11 May 2007
Key Points:
There's an increased use of mediation and expert determination in the resolution of reinsurance disputes. The trend away from arbitration may gain momentum as in NSW compulsory arbitration clauses in non-life reinsurance contracts are no longer enforceable.
In the last 15 years, the use of arbitration by the business community as a flexible, expedient and cost effective alternative to litigation has greatly increased.
The use of compulsory arbitration clauses has therefore been common in contracts in sectors such as reinsurance.[1] However, there is at times a perception that arbitration is increasingly mirroring the formality (and consequently expense) of traditional court proceedings and recognition that courts often prefer or require mediation prior to a court hearing.[2]
Accordingly, there has been a rise in number of mediation and expert determination clauses in local reinsurance contracts.
This trend looks set to continue with the recent NSW Supreme Court decision of HIH Casualty & General Insurance Limited (in liq) v Wallace [2006] NSWSC 1150 limiting the enforceability of compulsory arbitration clauses in non-life reinsurance contracts governed by NSW law.
HIH v Wallace
In HIH v Wallace, the HIH liquidator sought to sue Lloyd's Syndicate 683 to recover under policies of reinsurance. Syndicate 683 asked Justice Einstein in the NSW Supreme Court to stay the proceedings, arguing that the policies of reinsurance dictated that the parties had to go to arbitration instead of court.
Section 19 of the Insurance Act 1902 (NSW) states that arbitration clauses (either in a contract of insurance or other contract or agreement) do not bind the insured unless the dispute has already arisen and they agree at that stage to go to arbitration.
HIH argued that it was an insured and thus was not bound by the arbitration clause. Syndicate 683 on the other hand said first that section 19 did not apply to reinsureds, only insureds, and in any case the Commonwealth's International Arbitration Act 1974 overrode the State Act and made the arbitration clause binding.
Justice Einstein ruled that section 19 covers insureds and reinsureds alike. He then held the International Arbitration Act does not override the State Act; it applies only to arbitration agreements which are not "null and void, inoperative or incapable of being performed". Since section 19 of the State Act made the arbitration clause non-binding on the insured, the arbitration clause was "inoperative" and the Commonwealth Act did not apply to it.
The end result of this ruling is that, as in a direct insurance contract, an arbitration clause contained in a non-life reinsurance contract is wholly unenforceable. The parties are limited to entering into an agreement to arbitrate after a dispute has arisen.
Ramifications for non-life reinsurers and reinsureds?
Although it has long been suspected that section 19 had such an effect, this is the first decision which confirms that it does. While this potentially means that NSW is now out of step with reinsurance regimes in the other States and Territories, it remains to be seen whether this decision will have any influence on States with provisions similar to section 19, such as Victoria.
Non-life reinsurers will now have to review their dispute resolution processes as they can no longer automatically rely upon arbitration as an alternative to litigation. Reinsurance arbitration has frequently been very informal in Australia and consequently fairly cheap; if litigation becomes the primary option then dispute resolution costs overall will increase. Reinsurers should look at their processes for handling disputes and see what incentives they can offer reinsureds to induce them to arbitration.
Compulsory mediation or expert determination may fill the void arguably created by the limitations placed on compulsory arbitration clauses in NSW. Such options now have a distinct appeal over arbitration as they are enforceable without having to enter into a further agreement.
In comparison to other jurisdictions, Australia has long displayed comparatively high usage of mediation clauses in reinsurance contracts, with such clauses featuring in 30 percent on reinsurance contracts. It seems likely that in the current climate that mediation and expert determination will gain further popularity over arbitration.
Reinsureds should also be aware that any arbitration clause is not necessarily enforceable in NSW; this may give them a significant juridical advantage, as they can opt to litigate if they feel that such a course would be more favourable to their position.
Drawbacks associated with other forms of alternative dispute resolution
In the light of the likely rise in the use of mediation and expert determination, both reinsurers and reinsureds should be conscious of the potential drawbacks associated with the use of other alternative dispute resolution methods, including:
With respect to expert determination, the primary drawback manifests with respect to procedural assistance. If parties to an arbitration disagree as to, for example, the appointment of an arbitrator, legislation is in place to allow the courts to provide procedural assistance to keep the arbitration on foot.
In contrast, should expert determination proceedings break down because of disagreement over the appointment of an expert, the agreement to use expert determination may be unenforceable and thus void.
As only the contract that is the subject of the dispute can offer procedural guidance, it is essential that mechanisms are in place within the contract to enable a third party to select an appropriate expert in the event that the parties cannot agree.
Conclusion
The decision in HIH v Wallace is likely to further promote the uniquely Australian trend toward mediation and expert determination clauses in reinsurance contracts.
However, despite the perception of the mounting complexity and expense of arbitration, there remain drawbacks to other alternatives such as mediation and expert determination. Accordingly, non-life reinsurers and reinsureds choosing NSW law to govern their relationship would be well advised to keep the option of arbitration open after a dispute has arisen.
[1] Because of section 43(1) of the Insurance Contract Act 1984 (Cth), compulsory arbitration clauses are prohibited in direct insurance contracts. However, as this Act does not apply to reinsurance, compulsory arbitration clauses have long been standard fixtures in reinsurance contracts.
[3] Golvan G "Pitfalls in Mediation" (July 2001) Arbitrator and Mediator 41
For further information, please contact Peter Mann and Ray Giblett.
