Opportunities and Pitfalls in Securing Coverage for Arbitration

Opportunities and Pitfalls in Securing Coverage for Arbitration

By David A. Gauntlett*

Introduction

Arbitration, along with mediation and other forms of alternative dispute resolution, are increasingly preferred over the traditional courthouse approach to litigation. Indeed, their use may be mandated in some circumstances. Quicker results, which in turn means reduced attorneys’ fees, are obviously desirable, but arbitration does have some complications to be wary of from an insurance coverage perspective.

Mediation Briefs Must Serve as Substitutes to Complaints

While arbitration retains the binding effect of a judicial order and many of the formalities of ordinary litigation, the lack of a formal complaint presents a challenge for insurance coverage recovery. Policyholders must counteract this absence by securing as thorough an articulation of allegations against the policyholder as possible to present to insurers asked to evaluate potential coverage. The best opportunity for this are the parties’ opening arbitration briefs or, where necessary, the Points and Authorities that support a Petition for Rehearing.

While these briefs often lack the breadth and specificity of complaints, defense and coverage counsel working in coordination can integrate additional language for the briefs that clarifies the grounds for potential coverage of allegations under relevant insurance policies. For example, a claim for “unfair competition” without elaboration is unlikely to garner a favorable reaction from insurers. But detailed briefing can highlight fact allegations that evidence claims that potentially fall within the standard ISO “personal and advertising injury” offenses, such as (f) “use of another’s advertising idea in your advertisement” or (d) “publication of material that . . . disparages a person’s or organization’s goods, products, or services.”

Securing coverage and the consequential rights to insurer-funded settlements may be essential to secure a prompt resolution of arbitrated disputes that will compel insurers to indemnify claims in many cases.

Arbitrator Decision’s Lack of Precision May Complicate Indemnification

The rapid pace and lessened formality of arbitration may lead to less precise use of language. Such was the case in Primary Color Sys. Corp. v. Hiscox Ins. Co., Inc.[1] The underlying  dispute focused on claims made by an individual (Randazzo) against his former employer (Primary Color). Randazzo claimed Primary Color had falsely represented Randazzo would receive an equity interest in the company if he remained as an employee. The two parties entered arbitration after no equity was granted, and Randazzo asserted formal claims of Breach of Contract, Fraud, and Recovery of Unpaid Wages.

Although the arbitrator concluded that the evidence was insufficient to establish an enforceable contract by which he could award damages to Randazzo, he labeled his conclusion of misrepresentation about the grant of equity as “fraud,” apparently to fit an award into a labeled claim. None of the facts supporting the Arbitration Award revealed any heightened scienter or preconceived, malicious conduct. Nevertheless, Hiscox denied coverage for the award based on its exclusion for any claim “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.”[2]  This despite the policy’s coverage of “employment-related misrepresentations,” “whether committed directly, indirectly, intentionally or unintentionally.”[3]

The arbitrator’s own words stated that he granted “$450,000.00 representing the salary [Randazzo] lost by not accepting the offer from Orora, based upon the misrepresentations made by Primary Color.” Despite the arbitrator’s explanation plainly stating the award fell within the scope of covered misrepresentations, both the district court[4] and the Ninth Circuit[5] improperly focused on the label of “Fraud,” a practice contrary to coverage law principles in general[6] and especially when construing exclusions.[7] The Ninth Circuit panel also ignored the revisions in subsequent judicial confirmation of the Arbitration Award.[8]

Vandenberg Rule Alleviates Some Dangers

California law, as explained by Vandenberg v. Superior Court,[9] bars a non-party to an arbitration award from using that award as nonmutual collateral estoppel in a later action on different claims against one of the arbitral parties unless the arbitrating parties specifically agree to allow it. 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.[10] 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.[11]

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].’”[12]

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.[13]

The court determined the Vandenberg rule applies even if the arbitration result is subsequently judicially confirmed.[14] It should be noted, however, that Vandenberg limited its ruling to “issue preclusion” rather than “claim preclusion.”[15] That said, no subsequent cases have extensively addressed the precise line between the two as they relate to insurance coverage matters.

Conclusion

Arbitration is rightly viewed as an expedient alternative to courthouse litigation in many cases. That convenience can come at a cost to unwary policyholders. To take advantage of the opportunities and avoid the potential missteps, parties should consult coverage counsel to maximize their insurance benefits and fight against any wrongful denials.

*David A. Gauntlett is a principal of Gauntlett & Associates and represents policyholders in insurance coverage disputes regarding intellectual property, antitrust, and business tort claims, as well as in the underlying actions. Mr. Gauntlett can be reached at (949) 553-1010 by voicemail or dag@gauntlettlaw.com. For more information, visit Gauntlett & Associates at www.gauntlettlaw.com.

[1] Primary Color Sys. Corp. v. Hiscox Ins. Co., Inc., 654 F. Supp. 3d 982, 989 (C.D. Cal. 2023), aff'd, No. 23-55199, 2024 WL 489171 (9th Cir. Feb. 8, 2024).

[2] Id. at 985.

[3] Id.

[4] Id. at 989 (“[T]he arbitrator stated in no uncertain terms that the bonuses were awarded as part of the fraud claim, so an award for bonuses does not affect whether the arbitration award is within the policy exclusion.”)

[5] Primary Color Sys. Corp. v. Hiscox Ins. Co. Inc., No. 23-55199, 2024 WL 489171, at *1 (9th Cir. Feb. 8, 2024) (“Under California law, the arbitrator's holding that Randazzo prevailed on his claim for intentional fraud amounts to a final adjudication of that claim and Primary Color was therefore not entitled to indemnification under the insurance contract.”)

[6] Atlantic Mut. Ins. Co. v. J. Lamb, Inc., 100 Cal. App. 4th 1017, 1032 (2002) (“Coverage for personal injury is not determined by the nature of the damages sought in the action against the insured, but by the nature of the claims made against the insured in that action. Under the personal injury policy provision, ‘[c]overage . . . is triggered by the offense, not the injury or damage which a plaintiff suffers.’”); Syvertsen v. Great Am. Ins. Co., 700 N.Y.S.2d 289, 291–92 (N.Y. App. Div. 1999 (“A party’s characterization of the causes of action alleged . . . are not controlling . . . we . . . determine the nature of the claims based upon the facts alleged and not the conclusions which the pleader draws therefrom.”) (quotations omitted).

[7] J. Lamb, 100 Cal. App. 4th at 1039 (“Thus, an insurer that wishes to rely on an exclusion has the burden of proving, through conclusive evidence, that the exclusion applies in all possible worlds.”)

[8] See Primary Color Sys. Corp. v. Hiscox Ins. Co. Inc., No. 23-55199, Primary Color’s Petition for Rehearing, Docket No. 42-1 (filed Feb. 22, 2024).

[9] Vandenberg v. Superior Court, 21 Cal. 4th 815, 836–37 (1999).

[10] Id. at 827.

[11] Id. at 836–37.

[12] Id. at 831–32.

[13] Id. at 832.

[14] 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.”)

[15] TriPharma, LLC v. First Fruits Bus. Ministry, No. SACV12404JVSANX, 2012 WL 12887079, *14 (C.D. Cal. Aug. 21, 2012) (“In setting forth its central holding regarding issue preclusion, the California Supreme Court expressly preserved existing California law regarding the claim preclusive effect of arbitration awards.”)