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New reinsurance-related and arbitration developments from Carlton Fields

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COURT RULES AGAIN ON MOTION TO DISMISS IN MATTER INVOLVING UNFILED RATES CHARGED UNDER REINSURANCE AGREEMENT

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On July 21, 2016, we reported on a putative class action filed in a California U.S. district court by Shasta Linen Company against Applied Underwriters, Inc. and its affiliated entities, alleging that the “EquityComp” workers’ compensation insurance program marketed and sold by Applied Underwriters violated California insurance law and regulations. Shasta asserted that the defendants unlawfully used a Reinsurance Participation Agreement (“RPA”) to control workers’ compensation rates (and thus, charge higher rates) without first having the RPA filed and approved by the department of insurance as required by law. The court dismissed Shasta Linen’s claims to the extent that they sought to invalidate the RPA’s rates on the theory that the RPA was an unfiled plan pursuant to section 11735 of the California Insurance Code. The court reasoned that the use of a rate that has not been filed is not an unlawful rate unless and until the commissioner conducts a hearing and disapproves the rate.

On December 1, 2016, we reported that subsequent to the court’s ruling, the California Commissioner issued an order in an administrative proceeding, finding that the RPA was void because it had not been filed and approved by the department. Shasta Linen then sought reconsideration of the court’s prior dismissal, arguing that the Commissioner’s Order was a “change in controlling authority meriting reconsideration” by the court. On October 17, 2016, the court held that the Commissioner’s order misinterpreted the law, and was not “controlling.” The court denied reconsideration, but it did so “without prejudice as to attempts by plaintiff to invalidate the [RPA] on grounds other than the theory that defendants violated” section 11735.

Since our last blog on the case, Pet Food Express filed a separate class action against Applied Underwriters and its affiliates in California state court, which was removed to federal court. As they had in the Shasta case, the defendants moved to dismiss Pet Food’s complaint to the extent it sought to invalidate the RPA on the ground that it is an unfiled plan in violation of section 11735. The court denied the motion as Pet Food’s complaint did not rely on section 11735. Both plaintiffs in the two action then filed nearly identical amended complaints, asserting claims under RICO, the California Unfair Competition Law (“UCL”), California Business and Professional Code and for unjust enrichment. Defendants moved to dismiss. The court consolidated the actions for pre-trial purposes.

With respect to the motions to dismiss, the court granted them as to the RICO claims because plaintiffs had not sufficiently alleged a plausible basis to infer a specific intent to defraud with respect to the RPA. Consistent with its earlier rulings, it also again granted defendants’ motions to dismiss as to plaintiffs’ attempts to invalidate the RPA on the theory that defendants violated Insurance Code section 11735. The court denied as to plaintiffs’ UCL claim and unjust enrichment claim, and on the ground that plaintiffs lacked standing to seek injunctive relief and to seek restitution.

Shasta Linen Supply, Inc. v. Applied Underwriters, Inc., Case No. 2:16-cv-00158 and Pet Food Express Ltd. V. Applied Underwriters, Inc., Case No. 2:16-cv-012111 (E.D. Cal. Oct. 17, 2017).

This post written by Jeanne Kohler.

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ENGLAND’S HIGH COURT OF JUSTICE UPHOLDS ARBITRATION AWARD FINDING NO “SERIOUS IRREGULARITY”

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Claimant’s application under s. 68(2)(d) of the Arbitration Act 1996 alleged serious irregularity in the award of an arbitral tribunal alleging the tribunal failed to deal with all the issues that were put before it, and requested that the Court set aside or vary the award rather than remit it to the tribunal, as one of the arbitrators had acted inappropriately.

Claimant listed four aspects of its defense which were not addressed: (1) collateral estoppel; (2) conclusive evidence; (3) failure to meet the burden of proof; and (4) overstatement. The Court concluded none of the complaints were justified.

With respect to the alleged inappropriate behavior, claimant’s party-appointed arbitrator sent an email to its counsel, not copying the petitioner or any other member of the Tribunal, stating that “both party-appointed arbitrators were upset by the conduct of the chairman,” expressed highly negative views about him, and that the party-appointed arbitrator was going to ask the chairman to resign. The email was marked “highly confidential: not to be used in the arbitration” and explicitly stated that the email “could not be referred to in the arbitration or afterwards.” The chairman did not resign and the arbitration proceeded “with no suggestion that there were any other internal difficulties on the Tribunal.”

The Court was astonished that the email was sent, stating that “any communication by one arbitrator with one party which concerns the arbitration may give rise to concerns that that arbitrator is not acting fairly or impartially for the simple reason that it creates the impression of a close relationship between the arbitrator and the party and rises the specter of other such communications.” Despite this, the Court did not set aside the Award, noting that disclosure of the email “might have created a somewhat awkward working environment, it is not something that experienced, professional people could not deal with.”

With respect to the claimant’s request for confidentiality, the Court concluded that as the Award was not confidential by a U.S. lawsuit, it was “unrealistic to argue that [claimant] continues to have any expectation of confidentiality in the Award.”

Symbion Power LLC v. Venco Imtiaz Construction Company, Case No: HT-2016-000211 (Royal Courts of Justice, London March 10, 2017)

This post written by Nora A. Valenza-Frost.

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TAX COURT DISALLOWS DEDUCTIONS FOR PAYMENTS TO CAPTIVE INSURANCE COMPANY

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A husband and wife who paid $1.54 million in premiums to their captive insurance company and $720,000 in premiums to another insurer over two years, almost all of which ended up back in their bank accounts, have had their tax deductions for those payments disallowed in a lengthy opinion by the United States Tax Court.

The couple, Benyamin and Orna Avrahami, own a set of businesses and commercial properties in the Phoenix, Arizona area. In 2007, they set up a captive insurance company called Feedback, incorporated in St. Kitts and for which they elected treatment as a small insurance company under Internal Revenue Code section 831(b).  While their total insurance expense in the year before they set up Feedback was $150,000, the Avrahamis’ businesses paid Feedback insurance premiums of $730,000 in 2009 and $810,00 in 2010.  One of those businesses also paid Pan American Reinsurance Company $360,000 in both years for terrorism risk insurance, while Feedback participated in a “risk distribution program,” under which Pan American paid Feedback $360,000 in both years.  The Avrahamis then deducted all of these premiums—$1.09 million in 2019 and $1.17 million in 2010—as business expenses.

The IRS began an audit of the Avrahamis in 2012, ultimately disallowing their deductions for insurance expenses paid to Feedback and Pan American. The IRS took the position that the payments to Feedback and Pan American were not actually insurance premiums, and the Tax Court agreed.  The court found that Feedback did not meet the essential insurance characteristic of distributing risk because it only issued 7 policies insuring 3 stores, had 2 key employees, 35 other employees, and 3 commercial properties, all in the Phoenix area, in the relevant years.  Feedback’s purported reinsurance relationship with Pan American did not help to distribute that risk, the court found, because Pan American was not a bona fide insurance company.  The Court based this on its findings that: (1) the premiums Pan American charged were “grossly excessive” when compared with what was available on the market—particularly when the Avrahamis’ own witness could not identify a single event in history to which its terrorism insurance would provide coverage; (2) Pan American distributed virtually all of the premiums it received back to its policyholders or related entities; and (3) it was unlikely that it could actually pay claims if they arose.  The court also found that Feedback did not operate like an insurance company—it issued policies with unclear and contradictory terms, paid no claims until the IRS began its audit, unreasonably invested the premiums in unsecured loans to related parties, and charged “utterly unreasonable” premiums—and thus the premiums paid to it were not actually for insurance.

As a result, the court sustained the IRS’s finding that the Avrahami’s could not deduct the premiums they paid to Feedback and Pan American. However, the court found that these disallowed deductions did not justify imposing penalties on the Avrahamis, despite the fact that much of the advice they received was from an attorney who qualified as a promoter of these transactions, because, in setting up Feedback and taking those deductions, they also reasonably relied on the advice of another attorney who was not a promoter.   The court also found that, because it was not actually an insurer, Feedback did not qualify for treatment as a small insurer under section 831(b), but this also meant that, as a St. Kitts entity, it did not owe any U.S. taxes.

Avrahami et al. v. Commissioner of Internal Revenue, Docket Nos. 17594-13 and 18274-13 (U.S. Tax Ct. Aug. 21, 2017).

This post written by Jason Brost.
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DESPITE HEAVY CRITICISM OF THE RATIONALE, BRITISH COURT REFUSES TO ENFORCE ARBITRAL AWARD SET ASIDE BY RUSSIAN COURT

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The British High Court of Justice recently decided not to enforce an arbitral award in a dispute over the calculation of the purchase price of a Russian metallurgical company where a Russian court set aside that award and Russian appellate courts affirmed the decision. The plaintiff had argued the British court should not recognize the Russian judgments setting aside the award because it was the result of bias, while the defendant argued under the doctrine of ex nihilo nihil fit that because the award had already been set aside there was nothing for the British court to enforce.

The court started its analysis by observing the heavy burden borne by the party challenging the foreign court decision. Not only must the party show the decision is wrong or manifestly wrong, they must also show the decision is “so wrong as to be evidence of bias, or be such that no court acting in good faith could have arrived at it.” 

The original Russian judge decided to set the award aside on three grounds: (1) the non-disclosure of potential bias because of the arbitrator’s relationships with expert witnesses was non-waivable; (2) the arbitrators’ method of calculating the purchase price violated public policy because it did not follow the purchase agreement’s terms; and (3) the dispute involved a “corporate claim” which is non-arbitratable under Russian law. It is noteworthy that the latter two grounds were not ones raised by the parties and were only raised by the judge in her written opinion.

In a lengthy opinion, the British High Court criticized the Russian court’s decision on all three grounds. On the non-disclosure issue, the British court took issue with the Russian court’s failure to address the appropriate test for waiver (actual or constructive notice), and failure to reach any factual conclusions. The court also took issue with the sua sponte nature of the latter two grounds. On the public policy issue in particular, the court found it difficult to see how the arbitrators acted in contravention of the agreement terms in arriving at a price calculation. Moreover, even if it were in contravention, that would amount to an error of law at most, not an act against public policy. On the non-arbitrability issue, the court determined that the Russian judge might have been a pioneer in concluding that corporate disputes are not arbitrable, because it could not find any record of cases holding applying that rule. However, a number of Russian courts since have followed her ruling.

Despite taking issue with the “shaky” grounds upon which the Russian court decided to set aside the award, and with the Russian appellate courts’ decisions affirming, the High Court nevertheless refused to enforce the award. It held that the decisions were not “so extreme and perverse that they can only be ascribed to bias” against the Plaintiff. For that reason, the court dismissed the application to enforce the award and did not reach the ex nihilo nihil fit argument.

Maximov v. Open Joint Stock Co., [2017] EWHC 1911 (Comm) July 27, 2017.

This post written by Thaddeus Ewald .
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COURT CONFIRMS ARBITRATOR’S ENTRY OF INTERIM PRELIMINARY INJUNCTION, HOLDING THAT THE AWARD WAS SUFFICIENTLY “FINAL”

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This case concerns a 10-year agreement by which plaintiff, an endodontist, contracted to perform consulting services for defendant Dentsply, a business that manufactured and sold endodontic products for the dental industry. The agreement prohibited plaintiff from disclosing any confidential information about Dentsply’s business affairs or from competing with Dentsply for three years after the termination of the agreement. But immediately prior to the end of the 10-year term of the agreement, plaintiff brought suit contending that the confidentially and non-compete provisions of the agreement were unenforceable, and seeking declaratory and injunctive relief. The case proceeded to arbitration during which the arbitrator sided with Dentsply and enjoined plaintiff from breaching the confidentiality and non-compete provisions. Dentsply then filed a motion to confirm the arbitrator’s preliminary injunction award.

Plaintiff opposed Dentsply’s motion, asserting a number of arguments based on the notion that the preliminary injunction was not sufficiently final to be confirmed by the court. The court rejected each of plaintiff’s arguments and then considered “whether, in the absence of binding Supreme Court or Tenth Circuit precedent, the Court should join the district and circuit courts that have considered interim arbitral awards final for the purposes of judicial review and confirm the Ruling.” The court decided to join those courts and confirmed the arbitrator’s preliminary injunction. The court reasoned that the interim arbitration ruling “finally and definitively enjoin[ed] plaintiff from breaching the 2007 agreement’s confidentiality and non-compete provisions during the pendency of the arbitration, and if the Ruling [was] not enforced, a subsequent award of injunctive relief to defendant may be rendered meaningless.” Moreover, the Court reasoned that the Ruling was “not a preliminary or procedural trifle, and expending the judicial resources to confirm it does not frustrate our arbitration system’s goal of expediency.” Instead, the Court found, “confirming the Ruling [gave] teeth to the arbitrator’s interim award of equitable relief, thereby promoting arbitration as an efficacious and reliable alternative to the litigation process.” Johnson v. Dentsply Sirona Inc., Case No. 16-CV-0520-CVE-PJC (USDC N.D. Okla. Sept. 27, 2017).

This post written by Gail Jankowski.

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