Reinsurance REDUX. The redux on developments in the law of reinsurance IN THIS ISSUE. Reinsurance Redux Newsletter Contacts:

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1 INSURANCE PRACTICE GROUP AUGUST 2011 Reinsurance Redux Newsletter Contacts: Amy S. Kline Caitlin M. Piccarello Braden A. Borger Sean T. O'Neill Andrea P. Brockway Reinsurance The redux on developments in the law of reinsurance IN THIS ISSUE Commonwealth Court of Pennsylvania Denies Liquidator s Objection to Reinsurer s Request for Setoff of Obligations Against Insurer in Liquidation The Commonwealth Court of Pennsylvania overruled a Liquidator s preliminary objection to reinsurer s request for setoff of its obligations to an insurer in liquidation. The court held, among other things, that mutuality is satisfied in this case because the contracts arose from reciprocal relationships between the parties as cedent and reinsurer and the agreements between the parties permit inter-contract setoff. Republic Western Insurance Co. v. Reliance Insurance Co., In Liquidation, No. 12 REL 2009 (Pa. Cmwlth. Ct. June 29, 2011). PAGE 2 District Court Denies Insurer s Petition to Appoint Umpire and Orders Umpire Selection Process to Continue in Accordance with Parties Agreement The District Court of Massachusetts denied an insurer s petition to appoint an umpire in a reinsurance arbitration and, despite delays and the parties dispute, ordered that the umpire selection process should be carried out in accordance with the terms of the parties agreement. Liberty Mutual Insurance Company v. Nationwide Mutual Insurance Company, et al., No. 11-cv (D. Mass. July 6, 2011). PAGE 3 Commonwealth Court of Pennsylvania Affirms Liquidator s Determination That Captive Insurer s Claim is That of Reinsurance Rather Than Insurance The Commonwealth Court of Pennsylvania affirmed a Liquidator s classification and referee s recommendation that claims made by a captive insurer were reinsurance claims rather than insurance claims, despite the insurer existing solely for the purpose of insuring the parent company and complying with Mexican laws. Michael F. Consedine, Acting Insurance Commissioner of the Commonwealth of Pennsylvania v. Reliance Insurance Co., No. 269 MD 2001 (Pa. Cmwlth. Ct. Apr ). PAGE 3 District Court Confirms Arbitration Award Despite Panel s Refusal to Hear Certain Evidence The United States District Court for the Southern District of New York rejected a motion to vacate and modify a $5,695,124 award in a wrongful termination suit. In response to an argument that the panel committed misconduct when it denied the moving party the right to dispute an exhibit on a material issue submitted by the non-moving party, the court reasoned that arbitrators enjoy broad discretion to decide whether or not to hear certain evidence on an issue. It also held that a court cannot review an arbitration award without reconsidering the merits, which is improper. James B. Fellus v. Sterne, Agee & Leach, Inc., No. 10-CV-8881(SAS) (S.D.N.Y. 2011). PAGE 4 Supreme Court of New York, New York County, Upholds Arbitrator s Award of Attorney s Fees Where Both Parties Acquiesced to Such Fees The Supreme Court of New York, New York County, denied a motion to vacate or modify an award of attorney s fees, holding that although the parties agreement did not expressly provide for attorney s fees, the parties had acquiesced in permitting the panel to award such fees by, among other things, including a request for fees in their initial and revised pleadings and petitioner had not specifically withdrawn the claim before the close of the hearing. Bear Stearns v. International Capital & Management Co., /11 (N.Y. Sup. Ct., June 27, 2011). PAGE 5 REDUX

2 Commonwealth Court of Pennsylvania Denies Liquidator s Objection to Reinsurer s Request for Setoff of Obligations Against Insurer in Liquidation Republic Western Insurance Co. v. Reliance Insurance Co., In Liquidation, No. 12 REL 2009 (Pa. Cmwlth. Ct. June 29, 2011). The Commonwealth Court of Pennsylvania overruled a Liquidator s preliminary objection to reinsurer Republic Western Insurance Company s ( Republic Western ) request for setoff of its obligations to Reliance Insurance Company (in Liquidation) ( Reliance ). In its preliminary objection, the Liquidator unsuccessfully argued that a setoff is precluded by the relevant reinsurance contracts and by the terms of an arbitration award in favor of the Liquidator. Beginning in 1997, Reliance and Republic Western agreed to three separate contracts establishing reciprocal obligations between the parties in their roles as both reinsurer and cedent. Reliance reinsured Republic Western in two of the agreements, and Republic Western reinsured Reliance in the third. After Reliance entered into liquidation, Republic Western submitted proofs of claim for coverage in excess of $2.5 million. The Liquidator assigned Republic Western s claim as priority level (e), making recovery unlikely, and no value was assigned. No objections were taken to this determination. Thereafter, Reliance made claims against Republic Western under the treaties that Republic Western reinsured. The parties attempted to negotiate a settlement over their competing claims, but were unsuccessful, so the Liquidator demanded arbitration for Reliance s claims against Republic Western. In arbitration, Republic Western counterclaimed for a setoff of its obligations. The Liquidator opposed the claim for offset. In March 2009, an arbitration panel issued an award in favor of the Liquidator, and shortly thereafter, Republic Western petitioned for leave to file a claim seeking setoff in the liquidation proceeding. Subsequently, after the award became final, the arbitration umpire responded in an that a setoff was not permitted. In opposing Republic Western s petition, the Liquidator argued that Offset Guidelines issued by the Liquidator, the contracts between the parties, and the umpire s all indicated a setoff is not permitted. The Commonwealth Court granted leave for Republic Western to file its petition for setoff in the amount of $2,707, and a declaration that it is entitled to a setoff of future Reliance obligations, among other things. The Liquidator objected in the form of a preliminary objection, principally arguing that Republic Western cannot prevail because mutuality between the debts, as required under Section 532 of the Insurance Department Act of 1921 ( Act ), is defeated by provisions in the reinsurance contracts that explicitly limit setoff to obligations arising within the particular contract. The court overruled the preliminary objection, holding that mutuality is satisfied in this case because the contracts arose from reciprocal relationships between the parties as cedent and reinsurer. The court further held that its interpretation of the agreements permit inter-contract setoff; the arbitration award does not bar Western Republic s setoff right as the award makes no mention of setoff under Section 532 of the Act; the umpire s that a setoff was not permitted was only his opinion and not the opinion of the entire panel, and was made after the award became final; and finally, the setoff is an issue expressly within the court s jurisdiction and not within that of an arbitration panel that decided only one of the claims. Arbitration umpire s post-award , guidelines from Liquidator and parties contracts did not override terms of statute on point so that setoff relief was not precluded; Mutuality may be found where contracts arise from reciprocal relationships between the parties as cedent and reinsurer

3 District Court Denies Insurer s Petition to Appoint Umpire and Orders Umpire Selection Process to Continue in Accordance with Parties Agreement Liberty Mutual Insurance Company v. Nationwide Mutual Insurance Company, et al., No. 11-cv (D. Mass. July 6, 2011). The United States District Court for the District of Massachusetts denied Liberty Mutual Insurance Company s ( Liberty Mutual ) petition to appoint an umpire in a reinsurance arbitration and, despite delays and the parties dispute, ordered that arbitrators already appointed by the parties proceed with the umpire selection process in accordance with the terms of the agreement. Liberty Mutual was reinsured through a series of agreements with Nationwide Mutual Insurance Company, National Casualty Company, and Employers Insurance Company of Wausau (collectively, the Reinsurers ) dating from 1972 to Liberty Mutual looked to recover over $6.5 million from the Reinsurers for their shares of a reinsured loss related to asbestos settlements. Following the Reinsurers refusal to tender payment for the shares, Liberty Mutual demanded arbitration. The arbitration provision in the relevant agreement called for each party to select its own arbitrator, and then each selected arbitrator would jointly select an umpire. The parties appointed their respective arbitrators on January 28, Thereafter, however, a dispute arose as to the selection of an umpire and in April 2011, Liberty Mutual filed a motion with the court to appoint one of its proposed umpires. Liberty Mutual accused the Reinsurers of using dilatory tactics in an attempt to avoid paying the money owed to Liberty Mutual. The Reinsurers opposed the motion, denied the allegations and argued that Liberty Mutual was trying to circumvent the umpire selection process. The Reinsurers also took the position that the court should not interfere in the umpire selection process as set forth in the agreement. On July 6, 2011, the court denied Liberty Mutual s petition and ordered that the two arbitrators proceed with the umpire selection process as contemplated by the reinsurance treaties without intermeddling, obstruction, interference, or other direction from the parties or counsel. Even when faced with delay and a dispute between the parties, courts may refuse to intervene in umpire selection process when parties agreement expressly provides for umpire selection mechanism. Commonwealth Court of Pennsylvania Affirms Liquidator s Determination That Captive Insurer s Claim is That of Reinsurance Rather Than Insurance Michael F. Consedine, Acting Insurance Commissioner of the Commonwealth of Pennsylvania v. Reliance Insurance Co., No. 269 MD 2001 (Pa. Cmwlth. Ct. Apr ). The Commonwealth Court of Pennsylvania affirmed a Liquidator s classification and referee s recommendation that claims made by KOT Insurance Company ( KOT ), a captive insurer, were reinsurance claims rather than insurance. In sum, the claims were reinsurance claims despite the insurer existing solely for the purpose of insuring its parent company, Petroleos Mexicanos ( Pemex ), Mexico s stateowned petroleum company, and complying with Mexican laws. KOT was created by Pemex to cover certain of the risks of Pemex. KOT insured 97.5 percent of the risk, and insurer, Sequros Comercial

4 America S.A. de C.V. ( Seguros ), assumed the remaining 2.5 percent. Seguros ceded its risk in excess of the first $40 million to several subscribing reinsurers, including 10 percent to Reliance Insurance Company ( Reliance ). KOT filed a claim after Reliance went into liquidation. The Liquidator assigned KOT s claim a priority level (e), the level for reinsurance. KOT argued, on the other hand, that the reinsurance contract effectively operated as a direct insurance policy, and therefore a (b) priority level should have been assigned. The bases for KOT s argument were that: (1) the policy is an insurance contract because KOT is a captive insurer for Pemex created for strategic and statutory purposes, (2) KOT did not retain any of the actual risk, and (3) Pemex dealt directly with the reinsurers through a cut-through clause that in essence created privity between Pemex and Reliance. The court assigned the dispute to a referee who determined the dispute was controlled by another related matter before the court, Koken v. Reliance Ins. Co. (Objections of SOL Ins. Ltd. POC ), No. 269 M.D. 2001, and recommended the court sustain the Liquidator s decision. Principally, according to his findings and recommendations in Koken, the referee reasoned that the cut-through clause does not change the nature of the agreement, that the policy is unequivocally a reinsurance policy, and the policy was designed to provide insurance to Pemex by KOT, not Reliance. Moreover, according to the referee, whether there was privity between Pemex and Reliance is irrelevant because KOT is the claimant, not Pemex. Accordingly, the referee recommended the court grant the Liquidator s motion for summary judgment on the issue and order that the claim classification as reinsurance was proper. The Commonwealth Court affirmed the referee s decision and concluded there was no issue of material fact regarding the parties intent. Claims by a captive insurance company, created for statutory purposes and to cover the risks of its parent company, although resembling a direct insurance claim may nonetheless be treated as reinsurance. District Court Confirms Arbitration Award Despite Panel s Refusal to Hear Certain Evidence James B. Fellus v. Sterne, Agee & Leach, Inc., No. 10-CV-8881(SAS) (S.D.N.Y. 2011). In this case, the petitioner, James Fellus, moved to confirm an arbitration award of $5,695,124 issued by a Financial Industry Regulatory Authority ( FINRA ) arbitration panel in resolution of a wrongful termination suit between Fellus and his former employer, Stern, Agee & Leach, Inc. ( SAL ). SAL moved to vacate or modify the arbitration award, arguing principally that the arbitrators improperly denied SAL the opportunity to dispute an exhibit submitted by Fellus that arguably contained incorrect revenue figures regarding a key issue, and thus the panel was guilty of misconduct. The court ultimately rejected SAL s motion and confirmed Fellus award. Among other things, the court held that the arbitrators were not guilty of misconduct because they enjoy broad discretion to decide whether to hear certain evidence, and since SAL did not dispute that it made arguments throughout the hearing regarding the revenue numbers, this case was distinguishable from a proceeding where the parties are denied the opportunity to present any evidence, and the arbitrators conduct here did not amount to a denial of fundamental fairness. It also stated that a court cannot review an arbitration award without reconsidering the merits, which is improper. Arbitrators enjoy broad discretion to decide whether or not to hear certain evidence on an issue and need not hear every piece of relevant evidence on that issue

5 Supreme Court of New York, New York County, Upholds Arbitrator s Award of Attorney s Fees Where Both Parties Acquiesced to Such Fees Bear Stearns v. International Capital & Management Co., /11 (N.Y. Sup. Ct., June 27, 2011). In this case, following a FINRA arbitration, Bear Stearns & Co. Inc. ( Bear Stearns ) sought to confirm a $316, award of attorney s fees. International Capital & Management Co. ( ICMC ) moved to modify or vacate the award arguing that the arbitration panel had no contractual or statutory basis for such an award. The Supreme Court of New York, New York County, rejected this argument, holding that the parties had acquiesced in permitting the panel to award such fees by, among other things, including a request for fees in their initial and revised pleadings and petitioner had not specifically withdrawn the claim before the close of the hearing. In more detail, ICMC was a customer of Bear Stearns and made a $5 million investment in a hedge fund that ultimately went to zero in July ICMC submitted the case to arbitration, claiming Bear Sterns committed common-law and securities fraud, breach of contract, and breach of fiduciary duty, among other claims. In addition to other damages, ICMC sought attorney s fees and other costs and expenses. A few weeks before hearings were scheduled, and after the parties had engaged in extensive discovery, ICMC withdrew its fraud claims but did not strike its request for attorney s fees from the pleadings. Following a subsequent Bear Stearns petition for attorney s fees and costs incurred in connection with ICMC s prosecution of its now-withdrawn fraud claims, ICMC s response in opposition, an in camera review of documentation support Bear Stearns petition, and several days of the arbitration hearings, the panel directed ICMC to pay Bear Stearns $316, in attorneys fees and costs. A few weeks later, the panel issued an award denying and dismissing all of ICMC s claims with prejudice. In response to Bear Stearns petition to confirm the award in the Supreme Court of New York, New York County, ICMC moved to vacate and modify the award regarding the payment of attorney s fees. In support of its motion, ICMC argued that the panel exceeded its powers by awarding attorney s fees and costs because there was no consensual agreement between the parties, namely, neither the parties contract nor FINRA rules provided for such fees, there was no clear expression of the parties intention to waive the rule that parties are responsible for their own attorney s fees, and in its closing argument at the arbitration hearing it made clear to the panel that it withdrew the fraud claims that sought attorney s fees and objected to Bear Stearns request for such fees. The court denied ICMC s motion and confirmed the award in favor of Bear Stearns, finding that although the parties contract did not provide for attorneys fees, both parties had effectively agreed to allow the panel to award such fees by requesting and pursuing them during the course of the arbitration in their submissions and arguments (and ICMC s failure to specifically withdraw its claim for attorney s fees except in its closing statement at the conclusion of the hearing). As such, the court noted, ICMC failed to show that the panel s award was violative of public policy, was totally irrational, or exceeded a specifically enumerated limitation of power. Arbitrators can find that a party acquiesced to allowing the panel to award attorney s fees by merely requesting and pursuing such fees in its initial and revised pleadings. A party s request to withdraw its claim for attorney s fees during its closing argument at an arbitration hearing may be insufficient to modify its initial acquiescence that the panel be permitted to award attorney s fees. This publication has been prepared by the Insurance Practice Group for information purposes only. The provision and receipt of the information in this publication (a) should not be considered legal advice, (b) does not create a lawyer-client relationship, and (c) should not be acted on without seeking professional counsel who have been informed of the specific facts. Under the rules of certain jurisdictions, this communication may constitute Attorney Advertising Saul Ewing LLP, a Delaware Limited Liability Partnership. ALL RIGHTS RESERVED Baltimore, MD 500 East Pratt St. Charles O. Monk, II Boston, MA 131 Dartmouth St. Richard D. Gass Chesterbrook, PA 1200 Liberty Ridge Dr. Michael S. Burg Harrisburg, PA 2 North Second St. Eric L. Brossman Newark, NJ One Riverfront Plaza Stephen B. Genzer New York, NY 400 Madison Ave. John J. Jerome Philadelphia, PA 1500 Market St. Bruce D. Armon Princeton, NJ 750 College Rd. E Marc A. Citron Washington, DC 1919 Pennsylvania Ave, NW Mark L. Gruhin Edward R. Levin Wilmington, DE 222 Delaware Ave. Wendie C. Stabler William E. Manning