Published in Law 360 (July 8, 2019)
The United States Constitution, a U.S. treaty, two federal statutes, a state statute, and a commercial contract walk into a bar. The federal statutes are arguing. The Constitution, the treaty, one of the federal statutes, and the state statute are arguing. The treaty and the other federal statute are arguing. And the contract and the state statute are arguing. In what order does the bartender serve them? Which one does the bartender serve first?
From time to time, an insurance policy’s arbitration clause will run into the thresher-sharp conflict between (a) the U.S. Constitution’s Supremacy Clause (art. VI, cl. 2), which gives federal laws and international treaties preemptive authority over conflicting state law, and (b) the McCarran-Ferguson Act, which gives state insurance law reverse preemptive authority over federal statutes that interfere with state regulation of the insurance business. Who “wins”? It depends.
Most often, when a state insurance law provision conflicts with the Federal Arbitration Act (“FAA”), there may be reverse preemption due to McCarran-Ferguson. But the judicial decisions have been inconsistent. It may depend upon the precise laws that are said to be in conflict and on the precise procedural issue at bar.
Furthermore, the Federal Courts of Appeals are split regarding whether a non-self-executing arbitration-related U.S. treaty – e.g., the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the “New York Convention”) – and/or its implementing legislation can be reverse preempted pursuant to McCarran-Ferguson. There is not much disagreement that the New York Convention itself cannot be reverse preempted; there is considerable disagreement regarding whether U.S. legislation implementing the New York Convention – i.e., FAA ch. 2, 9 U.S.C. §§ 201, et seq. – can be reverse preempted; and there is significant case-wise disagreement regarding whether the terms of the treaty or the terms of the implementing legislation are even being addressed.
And if all of that uncertainty were not enough, enter the wildcard – a contractual “conformity to statute” term in an insurance policy, providing that any policy provision that is inconsistent with state law is automatically deemed amended to conform to state law. How does the preemption-reverse preemption analysis play out in that case?
The Fifth Circuit took up that question recently in McDonnel Group LLC v. Great Lakes Ins. SE, 923 F.3d 427, 2019 U.S. App. LEXIS 14177 (5th Cir. May 13, 2019). It held that Federal law preemption prevailed. But, inevitably, not all would agree.
McCarran-Ferguson Reverse Preemption
The McCarran-Ferguson Act provides that
“[n]o Act of Congress shall be construed to invalidate, impair or supersede any law enacted by any State for the purpose of regulating the business of insurance . . . unless such Act specifically relates to the business of insurance.” 15 U.S.C § 1012(b).
The U.S. Supreme Court has held that a state law is shielded from federal preemption by McCarran-Ferguson if the state law regulates the insurance business according to the following criteria: (1) it has the effect of transferring or spreading a policyholder’s risk; (2) the practice it affects is “an integral part of the policy relationship between the insurer and the insured;” and (3) that practice is “limited to entities within the insurance industry.” See Pilot Life Ins. Co. v. Dedeaux, 481 U.S. 41, 48-49 (1987).
Moreover, McCarran-Ferguson arguably enables such state laws to reverse preempt the FAA if: (1) the FAA does not specifically relate to the business of insurance; (2) the state law invalidating the arbitration agreement in an insurance contract was enacted to regulate the business of insurance; and (3) the FAA would “invalidate, impair, or supersede” that state law. See also Humana Inc. v. Forsyth, 525 U.S. 299, 307 (1999).
Generally, a narrowly framed state statute that in effect prohibits arbitration of insurance coverage disputes would reverse preempt a conflicting federal statute by reason of McCarran-Ferguson. Among the 50 states, (a) 24 apparently have no statute or regulation prohibiting or restricting the use of arbitration provisions in insurance contracts; (b) 16 have statutes that prohibit enforcement of arbitration clauses in insurance contracts; (c) 7 have laws or courts that restrict the application of arbitration clauses within insurance contracts; and (d) 3 have regulations restricting arbitration with respect to insurance contracts. Notably, arbitration of covered disputes is not in effect prohibited under the laws of many large states, including New York, California, Texas, New Jersey, Ohio, and Illinois.
A number of federal courts, including the Fifth, Eighth, Tenth, and Eleventh Circuit Courts of Appeal, have held that McCarran-Ferguson enables pertinent state law to reverse preempt the provisions of FAA ch. 1, 9 U.S.C. §§ 1, et seq., which is not directly related to any international treaty. FAA ch. 2 is another matter, however.
The McCarran-Ferguson Analysis vis-à-vis the New York Convention
In the recent Fifth Circuit case, McDonnel Group (“MG”) bought a builder’s risk insurance policy from some U.K. insurance companies concerning a construction project in New Orleans. In 2017, the property suffered water damage, and MG submitted a claim that the insurers rejected. 2019 U.S. App. LEXIS 14177 at *2. MG commenced suit in Federal District Court seeking declaratory relief and money damages, and the insurers moved to dismiss, relying on the policy’s arbitration clause. (The agreement provided for arbitration of disputes in New York under AAA International Arbitration Rules. Id. at *3.)
The policy also contained a “conformity to statute” provision:
“In the event any terms of this...
