Reinsurance Focus

New reinsurance-related and arbitration developments from Carlton Fields

U.S. Tax Court Finds Captive Insurer Is Not an “Insurance Company” Under the Internal Revenue Code

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In this case, Reserve Mechanical Corp. (“Reserve”), a captive insurer incorporated under the laws of Anguilla, sued the Commissioner of Internal Revenue in the U.S. Tax Court regarding the Commissioner’s findings of $477,261 in deficiencies in Reserve’s federal income tax for the tax years 2008 through 2010. During those years, 100% of Reserve’s stock was owned by Peak Casualty Holdings LLC (“Peak”), a Nevada limited liability company.

The U.S. Tax Court held that Reserve failed to qualify as an insurance company for federal income tax purposes under the Internal Revenue Code section 501 (a), (c)(15), which provides for the tax-exempt treatment of income received by insurance companies that meet certain criteria. Because Reserve did not qualify as an insurer, the Court also determined that Reserve is not eligible to make an election under section 953 to be subject to U.S. federal income tax as a U.S. company.

In determining whether Reserve could be considered an “insurance company,” the U.S. Tax Court looked at risk distribution, focusing on the number of insureds and the number of risk exposures to determine whether Reserve distributed risks. For 2008, Reserve issued 13 direct written insurance policies with Peak and two other named insureds. For 2009, Reserve issued 11 policies and, for 2010, Reserve issued 11 policies involving the same parties. The policies covered between $8 and $13 million in potential losses. Each policy listed PoolRe Insurance Corp. as the stop loss insurer. For each of the years at issue, Reserve and PoolRe executed a joint underwriting stop loss endorsement, which by its terms applied to all of the policies Reserve issued. PoolRe executed reinsurance agreements designed to redistribute them to entities of Capstone Partners, a Texas limited partnership. For each of the tax years, the Court noted that Reserve and the Capstone entities each executed a quota share reinsurance policy with PoolRe, and Reserve also executed a credit insurance coinsurance contract with PoolRe, under which Reserve agreed to assume a small portion of risk that PoolRe had agreed to assume from an unrelated company, CreditRe Reassurance Corp. Ltd.

As for the direct policies, the Court found that ‘‘the number of insureds and the total number of independent exposures were too few to distribute the risk that Reserve assumed.’’ The Court held that it was not a bona fide insurance company and that there was no legitimate business purpose for the policies that Reserve issued for the insureds, noting: ‘‘[t]he direct written policies increased Peak’s insurance coverage and expenses for the tax years in issue, when it also continued to hold policies with third-party insurers. In the light of all the facts and circumstances the premiums charged for the policies were unreasonable.’’ Therefore, the Court ruled that Reserve’s transactions were not insurance transactions. The Court also found that Reserve’s quota share policies with PoolRe were not bona fide insurance agreements because the quota share arrangement involved ‘‘a circular flow of funds’’ and that the ‘‘premiums were not negotiated at arm’s length.’’ The Court noted that it found no evidence that the premiums the insureds paid PoolRe and the premiums that PoolRe paid Reserve ‘‘were actuarially determined.’’ Thus, the Court held that PoolRe’s activities as they relate to the policies were not those of a bona fide insurance company.

Therefore, as a result of its finding that Reserve did not qualify as an “insurance company”, the Court held that for the tax years at issue, Reserve is not eligible to make an election under section 953(d). Thus, the Court concluded that Reserve was subject to the 30 percent withholding tax on the premium it had received under section 881 (a) of the Internal Revenue Code and that Reserve did not provide proof to the court that these amounts should not be considered fixed, determinable, annual, periodical income. The Court rejected Reserve’s contention that the amounts it received during the tax years were capital contributions or nontaxable deposits. It also found that Reserve is not entitled to deductions, explaining that Reserve failed to establish that ‘‘it was engaged in or received income treated as income effectively connected with a trade or business within the United States.’’

Reserve Mechanical Corp. v. Commissioner of Internal Revenue, No. 14545-16 (U.S. Tax Ct. June 18, 2018).

This post written by Jeanne Kohler.

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California Federal Court Finds Defendant Did Not Wave Right to Arbitrate Despite Delay in Initiating Arbitration

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Plaintiff argued that Defendant’s basis for removal was not applicable because Defendants waived their right to arbitration or because the case is not related to the agreement containing an arbitration provision. Finding the subject matter of the action related to the agreement, the Court looked at whether Defendants waived their right to arbitrate. Looking at the various factors articulated by the Ninth Circuit, the Court found Defendants had not waived their arbitration rights, and was “mindful of the presumption that waiver of the right to arbitrate is disfavored.” The Court’s key inquiry was “whether Plaintiff was prejudiced by Defendants’ action” in delaying bringing arbitration because of ongoing settlement negotiations. “[C]ourts have declined to find waiver in analogous cases where arbitration was not sought immediately, even after years of delay.”

Assad v. Josefsson, 18-cv-02470 (USDC C.D. Cal. June 19, 2018)

This post written by Nora A. Valenza-Frost.

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First Circuit Holds Online Mandatory Arbitration Agreement is Unenforceable

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The First Circuit recently held that an arbitration clause contained in the online contract of the ride sharing app, Uber Technologies, Inc., is unenforceable under Massachusetts law.

In this case, plaintiffs, Uber riders, filed a class action in Massachusetts state court, challenging certain fees and surcharges they were charged in addition to the ride-sharing costs to which they agreed as violations of state consumer protection laws. Uber removed the case to Massachusetts federal court and filed a motion to compel arbitration based on a mandatory arbitration clause included in Uber’s Terms of Service. In order to use the Uber app, the customers had been required to register for an Uber account and to agree to the company’s Terms of Service & Privacy Policy. The Terms of Service included an arbitration clause which required customers to resolve any disputes with Uber through binding arbitration and also contained a class action waiver. The Massachusetts district court granted Uber’s motion to compel arbitration and dismissed the lawsuit. The plaintiffs then filed an appeal to the First Circuit.

At the outset, the First Circuit acknowledged that federal policy favors arbitration under the Federal Arbitration Act (“FAA”). Despite this, the court stated a valid agreement to arbitrate must exist before the FAA applies. The Court then analyzed whether Uber’s mandatory arbitration clause was enforceable under Massachusetts law, and concluded that an online contract is enforceable only if it is reasonably communicated to the plaintiff, and accepted by the plaintiff. The First Circuit then found that Uber had not reasonably communicated its Terms of Service, including the mandatory arbitration clause, to its customers because the link to the Terms was not sufficiently conspicuous. The Court noted that Uber did not use a common method of conspicuously informing online app users of its terms by requiring users to click a box stating that they agree to the terms before continuing to the next screen. Instead, Uber displayed, on an enrollment screen, a rectangular box with the language “Terms of Service,” which customers were not required to click in order to review the contract. The Court noted that Uber’s terms were not conspicuously disclosed to its users because the link was not designed in a way that most users associate with hyperlinks and thus did not have the appearance of a hyperlink. Further, the hyperlink box was not sufficiently distinct from the rest of the screen, which had other links in bold with similarly sized font that were “more noticeable.” The First Circuit noted: “if everything on the screen is written with conspicuous features, then nothing is conspicuous.” Thus, the First Circuit found that the arbitration clause is unenforceable, and reversed the Massachusetts federal court decision and remanded the case.

Cullinane v. Uber Technologies, Inc., No. 16-2023 (1st Cir. June 25, 2018).

This post written by Jeanne Kohler.

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New York Federal Court Finds Section 1782 Petition Can Reach Documents Abroad

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In a petition brought under 28 U.S.C § 1782, petitioner sought discovery of documents outside the United States. Recognizing the Second Circuit had not ruled on whether such discovery was authorized by Section 1782, the Court looked to precedent from the Eleventh Circuit, which had previously allowed such discovery abroad. “Section 1782 imposes no geographical limit on the production of documents” and to the extent courts have done so, it was “for reasons of legislative history and policy.” The Court found that the factors discussed by the Eleventh Circuit favored petitioner’s application with respect to documents relating to a criminal proceeding in Monaco, and permitted some – but not all – of petitioner’s discovery requests.

The petition also sought discovery in aid of criminal proceedings in Switzerland. Finding the petitioner satisfied the statutory requirements with respect to the Monaco proceedings, the Court found Section 1782 did not require the petitioner to “satisfy the statutory requirements for each foreign proceeding for which he or she wishes to use the requested discovery.”

In re Application of Accent Delight Int’l Ltd and Xitrans Finance Ltd., 16-MC-125 (USDC S.D.N.Y. June 11, 2018)

This post written by Nora A. Valenza-Frost.

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Texas High Court Declines to Enforce Compel Arbitration Against Non-Signatory

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In a recent dispute involving a crop insurance policy, the Texas Supreme Court held that an independent insurance agency could not compel arbitration of certain claims brought against it in state court by an insured (JJ Farms) where the agency was not a signatory to the operative arbitration agreement in the subject policy.

The dispositive issue the Texas Supreme Court addressed was the question of arbitrability, on which the court decided the trial court was charged with determining whether a valid arbitration agreement existed because there was no clear and unmistakable evidence that JJ Farms agreed to arbitrate arbitrability with non-signatories such as the agency. Therefore, the Texas Supreme Court reviewed the decision on arbitrability de novo.

On de novo review, the court assessed under a myriad of legal theories whether the underlying arbitration agreement between the insurer (R&H) and JJ Farms allowed for arbitration of disputes with non-signatories. First, the court concluded the insurance policy’s arbitration agreement did not require arbitration with non-signatories because the plain terms limited disagreements to be arbitrated to only those between the insured and insurer. Second, the court rejected an agency theory of arbitrability because R&H did not exercise control over the agency. Third, the court declined to confer third-party beneficiary status upon the agency because the insurance contract did not facially benefit it, nor did any language in the federal statute governing crop insurance grant third-party beneficiary status to insurance agents. Fourth, the court considered and ultimately discarded both direct-benefits estoppel, because the insurance policy did not impose duties or obligations on the agency, and alternative estoppel, because even though JJ Farms’s claims were intertwined with the insurance policy the relationship between R&H and the agency was insufficiently close to infer consent by JJ Farms to arbitrate the dispute.

Jody James Farms, JV v. The Altman Grp., Inc., No. 17-0062 (Tex. May 11, 2018).

This post written by Thaddeus Ewald .

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