EDWARDS _ANGELL_ LLP by jizhen1947

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									      E                        EDWARDS &ANGELL, LLP
            &                  I NSURANCE & R EINSURANCE
                   A           U PDATE
Counsellors at Law since 1894                                                                                                                                                              December 2001

                                          THE POWER TO PROTECT: THE EXPANDED ROLE
                                          OF THE STATE INSURANCE COMMISSIONER
                                          AS RECEIVER
      IN THIS ISSUE                       by Jeffrey L.Williams, Janet M. Helmke and Doris E. Desautel

   The Power to Protect:                                                                            the United States to grant a                               audited financial statements it
   The Expanded Role of the                                                                         receiver standing to assert claims                         prepared for First Connecticut to
   State Insurance                                                                                  against third parties pursuant to                          file with the Connecticut
   Commissioner As Receiver 1                                                                       legislation based on the NAIC’s                            Insurance Department from 1992
                                                                                                    Model Insurers Rehabilitation and                          through 1994, that First
   Toxic Mold:                                                                                      Liquidation Act (“the Model Act”).                         Connecticut’s largest single asset
   The New “Black Gold”                                                                                                                                        was worthless, even though the
   — Or Is It?                    4       Jeffrey L.Williams         Janet M. Helmke                    A. The Complaint                                       defendant knew or recklessly
                                                                                                                                                               disregarded the fact that it was
                                                              The receiver of
   Security for                                                                                     George M. Reider, Insurance                                worthless.”3 It was further
                                                              an insolvent
   Reinsurance Obligations                                                                          Commissioner of the State of                               alleged by the Liquidator that the
                                                              insurance
   — Is Cash King?                7                                                                 Connecticut, as Liquidator (the                            asset in question was an account
                                                              company has the
                                                                                                    “Liquidator”) of First Connecticut                         receivable from Capital Benefit
                                                              power to initiate
   Statutory Issues in                                                                              Life Insurance Company (“First                             Plans, Inc., an affiliate of First
                                                              litigation against
   Arbitration with                                                                                 Connecticut”), commenced an                                Connecticut. Both entities “were
                                                              those parties the
   Insolvent Companies            9                                                                 action in the Connecticut                                  wholly owned, controlled and
                                                              receiver believes
                                          Doris E. Desautel                                         Superior Court against First                               operated by” a married couple
                                                              to be
                                                                                                    Connecticut’s outside auditing                             who “siphoned off a substantial
                                          responsible for the company’s
                                                                                                    firm for its purported role in                             amount of First Connecticut’s
       Insurance and                      financial demise.The receiver may
                                                                                                    misrepresenting the true financial                         funds, looted First Connecticut
        Reinsurance                       assert claims against former
                                                                                                    status of First Connecticut. Such                          for their personal gain, and
       Practice Group                     management, and against third
                                                                                                    misrepresentations, according to                           operated First Connecticut while
         Highlights                       parties, for alleged misconduct in
                                                                                                    the Liquidator, extended the                               it was insolvent.”4
                                          causing the failure of the
                                                                                                    business life of First Connecticut
   Ted Augustinos, Hartford,              company. Recently, in
                                                                                                    to the detriment of its creditors                          The Liquidator brought the first
   attended the annual                    Connecticut, the role of the
                                                                                                    and policyholders, as the company                          three counts of the complaint on
   convention of the                      regulator was broadened when the
                                                                                                    continued to issue policies and                            behalf of First Connecticut. The
   Connecticut Bankers                    State Insurance Commissioner
                                                                                                    incur debt well beyond the point                           remaining six counts were
   Association in Bermuda from            assumed the position of receiver
                                                                                                    when it became insolvent and                               brought “as to First Connecticut,
   September 27 through                   on behalf of creditors and
                                                                                                    should have been placed into                               Its Policyholders and Creditors.”5
   September 30, 2001.                    policyholders of a failed insurance
                                                                                                    receivership.2                                             The Commissioner claimed
                                          company. George M. Reider, Jr.,
   Pete Maloney, New York,                                                                                                                                     authority to pursue these claims
                                          Insurance Commissioner of the State of
   and John Emmanuel,                                                                               In a nine-count complaint                                  on behalf of policyholders and
                                          Connecticut, as Liquidator of First
   Hartford, attended the NAIC                                                                      consisting of statutory and                                creditors under Connecticut
                                          Connecticut Life Insurance Company,
   Commissioners’ Summit in                                                                         common law claims, the                                     General Statutes §§ 38a-
                                          v.Arthur Andersen, LLP (Conn.
   Washington, D.C. on                                                                              Liquidator alleged that Arthur                             923(a)(13), 38a-923(a)(19) and
                                          Super. Ct.,Complex Litigation
   October 22-24, 2001. The                                                                         Andersen, among other things,                              38a-923(b), legislation that is
                                          Docket, Jan. 31, 2001)1 “First
   Summit focused on the                                                                            “failed to disclose, in annual                             based on the NAIC Model Act.6
                                          Connecticut” is the first decision in
   impact of the events of
   September 11 on the
   insurance industry.                  Edwards & Angell, LLP’s Insurance and Reinsurance Update is published from time to time for the benefit of our clients, friends and fellow professionals on topical matters
                     continued on p.2   of interest. The discussions and information contained therein are not to be construed as legal advice or opinion. We provide such advice or opinion only after being
                                        engaged to do so with respect to particular facts and circumstances. This publication may be considered “advertising material.”
    Paul Kanefsky, New York,          THE POWER TO PROTECT: THE EXPANDED ROLE
    spoke on Reinsurance
    allocation and aggregation
                                      OF THE STATE INSURANCE COMMISSIONER
    issues at a program               AS RECEIVER
    sponsored by Hawksmere, in
    London on November 2.             Connecticut General Statutes §          B. The Connecticut                       the insurer’s business activities to
                                      38a-923 states, in pertinent part:     Superior Court Decision                   protect that interest. Though the
    Lenny Minches, Ft.                    (a) The liquidator has the                                                   Commissioner is not an ex officio
    Lauderdale, Jim Shanman,              power: … (13) to prosecute         The Complex Litigation Docket             member of the insurer’s Board of
    New York, and Pete                    any action which                   Judge denied the motion to strike,        Directors, he is legally
    Maloney attended the                  may exist on behalf of the                                                   empowered not only to
                                                                             expressly rejecting Arthur
    ARIAS•US meeting in New               creditors, members,                                                          participate in, but to control the
                                                                             Andersen’s arguments that the
    York on November 8-9,                 policyholders or shareholders                                                insurer’s business activities
                                                                             Liquidator lacked standing on
    2001.
                                          of the insurer against any         behalf of First Connecticut, and          whenever its solvency is
                                          officer of the insurer or any      on behalf of its policyholders and        threatened. [Connecticut]
    On November 13, John
                                          other person; …                    creditors.                                General Statutes § 38a-916(c).”13
    Haley, New York, attended
    the Fall Claims Mini-Session          [and] (19) to exercise and
    of the Intermediaries and             enforce all the rights,            Arthur Andersen had claimed                The Court also rejected the
    Reinsurance Underwriters              remedies, and powers of any        that, where the fraudulent                argument that the Liquidator
    Association held in New               creditor, shareholder,             conduct is alleged to have been           lacked standing to assert claims on
    York. The program focused             policyholder, or member,           perpetrated by the firm’s sole            behalf of First Connecticut, its
    on changes to commercial              including any power to avoid       owner and shareholder, his fraud          policyholders and creditors.
    general liability policy              any transfer or lien that may      must be imputed to the                    Relying on public policy
    wording, employment                   be given by the general law        corporation itself, which cannot          concerns, and citing to
    practices liability coverage in       and that is not included with      then recover from a defendant             Connecticut General Statutes §
    the healthcare industry and           sections 38a-928 to 38a-930,       whose only alleged role was               38a-923 the Court stated:
    coverage expansion in                 inclusive;7                        failing to blow the whistle on the
    uninsured motorist coverage.                                             corporation when he had the                    “[d]uring the life of the
                                      In response, Arthur Andersen           opportunity to do so.10                        insurer, the Insurance
    Laurie Kamaiko,Vince              moved to strike all nine counts of                                                    Commissioner has the
    Vitkowsky, Nick Pearson,          the complaint. It moved to strike      In response, the Liquidator relied             right and responsibility to
    John Haley, Jeff                  the three counts brought on behalf     “upon the “adverse interest                    receive and review annual
    Etherington and Tracey            of First Connecticut on the            exception” to the general rule                 audited financial
    Discepolo, New York, and          ground that the damages sought                                                        statements from the insurer
                                                                             imputing the knowledge and
    Janet Helmke and Cathy            were the result of the insurer’s                                                      to assure himself that the
                                                                             conduct of agents to their
    Heath, Hartford, attended         own fraudulent conduct or that of                                                     public’s interest in
                                                                             principals. Under that exception,
    the Association of
                                      its sole shareholder.With respect      “knowledge of an agent will not                its continuing solvency is
    Professional Insurance
                                      to the six counts brought on           ordinarily be imputed to his                   being protected …
    Women’s Silver Anniversary
                                      behalf of the policyholders and        principal where the agent is acting            [Furthermore, if] the
    Celebration in New York on
    November 14.                      creditors, the auditors argued,        adversely to the latter’s interest.” 11        Commissioner determines
    Edwards & Angell, LLP is          among other things, that the           (citing Mutual Assurance Co. v.                that the affairs of an insurer
    proud to serve the APIW as        Liquidator lacked standing to          Norwich Savings Society, 128 Conn.             are being so
    its pro bono counsel.             prosecute these claims, as each        510, 513, 24 A.2d 477 (1942)).                 mishandled as to threaten the
                                      such claim could only be asserted                                                     public’s vital interest in its
    On November 15 and 16,            by one or more policyholders or        In rejecting Arthur Andersen’s                 continuing solvency,
    2001, Ted Augustinos              creditors individually.8 The           argument, the Court stated that                he is given sweeping
    attended a privacy                defendant further argued that the      “[Arthur Andersen’s] argument                  statutory powers to take
    compliance seminar in             Liquidator lacked standing to          that there is a complete unity of              action to minimize that
    Washington, D.C.                  bring claims on behalf of the First    interest between a sole                        threat and avoid or lessen its
                                      Connecticut policyholders and          shareholder who loots his own                  potentially devastating
    David Griff, New York, and        creditors because each claim           insurance company and the                      consequences under
    Louis Mercedes, Boston,           belonged personally to one or          company itself is clearly without              [Connecticut General
    attended the National             more such individuals and, since       merit.” 12 “The public, through                Statutes §§ 38a-903 to 38a-
    Conference of Insurance           “[a] receiver may not…maintain a       the Insurance Commissioner, has a              961, inclusive].14
    Legislators Annual Meeting        suit in his representative capacity    vital interest in the continuing
    in Scottsdale, Arizona from       for their joint benefit,” such         solvency of the insurer and the           The Court further stated:
    November 15 to 18.                allegations must fail as a matter of                                                 “The harm claimed to have
                                                                             right, which it exercises through
                                      law.9                                  the Commissioner, to take over                resulted from the

2
THE POWER TO PROTECT: THE EXPANDED ROLE                                                                                                         Of Note
OF THE STATE INSURANCE COMMISSIONER                                                                                                  In light of the tragic events of
AS RECEIVER                                                                                                                          September 11, 2001, and their
                                                                                                                                     aftermath, the Reinsurance
                                                                                                                                     Association of America, (the
     Defendant’s misconduct …                      acting on behalf of the                suggests that it is likely that other      ”RAA”) and Edwards &
     was permitting the [owners]                   public, including First                jurisdictions will reach similar           Angell,LLP decided to
     to continue operating and                     Connecticut and its                    conclusions about the expanded             postpone their October 17-19,
     looting First Connecticut                     policyholders and                      role of the Insurance                      2001 Life Reinsurance
                                                                                                                                     Conference until February
     long after it had become                      creditors.”15                          Commissioner. The decision not             2002.
     insolvent and should have                                                            only protects the insurance-buying
     been placed into receivership            D. Conclusion                               public but to the extent the               The new dates for the
     [and that so pleaded, the                                                            receiver is able to effect recoveries      conference are February 20-22,
     allegations do not seek]                The First Connecticut decision               for the estates of insolvent               2002. The substance of the
                                                                                                                                     conference program remains
     damages for individual claims           provides the broadest                        companies, reduces the burden on           the same. We are also pleased
     by First Connecticut                    interpretation of the Insurance              state guaranty funds and benefits          to announce that we have added
     policyholders or creditors,             Commissioner’s role as receiver              domestic insurance companies.              a special session for discussion
     but for wrongful conduct                that has been seen to date. It is                                                       of issues resulting from the
     that allegedly diminished the           the first case of its kind in the                                                       events of September 11. This
                                                                                                                                     forum will address coverage
     insurer’s insolvency estate …           United States to grant a receiver                                                       issues, legislative issues, and the
     The Commissioner, in                    standing pursuant to legislation                                                        effects on the industry and the
     receiving and relying on                that is based on the NAIC Model                                                         world.
     Andersen’s audit report and             Act. The impact of the decision is
     the Andersen-audited                    not necessarily limited to                                                              The RAA/Edwards &
                                                                                                                                     Angell,LLP Life Reinsurance
     financial statements, was               Connecticut. Rather, its logic                                                          Conference is unique in that it
                                                                                                                                     is in the form of a hands-on,
                                                                                                                                     roll-up-your-sleeves,
1 Jeffrey L.Williams serves as co-counsel to the Liquidator in the Reider case.                                                      participative case study
2 (Memorandum of Decision on Motion to Strike Revised Complaint, Docket No. (XC2) CV 98-0151625 S., pgs. 1-2, Jan.                   designed and presented by
31, 2001, Sheldon, J.)                                                                                                               leading reinsurance
3 (Memorandum of Decision on Motion to Strike Revised Complaint, at 1-2, Jan. 31, 2001, Sheldon, J.) (quoting Revised                professionals who deal with the
Complaint, ¶¶ 19; 26(b)-(c); 28(a); 28(f); 29; 29 (d)-(e); 29(j); 30(a)).                                                            issues every day. The innovative
4 Id. at ¶¶ 5-8, 11.                                                                                                                 format allows the participants
5 Counts One through Three were based on breach of contract (First Count), negligence (Second Count), and aiding and                 to explore an entire range of
abetting breach of fiduciary duty (Third Count), respectively; Counts Four through Nine were based on negligent                      market-wide issues faced by the
misrepresentation (Fourth Count), recklessness (Fifth Count), intentional misrepresentation (Sixth Count), aiding and                industry, and to attempt to
                                                                                                                                     resolve the issues through panel
abetting breach of fiduciary duty (Seventh Count), aiding and abetting fraud (Eighth Count), and violation of the Connecticut
                                                                                                                                     and round table discussions,
Unfair Trade Practices Act (“CUTPA”), Connecticut General Statutes § 42-110g (Ninth Count).                                          mock negotiations, and
6 The Model Act gives the same power to the Liquidator as granted under Connecticut General Statutes § 38a-923 to “(15) …            presentations to a panel of
prosecute any action which may exist on behalf of the creditors, members, policyholders or shareholders”, and “(21) …                actual industry arbitrators.
exercise all rights, remedies and powers of any creditor, shareholder, policyholder, or member…”
7 The Liquidator also asserted authority to pursue such claims on behalf of the creditors and policyholders pursuant to              The conference features a list of
Connecticut General Statutes §§ 38a-923(a)(6) and (a)(12), which state that: “(a) The liquidator shall have the power…(6) to         prominent faculty - some of the
collect all debts and moneys due and claims belonging to the insurer, wherever located, and for this purpose…(c) to pursue           major players in the reinsurance
any creditor’s remedies available to enforce the creditor’s claims; [and] (12) … to institute in the name of the insurer or in the   community - to provide you
liquidator’s own name any and all suits and other legal proceedings, in this state or elsewhere, and to abandon the prosecution      with their expert insight into
                                                                                                                                     the arbitration process and a
of claims he deems unprofitable to pursue further…”
                                                                                                                                     balanced, informative view of
8 Andersen also alleged that the Liquidator had no legal right to recover damages on any of his claims as to First Connecticut       the presented issues.The Life
because, as they were pleaded, First Connecticut could not prevail on them if it were not in liquidation. Andersen argued that       Reinsurance Conference will be
such claims were barred because they seek damages for losses that are attributable to First Connecticut. Andersen challenged         valuable for executives,
the sufficiency of Counts Four through Nine as to causation and reliance. The Court rejected each of these claims.                   attorneys, consultants,
9 Memorandum of Decision on Motion to Strike Revised Complaint, at 23, Jan. 31, 2001, Sheldon, J. (quoting Cotton v.                 arbitrators and any other
Republic National Bank, 395 S.W.2d 930, 941 (Tex. Civ. App. 1965)).                                                                  professionals interested in
10 Id. at 8                                                                                                                          cutting-edge coverage issues in
11 Id. at 9 (citing Mutual Assurance Co. v. Norwich Savings Society, 128 Conn. 510, 513, 24A.2d 477 (1942)).                         the life, accident and health
12 Id. at 20                                                                                                                         reinsurance area and/or the
                                                                                                                                     arbitration process in general.
13 Id.
14 Id at 16-17 (quoting Connecticut General Statutes §38a-54).                                                                       For more detailed information
15 Id. at 25-27.                                                                                                                     or to register, visit the
                                                                                                                                     following web site:
                                                                                                                                      http://www.reinsurance.org
                                                                                                                                     /lifeconference.html.
                                                                                                                                                                           3
    TOXIC MOLD:
    THE NEW “BLACK GOLD”
    —OR IS IT?
    by John H. Haley

                         An increasing        companies. Some in the industry         professional E&O policies for          the allegedly toxic effects that
                         number of            say that premiums will have to          architects, engineers, designers       some mold growth—the so-called
                         insurance claims     increase 40 percent to offset mold      and other professionals involved in    “mycotoxins” associated with
                         and lawsuits are     claims.”3                               building construction, raising a       certain types of mold infestation—
                         being filed across                                           host of coverage issues, some of       allegedly has on human beings.
                         the U.S. due to      The recent torrent of mold claims       the more prominent of which are        Claims are made that exposure to
                         property damage      in Texas has caused much turmoil        examined below.                        certain mold mycotoxins, in
    John H. Haley        and personal         among homeowners and property                                                  particular those from the black and
                         injuries allegedly   insurers in that state, among them      Mold claimants can be current          blue-green mold known as
    arising out of mold damage in             State Farm and Allstate, which          property owners (including             Stachybotrys Chartum, has caused
    homes, apartments,                        have stopped writing new                homeowners associations), other        strange rashes, asthma, dizziness,
    condominiums, office buildings            homeowners coverage there. State        inhabitants of the affected            hearing loss, pulmonary bleeding,
    and commercial sites. What was            Farm representatives are quoted as      property, and even visitors to the     and massive cognitive failure.
    already a slow-growing trend has          stating that for every dollar in        property. If the building owner is
    picked up speed thanks to a rash of       premium they are receiving, they        a public entity, governmental          What makes the mold claims for
    claims in Texas, including one well-      are spending $1.69 for mold             entities may be involved.              personal injury so controversial is
    publicized case, Mary Melinda             claims, and recent news reports         Defendants may include any             that medical research thus far has
    Ballard v. Fire Insurance Exchange,       indicate that the Texas State Farm      person who had any involvement         not backed up such claims with
    No. 99-05252,Texas Dist.,Travis           entity is encountering solvency         in construction of the building,       solid scientific evidence. The
    Co., 6/1/01 (subsequent decision          problems due to heavy mold claim        including owners, builders,            highly respected U.S. Center for
    reported at 2001 WL 883550                payouts. All of this is occurring in    subcontractors and suppliers.          Disease Control has stated point-
    (Tex.Dist.)), in which after a four       a state that, according to the          Architects also may be named for       blank that there is no evidence of a
    week trial, a sympathetic jury            NAIC, already has the highest           alleged failure to take climate        causal link between exposure to
    awarded a family $32 million based        homeowners rates in the nation          effects and moisture retention into    mold and the various claimed
    upon mold damage to their 22-             due to the threat of hurricanes,        account in the design of a building.   symptoms, except in a limited
    room mansion in Dripping                  tornadoes and hailstorms.               In addition, sellers of a property     number of cases of persons having
    Springs,Texas. This exceptional                                                   may be sued for failure to disclose,   specific allergies to Stachybotrys
    result included $12 million in            Insurers in other states are bracing    detect or warn of a mold problem.      Chartum.5 Thus we have the
    punitive damages, $5 million in           for what many fear will be “the         Building managers, condominium         situation where the rash of claims
    emotional distress damages, and           next asbestos.” Insurers’ fears of      directors and officers, and other      precedes the scientific evidence to
    $8.9 million for legal fees.1             course mirror the plaintiff bar’s       entities responsible for maintaining   support it. Moreover, the large
                                              fondest hopes and dreams, with          properties may also be named.          economic forces driving the
    The trend is being driven (or             the result that some are dubbing        The “fallout” from mold claims is      present claims furor may tend to
    accompanied, based upon one’s             the mold claims the new “black          also likely to have a secondary        color the objectivity of the future
    viewpoint) by heavy media                 gold” for lawyers, not to mention a     impact in the form of indemnity        research.
    attention, and the resulting              host of other professionals such as     claims against manufacturers,
    heightened public awareness has           building contractors, appraisers,       distributors and installers of         The “New Asbestos?”
    brought on more mold cases and            and an army of new “mold                building products, real estate
    an onslaught of insurance claims in       experts.” According to The Wall         agents, and insurance brokers and      Many among the plaintiff’s bar
    affected areas. Among the more            Street Journal, the insurance           agents, as well as claims under        hope that the billowing mass of
    notable examples of publicity             industry as a whole has paid out        workers compensation policies and      mold claims represents the “next
    featuring the Ballard case are an         $21.6 billion in asbestos claims        in certain states, surety bonds—       great thing” in popular plaintiff
    article in USA Weekend, a news            and the problem is not over.4           each to the extent that they can be    cases, just like the decades-old
    feature on the television program                                                 blamed for some or all of a mold-      “gold mine” that asbestos litigation
    48 Hours, and a New York Times            Mold-related claims can affect          related loss.                          has proved to be. While there is
    Magazine cover story entitled             various lines of business in addition                                          no doubt that the present mass of
    Haunted by Mold.2 The latter              to homeowners. Claims are being         The claimed damages include both       mold claims presents a real and
    contends that “[w]hat looks like          made under commercial property          property damage, which can be so       present threat to the insurance
    Genesis to lawyers looks like             policies, commercial general            serious that a “tear-down” is          industry, in the long run the
    Armageddon to insurance                   liability (CGL) policies, and           required, and personal injury, for     hopeful plaintiff’s bar may find

4
TOXIC MOLD:
THE NEW “BLACK GOLD”
—OR IS IT?
itself disappointed with mold, for a    Mold spores are airborne and           accepted as a reliable method in        intended to cover mold as a cause
number of reasons, including the        omnipresent, requiring only the        the scientific community. While         of loss will be addressing any
following:                              right amount of moisture and           some state standards are looser,        shortcomings in their policy
                                        some appropriate organic host          the current legal climate clearly       wordings and revising them
• A great many policies, even           substance (like sheetrock) to fester   does not favor “junk science” as a      accordingly. This will be especially
those that have been forced to pay,     and grow. In contrast, most            replacement for scientific proof.       so where a policy allows coverage
have clearly meant to exclude           asbestos cases are based upon a        Mold is a long way from becoming        for a certain type of damage where
mold as a covered cause of              manufactured product that              the “new asbestos” in this respect.     the “efficient proximate cause” that
damage. For example, in Home Ins.       incorporated asbestos, bringing                                                set the problem in motion is
Co. v. McClain, 2000 WL 144115          into play various strict liability     • As every lawyer who handles           covered, even though an express
(Tex.App.—Dallas, 2/10/00), the         rules for products liability cases.    asbestosis cases can attest, after a    exclusion might otherwise
homeowners policy specifically          Mold is not part of any product,       while a great many of them start        eliminate coverage. Policy
excluded loss caused by “rust, rot,     manufacturers are not typically the    to look alike, involving similar        wordings should be scrutinized
mold or other fungi,” but the court     primary target defendants, and no      issues as to exposure, similar          carefully to eliminate and clarify
nevertheless seized upon other          strict liability doctrine will         medical problems, and ultimately        confusion as to their real intent.
language in the policy to find          generally apply. Rather, the           similar kinds of damage issues. In
coverage. The policy provided that      current mold crisis is largely the     many of them, liability issues are as   Pollution Exclusions
“[w]e do cover ensuing loss cause       result of widespread modern            much a matter of history and
by … water damage … if the loss         construction methods, such as          formula as a matter of new case-        Most third-party liability policies
would otherwise be covered by           “slab on grade” home designs, that     specific investigation and proof.       these days, such as CGL policies,
this policy.” Since mold only           can allow moisture in and then         This kind of uniformity is much         include pollution exclusions.
grows where it can find moisture,       trap it inside for long periods of     less likely to occur in mold cases,     While some commentators have
the court found that the damage         time, presenting a more difficult      which are likely to be much more        “made the case” for ambiguity
was a covered consequence of            burden of proof with much less         variable in their facts, causation,     and/or non-applicability of CGL
water damage, even though one           identifiable causes and effects than   and evidence. Big verdicts and          pollution exclusions to mold
might have thought that mold            is the situation in asbestos cases.    settlements may happen, but it is       claims,6 and while a number of
damage was not “otherwise …                                                    likely that plaintiffs’ lawyers are     precursor cases have gone both
covered by [the] policy.” Not every     • A mountain of scientific             going to have to work a lot harder      directions, the applicability of the
court in every state is going to buy    evidence has established that          for them (and lose a great many         “absolute pollution exclusion” to
into this coverage approach, where      asbestosis occurs as a result of       more cases along the way). Mold         mold claims is still a legal battle
“mold or other fungi” is specifically   asbestos particle inhalation, with     cases are much less likely to           largely to be fought.
excluded, as if frequently is.          damning knowledge of that fact on      conform to any formulas, and
Further, insurers that have always      the part of manufacturers raising      every legal element of mold cases       The basic issue is whether mold
intended to exclude mold are of         the stakes substantially in certain    is likely to be hotly contested, at     falls within the definition of
course going to immediately             cases. As pointed out above,           least in the immediate future.          “pollution,” which in a CGL policy
strengthen their wordings,              nothing of the kind presently exists                                           is typically defined thus:
eliminating coverage for future         to scientifically prove that mold      Overview of Prominent
mold losses. This situation is          causes specific harm to human          Coverage Issues                              “Pollutants” means any solid,
unlike asbestosis, which can be         beings, and thus the basic causation                                                liquid, gaseous or thermal
based upon a person’s exposure to       issue at the heart of every mold       Specific Mold Exclusions                     irritant or contaminant,
asbestos 40 years ago, invoking         case is clouded with scientific                                                     including smoke, vapor, soot,
decades-old policies. If the            uncertainty. This is not a small        As pointed out above, many                  fumes, acids, alkalis,
insurance industry can avoid            problem for plaintiffs, as the U.S.    homeowners policies, as well as              chemicals and waste. …
picking up the tab in the future,       Supreme Court held in Daubert v.       commercial property policies,
mold claims are likely to lose          Merrell Dow Pharmaceuticals, Inc.,     contain exclusions that apply           Coverage is generally excluded if
much of their interest, once the        509 U.S. 579, 113 S.Ct. 2786, 125      expressly to mold and fungi.            “bodily injury” or “property
present crisis is past.                 L.Ed.2d 469 (1993) that the            Depending upon the wordings at          damage” arises out of “the actual,
                                        admissibility of expert testimony      issue, these exclusions may prevail     alleged or threatened discharge,
• Mold is a naturally occurring         relating to bodily injury requires     in many contested coverage              dispersal, seepage, migration,
substance that has been around          that the injury must be proved by      disputes. And certainly, looking to     release or escape of pollutants.”
much longer than humankind.             scientific methodology that is         the future, insurers that never



                                                                                                                                                              5
    TOXIC MOLD:
    THE NEW “BLACK GOLD”
    —OR IS IT?
    Analogies are frequently made in             CGL policy is triggered at the time           insurance contexts, so it is difficult        astonishing. Obviously, with
    this area to a spate of cases around         of injury to the plaintiff, while             to predict that they will be applied          respect to some Texas cases and a
    the country where the issue is               property policies are triggered at            to mold claims.                               few other large mold awards in
    application of the pollution                 the time that the physical damage                                                           other states, juries have been
    exclusion to what is known as “sick          occurs. In contrast, E&O policies             Defective Work Exclusions                     ruthless in assessing punitive
    building syndrome.” One such                 are generally “claims made”                                                                 damages where an insurer has
    case in New York, Advanced                   policies triggered by the making of           Typical CGL policies issued to                denied coverage, or as in the case
    Healthcare Resources, Inc. v. Merchants      a claim against the insured, but              builders and construction industry            of Ms. Ballard, offered her much
    Ins. Co., N.Y.L.J., October 22,              coverage is also often limited by             entities contain several exclusions           less than expected. “Bad faith” is
    1997, p. 33, held squarely for the           “prior acts,” “prior knowledge” or            resulting in the defective work               mentioned here because at least in
    insurer, holding that a case                 “retroactive date” provisions that            itself not being covered, while               some mold cases, emotions can
    involving “sick building syndrome”           eliminate coverage for wrongful               damage to other property caused               obviously run high, and such a case
    was excluded by a pollution                  acts actually or allegedly                    by defective work is covered. For             is a “natural” for a plaintiff to seek
    exclusion. The complaint had                 committed or known about by the               example, under a roofing                      damages based upon an insurer’s
    alleged that the injuries were               insured prior to a certain date.              contractors CGL policy, a badly               perceived “bad faith” resistance to
    caused by exposure to airborne               For the few E&O policies written              installed roof might let water leak           coverage.
    “fungi, mycotoxins” and “bacteria.”          on an “occurrence” basis, the                 into a building resulting in mold
    Faced with a pollution exclusion             trigger is usually the date that the          damage destroying the walls, with             The alarm has sounded, and
    similar to that quoted above, the            wrongful act was committed by                 the result that a claim for the wall          insurers must review their
    court held that the alleged damage           the insured. Unlike CGL                       damage would be covered, but a                wordings and claims handling
    was caused by a contaminant and              wordings, the trigger for E&O                 claim for replacement of the                  procedures to take into account
    was therefore excluded.                      policies is rarely the date of                defective roof itself would not.              the unique exposures presented by
                                                 damage to the plaintiff.                      However, where the insured has                the outburst of toxic mold claims.
    It should be noted that many types                                                         used a subcontractor who caused               Edwards & Angell, LLP’s Insurance
    of policies other than CGL also              In the case of a substantial mold             the problem, under the standard               and Reinsurance Practice Group is
    have pollution exclusions, and               infestation found growing behind              CGL wording the result can be                 well-versed in insurance coverage
    wordings are anything but                    the walls of a building where                 different, and there are other                issues that can arise in the context
    standard. The extent to which                sufficient moisture has entered and           exceptions. Coverage based upon               of mold claims, as well as having
    they may eliminate coverage is               been present for a long time, it is           application of these exclusions to            expertise in reviewing and revising
    necessarily a case-by-case                   obvious that insurance trigger                mold claims can probably be                   policy wordings and establishing
    determination.                               questions are going to be difficult.          predicted in many instances based             appropriate claims procedures, and
                                                 If courts decide to analogize to              upon existing case law, although of           can be of assistance where needed.
    Coverage Trigger Issues                      asbestos claims, then it will                 course factual scenarios can easily
                                                 depend upon whether a particular              be envisioned (and will no doubt
    Again, the “critical mass” of                state is a “manifestation” or                 occur) where application of these
    applicable case law has not been             “continuous trigger” state.                   exclusions is unclear.
    reached on this issue in the context         However, legal research into
    of mold claims to enable                     insurance trigger issues outside the          Bad Faith Claims
    predictability of outcome. “Bodily           context of asbestos claims
    injury” and “property damage”                frequently reveals that those                 The variation in “bad faith” law
    liability coverage under a typical           doctrines are not applied in other            from state to state can be


    1 In 2000, a California federal jury awarded a homeowner $18 million against an insurer that had declined coverage for mold damage, but the judge reduced the award
    to $3 million. The insurer reportedly appealed. Anderson v.Allstate Ins. Co., No. 00-907 (E.D. Cal. 2000). For a review of several other “big dollar” mold cases, see Raskoff,
    Mold Contamination Liability and Coverage Issues, Mealey’s Litigation Reports: Mold, April, 2001.
    2 See Belkin, Haunted by Mold, The New York Times Magazine, August 12, 2001, cover and p.28, et seq. The lurid catch line reads “It grows in the walls. It chokes your
    child and renders your husband senseless. It’s your—and your insurers’—worst nightmare.”
    3 Id. at p. 32.
    4 Oster, Insurers Blanch at Proliferation of Mold Claims,The Wall Street Journal, June 6, 2001, p. B1.
    5 See Woodward & Taddeo, Mold and the Hypersensitive Plaintiff, Mealey’s Litigation Reports: Mold, May, 2001.
    6 See Bartell, Perrone & Gottlieb, Builders, Subcontractors and Architects: Finding Insurance Coverage for Mold Litigation, Mealey’s Litigation Reports: Insurance, March 13, 2001.




6
Security for Reinsurance Obligations
– Is Cash King?
by Thomas F.X. Hodson and Cathleen T. Heath


                                         unlicensed, unauthorized               without obtaining security from       by an unlicensed reinsurer.
                                         reinsurers are not subject to state    the reinsurer because the solvency    Permissible forms of security are:
                                         solvency regulation and, therefore,    of such reinsurer is regulated in
                                         ceding companies are prohibited        the United States.                         (i) Cash;
                                         from taking credit for reinsurance
                                         from such reinsurers as an asset or    Alternatively, any reinsurer not           (ii) Securities listed by the
                                         a deduction from liability unless      meeting one of the four criteria           Securities Valuation Office of
                                         the obligations are adequately         above is considered “unlicensed”           the NAIC;
Thomas F.X. Hodson   Cathleen T. Heath   secured.                               under the terms of the Model Act.
Introduction                                                                    Consequently, ceding companies             (iii) Letters of credit
                                         Credit for Reinsurance                 wishing to take credit on statutory        (meeting certain standards
Here’s a quiz: Your company has          Laws                                   financial statements for                   and issued or confirmed by a
secured reinsurance from an                                                     reinsurance assumed by such a              qualified U.S. financial
unlicensed, unauthorized reinsurer       The National Association of            reinsurer must obtain security             institution); or
and in order to receive credit for       Insurance Commissioners (the           from the reinsurer in an amount
such reinsurance on statutory            “NAIC”) adopted the Model Law          equal to 102 percent of its                (iv) Any other form of
financial statements, your               on Credit for Reinsurance (the         reinsurance obligations to the             security acceptable to the
company is required to obtain            “Model Act”) and its accompanying      ceding company. Those                      commissioner of insurance.
security for the reinsurer’s             regulation (the “Model                 reinsurance obligations are
obligations. There are, essentially,     Regulation”) in 1984. All but          identified in Section 10 of the       The security, regardless of the
three choices for security: (i)          three jurisdictions in the U.S. have   Model Regulation generally as:        form, must be held by or on behalf
cash; (ii) trust fund; or (iii) letter   adopted the Model Act in                                                     of the ceding company. If the
of credit. The question is, what is      substantial form (Kansas,                   (i) Obligations to pay or        security is held on behalf of the
the best form of security for your       Maryland, and Washington have               reimburse the ceding             ceding company, it must be held
company to obtain?                       not adopted the Model Act but               company for the reinsurer’s      by a qualified U.S. financial
                                         have passed related laws).                  share under a specific           institution pursuant to a trust
While all three of the above             Therefore, this article will focus          reinsurance agreement of any     agreement containing specified
choices provide adequate security        on the Model Act and Model                  losses and allocated loss        provisions. When a trust is
under most circumstances and             Regulation.                                 expenses paid by the ceding      established among the ceding
permit your company to take                                                          company and not recovered        company, the reinsurer, and a
credit for the underlying                Generally, the Model Act regulates          from the reinsurer;              trustee, it must be for the sole
reinsurance on statutory financial       reinsurers under one of two                                                  benefit of the ceding company,
statements, a letter of credit can       categories: licensed or unlicensed.         (ii) Obligations to pay or       which must have the power to
provide more reliable security in        Those reinsurers that are                   reimburse the ceding             withdraw assets at any time
the context of a reinsurer               considered “licensed” under                 company for unearned             without notice to the reinsurer.
insolvency. This article will            Section 2 of the Model Act are              premiums or returned             The only true restriction on the
provide an overview of the credit        those that are: (i) licensed in the         premiums due to the ceding       ceding company’s ability to
for reinsurance laws, compare and        state of domicile of the ceding             company, if not otherwise        withdraw assets from the trust is
contrast different forms of security     company; (ii) licensed in at least          paid by the reinsurer; or        that the ceding company must
in general terms, and examine            one state and accredited in the                                              provide notice to the trustee of its
why letters of credit may offer          domicile of the ceding company;             (iii) Obligations to pay the     desire to make such a withdrawal.
superior security to the ceding          (iii) domiciled in a state employing        reinsurer amounts held in        Furthermore, the trust must not
insurer for reinsurance obligations.     credit for reinsurance standards            excess of the amount             be subject to any conditions or
                                         substantially similar to that of the        necessary for the ceding         qualifications outside of the trust
There is little doubt a “hard”           domicile of the ceding company;             company to secure credit for     agreement.
insurance market is upon us. This        or (iv) employing a single trust            reinsurance.
means, among other things, that          fund for the benefit of all its U.S.                                         The Model Act and Model
insurers seeking reinsurance will        reinsureds (i.e., Underwriters at      Forms of Security                     Regulation identify the criteria to
find higher rates and lower              Lloyd’s, London and the                                                      which letters of credit must
capacity for coverage among              International Underwriting             The Model Act, together with the      adhere for the ceding company to
licensed reinsurers. As a result,        Association). Under the terms of       Model Regulation, outline the         take credit on its statutory
more insurers will be buying             the Model Act, a ceding company        form of security that a ceding        financial statements. A suitable
reinsurance from unlicensed,             may take credit for reinsurance        company must utilize to be eligible   letter of credit must be “clean.”
unauthorized reinsurers. These           assumed by a licensed reinsurer        for credit for reinsurance assumed    This means that there cannot be


                                                                                                                                                             7
    Security for Reinsurance Obligations
    – Is Cash King?

    conditions on the ceding company’s      the ceding company as security for        trust and, therefore, the liquidator       payment of a specified sum by the
    ability to draw on the letter of        reinsurance obligations become part       has a duty to protect and maximize         bank. Therefore, a letter of credit
    credit. The letter of credit must       of the general assets of the insolvent    that interest for the benefit of the       creates a separate legal relationship
    also be “irrevocable” in that it        estate. Generally, liquidation orders     insolvent reinsurer’s other                between the ceding company and
    cannot be terminated by either the      obtained by the state regulator vest      creditors.                                 the issuing bank which, in most
    reinsurer or ceding company before      title in the liquidator for all assets,                                              instances will, survive the
    its stated expiration date. Finally,    whatever their nature, wherever           Furthermore, Section 10.B.(14) of          insolvency of the reinsurer. The fact
    the letter of credit must be            located and whether held directly         the Model Regulation provides that         that the bank typically holds
    “evergreen.” This means that the        or indirectly. Therefore, in the          all trust agreements established for       collateral from the reinsurer to
    letter of credit will be continuously   event that an insolvent reinsurer is      the purpose of credit for                  secure the bank’s extension of
    renewed unless the trustee provides     placed into liquidation, a ceding         reinsurance eligibility must provide       credit to the reinsurer has no
    the ceding company at least 30 days     company will be required to turn          that, in the event that the grantor of     bearing on the bank’s obligation to
    advance notice that it will not be      over to the liquidator all cash and       a trust is declared insolvent, the         the ceding company. In fact, a
    renewed upon expiration.                securities it holds on behalf of the      trustee must comply with orders            number of courts have stated that to
                                            reinsurer. Such funds are subject to      requiring it to turn over to the           allow a debtor’s bankruptcy to
    The Reinsurer’s Insolvency              any right of offset.                      liquidator all assets of the insolvent     interfere with payment on a clean,
                                                                                      reinsurer. Such assets must then be        irrevocable letter of credit would be
    When a ceding company enters into       Where a trust fund is established as      applied in accordance with the             devastating to international
    an agreement with an unlicensed         security for specific reinsurance         appropriate creditor priority laws of      commerce. It must be cautioned
    reinsurer, its primary purpose for      obligations, a ceding company will        the state in which the trust is            that liquidators can make several
    seeking security for the reinsurer’s    realize a more favorable result in        domiciled.                                 arguments to enjoin payment under
    obligations is to obtain credit for     the event that the reinsurer                                                         a letter of credit, including voidable
    that reinsurance. The ceding            becomes insolvent. In the case of a       State creditor priority laws outline       preference and antecedant debt.
    company, at the inception of this       trust fund, only a portion of the         the order in which the liquidator is
    relationship, does not expect that      trust assets will become part of the      able to pay debts of the insolvent         Conclusion
    the reinsurer will become insolvent.    general assets of the insolvent           reinsurer. NAIC’s Insurers
    If it did suspect that the reinsurer    reinsurer’s estate. The law views         Rehabilitation and Liquidation             In summary, a ceding insurer that
    would become insolvent, the ceding      the assets put into trust by a            Model Act (“Liquidation Model              has obtained security from its
    company would not do business           reinsurer for the benefit of a ceding     Act”) provides an example of a state       reinsurer in the form of cash or
    with that reinsurer. However, as a      company as one of two types of            priority structure. Under the              securities will likely forfeit such
    practical matter, reinsurer             assets. The first type are assets         Liquidation Model Act, claims of a         security to the liquidator if the
    insolvencies do occur. Further, as a    retained by the trustee in order to       ceding company under a                     reinsurer becomes insolvent, unless
    general rule, liquidators vigorously    compensate the ceding company.            reinsurance agreement are paid only        the ceding insurer has a right of set-
    defend against claims against the       These assets are not the reinsurer’s      after the following are paid: the          off. A ceding insurer that obtains a
    assets of insolvent companies.          property. Generally, the purpose of       receiver’s expenses, any Guaranty          trust as security for specific
    Therefore, the true purpose for         a trust is to place certain assets        Association’s expenses, policyholder       reinsurance obligations will not
    obtaining security for an unlicensed    outside the reinsurer’s control and       claims, claims by the federal              forfeit the trust’s assets in the event
    reinsurer’s obligations is to protect   use. Upon the establishment of a          government, and debts and                  of the reinsurer’s insolvency, but it
    the ceding company’s interests in       trust, the assets of the trust cease to   compensation owed to the                   may be forced to defend its claim
    the unanticipated event of its          belong to the grantor/reinsurer and       employees of the reinsurer. Often,         against the liquidator, whose
    reinsurer’s insolvency.                 are, in most cases, beyond the reach      an estate will run out of money and        incentive is to preserve the estate’s
                                            of the liquidator.                        assets before all of the claims and        reversionary right to the trust.
    Clearly, when security is obtained                                                debts of the estate are paid.              Finally, a ceding insurer who obtains
    from an unlicensed reinsurer, a         The second type of trust asset is the     Therefore, there is no guarantee           a letter of credit from its reinsurer
    fundamental priority of the ceding      reversionary interest in the trust,       that claims based on reinsurance           as security for specific reinsurance
    company should be the collectibility    which is retained by the reinsurer.       obligations will be paid by an             obligations will, in most instances,
    of that security if the reinsurer       That is, to the extent that trust         insolvent reinsurer’s estate.              recover the entire amount of its
    becomes insolvent. It is in the         assets exceed the purposes for                                                       claim in the event that the reinsurer
    context of the reinsurer’s insolvency   which the trust was established,          Finally, a letter of credit is a form of   becomes insolvent.
    that the form of the security may       such assets will be returned to the       security whereby the reinsurer
    become critical.                        reinsurer. Those assets will be paid      posts collateral and arranges for a        While nothing in the context of
                                            over to the reinsurer after               third party bank to issue a letter of      reinsurer insolvency is certain, a
    When a reinsurer becomes                satisfaction of the obligations of the    credit to the ceding company as            letter of credit arguably provides
    insolvent, all of the assets of the     trust. This reversionary interest can     collateral for specific reinsurance        the most effective and reliable
    reinsurer are seized by the state       become problematic to a ceding            obligations. This form of security         means for securing reinsurance
    regulator, in its capacity as           company when it attempts to draw          requires two transactions: (i) the         provided by unauthorized reinsurers
    liquidator, and they become part of     on the trust. A liquidator has an         reinsurer secures credit from the          and obtaining financial statement
    the general assets of the insolvent     incentive to challenge each claim         bank; and (ii) the bank issues a           credit for such reinsurance.
    estate. In this context, any cash or    against the trust because the estate      letter of credit to the ceding
    securities of the reinsurer held by     has the reversionary interest in the      company entitling the company to
8
STATUTORY ISSUES IN ARBITRATION
WITH INSOLVENT COMPANIES
by Peter T. Maloney and Jeanne M. Kohler


                                       Foreign Arbitral Awards (the            In the majority of U.S.                 policy in favor of arbitration.12
                                       “Convention”),2 facilitates the         jurisdictions, both federal and state   The court therefore held that the
                                       enforcement and recognition of          courts have held that the statutory     arbitration clauses were “incapable
                                       international arbitration               successor of an insolvent ceding        of being performed” and that the
                                       agreements and awards. Given that       company, whether a liquidator,          claims at issue were not “capable of
                                       reinsurance is an international         rehabilitator, supervisor or            settlement by arbitration” within
                                       industry, either the domestic or        receiver, may be compelled to           the meaning of the Convention.13
                                       international provisions of the FAA     arbitrate with a reinsurer.7 This is
Peter T. Maloney   Jeanne M. Kohler
                                       can be called into play in              because of the strong federal policy    Statutory Issues In
Arbitration provisions in              reinsurance arbitration disputes.       in favor of arbitration, as
                                                                               exemplified by the FAA, and
                                                                                                                       Arbitration
reinsurance agreements are
common and generally enforceable.      Absent any other federal mandate,       because the statutory successor is
                                                                                                                       The Ardra decision is contrary to
However, historically, when a          the FAA would generally require         deemed as a matter of state law to
                                                                                                                       the weight of authority supporting
ceding company has entered             the arbitration of a dispute between    “step into the shoes” of the
                                                                                                                       post-solvency arbitration.14 Ardra’s
liquidation, rehabilitation,           an insolvent U.S. insurer and its       insolvent company and assume its
                                                                                                                       departure from the trend in other
supervision or receivership, the       domestic or alien reinsurer.            obligations, including the obligation
                                                                                                                       jurisdictions is its focus on the
binding effect of an arbitration       However, in addition to the FAA,        to arbitrate.8
                                                                                                                       overall statutory scheme for the
clause has not always been clear.      Congress has enacted the
                                                                                                                       resolution of insurance
Traditionally, liquidators and         McCarran-Ferguson Act,3 which           Significantly, however, in New York
                                                                                                                       insolvencies, and its implication
rehabilitators have attempted to       places limits on the preemptive         that is not the case. In Corcoran v.
                                                                                                                       that the scheme’s failure to address
resist arbitration with reinsurers,    effects of non-insurance specific       Ardra Ins. Co. Ltd.,9 a matter
                                                                                                                       arbitration must mean that
based on the hopefully mistaken        federal laws such as the FAA and        involving an international
                                                                                                                       arbitration is inimical to it.
perception that in a given dispute,    gives the states broad power to         arbitration, New York’s highest
                                                                                                                       However, most courts have not
state insolvency courts will favor     regulate the business of insurance.     state court acknowledged that the
                                                                                                                       accepted that implication,
the insolvent cedent to the            Therefore, the states have              Convention mandated arbitration
                                                                                                                       reasoning that the federal and
reinsurer’s detriment. While the       promulgated extensive legislation       absent preemption by the
                                                                                                                       international policies and everyday
trend in U.S. jurisdictions is to      to deal with the business of            McCarran-Ferguson Act and New
                                                                                                                       practicalities supporting arbitration
enforce the clauses and require        insurance, including the insolvency     York state precedent prohibiting
                                                                                                                       would require a much more
insolvent cedents to arbitrate with    of insurance and reinsurance            arbitration with an insolvent
                                                                                                                       explicit statutory prohibition
their reinsurers, the scope of such    companies.                              cedent.10 Therefore, the Ardra
                                                                                                                       before they would find a conflict.
arbitrations remains subject to                                                court focused on whether the
                                                                                                                       While, therefore, liquidators and
continued dispute. Liquidators and     State insolvency law is generally       Convention itself exempted the
                                                                                                                       rehabilitators in most states may
rehabilitators routinely attempt to    uniform and furnishes a                 liquidator, in that case the State
                                                                                                                       not rely upon generalized statutory
exclude certain issues from the        comprehensive method for winding        Superintendent of Insurance, from
                                                                                                                       antagonism towards arbitration,
arbitrators’ jurisdiction and keep     up an insolvent company,4 often         arbitration. The court noted that
                                                                                                                       they nonetheless commonly
those issues within the purview of     vesting exclusive jurisdiction over     Article II of the Convention
                                                                                                                       attempt to exclude various specific
the state courts, and reinsurers       insurer liquidations and                requires recognition of an arbitral
                                                                                                                       issues from arbitration with
routinely attempt to maximize the      rehabilitations in state courts.5       agreement only when it pertains to
                                                                                                                       reinsurers, arguing that those issues
arbitration process by submitting as   Therefore, a conflict often arises      a subject matter “capable of
                                                                                                                       concern matters of statutory
many issues to arbitration as          between the reinsurer’s right or        settlement by arbitration”, and that
                                                                                                                       interpretation or relief only
possible.                              desire to arbitrate pursuant to the     the court may refuse to compel
                                                                                                                       appropriate for determination by
                                       FAA and the liquidator’s right or       arbitration if the agreement is “null
                                                                                                                       state insolvency courts. To some
The Federal Arbitration                desire to resolve a ceding              and void, inoperative or incapable
                                                                                                                       extent, these arguments reiterate
and McCarran-                          company’s insolvency in state court     of being performed”.11 The Ardra
                                                                                                                       arguments previously made and
Ferguson Acts                          under the protection of the             court found that New York’s
                                                                                                                       lost respecting the arbitrability of
                                       McCarran-Ferguson Act. Because          insurance statutes, as enabled by
                                                                                                                       causes of action arising under
The starting point in deciding these   of the strong federal and               McCarran-Ferguson, granted the
                                                                                                                       federal statutes such as the
disputes has been the Federal          international policies favoring         Superintendent plenary powers to
                                                                                                                       Securities, Antitrust, RICO and
Arbitration Act (“FAA”).1 The          arbitration, reinsurers typically       manage the affairs of an insolvent
                                                                                                                       Age Discrimination Acts.
FAA provides that binding              attempt to resolve these disputes in    company, but did not authorize the
arbitration agreements involving       the federal courts, which are           Superintendent’s participation in
                                                                                                                       Thus, historically, federal courts
interstate commerce are                generally made accessible in the        arbitration proceedings. In
                                                                                                                       had been resistant to the arbitration
enforceable. In the international      event of international arbitration by   reaching that conclusion, the court
                                                                                                                       of federal statutory claims and the
field, Section 2 of the FAA, the       a specific federal removal section in   followed Matter of Knickerbocker
                                                                                                                       U.S. Supreme Court had ruled that
United Nations Convention on the       the Convention.6                        Agency, a 1958 case predating the
                                                                                                                       such statutory claims could not be
                                                                               formulation of the strong national
Recognition and Enforcement of                                                                                         arbitrated.15 However, over the

                                                                                                                                                               9
     STATUTORY ISSUES IN ARBITRATION
     WITH INSOLVENT COMPANIES

     past twenty years, the U.S. Supreme        their jurisdiction, or “abstain,” from   District Court for the Middle            setoff and cancellation of the stop
     Court has held that federal statutory      the dispute between the liquidator       District of Pennsylvania thoroughly      loss agreement.
     claims are appropriate for                 and Allstate because it concerned        examined the issues of whether a
     arbitration.16 Similarly, in those         matters of state insolvency law. The     liquidator of an insolvent cedent        In In re Liquidation of Inter-American
     jurisdictions allowing post-solvency       Court reaffirmed that abstention is      could be compelled to arbitrate with     Ins. Co. of Illinois, an Illinois appellate
     arbitrations, issues with alleged          rarely appropriate and recognized        a reinsurer and whether statutory        court reversed a trial court’s order
     statutory origins have been                that Allstate’s motion to compel         claims are arbitrable. In Cologne, the   which precluded an arbitration panel
     submitted to arbitration.                  arbitration implicated “a substantial    reinsurer had reinsured the cedent’s     from deciding whether certain
                                                federal concern for the enforcement      policies under a coinsurance             claims were covered under
     Quackenbush v.Allstate Ins. Co.17          of arbitration agreements.”23            agreement. The reinsurer and             reinsurance contracts. 31 In that
     involved the issue of whether, under       Therefore, Allstate is a strong          cedent had also entered into a stop      case, the Illinois Director of
     California Insurance Code § 1031,18        direction by the Supreme Court that      loss agreement under which the           Insurance, as liquidator, argued in
     a reinsurer was entitled to offset its     on removal from state court, federal     cedent reinsured the reinsurer. The      the lower court that the reinsurer
     obligations to an insolvent ceding         courts should exercise jurisdiction      Pennsylvania Insurance                   was obligated to compensate the
     company against debts owed by the          even when alleged statutory issues       Commissioner, as statutory               cedent’s living insureds for the value
     insolvent cedent to the reinsurer          are presented.                           liquidator of the cedent, brought suit   of the policies and that the
     under other reinsurance agreements.                                                 in state court seeking damages           reinsurance contracts were not
     The Court of Appeals for the Ninth         Selcke v. New England Ins. Co.24 was     against the reinsurer and a              executory. The reinsurer countered
     Circuit, relying on Mitsubishi Motors      another dispute between a reinsurer      declaration that (1) the reinsurer       that the reinsurance contracts were
     Corp. v. Soler Chrysler-Plymouth, Inc.,    and the rehabilitator of an insolvent    could not invoke its right to set off    executory, and had been rejected by
     supra,19 held that statutory issues in     ceding company respecting setoff.        one contract against the other           the liquidator upon the company’s
     insolvency, in some circumstances,         In Selcke, each of the reinsurance       pursuant to § 221.3227 of the            entry into liquidation.32 The trial
     are arbitrable. In Mitsubishi, the         contracts at issue included a clause     Pennsylvania insolvency laws; and        court ruled in favor of the liquidator,
     United States Supreme Court had            which called for the arbitration of      (2) that the liquidator had              holding that the contracts were not
     held that “[h]aving made the bargain       disputes concerning the                  appropriately cancelled the stop loss    executory.
     to arbitrate, the party should be held     interpretation of the contract. The      agreement but not the coinsurance
     to it unless Congress itself has           rehabilitator brought suit against the   agreement pursuant to her statutory      The reinsurer then moved to compel
     evinced an intention to preclude a         reinsurer in the United States           powers under § 221.2128 of the           arbitration on the remaining issues in
     waiver of judicial remedies for the        District Court for the Northern          Pennsylvania insolvency laws. The        dispute and the liquidator opposed
     statutory rights at issue,” or “legal      District of Illinois. The reinsurer      reinsurer removed the case to the        the motion. The trial court granted
     constraints external to the parties’       moved to stay the action pending         district court and moved for an          the reinsurer’s motion to compel
     agreement foreclose[s] the                 arbitration. The district court          order compelling arbitration. The        arbitration but excluded from
     arbitration of claims.”20 Based on         denied the reinsurer’s motion,           Liquidator moved to remand and           arbitration the issues of whether the
     this standard, the Allstate court noted    finding that the claim for setoff was    opposed arbitration claiming: 1) the     contracts were executory and
     that “Congress has not expressed an        statutory and not a dispute over         McCarran-Ferguson Act preempted          whether the insureds’ claims against
     intent to prevent arbitration of this      contract interpretation. The Court       the FAA; 2) under Ardra, arbitration     the estate were among the benefits
     claim, and no external legal               of Appeals for the Seventh Circuit       would impair Pennsylvania’s              covered under the reinsurance
     constraints counsel against                reversed the district court, noting      statutory scheme and the federal         contracts. The reinsurer conceded
     arbitration. Furthermore, this             that there is a “favorable judicial      court should therefore abstain from      that the executory contract issue was
     claim, while it may indirectly relate      attitude toward arbitration” and that    hearing the case; and 3) Article II of   no longer arbitrable but appealed the
     to the California Insurance Code,          the arbitration clause at issue was      the Convention did not authorize         arbitrability of the benefit coverage
     involves contractual rights, not rights    quite similar to others in the           arbitration because the arbitration      issue. The liquidator argued that the
     created by statute.”21                     insurance and reinsurance industries     agreement was “null and void,            reinsurer, by raising the coverage
                                                which were interpreted broadly.25        inoperative or incapable of being        issue before the trial court, had
     Significantly, the Allstate decision was   Thus, the Seventh Circuit held that      performed.”29 The Cologne court          waived arbitration on it. However,
     decided after remand from the U.S.         the statutory right to setoff was in     rejected the Liquidator’s arguments      the appellate court held that merely
     Supreme Court, which had held on           fact an implied term in the              and held that “the arbitration           raising the issue in court without
     appeal that federal courts should not      reinsurance contracts, and therefore     agreement was operative and that         obtaining a determination had not
     be overly hesitant to exercise their       was within the scope of the              the Liquidator stands in the shoes of    amounted to a waiver.33 Further,
     jurisdiction in matters involving the      arbitration clauses which required       the insolvent insurer and is bound by    the court found no support in the
     application of state insurance             arbitration of that implied “term’s”     the insurer’s contractual agreements     record for the lower court’s ruling
     statutes, such as the California setoff    interpretation.                          . . . even as to arbitration.”30 The     that, alone among its contract
     statute.22 In that case, the Court                                                  court therefore compelled                defenses, the reinsurer could not
     considered whether the federal             In Koken v. Cologne Reinsurance          arbitration of the liquidator’s claims   arbitrate the coverage issue. The
     courts should refuse to exercise           (Barbados), Ltd.,26 the United States    for declaratory relief respecting        appellate court noted that “contracts




10
STATUTORY ISSUES IN ARBITRATION
WITH INSOLVENT COMPANIES
. . . contained broad arbitration           issued an award in favor of the              to avoid arbitration with its               caselaw that the mere fact that a
clauses, which, under the [FAA], the        reinsurer, which was later                   reinsurers, the majority of courts          claim or issue allegedly arises in
court has a duty to enforce”.34             confirmed. 35                                have held that statutory successors         connection with a state insolvency
Thus, the court held that the lower                                                      are not exempt from arbitration             code does not render it non-
court had erred in singling out the         Conclusion                                   simply because arbitration is not           arbitrable.
benefits issue as non-arbitrable, and                                                    specifically addressed in state
ordered arbitration on it.                  Although the statutory successor of          insolvency laws. Moreover, there is
Subsequently, the arbitration panel         an insolvent company may attempt             a developing trend within that


1 9 U.S.C.A. § 1 et seq. (West 2001).
2 21 U.S.T. 2517 (June 10, 1958). Congress has implemented the Convention as Chapter 2 of the FAA (9 U.S.C.A. §§ 201-208 (West 2001)).
3 15 U.S.C.A. §§ 1011-1015 (West 2001). Specifically, the McCarran-Ferguson Act provides that “[n]o Act of Congress shall be construed to invalidate, impair or
supercede 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.” 9
U.S.C. § 1012 (b).
4 See, e.g., N.Y. INS. LAW §§ 7401-7409 (McKinney 2001).
5 See, e.g., N.Y. INS. LAW § 7409 (c) (McKinney 2001).
6 9 U.S.C.A. § 205 (West 2001).
7 See, e.g., Suter v. Munich Reinsurance Co., 223 F.3d 150 (3d Cir. 2000) (New Jersey); Quackenbush v.Allstate Ins. Co., 121 F.3d 1372 (9th Cir. 1997) (California); Selcke v.
New England Reins. Co., 995 F.2d 688 (7th Cir. 1993) (Illinois); Bennett v. Liberty National Fire Ins. Co., 968 F.2d 969 (9th Cir. 1992) (Montana); Nichols v.Vesta Fire Ins.
Corp., 56 F. Supp. 2d 778 (E.D. Ky. 1999); Koken v. Cologne Reinsurance (Barbados), Ltd., 34 F. Supp. 2d (M.D.Pa. 1999); Costle v. Fremont Indemnity Co., 839 F. Supp. 265
(D.Vt. 1993); Phillips v. Lincoln Nat’l Health & Cas. Ins. Co., 774 F. Supp. 1297 (D. Colo. 1991); Ainsworth v.Allstate Ins. Co., 634 F. Supp. 52 (W.D. Mo. 1985); In re
Liquidation of Inter-American Ins. Co., 303 Ill. App. 3d 95, 707 N.E.2d 617 (1st Dist. 1999); Foster v. Philadelphia Manufacturers, 140 Pa. Cmwlth. 186, 592 A.2d 131
(1991); Fabe v. Columbus Ins. Co., 587 N.E.2d 966 (Ohio App. 1990); Massachusetts Commissioner of Ins. v. Underwriters at Lloyds, No. 91-7877-C (Mass. Super. Ct. December
8, 1996). See also KY. REV. STAT. ANN. § 304.33-010(6) (Banks-Baldwin 2001) (Kentucky statute preserving reinsurer’s right to arbitrate with insolvent company).
But see Davister Corp. v. United Republic Life Ins. Co., 152 F.3d 1277 (10th Cir. 1998) (Utah); Munich American Reinsurance Co. v. Crawford, 141 F.3d 585 (5th Cir. 1998)
(Oklahoma); MO. ANN. STAT. § 435.350 (West 2001) (Missouri statute barring arbitrations against an insolvent ceding company or liquidator).
8 See, e.g., Philadelphia Manufacturers, supra, 140 Pa. Cmwlth. 186, 592 A.2d 131; Columbus Ins. Co., supra, 587 N.E.2d 966.
9 77 N.Y.2d 225, 567 N.E.2d 969 (1990), cert. denied, 111 S.Ct. 2260 (1991).
10 77 N.Y.2d at 232-33, 567 N.E.2d at 972-73 citing Matter of Knickerbocker Agency, 4 N.Y.2d 245, 149 N.E.2d 885 (1958).
11 77 N.Y.2d at 232-33, 567 N.E.2d at 972-73 (discussing the Convention, 9 U.S.C.A. §§ 201-208).
12 4 N.Y.2d 245, 149 N.E.2d 885 (1958).
13 Id.
14 See footnote 6 supra.
15 Barrentine v.Arkansas – Best Freight System, Inc., 450 U.S. 728 (1981) (claims arising under the Fair Labor Standards Act not arbitrable); Alexander v. Gardner-Denver Co.,
415 U.S. 36, 9 S. Ct. 1011 (1974) (claims arising under Title VII of the Civil Rights Act not arbitrable); Wilko v. Swan, 346 U.S. 427, 74 S. Ct. 182 (1953) (claim arising
under the Securities Act of 1933 not arbitrable).
16 Rodriguez de Quijas v. Shearson/American Express, Inc., 490 U.S. 477 (1989) (claims based on the Securities Act of 1933 held arbitrable) (reversing Wilko v. Swan, supra);
Shearson/American Express, Inc. v. McMahon, 482 U.S. 220 (1987) (claims based on Security Exchange Act of 1934 and RICO are arbitrable); Gilmer v. Interstate/Johnson
Lane Corp., 500 U.S. 20 (1991) (compelling arbitration of employment discrimination claim); Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, Inc., 473 U.S. 614 (1985)
(antitrust claims under the Sherman Act are arbitrable); Southland Corp. v. Keating, 465 U.S. 1 (1984) (claims under California Franchise Investment Law are arbitrable).
17 121 F.3d 1372, 1380 (9th Cir. 1997).
18 CAL. INS. CODE § 1031 (West 2001).
19 473 U.S. 614, 105 S. Ct. 3346 (1985).
20 Id. at 628.
21 121 F.3d at 1380. (emphasis in original).
22 Quackenbush v.Allstate Ins. Co., 517 U.S. 706, 116 S. Ct. 1712 (1996) (emphasis supplied).
23 Id
24 995 F.2d 688.
25 Id. at 689-90.
26 34 F. Supp. 2d 240 (M.D.Pa. 1999).
27 PA. STAT. ANN. tit. 40 § 221.32 (West 2001).
28 PA. STAT. ANN. tit. 40 § 221.21 (West 2001).
29 Cologne, 34 F. Supp. 2d at 255-56.
30 Id. at 256 citing Commonwealth ex. rel. Kelly v. Commonwealth Mutual Ins. Co., 450 Pa. 177, 299 A.2d 604 (1973).
31 303 Ill. App. 3d 95, 707 N.E.2d 617 (1st Dist. 1999).
32 303 Ill. App. 3d at 97, 707 N.E.2d at 619 citing Collier on Bankruptcy § 70.43 (14th ed. 1978).
33 303 Ill. App. 3d at 103, 707 N.E.2d at 623.
34 303 Ill. App. 3d at 104, 707 N.E.2d at 623.
35 No. 91-CH-10189 (Ill. Cir. Ct. Dec. 22, 2000) (reported in 11 Mealey’s Litigation Reports: Reinsurance 17 (Mealey Publications Jan. 11, 2001) and (Ill. Cir. Ct.
April 30, 2001) (reported in 12 Mealey’s Litigation Reports: Reinsurance 1 (Mealey Publicat
                                                                                                                                                                                 11
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