Power to the Arbitrators

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In the beginning, arbitration was unfavored and the courts intervened with frequency. Then came the Federal Arbitration Act (“FAA”), which created a federal policy in favor of arbitration. This policy applies equally in federal or state court as long as the contract involves interstate commerce.

The courts, however, were still involved in gateway issues like whether there was a valid arbitration agreement entered into by the parties (arbitrability). But as case law on arbitrability developed, the courts found that where the parties delegated the authority to decide gateway issues like arbitrability to the arbitrator, it was then up to the arbitrator, and not the court, to determine those arbitrability questions in the arbitration. Sounds counterintuitive, but there you have it in a brief summary.

That brings us to a short decision by a New York intermediate appellate court highlighting this issue in an insurance arbitration context.

In The Matter of Bergassi Group LLC v. Allied World Insurance Co., No. 2020-01264 (N.Y. App. Div. 1st Dep’t Apr. 13, 2021), an insurance agent brought a petition to permanently stay arbitration brought against it by an insurer. The two had entered into a Surety Agency Agreement, which allowed the agent to issue contractor’s surety bonds on the insurer’s paper. Allegedly, the agent issued a contractor’s surety bond based on erroneous information in the application process (one of the applicants was a reputed Gambino crime family member) and a loss ensued. The insurer demanded arbitration under their contract for breach of contract, breach of fiduciary duty and negligence.

After the motion court granted the petition to stay the arbitration, the insurer appealed and the appellate court reversed. The Surety Agency Agreement had this sentence in its arbitration provision:

If a dispute or disagreement arises in connection with this Agreement, including a dispute or disagreement as to its formation or validity, such dispute or disagreement shall be submitted to arbitration.

In reversing the motion court, denying the petition and dismissing the proceeding, the appellate court invoked the FAA and noted that parties had the power to agree to arbitrate gateway issues of arbitrability. Citing to one of the court’s earlier decisions, Nova Casualty v. Harleysville Worchester Insurance Co., 146 A.D.3d 428 (1st Dep’t 2017), the court noted that language like that in the arbitration provision in the Surety Agency Agreement “refers any disputes over the validity or formation of the arbitration provision in question to arbitration.”

The decision is short and sweet, but reemphasizes the point that if the parties agree in their arbitration agreement to expressly delegate authority over arbitrability to the arbitrator, then the courts have no authority to decide the issue, which is left to the authority of the arbitrator as the parties agreed. When drafting an arbitration provision, it is important to consider whether disputes over the validity or formation of the contract and its arbitration provision are issues the parties want decided by a court or an arbitrator.

Arbitrators, of course, are perfectly capable of deciding issues of validity or formation of the agreement, just as they are in determining issues concerning performance under the contract. Power to the arbitrators.