Your insurer wrongfully denies coverage—so you file a complaint in court, right? Not so fast! Many new insurance policies now include mandatory arbitration provisions. While at one time arbitration clauses were common only in policies issued by foreign insurers, they are now finding their way into policies issued by domestic insurers and in all types of coverages, including commercial liability insurance policies, D&O, E&O, employment liability, and cyber insurance. While the terms of these clauses vary, to the extent they are enforceable or cannot be negotiated out of the coverage, arbitration provisions close the courthouse doors to insurance disputes and force policyholders and their insurers to resolve disputed issues in private and free from judicial scrutiny.
Only about half of the states will enforce mandatory arbitration clauses contained in insurance policies. Many states, such as Washington, Virginia and Kentucky, have statutes prohibiting insurers from including mandatory arbitration clauses in insurance contracts. Whether such statutes will be enforced depends on a jurisdiction’s view of the relationship between the Federal Arbitration Act (FAA), which generally trumps state laws prohibiting arbitration agreements, and the McCarran-Ferguson Act, which reserves the regulation of insurance to the states. In State of Washington v. James River Ins. Co., the Supreme Court of Washington invalidated a mandatory arbitration clause in two liability insurance policies, finding that McCarran-Ferguson protected a state statute prohibiting arbitration provisions in insurance contracts from FAA preemption. But other states, including Massachusetts, have found that the FAA preempted similar state statutes, notwithstanding McCarran-Ferguson, and have enforced mandatory arbitration provisions in insurance contracts. In states that have no statutes or regulations prohibiting arbitration provisions in insurance contracts, such as California (with an exception for HMO contracts) and New York, arbitration provisions are enforceable.
For states that permit mandatory arbitration of insurance disputes, the existence of arbitration clauses in policies that cover emerging risks, such as cyber coverage, may be particularly troublesome. Over the past few decades, courts across the country have ruled on the meaning of terms in standard form commercial general liability insurance policies. While not all courts ruled the same way on issues such as trigger of coverage, the scope of policy exclusions, the meaning of the term “suit,” and the like, there nevertheless developed a body of law on insurance coverage that provided guidance for both policyholders and insurers regarding policy interpretation. The private nature of arbitration, however, offers no systematic collection of insurance jurisprudence. Instead, each case stands on its own, and there is no assurance that the same policy term will be interpreted the same way, even with respect to the same type of claim. For cyber coverage—where the policies are too new for coverage disputes to have percolated through the court system to binding appellate decisions—this means that there may be a paucity of published case law to guide parties in evaluating coverage and claims relating to coverage.
Policyholders can seek to avoid such provisions by negotiating with their insurers to remove them or, at a minimum, to limit the clause to non-binding arbitration or mediation. The supposed advantages to arbitration—speedier resolution and less expense—are often non-existent. Agreeing on an arbitration panel, the rules governing the arbitration, and evidentiary issues can be time-consuming. Even with the backlog that exists in most courtrooms for civil litigation, a policyholder may not obtain relief in an arbitration proceeding sooner than it would with a trial. Arbitration also may not offer a cost savings over a trial, especially where the arbitration provision requires a three-person panel or mandates a forum away from the insured’s business or in a foreign country.
Where an insurer will not consent to negotiate away an arbitration provision, the policyholder may try to negotiate terms that will make the arbitration less expensive or onerous. For example, the policyholder may attempt to negotiate the forum, number of arbitrators, cost-sharing and whether the prevailing party will be entitled to attorneys’ fees. In some cases, an arbitration provision will also include a choice of law provision, which will require the terms of the policy to be interpreted in accordance with the law of the designated state or foreign jurisdiction—one that generally favors the insurer. The policyholder may want to negotiate a more favorable choice of law provision or eliminate such a provision in favor of having the arbitrator(s) determine the applicable law.
Nevertheless, while policyholders generally favor resolving coverage disputes in court and before a jury, particularly for appropriate claims, including claims for bad faith, at times arbitration clauses can work to the policyholder’s advantage. Because of the confidential nature of arbitration, there may be some circumstances where a policyholder would prefer not to have coverage disputes made public, for example, where the facts related to the underlying claim involve private or sensitive data or proprietary business information. While a policyholder may ultimately decide it is in its interest to include an arbitration provision, it nevertheless should make this decision after fully considering its options.