A.        The Substance of the Article

In law school, students are taught the law via the Case Study Method. Simply, the teacher uses an actual Case and Decision, (that the students presumably read the night before), to illustrate the principals of law that the court applied to those facts to reach the conclusion that it did. The more compelling the facts, the easier it is to get the legal principles to stick in the students' heads. I am going to use that method now as the facts I have in a current matter I am handling to illustrate the dangers of Arbitration provisions.

B.        What is Arbitration

Arbitration is BINDING private dispute resolution. Its procedures can be based on those created and administered by private organizations (like the “American Arbitration Association")  or by agreement by the parties.

Generally, the Parties often select arbitrators on the basis of their expertise. It can be 1 or more. Typically, each party picks one arbitrator each and those arbitrariness pick a third. Clearly the underling rationale is that everyone will pick someone who will be favorably biased so only the 3rd Arbitrator will be fair and not in the tank for one side or the other. (I call that a “Judge")

The Decision of the Arbitrator(s) is final and binding, subject only to a very narrow and limited ability for court review. (Fraud, Corruption, Misconduct, Partiality or Exceeding their powers.)

The Law applied is usually found in the companion “Choice of Law" provision in the contract that contains the Arbitration provision. If there is none, the Arbitrators can then do whatever they want.

So vast is the power of the Arbitrators that they can decide on the scope of THEIR OWN POWER! ["[t]he tribunal shall have the power to rule on its own jurisdiction, including objections with respect to the existence, scope or validity of the arbitration agreement," and employs language referring "all disputes" to arbitration, courts will "leave the question of arbitrability to the arbitrators". Matter of Smith Barney Shearson v Sacharow, 91 NY2d 39 (1997).]

C.        The Problem of Arbitration

There is the age old allegory of the Boiling Frog that goes like this. If a frog is suddenly put into boiling water, it will jump out. But, if the frog is put in cool water which is then brought to a boil slowly, it will not perceive the danger and will be cooked to death. That  apologue is often used as a metaphor for the inability or unwillingness of people to react to or be aware of threats that arise gradually rather than suddenly.

Sadly, it has been proven true time and time again. I remember when the Sales Pitch for Cable TV vs FREE Broadcast TV was that “IF YOU PAY FOR IT….WE WONT NEED TO HAVE COMMERCIALS".  How is that working out? Arbitration is no different and it is insidious.

It is everywhere, in everything and there is almost no escape. It robs people and businesses of their constitutional rights to access the Judicial System to resolve disputes with the critical  ability to (1) have a recognized standard to be applied and (2) to be able to appeal! [1]

  

D.        Its History, Original Purpose, Current Use & Abuse

The foundation of the use of Arbitration provisions in contracts and agreements comes from the Federal Arbitration Act. (“FAA")

The FAA was originally enacted in 1925 to overcome the judiciary's longstanding refusal, (based on the same hostility of English Courts) to enforce agreements to arbitrate disputes, and to treat these agreements as other contracts since that infringed on the jurisdiction and power of the Court system itself.

It has been widely recognized that the American Bar Association and the National Chamber of Commerce was the driving force behind the enactment of the FAA. Its original purpose, (valid in its LIMITATION) was to allow Sophisticated Commercial Entities -- ON EQUAL FOOTING…to agree to resolve their disputes outside the Court System.

So, Congress enacted the FAA to legislatively overrule the courts' refusal to enforce arbitration agreements. Thus, the purpose of the FAA was to force courts to enforce agreements to arbitrate, like any other contract provision. The FAA, since it was meant to affect “Interstate Commerce", has been ruled as applying to the States.

For much of its early history, the U.S. Supreme Court interpreted the FAA on a “Case-by- Case" basis. But over the last few decades that has shifted toward a “One-Size-Fits-All" approach ignoring distinctions that were once crucial to contract enforcement. This has allowed the parties with the power to enforce arbitration clauses in scenarios Congress never intended.

For example, I always enjoyed dining in Hoboken, NJ which is about 7 miles away from where I live. About 4 years ago I stopped going…here is why. The City of Hoboken removed all parking meters forcing anyone who wants to avail themselves of parking on the Street, (a municipal function!), to pay for parking via an APP. While I have no issue with using an official Municipal Parking App, (as they have in White Plains by my office), this was different. This was a PRIVATE APP. I refused and came back home. Thats night I read the 40 Page Digital User Agreement for the App. It contained an Arbitration provision forcing me to Arbitrate in the State of Georgia under Georgia Law if I got a parking ticket because the App did not work correctly. This particular company's Private App is in use in many Cities and Towns in New Jersey and Nationwide.

A week ago I bought a Scent Diffuser from Amazon for my home. The ONLY way to operate it is via an App that requires you to input your personal information including Birthday and has an Arbitration Provision with a Florida Choice of Law.

There is no part of digital life that does not contain Arbitration Provisions with the application of law from a State in which you are NOT IN. Literally, the mere CLICK [2] of a mouse to browse a Website has been held to be your CONSENT to the Arbitration provision. No one notices or cares.

E.        Use in the Insurance Industry

In the last few years Arbitration Provision endorsements have been appearing in all sorts of Insurance Policies issued by many insurance companies. They void the right of the Insured to sue in court for breach of the Insurance policy. They are often coupled with a Choice of Law provision tied to a State that has law more favorable to the carrier. I am not aware of any prohibition by the State of New York or Connecticut to such provisions.

But what has prompted this article is an Arbitration provision with a Pennsylvania Choice of Law provision in an Agency Agreement for a policy issued in Texas.

F.         My Facts

My client is an Agent of ABC Ins. Co. pursuant to a written Agency Agreement with an Arbitration provision and a Pennsylvania Choice of Law provision for anything ARISING OUT OF THE AGENCY AGREEMENT.

Agent has an office in Texas and bound coverage and issued a policy on 10/12/17 for a Recycling Risk. On 7/1/18, a fire destroyed the building. ABC paid $1M for the loss.

In summer 2025, (7 years later) ABC demanded its $1M back saying that Agent bound coverage in violation of the Underwriting Guidelines (“UG") which prohibited Recycling. While the UG did prohibit insuring such risks, this was not a pure Recycling Risk and the ABC Underwriter “orally" approved issuance. (If I had that email there would be no case clearly.)

HOWEVER, on 11/2/17, (21 days after policy issuance), Agent emailed ABC with ALL THE BINDING documents including the APPLICATION that said “RECYCLING". Thus, as a matter of law, ABC knew and agreed to insure this risk when it accepted the premium knowing it was Recycling.

Better still, is that under Texas Law, an Insurer can CANCEL the policy without giving a reason within the first 60 days after issuance. So…ABC had 39 days LEFT to cancel a policy it KNEW was covering a Recycling business.

Here is the problem.

As you know when a Broker or Agent is sued it Stands-in the Shoes of the Insurer. That means that certain doctrines of “Causation" can be used to negate the claims against the Broker/Agent. As a New York appellate Court said in US Pack Network Corp. v Travelers Prop. Cas. 42 A.D.3d 330 (1st Dept., 2007) said “It is irrelevant whether defendant broker breached its agreement with plaintiff by obtaining a policy that failed to provide the full coverage plaintiff sought. The damages plaintiff claims here as a result of the alleged breach of contract were not caused by the breach of that contract. They would have been suffered in any event, since even had the broker obtained more inclusive coverage, plaintiff itself failed to provide the timely notice necessary to obtain the benefits."

Applied to my Agent-ABC facts it means that the Payment of the Fire Claim was NOT THE FAULT of Agent, but the FAULT OF ABC for not Cancelling the policy under Texas Insurance law within the first 60 days after issuance. BUT….. given the Arbitration provision, how does AGENT get a decision on that??

If we were in court we could ask the Court to rule on the failure of ABC to cancel under Texas Law. (Any Court can apply the law of another state if required). But since the Cancellation issue is between ABC and its Insured, (even though we can raise it), and thus it is NOT part of the Agency Agreement, I am going to argue that the Arbitrators have NO right to decide this issue and a Texas Court must. But then how do I stay the arbitration pending the decision of the Texas Court.

Parties can ALWAYS agree to arbitrate even if there is no Arbitration provision. You can even agree to mediate a dispute rather than sue in court.

But agreeing to standard Boilerplate Arbitration/Choice of Law provisions without considering the WHAT IF scenarios, like this, are fraught with danger and may wind up costing you and your E&O carrier more than litigation would.

My recommendations are (1) NEVER allow an arbitration provision in any policy for your insureds and (2) NEVER agree to any Arbitration/Choice of Law provision in any Agency, Producer etc. Agreement without vetting it completely. What it fails to state is as important as what it does state.