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Note: Pacific States Industries Incorporated (Insured), a Californian timber company, purchased workers’ compensation policies from American Zurich Insurance Co. (Insurer), an Illinois company, between 2004 and 2017. As part of these policies, Insured was required to provide Insurer with collateral to secure Insured’s deductible payment obligations and did so by obtaining a letter of credit in favor of Insurer. The value of the LC was apparently amended to correspond with any annual change in Insured’s deductible amount. In 2018, however, Insured chose not to renew the policy when Insurer proposed that the letter of credit be increased by USD 150,000. Later, claiming that Insured owed it collateral for prior policy years, Insurer “demanded additional collateral of over [USD]1 million.” Insured refused.

Insured sued Insurer for breach of contract; breach of the implied covenant of good faith and fair dealing; a state claim for unfair business practices; and declaratory relief. Insurer, however, initiated arbitration and filed a motion in response to Insured’s complaint to compel arbitration. Following a bevy of administrative and discovery motions, the United States District Court for the Northern District of California, Koh, J., granted Insurer’s motion to compel arbitration.

The Judge noted that the Federal Arbitration Act (FAA) is applicable to all arbitration agreements “affecting interstate commerce.” Facing a motion to compel, a court must determine “(1) whether the parties agreed to arbitrate; and, if so, (2) whether the scope of that agreement to arbitrate encompasses the claims at issue.” Federal policy favors arbitration but determining the parties’ intention regarding arbitrability rests on principles of state contract law. Insured advanced a “reverse preemption” of federal law argument on the basis that Congress’ McCarran-Ferguson Act rendered the FAA completely inapplicable to insurance policy disputes. The Judge rejected this argument and noted that Insured failed to show how applying the FAA would “invalidate, impair, or supersede” any California law regulating the insurance business. As to whether the parties agreed to arbitrate, the Judge noted that even though Insurer failed to provide specific dispute resolution terms as part of the policy and as required by state law, the consequence was merely “a default to California as the choice of law and forum” for resolution by arbitration.

On whether the claims at issue were covered by the agreement to arbitrate, the Judge noted that the policy stated that binding arbitration would be administered by the American Arbitration Association under its rules and that such was “clear and unmistakable evidence” that the parties intended for issues of the scope of arbitration to be decided by the arbitrator. Having so determined, the Judge granted Insurer’s motion to compel arbitration and decided to stay the case pending resolution of arbitration as doing so would “help clarify what claims and issues will remain for the Court to decide.”

[MJK]

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The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of the ICC or Coastline Solutions.