Notwithstanding an arbitration clause expressly providing that disputes over the reinsurance agreements' "formation and validity" would be submitted to arbitration, the U.S. Court of Appeals for the Second Circuit, affirming the lower court, held that there was no legal basis for compelling arbitration when the reinsurer filing the motion contended that the reinsurance contracts were void because its agents had no authority to form them.
The cedent, Platinum Indemnity Limited and its assignee, brought this litigation against a reinsurer, Diamond State Insurance Co., alleging breach of contract and tort claims of negligence and recklessness involving multiple reinsurance contracts containing the following arbitration clause:
"Any unresolved difference of opinion between the REINSURER and the CEDENT with respect to the interpretation of this POLICY or the performance of the obligations under this POLICY including its formation and validity, whether such dispute arises before or after the termination of this POLICY, shall be submitted to arbitration."
Platinum Indemnity contended that Diamond State acted negligently in the appointment and supervision of its alleged agents. The reinsurer denied that these "agents" had either actual or apparent authority to bind it to the disputed reinsurance agreements but insisted that the cedent's claims were arbitrable pursuant to the arbitration clauses. The cedent countered that the reinsurer's denial of the reinsurance contracts' existence required that the court first determine whether the contracts were valid before invoking their arbitration provisions.
Concluding that sufficient evidence was produced substantiating an "unequivocal denial" by the reinsurer that an agreement was made, the Second Circuit agreed with the district court that it was "well-settled" that a court cannot compel arbitration until it first resolves, by means of a trial, the question of the very existence of the contract embodying the arbitration clause. This is because arbitrators derive their authority to resolve disputes from the parties, and without a determination that the governing contracts exist, there would be no source of authority empowering the arbitrators to decide the case.
With regard to the broad "formation and validity" wording in the arbitration clause, the Second Circuit disagreed with the reinsurer's argument that it "clearly and unmistakably" provided that the question of whether the parties agreed to arbitrate was to be decided by an arbitrator, i.e., that it encompassed the question of the very existence of the contract. The court suggested that this language simply meant that, assuming the existence of the contracts, the parties must arbitrate issues of formation and validity that affect contract enforceability, such as a dispute over fraud in the inducement of a contract, not whether the contracts were void because the reinsurer's agents allegedly lacked the requisite authority to bind it.
Bank of America, N.A. v. Diamond State Insurance Co., No. 01-9075, 2002 U.S. App. LEXIS 12711 (2nd Cir. June 26, 2002).