California Courts Cannot Base Coverage Analysis on Arbitration Results
California Courts Cannot Base Coverage Analysis on Arbitration Results
By David A. Gauntlett*
Introduction
In most states, an arbitrator’s conclusions can be used by insurers as the basis of a coverage denial.[1] California, however, represents an exception to that general rule. In Vandenberg v. Superior Court, 21 Cal. 4th 815, 836–37 (1999), the California Supreme Court determined that arbitration results should not be usable by non-parties unless both arbitrating parties specifically agree otherwise. The impact of this decision should not be underestimated, particularly in the context of Employment Practices Liability Insurance (“EPLI”) coverage where employer-employee disputes so often turn to arbitration as a first option for a resolution.
Vandenberg Decision
Vandenberg was an insurance coverage case where a CGL insurer denied coverage for defense and indemnity under a pollution exclusion based on an underlying arbitration between the insured, Vandenberg, and underlying claimant, Boyd.[2] Vandenberg’s insurer United States Fidelity and Guaranty Company (USF&G) later obtained a summary adjudication of no coverage based on the results of the arbitration.[3] The Supreme Court affirmed a Court of Appeals reversal of that coverage decision holding that USF&G, as a non-party to the private arbitration, could not receive any benefit from the award, characterized as a “nonmutual collateral estoppel effect,” to support a denial of insurance coverage.[4]
The Vandenberg court explained the significant differences between a judicial determination of facts and the private arbitration process that justifies California’s prohibition against using an arbitration award to support the claims of a stranger to the arbitration against a party to the arbitration:
[P]rivate arbitration is a process in which parties voluntarily trade the safeguards and formalities of court litigation for an expeditious, sometimes roughshod means of resolving their dispute. The traditional rule is that “‘[a]rbitrators, unless specifically required to act in conformity with rules of law, may base their decision upon broad principles of justice and equity, and in doing so may expressly or impliedly reject a claim that a party might successfully have asserted in a judicial action.’ [Citations.] As early as 1852, this court recognized that, ‘The arbitrators are not bound to award on principles of dry law, but may decide on principles of equity and good conscience, and make their award ex aequo et bono [according to what is just and good].’”[5]
Because of the “expeditious [but] sometimes roughshod means of resolving their dispute,” the parties to a private arbitration cannot be subject to a stranger’s use of the arbitration result against any of them, a collateral estoppel use.
[W]hile the informal and imprecise nature of private arbitration, and its insulation from judicial interference, are “‘the very advantages the . . . parties [seek] to achieve’” in arbitrating their own claims . . . these same features can be serious, unexpected disadvantages if issues decided by the arbitrator are given leveraged effect in favor of strangers to the arbitration.[6]
What If the Judgment Deviates from the Arbitration Award?
Importantly, the court determined the Vandenberg rule applies even if the arbitration result is subsequently judicially confirmed.[7] No court has contested this view, so the coverage analysis is necessarily determined by the facts presented to that Arbitrator. Neither its ruling nor any subsequent Judgment entered following the Arbitration Awards are material to coverage review. However, if the Judgment is inconsistent with any challenge to coverage, then the party cannot assert it as support for its arguments.
Subsequent Cases Clarifying Vandenberg Rule
California courts have universally followed the Vandenberg rule. Benasra v. Mitchell, 96 Cal. App. 4th 96, 105 (2002), for example, explained:
[C]ollateral estoppel cannot be used to foreclose later litigation on issues decided by private arbitrators. That principle was conclusively established by the Supreme Court in Vandenberg v. Superior Court (1999) 21 Cal. 4th 815, where two parties, a lessor and lessee, had submitted their dispute over underground pollution to binding arbitration. The arbitrator found that the discharge of contaminants was not sudden and accidental. In later litigation, the lessee's insurers attempted to use the arbitrator's factual determination to preclude the lessee's claim for indemnity under his policies . . . . The Supreme Court disagreed.
In Chiarello v. Samson (In re Samson), No. 98-16088, No. 98-16093, 1999 U.S. App. LEXIS 28441, at *6–7 (9th Cir. (Cal.) Oct. 29, 1999), the Ninth Circuit followed Vandenberg, noting that because arbitration has little or no judicial review and is “an informal, expeditious, and efficient alternative means of dispute resolution . . . . It thus appears that, under California law, absent agreement to the contrary, private arbitrations do not have collateral estoppel effect.” (Citing Vandenberg, 21 Cal. 4th at 376–77). Chiarello went on to hold that even a party to the arbitration could not use the arbitration decision for an issue preclusive effect in a subsequent bankruptcy adversary proceeding against the other party in the arbitration.[8]
Impact for Policyholders
Policyholders must be informed of the Vandenberg rule as it directly impacts commonly asserted reasons for denials. For example, a typical policy exclusion states:
The Insurer shall not be liable to make any payment for Loss in connection with any Claim made against any Insured:
A. arising out of, based upon or attributable to the committing of any deliberate criminal or deliberate fraudulent act if any final adjudication establishes that such deliberate criminal or deliberate fraudulent act was committed[.][9]
A variety of insurance contracts, including both EPLI and Directors and Officers (“D&O”) policies, include the “final adjudication” requirement in several exclusions. Because of this prerequisite and Vandenberg’s rule barring use of arbitration results by non-parties, insurers can be left in the awkward position of being contractually obligated to indemnify an arbitration award while simultaneously unable to use that award as the basis for asserting exclusions. As Vandenberg determined, this result holds even if a judge subsequently confirms the arbitration award.[10]
Conclusion
The Vandenberg rule can make or break a case and provides an excellent example of how choice of law can impact a coverage result. This unique California rule favors policyholders by complicating the assertion of several common exclusions requiring a “final adjudication.” Employers seeking EPLI coverage should be especially aware of this as arbitration is so commonly used to resolve employee disputes, but any policyholder with a contract including the “final adjudication” requirement can just as easily wield the Vandenberg sword to cut through insurer denials relying on the results of an arbitration.
*David A. Gauntlett is a principal of Gauntlett & Associates and represents policyholders in insurance coverage disputes. For more information, visit Gauntlett & Associates at www.gauntlettlaw.com.
[1] See James M. Westerlind, The Preclusive Effect of Arbitration Awards, https://www.afslaw.com/sites/default/files/Downloads/bio/2016201620162016FebFebTueTue/Mealeys-Article-PreclusiveEffectofArbAwards.pdf (Aug. 20, 2010) (party in a lawsuit can be bound by results of prior arbitration “if the party in the subsequent lawsuit is deemed to be in privity with a party in the prior arbitration[,]” which includes insurers).
[2] Id. at 827.
[3] Id.
[4] Id. at 836–37.
[5] Vandenberg, 21 Cal. 4th at 831–32.
[6] Id. at 832.
[7] Id. at 824 (“We reach the following conclusions: First, a private arbitration award, even if judicially confirmed, may not have nonmutual collateral estoppel effect under California law unless there was an agreement to that effect in the particular case.”)
[8] Chiarello, 1999 U.S. LEXIS 28441 at *7.
[9] Hiscox Insurance Company Policy Form PVT P003 CW (07/09) (bold terms defined in policy) (italic emphasis added).
[10] Vandenberg, 21 Cal. 4th at 824.