noted that the plaintiff's “substantive unconscionability arguments assailed arbitration procedures called for by the [arbitration] contract—the fee-splitting arrangement and the limitations on discovery—procedures that were to be used during arbitration under both the agreement to arbitrate employment-related disputes and the delegation provision. It may be that had [the employee] challenged the delegation provision by arguing that these common procedures as applied to the delegation provision rendered that provision unconscionable, the challenge should have been considered by the court. To make such a claim based on the discovery procedures, [the employee] would have had to argue that the limitation upon the number of depositions causes the arbitration of his claim that the Agreement is unenforceable to be unconscionable. That would be, of course, a much more difficult argument to sustain than the argument that the same limitation renders arbitration of his factbound employment-discrimination claim unconscionable. Likewise, the unfairness of the fee-splitting arrangement may be more difficult to establish for the arbitration of enforceability than for arbitration of more complex and fact-related aspects of the alleged employment discrimination. [The employee], however, did not make any arguments specific to the delegation provision; he argued that the fee-sharing and discovery procedures rendered the entire Agreement invalid.” (Rent-A-Center, supra, 561 U.S. at p. 74.)
This hypothetical—that if the plaintiff had directed the unconscionability challenges (the unfairness of the discovery limitations and the fee-splitting requirements) against the delegation clause in addition to asserting the same unconscionability challenge against the arbitration agreement itself, the “challenge [to the delegation clause] should have been considered by the court”—illustrates that the focus of the court's attention must be on whether the particular challenge is directed at the delegation clause, not whether the same challenges are also directed at the agreement or agreements into which the delegation clause is embedded or nested. (Rent-A-Center, supra, 561 U.S. at p. 74.) Under Rent-A-Center's reasoning, whether the challenge is the same as or different from the challenge to other provisions of the arbitration clause or underlying agreement is not dispositive of whether the challenge is specifically directed at the delegation clause. (See Malone, supra, 226 Cal.App.4th at pp. 1559–1560.)
The appellate court also found support for its position in a recent federal decision relying on Rent-A-Center and addressing a similar RPA with AUCRA in an EquityComp program:
In Minnieland, the specific challenge to the delegation clause was the same as the challenge to the arbitration clause as a whole, but this fact did not preclude the reviewing court from upholding the district court's conclusion that it was the proper entity to rule on the enforceability of the delegation clause. (Ibid.)
The appellate court agreed that a party merely stating that it was challenging the delegation provision was insufficient to trigger judicial determination of the issue if it was merely a subterfuge to challenge the entire agreement as unenforceable,
[ b ]ut the need for a careful inquiry regarding the nature of the party's challenge does not support a blanket rule that any time there is a similar challenge to the delegation clause and to other contractual provisions, a court must ignore its statutory obligation to rule on state law contract defenses specifically asserted against the enforceability of the delegation clause.
The record supported the trial court’s determination that Nielsen had asserted a specific, substantive challenge to the delegation clause separate from the challenge to the arbitration clause and underlying contracts, which was not merely a device to challenge other provisions in the contract.
After determining that the court had the authority to decide the issue of enforceability of the delegation clause and arbitration provision, the Court of Appeal turned to the issue of whether such provisions were enforceable, finding that the trial court had properly determined that the provisions were void and unenforceable because Defendants had not filed them with the Insurance Commissioner as required by Insurance Code section 11658 and Code of Regulations section 2268, which provided as follows:
Section 11658 states in relevant part:
“(a) A workers' compensation insurance policy or endorsement shall not be issued by an insurer to any person in this state unless the insurer files a copy of the form or endorsement with [the Workers Compensation Insurance Rating Bureau] … and 30 days have expired from the date the form or endorsement is received by the commissioner from the rating organization … , unless the commissioner gives written approval of the form or endorsement prior to that time.
“(b) If the commissioner notifies the insurer that the filed form or endorsement does not comply with the requirements of law, specifying the reasons for his or her opinion, it is unlawful for the insurer to issue any policy or endorsement in that form.” (Italics added.)
At the time the RPA was executed, Regulations section 2268 provided: “No collateral agreements modifying the obligation of either the insured or the insurer shall be made unless attached to and made a part of the policy … .” (Italics added.) In 2016, this Regulations section was amended to delete the reference to “collateral agreements” and instead state: “An insurer shall not use a policy form, endorsement form, or ancillary agreement except those filed and approved by the Commissioner in accordance with these regulations.” (Regs., § 2268, subd. (b), italics added.) The Regulations were also amended to define an “Ancillary agreement” to include a “dispute resolution agreement.” (Regs., § 2250, subd. (f).)
In Nielsen, Applied had properly filed the CIC policy with the Insurance Commissioner and the Workers Compensation Rating Bureau, but Defendants did not file the RPA with the Insurance Commissioner. As only the RPA contained the delegation clause and arbitration provisions, the Commissioner had no opportunity to evaluate these provisions.
In Shasta Linen, the Insurance Commissioner found the RPA between Shasta Linen and AUCRA was a “collateral agreement” within the meaning of Regulations former section 2268 because it modified and supplanted the terms of the CIC policies and therefore it should have been filed with, and approved by, the Insurance Department before it became effective. (Shasta Linen, at pp. 1, 46, 53, 58.) The Insurance Commissioner also found the failure to do so rendered the RPA void as a matter of law. (Id. at p. 65.) The Insurance Commissioner emphasized section 11658's mandatory language that an unfiled policy or endorsement “‘shall not be issued by an insurer’” and that “issuing an unapproved policy or endorsement ‘is unlawful.’” (Shasta Linen, at p. 65, second italics added.)
The Insurance Commissioner also observed:
“By its own admission [Applied] designed EquityComp and the RPA to circumvent workers' compensation policy. It would defeat the statutory purpose to allow CIC to bypass the governmental review process by simply waiting until after the insurance policy has gone into effect to introduce additional or modified terms to its insurance program. Workers' compensation insurance is mandatory and California employers expect the statute's protection. CIC knew of the review and pre-approval process and deliberately ignored that process with regard to the RPA. …
“… [T]he legal requirement for modifying any workers' compensation insurance obligation is to endorse the agreement to the insurance policy. This is done by filing the agreement with the [Rating Bureau], which in turn will file it with the Insurance Commissioner, and endorse it to the insurance policy after the requisite time or approval. Unfiled side agreements are prohibited and shall not be used without complying with these requirements; otherwise, they are not permitted in this state and are void as a matter of law.” (Shasta Linen, at p. 66, fns. omitted.)
Although Shasta Linen pertained primarily to the validity of the entire RPA agreement, the Insurance Commissioner also considered the RPA's arbitration provisions. The Insurance Commissioner found the RPA's arbitration clause was intended to “supplant [the dispute resolution provisions] of the [CIC] guaranteed cost policy” and the arbitration clause substantially modified these CIC provisions. (Shasta Linen, at p. 56.) The Insurance Commissioner found that Regulations former section 2268 was “clear on its face” that “unendorsed side agreements are prohibited” and an “arbitration obligation” comes within the definition of a “side agreement” that must be filed before it is effective. (Shasta Linen, at p. 43.)
The appellate court noted that the RPA considered in Shasta Linen and the RPA issued to Nielsen were essentially identical. Although the court was not bound by the decision in Shasta Linen, it found its analysis persuasive.
The appellate court further rejected Defendants’ arguments that the RPA provisions were not subject to the filing requirement because AUCRA is not an insurer, the RPA was not an insurance policy, and the RPA did not modify the CIC-issued policies, as well as their argument that the arbitration provision was not an “endorsement” or “collateral” agreement under applicable law.
The Insurance Commissioner rejected identical arguments. After carefully reviewing the terms of Shasta Linen's RPA, the Insurance Commissioner found that “it is clear the RPA's dispute resolution … provisions are meant to replace those of [the CIC policies]” and that the “affiliated entities” (Applied, AUCRA, and CIC) were “so enmeshed” and “intertwined” that they should be considered together in determining whether the RPA constitutes a modification of the CIC policies. (Shasta Linen, at pp. 57, 49.)
The record here supports those findings. The RPA expressly pertains to Nielsen's workers' compensation coverage and states that it “represents the entire understanding … between the parties with respect to the subject matter hereof and supersedes all prior negotiations, proposals, letters of intent, correspondence and understandings relating to the subject matter hereof.” The RPA additionally states that its terms apply “to all payroll, premium, and losses occurring under the Policies … .” In materials provided to Nielsen, Applied stated that its EquityComp program (that includes the CIC policies and the RPA agreement) “is a seamlessly integrated package providing nationwide workers' compensation coverage … .” Based on this evidence, we are unpersuaded by defendants' attempt to recharacterize their integrated EquityComp program to suggest that the statutory filing requirements should not apply.
. . .
As found by the Insurance Commissioner, the RPA's arbitration provision and delegation clause are endorsements and/or collateral agreements to the CIC policies because they relate to and materially alter the dispute resolution provisions in the earlier approved policy. (See American Zurich Ins. Co. v. Country Villa Service Corp. (C.D.Cal., July 9, 2015, No. 2:14-cv-03779-RSWL-AS) 2015 WL 4163008, pp. *5–*6 (American Zurich).)
Finally, the appellate court determined that the delegation clause and arbitration provision were unenforceable because they were not properly filed with the Insurance Commissioner in violation of California statute and regulations.
Section 11658, subdivision (b) expressly states it is “unlawful” for an insurer to issue any policy or endorsement or form that is not approved by the Insurance Commissioner, and the regulations implementing this law made clear that collateral agreements must be filed to be effective. (See Regs., former § 2268.) These prohibitions would have no meaning if the insurer could enforce contracts despite having violated the disclosure and approval requirements. Allowing the insurer to make material modifications to the filed and approved dispute resolution mechanism without the knowledge of the Rating Bureau or the Insurance Commissioner would effectively remove any regulatory oversight of this process.
In California, workers' compensation insurance (or an adequate substitute) is mandatory, and the Insurance Commissioner is charged with closely scrutinizing insurance plans to protect both workers and their employers. (See American Zurich, supra, 2015 WL 4163008 at p. *17.) To accomplish this objective, the Legislature mandated that the Commissioner have full access to insurance information through mandatory filing requirements. (Regs., former § 2268.) It follows that a violation of these requirements prevents crucial regulatory oversight and thus renders the unfiled agreement unlawful and void as a matter of law.
In doing so, the court rejected Defendants’ arguments that the arbitration provisions were not void and unenforceable because Insurance Code section 11658 and Code of Regulations section 2268 do not provide for this specific remedy, and that the Legislature specifically rejected the rule that an unfiled arbitration provision or delegation clause is void as a matter of law.