A Potential Surety Defense Under the McCarran-Ferguson Act Against An Arbitration Demand
October 10, 2023
In this issue of the Surety Today Blog I will continue on the same theme that we have been on for the past four weeks – the Surety and Arbitration. The first post on arbitration was on September 12, discussing a new case dealing with California law on the unconscionability defense to an arbitration provision. Next, on September 19, I discussed another new case on the enforceability of an arbitration provision under Texas law. On September 26, the blog post dealt with an overview of arbitration and on October 3, I outlined some common defenses to avoid an arbitration provision.
In this post, I will discuss a potential defense against arbitration that a surety may wish to consider if the surety desires to avoid arbitration in states where the legislature or the courts have defined suretyship as insurance. This potential defense arises from the application of the federal McCarran-Ferguson Act (15 U.S.C. § 1012(b)). If you called in live to the Surety Today Podcast yesterday you will know we discussed this topic, but it is probably better to see it in writing. If you are like me, I absolutely hate it when courts and statutes treat suretyship as insurance. But, if you are in a jurisdiction where that is an unfortunate reality you might as well try to get some advantage out of it.
As you know, through the Federal Arbitration Act (“FAA”) Congress has declared a strong, liberal national policy favoring arbitration and under the FAA there is a strong presumption favoring enforcement of agreements to arbitrate. Southland Corp. v. Keating, 465 U.S. 1, 10, 104 S.Ct. 852, 79 L.Ed.2d 1 (1984); see also Moses H. Cone Memorial Hospital v Mercury Constr. Corp. 460 US 1, 24, 74 L Ed 765, 103 S Ct 927 (1983). In Southland Corp., supra., the Supreme Court held that the substantive law created by the FAA was applicable in state courts as well as in federal courts. The Court stated “[i]n creating a substantive rule applicable in state as well as federal courts, Congress intended to foreclose state legislative attempts to undercut the enforceability of arbitration agreements.” 465 U.S. at 16. Because the FAA creates a substantive body of federal law to the full limit of the Commerce Clause, under the Supremacy Clause the FAA preempts inconsistent state laws. Thus, if there was a state statute that provided that there was no right to arbitrate in a matter involving interstate commerce, the FAA would typically preempt and invalidate that law. However, under the McCarran-Ferguson Act, Congress has created an exception. The Act provides in pertinent part:
No 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 purpose of the McCarran-Ferguson Act is to affirm “the supremacy of the States in the realm of insurance regulation.” United States Dep’t of Treasury v. Fabe, 508 U.S. 491, 500 (1993). The Act exempts the insurance industry from general Commerce Clause restrictions unless Congress expressly intends a specific statute to relate to the business of insurance. American Homeland Title Agency, Inc. v. Robertson, 930 F.3d 806 (7th Cir. 2019); Group Life & Health Ins. Co. v. Royal Drug Co., 440 U.S. 205 (1979). Congress intended to give support to existing and future state systems for regulating and taxing the business of insurance, and to sustain such state systems from attacks under the Commerce Clause (U.S.C.A. Const. Art. 1, § 8, cl. 3). Prudential Ins. Co. v. Benjamin, 328 U.S. 408 (1946); Cochran v. Paco, Inc., 606 F.2d 460 (5th Cir. 1979). The court in Merchants Home Delivery Service, Inc. v. Frank B. Hall & Co., Inc., 50 F.3d 1486, 1488-89 (9th Cir. 1995), stated that “Congress enacted the McCarran–Ferguson Act in part to allow the states to regulate the business of insurance free from inadvertent preemption by federal statutes of general applicability. . . . Section 2(b) of the Act accomplishes this purpose through a limited ‘inverse preemption,’ by directing that a federal law of general applicability does not apply to the ‘business of insurance’ if the federal law conflicts with state laws enacted to regulate that business.” See also Allstate Ins. Co. v. Lanier, 361 F.2d 870 (4th Cir. 1966). An additional purpose of the Act is to give insurance companies limited immunity from antitrust laws. Hahn v. Oregon Physicians Service, 689 F.2d 840 (9th Cir. 1982), cert, den., 462 U.S. 1133; McDiarmid v. Economy Fire & Cas. Co., 604 F. Supp. 105 (S.D. Ohio 1984); Sanborn v. Palm, 336 F. Supp. 222 (S.D. Tex. 1971).
To determine whether the McCarran-Ferguson Act saves a state insurance statute from preemption by a federal statute, such as the FAA, one must consider a three-part test: (1) whether the federal statute specifically relates to the business of insurance; (2) whether the state law at issue was enacted for the purpose of regulating the business of insurance; and (3) whether the application of the federal law invalidates, supersedes or impairs the state law. Merchants Home Delivery Service, Inc., supra.; Humana Inc. v. Forsyth, 525 U.S. 299, 307 (1999); Villafane-Neriz v. F.D.I.C., 75 F.3d 727 (1st Cir. 1996); Mutual Reinsurance Bureau v. Great Plains Mut. Ins. Co., Inc., 750 F. Supp. 455 (D. Kan. 1990).
Addressing the three part test, clearly, the FAA is a federal statute that does not specifically relate to the business of insurance. See Stephens v. American Int’l Ins. Co., 66 F.3d 41, 44 (2d Cir. 1995) (“No one disputes the fact that the FAA does not specifically relate to insurance.”); McKnight v. Chicago Title Ins. Co., 358 F.3d 854, 857 (11th Cir. 2004)(“we agree that the Federal Arbitration Act does not itself specifically relate to the business of insurance.”).
The second part of the test is whether there is a state law that was enacted relating to the “business of insurance.” In Securities and Exchange Comm’n v. National Sec., 393 U.S. 453 (1969), the Supreme Court construed the term “business of insurance” under the McCarran–Ferguson Act and emphasized that it is the relationship between the insurer and the insured that should be the focus in determining what constitutes the “business of insurance.” Statutes aimed at protecting or regulating this relationship, directly or indirectly, are laws governing the business of insurance. Id. at 460.
Similarly, in United States Dep’t of Treasury v. Fabe, 508 U.S. 491 (1993), the Supreme Court held that an Ohio statute was saved from preemption by the McCarran–Ferguson Act as a state statute enacted “for the purpose of regulating the business of insurance” because its purpose was to protect policyholders. Id. at 2212. The Court gave a broad reading to the phrase, stating that any law with the “end, intention, or aim of adjusting, managing, or controlling the business of insurance” is a law “enacted for the purpose of regulating the business of insurance” for purposes of the McCarran–Ferguson Act. Id.
Based on this authority, both federal and state courts have held that state statutes that invalidate arbitration clauses specifically as to insurance contracts are indeed “enacted for the purpose of regulating the business of insurance” and thus not preempted by the FAA by virtue of the McCarran–Ferguson Act. See Standard Security Life Ins. Co. v. West, 267 F.3d 821, 823–24 (8th Cir. 2001) (holding that FAA was reverse-preempted under McCarran–Ferguson Act by provision of Missouri Arbitration Act prohibiting arbitration clauses in insurance contracts); Stephens, 66 F.3d at 45–46 (holding that anti-arbitration provision of Kentucky Liquidation Act was exempt from preemption by FAA under McCarran–Ferguson Act); Friday v. Trinity Universal of Kansas, 262 Kan. 347, 939 P.2d 869, 872–73 (1997) (holding that McCarran–Ferguson Act prevented FAA from preempting Kansas statute invalidating arbitration clauses in insurance contracts); and Nat’l Home Ins. Co. v. King, 291 F. Supp. 2d 518, 528–30 (E.D. Ky. 2003)(holding Kentucky statute directed specifically at the relationship between the insurer and insured with the aim of protecting policyholders from mandatory arbitration agreements was not preempted by the FAA); see also Am. Bankers Ins. Co. of Fla. v. Inman, 436 F.3d 490, 492 (5th Cir. 2006); McKnight, supra., 358 F.3d at 855; Standard Sec. Life Ins. Co. of N.Y. v. West, 267 F.3d 821, 823–24 (8th Cir. 2001); Mut. Reinsurance Bureau v. Great Plains Mut. Ins. Co., 969 F.2d 931, 931–32 (10th Cir. 1992).
As to the third part of the test, clearly the FAA, as a federal statute, if applied, would “invalidate, impair, or supersede” any state insurance laws stating that arbitration provisions are invalid in insurance contracts.
According to research, across the US many jurisdictions have adopted varying laws affecting whether insurance disputes can be arbitrated. See US Anti-Arbitration Laws Applicable to Insurance Policies, by Peter A. Halprin, Stephen Wah, Kayla N. Auza, West Law Practical Law (W-039-3244 – 2023). This research suggests that twenty-four states do not regulate the arbitration of insurance disputes and ten states have limited restrictions. Thirteen states have more robust restrictions and three states have restrictions that courts have determined are inapplicable to insurance disputes. So, for example, according to this same research, under the Arkansas Code Ann. §§ 16-108-201 to 233 the Uniform Arbitration Act does not apply to matters involving an “insured or beneficiary under any insurance policy or annuity contract.” The Hawaii insurance code specifically bars the arbitration of insurance disputes, providing that insurance contracts delivered in the state and covering subjects located in or to be performed in the state, may not deprive Hawaii courts of jurisdiction against the insurer (HRS § 431:10-221). Louisiana’s Insurance Code provides that insurance contracts delivered in the state and covering subjects located in or to be performed in the state may not deprive Louisiana courts of jurisdiction against the insurer. (La. R.S. 22:868.). Nebraska prohibits the arbitration of disputes concerning or relating to an insurance policy, providing that written arbitration agreements are valid, enforceable, and irrevocable except as they relate to an insurance policy that is not a contract between insurance companies, including a reinsurance contract (Neb. Rev. St. § 25-2602.01). South Carolina code provides that a written arbitration agreement does not apply to an insured party or to an insurance policy beneficiary. (S.C. Code Ann. § 15-48-10(b)(4).). There are other examples.
In order to make this argument work as a defense you need to put a clothes pin on your nose and take the position, if you are in the applicable jurisdiction where arbitration is barred in insurance agreements, that suretyship and surety bonds have been defined or held to be insurance. There are many states out there, which I will not name here so that it is not thrown back in my face some day, that have held or defined suretyship and surety bonds as insurance.
Therefore, IF the surety is faced with an arbitration demand and the surety does not wish to arbitrate, check to see if the jurisdiction you are in has a statute that exempts or excludes arbitration clauses from insurance contracts. These statutes might be stand alone or they might be part of the state’s Uniform Arbitration Act. Then check to see if suretyship or bonds are defined as or ruled to constitute insurance. If you can meet those requirements, the McCarran-Ferguson Act may reverse preempt the FAA and the surety can then assert that it is not bound to arbitrate.
If you have questions regarding the issues discussed in this post, please do not hesitate to contact Michael A. Stover, Esq. (410-659-1321/mstover@wcslaw.com) or any member of the Surety and Fidelity Practice Group.