Consumers in a bind.

The proliferation of binding arbitration clauses in consumer contracts threatens, to erode the right to a jury trial. The McCarran-Ferguson Act can help insurance policyholders combat this threat.

Not long ago, a clause in a consumer contract requiring binding arbitration of disputes was unheard of. Now, arbitration clauses appear in nearly every type of contract imaginable. Whether a consumer is purchasing a home, using a credit card, repairing a car, or even having a home inspected for termites, chances are good that the transaction will involve an arbitration clause.

Consumer advocates are especially concerned about the use of mandatory binding arbitration clauses in insurance contracts. Although some states have consumer-friendly, anti-arbitration insurance laws, the industry generally seeks to enforce the clauses under the Federal Arbitration Act (FAA). But consumer attorneys can use another federal statute, the McCarran-Ferguson Act, to help policyholders stop the clauses from being enforced.

The FAA was enacted in 1925 to provide a forum for the speedy resolution of business and maritime disputes.(1) The act states that a written agreement to arbitrate contract disputes shall be valid, irrevocable, and enforceable.(2)

For the next 60 years, the U.S. Supreme Court refused to apply the FAA to any statutory claims. For example, the Supreme Court refused to enforce arbitration clauses in actions filed under 42 U.S.C. [sections] 1983,(3) Title VII,(4) and the Fair Labor Standards Act.(5) The Court reasoned that Congress intended these statutes to be "judicially enforceable, and arbitration [was] not ... an adequate substitute for judicial proceedings in adjudicating claims under [the] statutes."(6)

In 1985, the Court reversed its longstanding presumption against the enforcement of predispute agreements to arbitrate statutory claims.(7) In Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, Inc., the Court rejected the argument that, as a matter of law, a court may not construe an arbitration agreement to encompass claims arising out of statutes designed to protect a class to which the party resisting arbitration belongs "unless [that party] has expressly agreed to arbitrate those claims."(8) The Court specifically found that a party does not forgo the substantive rights afforded by a statute simply by agreeing to arbitrate a statutory claim.(9) Six years later, the Court, citing the FAA, upheld the enforcement of an arbitration provision in a contract between an employee and a party of greater bargaining power.(10)

Eager to jump on the arbitration bandwagon, insurance companies began to insert arbitration clauses into their contracts with policyholders in the mid-1980s.(11) Since then, any policyholder seeking to take a dispute with an insurer to court has had to find a way to show that the FAA does not apply to the insurance contract at issue.

McCarran-Ferguson Act

Over 100 years ago, the Supreme Court adopted the view that insurance contracts were governed by local law and that the business of insurance was not considered interstate commerce under the Commerce Clause of the U.S. Constitution.(12) However, in 1944 the Court reversed that position in United States v. South-Eastern Underwriters Association. The justices held that a transaction between an insurer and a policyholder from a different state constitutes interstate commerce. The transaction is therefore subject to federal antitrust laws and regulations.(13)

Congress responded in 1945 by passing the McCarran-Ferguson Act, which provides that a federal law may not invalidate, impair, or supersede a state law enacted for the purpose of regulating the business of insurance, unless the federal law specifically relates to insurance.(14) Although the interpretation of insurance contracts is ordinarily a question of state law, most involve interstate commerce, and the FAA clearly governs contracts in interstate commerce.(15) Consequently, the FAA arguably applies to insurance contracts that include an arbitration clause.

Policyholders who wish to resolve disputes with insurers in a court of law rather than before an arbitration panel have argued that the FAA conflicts with state statutes that prohibit arbitration of insurance disputes.(16)

As a federal statute, the FAA would normally preempt inconsistent state law under the Supremacy Clause. However, under McCarran-Ferguson, if a federal statute that does not specifically relate to insurance conflicts with a state statute passed to regulate the business of insurance, the federal lave could not invalidate, impair, or supersede the state law.(17) Therefore, the McCarran-Ferguson Act "reverse preempts" federal laws that do not specifically relate to insurance--such as the FAA--thus preserving state anti-arbitration insurance laws.(18)

Reverse preemption 

In United States Department of the Treasury v. Fabe, the Supreme Court established a three-pronged test for determining whether the McCarran-Ferguson Act's reverse-preemption provision applies. The Court held that reverse preemption occurs if the following factors are present:

* the federal statute at issue in the case does not specifically relate to the business of insurance;

* the state statute was enacted for the purpose of regulating the business of insurance; and

* application of the federal statute invalidates, impairs, or supersedes the state statute.(19)

In insurance arbitration cases, the first prong of the Fabe test is easy to satisfy, as courts have unfailingly found that the FAA does not specifically relate to the business of insurance.(20) While courts have also addressed the third prong of the Fabe analysis,(21) much of the litigation involving reverse preemption concerns the second prong.

The Supreme Court has identified three main factors that courts should consider in determining whether a regulated practice involves the business of insurance:

* whether the practice that the statute addresses or regulates has the effect of transferring or spreading a policyholder's risk;

* whether the practice is an integral part of the policy relationship between the insurer and the insured; and

* whether the practice is limited to entities within the insurance industry.(22)

At least 10 states have enacted laws that prohibit arbitration for disputes involving insurance policies.(23) While these statutes clearly were "enacted for the purpose of regulating the business of insurance," courts usually do not allow reverse preemption unless the state law is part of the insurance code. Even then, courts make sure that the statute meets the Supreme Court's "regulating the business of insurance" test.(24)

Some courts have concluded that state arbitration laws are statutes of general applicability and, therefore, do not satisfy the second prong of the Fabe analysis.(25) For example, in Hamilton Life Insurance Co. of New York v. Republic National Life Insurance Co., the Second Circuit held, "It is quite plain that arbitration statutes, including those of Texas and New York, are not statutes regulating the business of insurance, but statutes regulating the method of handling contract disputes generally."(26)

Similarly, in Hart v. Orion Insurance Co., the Tenth Circuit held:

   None of the provisions of the Montana, Illinois, and Colorado statutes to
   which our attention has been called regulate the business of insurance.
   Instead, they are laws of general application pertaining to the method of
   handling contract disputes.... Accordingly, the McCarran-Ferguson Act does
   not bar the application of the Federal Arbitration Act, and the arbitration
   provisions are enforceable in the case at bar.(27)

More recently, though, in Davister Corp. v. United Republic Life Insurance Co., the Tenth Circuit found that the McCarran-Ferguson Act trumps the FAA in an insolvency proceeding against an insurer. Relying on Fabe, which also involved a liquidation statute, the court determined that a state law enacted specifically to protect insurance policyholders satisfied the statutory meaning of "regulating the business of insurance" and triggered application of the McCarran-Ferguson Act.(28)

The Tenth Circuit relied in large part on the Fifth Circuit's opinion in Munich American Reinsurance Co. v. Crawford. That court decided that the state laws governing insurance company delinquency proceedings were enacted for the purpose of regulating the business of insurance. Therefore, these laws reverse-preempted the FAA under McCarran-Ferguson.(29)

A decision by a federal district court in New York involving the state's Article 74, which deals in part with rehabilitation or liquidation of a domestic insurer, clearly summarized the analysis:

   The [Federal] Arbitration Act is an "act of Congress" that does not
   "specifically relate to the business of insurance." Article 74 is a "law
   enacted by a ... state for the purpose of regulating the business of
   insurance." Enforcement of the [FAA] to require arbitration where it is
   forbidden by Article 74 ... would undermine the scheme of exclusive
   jurisdiction established by Article 74.... Congress has determined that in
   such an instance the [FAA] shall yield to the state law regulating the
   business of insurance.(30)

Although the circuit courts have disagreed for years on whether state arbitration laws satisfy the Fabe test so as to trigger reverse preemption of the FAA under McCarran-Ferguson, the Supreme Court has been less than helpful in resolving the issue. In fact, it has been silent.(31)

Getting to the jury

The past several years have been one long chess match between attorneys who want their clients to have their day in court and advocates of arbitration who want to usurp the constitutional right to trial by jury. The history of arbitration clearly shows that the FAA was designed to allow sophisticated businesspeople to agree to waive a trial and work out differences through arbitration.(32) It was never intended to blindside citizens into forfeiting their constitutional rights.

As the Supreme Court held in Brady v. United States, "Waivers of constitutional rights not only must be voluntary but must be knowing, intelligent acts done with sufficient awareness of the relevant circumstances and likely consequences."(33) Often, consumers have no idea of the consequences that may follow from an arbitration clause buried in the fine print of their insurance policy.

If you have a case that involves an arbitration clause but your client needs to be heard by a jury, what can you do? Consumers have been able to avoid arbitration by proving that the contract at issue is one of adhesion and that its terms are unconscionable. An adhesion contract is a standard form contract prepared by one party and submitted to another on a take-it-or-leave-it basis; there is no equality of bargaining power.(34)

The most widely recognized example of an adhesion contract is an insurance policy. As the New Jersey Supreme Court has noted:

   Insurance policies ... are not ordinary contracts but contracts of adhesion
   between parties who are not equally situated. Even the most astute insured
   might find his or her bargaining power is necessarily limited. Insurance
   policies are often unilaterally prepared by the company's experts ... and
   then given to the insured in printed form upon the payment of the premium.
   Moreover, insurance contracts are not typically read or reviewed by the
   insured, whose understanding is often impeded by the complex terminology
   used in the standardized forms.(35)

Courts may decline to enforce arbitration clauses on the basis of generally applicable contract defenses, such as fraud, duress, or unconscionability, without violating the FAA.(36) One of the best arguments for defeating an arbitration clause in a contract of adhesion is that it is unconscionable. Courts have found arbitration clauses to be unconscionable in the following circumstances:

* the arbitration procedure called for is too biased, or there is no mutuality (for example, when the party with greater bargaining power may avoid arbitration but the other party may not);(37)

* the arbitration is to take place in an unreasonable location that denies effective process (for example, a clause that requires consumers from all over the world to arbitrate their disputes in Chicago);(38)

* the arbitration will deprive the plaintiff of an adequate remedy, such as when compensation is limited to actual damages;(39) or

* the cost of the arbitration is unreasonably high for the consumer.(40)

Fortunately, many courts have begun to recognize the problems of mandatory binding arbitration clauses in consumer contracts and have refused to enforce them.(41)

What advice should you give a client who has been asked to sign an insurance policy that requires binding arbitration of disputes? The law regarding the enforceability of arbitration agreements in insurance contracts is unsettled. Unless your client can afford arbitration and is willing to forfeit the right to a jury trial if things should go awry, the best advice you can give might be "just say no."

Notes

(1.) See generally Sales and Contracts to Sell in Interstate and Foreign Commerce, and Federal Commercial Arbitration, Hearing S. 4213 and 4214 before a Subcomm. of the Comm. on the Judiciary, 67th Cong. 9-10 (1923) [hereafter Arbitration Hearing].

(2.) 9 U.S.C. [sections] 2 (2001).

(3.) McDonald v. West Branch, 466 U.S. 284, 290-92 (1984).

(4.) Alexander v. Gardner-Denver Co., 415 U.S. 36, 57-60 (1974).

(5.) Barrentine v. Arkansas-Best Freight Sys., Inc., 450 U.S. 728, 740-41 (1981).

(6.) McDonald, 466 U.S. 284, 289.

(7.) Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, Inc., 473 U.S. 614, 639-40 (1985).

(8.) Id. at 625.

(9.) Id. at 628.

(10.) Gilmer v. Interstate/Johnson Lane Corp., 500 U.S. 20, 33 (1991).

(11.) Murray D. Sacks & Stacey A. Feldman, Arbitration Clauses in Insurance Policies--Blockade or Opportunity, 11 INS. COVERAGE LITIG. REP. 27 (2000).

(12.) Willy E. Rice, Federal Courts and the Regulation of the Insurance Industry: An Empirical and Historical Analysis of Courts' Ineffectual Attempts to Harmonize Federal Antitrust, Arbitration, and Insolvency Statutes with the McCarran-Ferguson Act, 43 CATH. U. L. REV. 399, 400-02 (1994) (quoting Paul v. Virginia, 75 U.S. (8 Wall.) 168,183-86 (1869)).

(13.) 322 U.S. 533, 561-62 (1944); id. at 401.

(14.) 15 U.S.C. [sections] 1012(b); Legal Review: U.S. Trial Trends, REINSURANCE MAGAZINE, Dec. 22, 2000, at 17.

(15.) Allied-Bruce Terminix Cos. v. Dobson, 513 U.S. 265, 274-77 (1995).

(16.) See, e.g., id. at 273.

(17.) Humana, Inc. v. Forsyth, 525 U.S. 299, 307 (1999).

(18.) Mitchell F. Dolin, Insurance Coverage Disputes and Emerging Legal Problems in Arbitration, II ALI-ABA COURSE OF STUDY MATERIALS: CIVIL PRACTICE AND LITIGATION TECHNIQUES IN FEDERAL AND STATE COURTS (Apr. 2000).

(19.) 508 U.S. 491,500-01 (1993).

(20.) See, e.g., Stephens v. Am. Int'l Ins. Co., 66 F.3d 41, 44 (2d Cir. 1995) (holding "No one disputes the fact that the FAA does not specifically relate to insurance"); see also Transit Cas. Co. v. Certain Underwriters at Lloyd's of London, 119 F.3d 619, 622 (8th Cir. 1997); Munich Am. Reinsurance Co. v. Crawford, 141 F.3d 585, 593 (5th Cir. 1998).

(21.) See, e.g., Munich Am., 141 F.3d 585, 594 (holding that the FAA operated to "invalidate, supersede, or impair" the Oklahoma law in question). See also Davister Corp. v. United Republic Life Ins. Co., 152 F.3d 1277, 1281- 82 (10th Cir. 1998).

(22.) Union Labor Life Ins. Co. v. Pireno, 458 U.S. 119, 129 (1982).

(23.) Dolin, supra note 18. See ARK. CODE ANN. [sections] 16-108-201(b) (Michie 1997); GA. CODE ANN. [sections] 9-9-2(c)(3) (Michie 1997); KAN. STAT. ANN. [sections] 5-401(c) (1991); KY. REV. STAT. ANN. [sections] 417.050(2) (Michie 1996); LA. REV. STAT. ANN. [sections] 22:629a (West 1986); MO. ANN. STAT. [sections] 435.350 (West 1992); MONT. CODE ANN. [sections] 27-5-114(2)(c) (1998); NEB. REV. STAT. ANN. [sections] 25-2602(f)(4) (Michie 1997); OKLA. STAT. ANN. tit. 15 [sections] 802 (West 1993); S.D. CODIFIED LAWS [sections] 21-25a-3 (Michie 1998). See also R.I. GEN. LAWS [sections] 10-3-2 (1996) (allowing arbitration at the option of the insured).

(24.) See, e.g., Stephens v. Am. Int'l Ins. Co., 66 F.3d 41, 45 (2d Cir. 1995) (holding that a Kentucky statute explicitly prohibiting an insurance liquidator from being compelled to arbitrate disputes concerning delinquency proceedings was "enacted for the purpose of regulating the business of insurance"); see also Quackenbush v. Allstate Ins. Co., 121 F.3d 1372, 1380-81 (9th Cir. 1997).

(25.) See, e.g., Am. Bankers Ins. Co. of Fla. v. Crawford, 757 So. 2d 1125, 1134 (Ala. 1999).

(26.) 408 F.2d 606, 611 (2d Cir. 1969).

(27.) 453 F.2d 1358, 1360 (10th Cir. 1971) (citing Hamilton Life Ins. Co., 408 F.2d 606, 611); see also Woodmen of the World Life Ins. Soc'y v. White, 35 F. Supp. 2d 1349 (M.D. Ala. 1999).

(28.) 152 F.3d 1277, 1279 (10th Cir. 1998); see also Kristen Angus, Tenth Circuit Surveys: Arbitration, 76 DENV. U. L. REV. 681,689-90 (1999).

(29.) 141 F.3d 585 (5th Cir. 1998), cert. denied, 525 U.S. 1016 (1998).

(30.) Washburn v. Corcoran, 643 F. Supp. 554, 557 (S.D.N.Y. 1986).

(31.) See Angus, supra note 28, at 692.

(32.) Arbitration Hearing, supra note 1; Allstar Homes, Inc. v. Waters, 711 So. 2d 924, 934 (Ala. 1997) (Cook, J., concurring specially).

(33.) 397 U.S. 742, 748 (1970).

(34.) See Standard Oil Co. of Cal. v. Perkins, 347 F.2d 379, 383 n.5 (9th Cir. 1965); Brown v. KFC Nat'l Mgmt. Co., 921 P.2d 146, 168 (Haw. 1996).

(35.) Doto v. Russo, 659 A.2d 1371, 1376 (N.J. 1995) (citations omitted).

(36.) Doctor's Assocs., Inc. v. Casarotto, 517 U.S. 681, 687 (1996).

(37.) Hooters of Am., Inc. v. Phillips, 173 F.3d 933, 940 (4th Cir. 1999).

(38.) Hill v. Gateway 2000, Inc., 105 F.3d 1147, 1150 (7th Cir. 1997).

(39.) Stirlen v. Supercuts, Inc., 60 Cal. Rptr. 2d 138, 150 (Ct. App. 1997).

(40.) Paladino v. Avnet Computer Techs., Inc., 134 F.3d 1054, 1056 (11th Cir. 1998).

(41.) See, e.g., Shankle v. B-G Maint. Mgmt. of Colo., 163 F.3d 1230, 1235 (10th Cir. 1999); Knepp v. Credit Acceptance Corp., 229 B.R. 821, 846 (N.D. Ala. 1999); Badie v. Bank of Am., 79 Cal. Rptr. 2d 273, 291 (Ct. App. 1998), review denied, 1999 Cal. LEXIS 1198 (1999).

Angela L. Kimbrough practices with Ford & Kimbrough in Eutaw, Alabama.