To Go to Arbitration or Litigation in Subrogation Cases?

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1 To Go to Arbitration or Litigation in Subrogation Cases? Dr. Zhan Hao, managing partner of AnJie Law Firm One of the questions in China is whether an insurer should go to arbitration or litigation in subrogation cases. 1. The contradiction between bulks of insurance disputes and less efficient resolution channels China is facing an increasing number of insurance disputes in respect of all business lines such as construction insurance, credit insurance, marine insurance, product liability insurance, car insurance, D&O liability insurance, environment protection insurance, investment-linked insurance, and life insurance. According to a speech of the Assistant Chief Justice of the PRC Supreme People's Court, 14,465 insurance litigations were formally accepted by courts in 2005, and in 2010, the number of cases accepted reached 59,747 cases. Some legal experts have estimated that the number of insurance litigations in 2012 is around 1.5 times of that in Insurance disputes frequently arise from disagreements on the scope of clauses limiting or excluding coverage ( excluding clauses ), the obligation of the insurer to clearly explain the excluding clauses to the applicant, and the disclosure obligation of the applicant and insured. The biggest proportion of insurance disputes belongs to automobile insurance disputes. Conducting insurance litigations in the PRC is problematic for several reasons: Insurance products are rather young as the PRC government only allowed the insurance industry to operate in As a consequence, various conflicts and debates have not yet been clarified and there is a lack of experienced judges, lawyers and mediators to handle insurance disputes as well as dispute resolution means such as ADR. Most insurers, insurance brokerage companies, insurance agencies and loss adjustors prefer arbitrations. The reasons underlying such preferences are obvious: time-efficiency, greater flexibility and privacy, and better human capital as the experienced arbitrators have been immersed in the insurance industry for a long time. The lawyer s fee is another essential factor in consideration as a reasonable fee is likely to be awarded to the winning party by arbitrators but is always ignored or rejected by judges. 1 / 5

2 2. How should the arbitration clause be treated in subrogation cases? If an insured executes an arbitration clause with a third party, and an insured accident happens because of the liability of this third party, the insurance policy stipulates that the insurer shall give insurance proceeds to the insured and has the right to subrogate in order to recover its loss from the third party. Hence, the question becomes: should the insurer have the right to commence an arbitration process? Based on Article 60 of the PRC Insurance Law, some people who prefer arbitration believe that the insurer's right of subrogation is not an original right incurred by the insurer itself but a right adopted from the insured. The insurer in a subrogation case shall be deemed as standing in the shoes of the insured, so the arbitration clause will naturally apply to the insured. Therefore, when an insurer wants to claim recovery against the third party under the agreement between the insured and the third party, the insurer shall execute the arbitration clause binding both the insured and the third party. Others disagree with this interpretation referring to Article 4 of the PRC Arbitration Law which requires a free will of parties to refer a dispute to arbitration and an arbitration agreement reached by them. Thus, the question revolves around how to define an arbitration agreement. On this issue, the PRC Supreme People's Court issued the Judicial Interpretation on Certain Issues Concerning the Application of the Arbitration Law of the People's Republic of China ( the Judicial Interpretation ). Article 1 of the Judicial Interpretation stipulates that other written agreements shall mean those agreements on arbitration requests concluded in the form, such as a written contract, letter, or electronic data text (including telegram, telex, facsimile, electronic data interchange, and ). According to one school of thought, the insurer and the third party did not reach a contract containing an arbitration clause, nor did they sign any written forms of agreement to submit the dispute to arbitration. Thus, the arbitration clause should not be binding to the insurer, and the arbitration institution has no jurisdiction over the dispute between the insurer and the third party. In response to such reasoning, those who prefer arbitration also quote the Judicial Interpretation to back up their opinion. Article 9 of the Judicial Interpretation stipulates that: where all or part of the creditor's rights and/or debts are transferred, the arbitration agreement shall be binding upon the transferee unless the parties 2 / 5

3 agree otherwise or the transferee explicitly objects to or is unaware of the existence of a separate arbitration agreement when the creditor's rights and/or debts are transferred thereto. Based on this legal provision, an insurance subrogation right could be deemed as having been transferred from the creditor (the insured) to the transferee (the insurer), and as such, the arbitration agreement will be binding upon the insurer. In legal practice, different judges in local courts have varied thoughts over this interpretation. Some are of opinion that since the right is transferred from the insured to the insurer, the binding force of the arbitration clause is also transferred to the insurer and the third party. Dissenters will elaborate that Article 9 of the Judicial Interpretation is applied in cases where parties of a contract and the transferees agree to intentionally transfer the whole contract, including their rights and obligations under the contract, rather than insurance subrogation, which is a kind of right that is transferred automatically, or the transference of rights compelled by PRC Insurance Law. In such circumstances, the substantial right of the insured to claim for compensation against the third party is transferred, but as there was no meeting of mind between the insurer and the third party to submit to arbitration, it is hard to envision the arbitration agreement has been transferred too. Due to these legal uncertainties, the third party in subrogation process is likely to challenge the validity of the arbitration agreement in accordance with Article 20 of the PRC Arbitration Law. The arbitration tribunal then has to suspend the arbitration procedure and wait for the ruling of the court which is unappealable. As a consequence, the correct insurance subrogation venue can hardly be determined in advance. In short, the competition over subrogation cases between courts and arbitration institutions has become an exhausting and time-consuming game, and makes insurers bewildered for their recovery right. 3. Can an arbitral award be set aside? After an intense and fierce trial where the wining party has the arbitral award in hand, he will face another obstacle: the court's review of the arbitral award. The review procedure of the arbitral award by court can be divided into two aspects: domestic arbitration and foreign-related arbitration. Article 58 of PRC Arbitration Law is applicable to domestic arbitration. This clause allows the court to set aside an arbitration award in the following situations: (1) There is no arbitration agreement; (2) The matters decided in the award exceed the 3 / 5

4 scope of the arbitration agreement or are beyond the arbitral authority of the arbitration commission; (3) The formation of the arbitration tribunal or the arbitration procedure was not in conformity with the statutory procedure; (4) The evidence on which the award is based was forged; (5) The other party has withheld the evidence which is sufficient to affect the impartiality of the arbitration; or (6) The arbitrators have committed embezzlement, accepted bribes or done malpractices for personal benefits or perverted the law in the arbitration of the case. If the court determines that the arbitration award violates the public interest, it shall also set aside the award. Article 70 of the PRC Arbitration Law applies on foreign related arbitrations and sets up a similar standard. In the past, almost every reason for setting aside an award was related to procedural issues, except for one case where it was related to public interest. Local courts sometimes set aside awards by reference to reasons irrelevant to law and judicial interpretation. For instance, if a third party loses in arbitration, it is likely to challenge the validity of the insurance contract and the insurer's position of subrogation. Even if the third party is not a party to the insurance contract, it will always challenge the award by reference to the insurance contract and question the insurable interest, premium, coverage, excluding clauses, disclosure and waiver issues in the execution of insurance contract. In the framework of Chinese jurisprudence, the subrogation dispute relationship between the insurer and the third party is different from the contractual relation between the insurer and the insured. Per legal doctrine, each litigation instance shall focus on a single legal relation. Checking evidence and investigating facts that are not closely related to the relation being focused on shall be deemed as overstepping jurisdiction. Thus, in the review procedure, the above-mentioned probing exceeds not only the limit between a substantial issue and a procedure issue but also the limits proscribed by juridical doctrine. Since there is a lack of detailed and specific law that touches upon this issue, despite insurer s objection, some judges will check the whole case in detail, including evidence discovery, debate, and loss adjuster report in the arbitration procedure, and set aside the arbitral award. 4. The enforcement procedure of an award Once the insurer manages to get through the burdensome review procedure without additional tumult, it may think that it has approached the peak, but the enforcement procedure will teach it a lesson: now, it is just halfway up the mountain. 4 / 5

5 If the third party does not execute the payment obligation according to the arbitral award, the insurer has to apply to court to enforce the award which is governed by Article 237 of the PRC Civil Procedure Law. With respect to the foreign-related arbitral award, the reason for disallowance is the same as the reasons for setting aside domestic arbitral awards, namely that the parties have no arbitration clause in their contract nor have they subsequently reached a written agreement on arbitration. In the PRC practice, the enforcement procedure jeopardizes far more awards than review procedure. The reason is simple: venue. The court which hears the claim regarding the setting aside of an arbitral award is the intermediate court which has jurisdiction over where the arbitration commission is located. In contrast, the court in charge of arbitral award enforcement, including both domestic and foreign-related awards, is the court where the losing party has their domicile or where their property is located. Generally speaking, the intermediate court in review procedure is hospitable to the arbitration institution, but it is hard to say the same for an enforcement court, which is friendlier toward the target entity. Taking regional protectionism into account, the enforcement procedure will sometimes make the energy and resources devoted by insurers in subrogation arbitration to be of no use. This is the main reason why the subrogation success ratio for insurers via arbitration is so low. If the insurer is defeated in the enforcement procedure, the insurer will face another frustrating puzzle: if the execution of an arbitral award is disallowed by the court, the parties may, in accordance with a written agreement on arbitration reached between them, apply for arbitration again or they may bring an action to a court. In conclusion, it appears difficult for insurers to untangle the options for subrogation on whether it is better to go to arbitration or litigation? 5 / 5