ERISA - Arbitration Archives - McKennon Law Group

Los Angeles Daily Journal Publishes Article on August 28, 2019 by Robert McKennon Entitled “Ruling Could Send Shock Waves Through ERISA Claims Industry”

In the August 28, 2019 issue of the Los Angeles Daily Journal, the Daily Journal published an article written by the McKennon Law Group PC’s Robert J. McKennon. The article addresses a recent case by the Ninth Circuit Court of Appeals, Dorman v. Charles Schwab, which overruled the Ninth Circuit precedent Amaro v. Continental Can Co. and enforced an arbitration clause in a pension plan on the basis that Supreme Court precedent had impliedly overruled its opinion in Amaro. Given the expansive reading of arbitration clauses by the Supreme Court and now the Ninth Circuit, it is likely that more ERISA pension claims will be litigated on an individualized basis and will be litigated in arbitration proceedings.

Ruling Could Send Shock Waves Through ERISA Claims Industry

A 9^th Circuit ruling will have the effect of limiting claimants’ much-needed access to the federal courts and class actions.

By Robert J. McKennon

The Employee Retirement Income Security Act of 1974 was the largest statute ever passed by Congress at the time it was enacted. ERISA established pension and employee benefit plan standards for private employers. As the number of retirees and employees covered by ERISA retirement and benefit plans continued to grow, many found that their plan fiduciaries, including former employers and their insurers, were not meeting their obligations with respect to their retirement and other employee benefits. Thus, the last two decades have seen a significant rise in class action litigation involving fiduciaries of 401(k) and pension plans under various legal theories. These class actions typically allege some type of wrongful conduct by plan fiduciaries that resulted in the reduction of plan assets, usually because of excessive fees charged and/or some type of imprudent investment activity.

These actions have been almost exclusively litigated in the federal courts. This is because in the 9th Circuit, plan participants and their beneficiaries were protected from being forced into arbitrating these claims by Amaro v. Continental Can Co., 724 F.2d 747 (9th Cir. 1984), in which the 9th U.S. Circuit Court of Appeals held that ERISA claims were not arbitrable. The Amaro court based its decision in large part on the premise that arbitrators “lack the competence of courts to interpret and apply statutes as Congress intended.” Amaro was widely seen as rejecting binding arbitration in the ERISA context.

Since the Amaro decision, the U.S. Supreme Court has pushed back on its past criticism of arbitration clauses. In AT&T Mobility LLC v. Concepcion, 563 U.S. 333, 345 (2010), ideologically split justices ruled 5-to-4 that an arbitration provision in consumer contracts requiring individual arbitration and preventing class actions or class-wide arbitration was enforceable. The Supreme Court noted that Congress enacted the Federal Arbitration Act in response to widespread judicial hostility to arbitration and that the principal purpose of the FAA is to ensure that private agreements are enforced according to their terms. Id. at 339. In American Exp. Co. v. Italian Colors Restaurant, 570 U.S. 228, 238 n.5 (2013), the Supreme Court ruled that arbitrators are competent to interpret and apply federal statutes and dismissed the interest in ensuring the prosecution of low-value claims in favor of arbitration, permitting the waiver of the class action procedure.

In a momentous decision in Dorman v. Charles Schwab Corp., 2019 DJDAR 7932 (9th Cir. Aug. 20, 2019), the 9th Circuit overruled Amaro and enforced an arbitration clause in a pension plan on the basis that Supreme Court precedent in cases such as American Exp. Co. had impliedly overruled its ruling in Amaro.

Michael Dorman was employed at Schwab from February 2009 to October 2015. Dorman joined the Schwab Retirement Savings and Investment Plan, and voluntarily contributed to his retirement account through payroll deductions until he left Schwab. In December 2014, the plan was amended to add an arbitration provision, which states that “[a]ny claim, dispute or breach arising out of or in any way related to the Plan shall be settled by binding arbitration.” The arbitration provision includes a waiver of class or collective action that requires individual arbitrations, even if, absent the waiver, Dorman could have represented the interests of other plan participants.

In 2017, Dorman filed a class action suit in district court alleging that the defendants violated ERISA and breached their fiduciary duties by including Schwab-affiliated investment funds in the plan, despite the funds’ poor performance, to generate fees for Schwab and its affiliates. In response to his complaint, the defendants moved to compel individual arbitration of the asserted claims pursuant to the arbitration provision in the plan. The district court denied Defendants’ motion.

The court in Dorman addressed these Supreme Court rulings and reasoned further that in Comer v. Micor, Inc., 436 F.3d 1098 (9th Cir. 2006), the 9th Circuit acknowledged in dicta that its past “expressed skepticism about the arbitrability of ERISA claims … seem[ed] to have been put to rest by the Supreme Court’s opinions.” The Dorman court further noted that in American Exp. Co., the Supreme Court expressed that arbitrators are competent to interpret and apply federal statutes and that its opinion in Amaro was thus no longer valid.

The 9th Circuit reasoned that while a three-judge panel may generally not overrule a prior decision of the court, if an intervening Supreme Court decision undermines an existing precedent of the 9th Circuit, the three-judge panel may then overrule prior circuit authority. The court found that the holding in American Exp. Co. that federal statutory claims are generally arbitrable and arbitrators can competently interpret and apply federal statutes constitutes intervening Supreme Court authority that is irreconcilable with Amaro. The court thus reversed and remanded the district court’s ruling. Id.

In an accompanying unpublished order, the same panel enforced the arbitration clause in the plan document, finding that Dorman was bound by the plan’s arbitration provision, that the dispute fell within the scope of the arbitration provision, and that the claims challenging the use of Schwab’s proprietary funds were subject to arbitration and had to be arbitrated on an individual rather than a class basis, with recovery limited to the individual plaintiff’s damages.

To be contrasted with Dorman is the 9th Circuit’s ruling in Munro v. University of Southern California, 896 F.3d 1088 (9th Cir. 2018), which recently addressed a situation where an employee sued his employer not on his own behalf, but on behalf of another entity for claims that the employee cannot bring in his individual capacity. In Munro, nine current and former employees of the University of Southern California brought suit against their employer for breach of fiduciary responsibility in the administration of two ERISA plans offered by the employer. The relief sought by the plaintiffs included the following: a determination as to the method of calculating losses, removal of breaching fiduciaries, a full accounting of plan losses, reformation of the plans and an order regarding appropriate future investments.

Since the plaintiffs all signed arbitration agreements as part of their employment contracts, USC filed a motion to compel arbitration. The district court denied USC’s motion and ruled that the arbitration agreements, which the employees entered into in their individual capacities, do not bind the plans because the plans did not themselves consent to arbitration of the claims. The 9th Circuit upheld the district court’s ruling, finding that the claims for breach of fiduciary duty fell outside the scope of the arbitration agreements. In reaching its decision, the court turned to the language of the arbitration agreements, which state that the parties agreed to arbitrate “all claims … that Employee may have against the University or any of its related entities … and all claims that the University may have against Employee.” The court noted that this language does not extend to claims that other entities have against the university.

Unlike Munro, in Dorman, the arbitration provision was contained in the plan document itself and thus the plan is deemed to consent by virtue of the arbitration provision. Considering the expansive potential reading of the arbitration provision in Dorman and location in the plan document, a claim on behalf of the plan for breach of fiduciary duties under ERISA could reasonably be considered as falling under the purview of the clause.

Dorman has the potential to send shockwaves through ERISA claims industry and will have the effect of limiting claimants’ much-needed access to the federal courts and class actions. Dorman and the above-cited Supreme Court cases appear to stand for the proposition that many types of ERISA claims will be subject to arbitration if the plan documents are drafted properly. Expect that following the Dorman decision, arbitration and class action waiver clauses will become more prevalent in ERISA plans. Given the expansive reading of arbitration clauses by the Supreme Court and now the 9th Circuit, it is likely that more ERISA claims will be litigated on an individualized basis and will be litigated in arbitration proceedings. It remains to be seen whether employers and plans will benefit by this trend.

Robert J. McKennon is a shareholder of McKennon Law Group PC in its Newport Beach office. His practice specializes in representing policyholders in life, health and disability insurance, insurance bad faith, ERISA and unfair business practices litigation. He can be reached at (949) 387-9595 or rm@mckennonlawgroup.com. His firm’s California Insurance Litigation Blog can be found at www.californiainsurancelitigation.com.

Do Arbitration Clauses in Employment Contracts Automatically Preclude Employees From Litigating ERISA Claims?

Many times, employees must sign written employment contracts before beginning a new position. These contracts generally set forth the terms of the relationship between the employer and employee. They also establish both the rights and responsibilities of the two parties. Employers often include an arbitration clause in their employment contract. This means that any disputes that arise between the employer and employee must be settled through arbitration, rather than through the courts.

But what happens when an employee sues his employer not on his own behalf, but on behalf of another entity for claims that the employee cannot bring in his individual capacity? For instance, in the context of ERISA, employees who participate in an employer-sponsored ERISA plan can bring a claim for breach of fiduciary duty on behalf of the ERISA plan against the employer. If the employee signed an arbitration agreement, does that preclude the employee from litigating this particular claim in court?

The Ninth Circuit Court of Appeals recently addressed this issue in the matter of Munro v. University of Southern California, No. 17-55550 (9th Cir. July 24, 2018). In Munro, nine current and former employees of the University of Southern California (“USC”) brought suit against their employer for breach of fiduciary responsibility in the administration of two ERISA plans offered by the employer (collectively, the “Plans”). The relief sought by the plaintiffs included the following: a determination as to the method of calculating losses; removal of breaching fiduciaries; a full accounting of Plan losses; reformation of the Plans and an order regarding appropriate future investments

Since the plaintiffs/employees all signed arbitration agreements as part of their employment contracts, USC filed a motion to compel arbitration, arguing that the arbitration agreements bar the plaintiffs from litigating the claims at issue. The district court denied USC’s motion and ruled that the arbitration agreements, which the employees entered into in their individual capacities, do not bind the Plans because the Plans did not themselves consent to arbitration of the claims. The Ninth Circuit upheld the district court’s ruling, finding that the claims for breach of fiduciary duty fall outside the scope of the arbitration agreements. In reaching its decision, the court turned to the language of the arbitration agreements, which state that the parties agreed to arbitrate “all claims…that Employee may have against the University or any of its related entities…and all claims that the University may have against Employee.” The court noted that this language does not extend to claims that other entities have against the University.

The Munro court concluded that the ERISA claims for breach of fiduciary duty were not claims that the “Employee may have against the University or any of its related entities.” Rather, the employees brought the claims on behalf of the Plans, and, since the Plans never consented to arbitration of the claims, the arbitration provision did not apply in this instance. In reaching its conclusion, the court looked to the case of United States ex rel. Welch v. My Left Foot Children’s Therapy, LLC, 871 F.3d 791 (9th Cir. 2017), which dealt with a similar issue, specifically, whether a standard employment arbitration agreement covered qui tam claims brought by the employee on behalf of the United States under the False Claims Act (“FCA”). The court in Welch found that because the underlying fraud claims asserted in a FCA case belong to the government and not to the employee, the claims were not claims that the employee had against the employer and therefore were not within the scope of the arbitration agreement. Welch, 871 F.3d at 800 & n.3. In Munro, the Ninth Circuit found similarities between the type of claim brought in Welch and the ERISA claims at issue in Munro. Specifically, the court noted that the ERISA plaintiffs did not seek relief for themselves, but rather sought recovery for injury done to the Plans. This was evident in the relief sought by the plaintiffs, which included removal of breaching fiduciaries, a full accounting of Plan losses, and reformation of the Plans. Furthermore, since the Plans were not parties to the arbitration agreements between the employer and employees, and therefore never consented to arbitration, the court could not compel arbitration in this instance.

The issue of whether a party can be compelled to arbitrate an ERISA claim where the party did not sign an arbitration agreement arose in a prior Ninth Circuit decision, Comer v. Micor, Inc., 436 F.3d 1098 (9th Cir. 2006). The plaintiff in Comer participated in an ERISA plan offered by his employer. The plan trustees retained a company, Salomon Smith Barney, Inc. (“Smith Barney”) to provide investment advice. The plan and Smith Barney entered into an investment management agreement that contained an arbitration clause. After Comer sued Smith Barney for breach of fiduciary duty under ERISA, Smith Barney moved to compel arbitration. The court found that pursuant to ordinary contract and agency principles, Comer could not be bound to the terms of a contract he did not sign and could not enforce. Therefore, the arbitration agreement did not apply to Comer’s ERISA claim. The same argument could be made in Munro, where the Plans were not signatories to the individual employment contracts and, therefore, were not bound by the arbitration agreements.

In summary, even though an employee has signed an employment contract containing an arbitration provision, this does not necessarily preclude the employee from bringing a lawsuit against his employer for ERISA violations when the employee is suing on behalf of the ERISA plan and not simply in an individual capacity. In such cases, the claims belong to the ERISA plan itself and, if the plan did not consent to arbitration, then this opens the door for the employee to bring his ERISA breach of fiduciary duty claim in federal court.

Court Refuses to Enforce Health Net Arbitration Provision Because It Was Insufficiently Prominent

In the unpublished case of Probst v. Superior Court (Health Net of California, Inc., et al), No. A133742 (March 6, 2012), Division Five of the First Appellate District refused to enforce an arbitration provision in an enrollment form. Brian Probst (who filed a putative class action alleging that Health Net of California, Inc. and Health Net, Inc (“Health Net”) failed to adequately protect private personal and medical information from unauthorized disclosure to third-parties) sought writ relief from an order compelling him to arbitrate his claims against Health Net. The Court granted the requested relief because the health plan enrollment form signed by Probst failed to comply with the disclosure requirements of the Knox-Keene Health Care Service Plan Act of 1975 (Knox-Keene Act, Health & Saf. Code, § 1363.1, subdivision (b)), rendering the arbitration agreement unenforceable.

The Knox-Keene Act, Health & Saf. Code section 1363.1 provides:

“Any health care service plan that includes terms that require binding arbitration to settle disputes and that restrict, or provide for a waiver of, the right to a jury trial shall include, in clear and understandable language, a disclosure that meets all of the following conditions: [¶] . . . [¶] (b) The disclosure . . . shall be prominently displayed on the enrollment form signed by each subscriber or enrollee.”

The Court relied heavily on Zembsch v. Superior Court (2006) 146 Cal. App. 4th 153, 160-161, where another arbitration agreement was held unenforceable. The Court ruled that the disclosure provided by Health Net “does not command attention to its existence.” The provision was contained in a comparatively small and dense section of text. The Court explained that the arbitration disclosure is “essentially buried on the lower one-third of the second page” of the enrollment form. It appeared within a crowded group of other provisions beneath an “Acceptance of Coverage” heading. In explaining why the arbitration provision did not satisfy the “prominently displayed” requirement, the Court stated:

Relative to the bulk of the provisions contained in the enrollment form, the arbitration provision is contained in a comparatively small and dense section of text that does not capture the reader’s attention. As previously described, the first page and the first two-thirds of the second page of the enrollment form contain various provisions which stand out and are readily noticeable, including the sections governing personal, employee and family information, disclosure of other health care coverage, declination of coverage, and selected coverage. Those sections are preceded by headings appearing in white typeface in dark gray boxes stretching seven inches across the page. They also include boxes that are required to be checked, and generous spacing between individual questions and provisions.

In contrast, the arbitration disclosure is essentially buried on the lower one-third of the second page of the enrollment form. The arbitration disclosure appears within a crowded group of provisions appearing beneath the “ACCEPTANCE OF COVERAGE” heading. The small, narrow font used in this section is surrounded by narrow spacing, giving an overall compressed appearance and making it more difficult to read. While the font used in the arbitration disclosure appears to be somewhat larger and perhaps slightly darker than the other provisions in this section, and the line spacing somewhat greater, this is so by only the most minimal degree. The arbitration provision is not written in a significantly larger or bolder font, it is not italicized, underlined, or in all caps, and the spacing around the provision is not sufficiently large so as to highlight the provision and make it readily noticeable.

Furthermore, the arbitration disclosure is divided between two columns, unlike the other provisions appearing beneath the “ACCEPTANCE OF COVERAGE” heading. The breaking up of the disclosure between two columns hinders its readability, and serves to make the disclosure even less noticeable than the other provisions in this section.

The Court concluded:

In enacting section 1363.1, subdivision (b), the Legislature plainly intended that arbitration disclosures in health care service plans be readily observable by the reader. While health plans have flexibility in selecting elements to give prominence to arbitration disclosures (Burks, supra, 160 Cal.App.4th at p. 1028), defendants did not achieve the required prominence in the enrollment form signed by plaintiff. It is apparent from reviewing other, nonarbitration related provisions of plaintiff’s enrollment form that defendants possessed the ability to make the arbitration disclosure prominent. (See Zembsch, supra, 146 Cal.App.4th at p. 165 [when measured against other portions of the form, “Health Net clearly could have made the text of the disclosure more prominent had it chosen to do so”].) However, it cannot reasonably be said in this case that the arbitration disclosure stands out, or is readily noticeable, conspicuous, or striking. (Imbler, supra, 103 Cal.App.4th at p. 579; Burks, supra, 160 Cal.App.4th at p. 1026.)

Consequently, the superior court erred in compelling plaintiff to arbitrate his claims against defendants. (Zembsch, supra, 146 Cal.App.4th at p. 168 [violation of section 1363.1 renders any arbitration agreement unenforceable].)

This case is the latest case from the Court of Appeals to invalidate arbitration provisions by health service plans governed by the Knox-Keene Act.

Right to Jury Trial Trumps Binding Arbitration When Insurer Unreasonably Delays Paying Independent Defense Counsel

In an article appearing in the April 12, 2010 editions of the Los Angeles and San Francisco Daily Journals, I discuss the impact of the California Fourth Appellate District’s Intergulf Development, LLC. v. Superior Court (Interstate Fire & Casualty Company). Here it is:

In an important vindication of a California policyholder’s right to a jury trial to enforce an insurer’s duty to defend, the California Fourth Appellate District recently held that a liability insurer that fails to promptly acknowledge its insured’s right to independent counsel and begin funding that defense forfeits its rights to binding arbitration under Civil Code section 2860. Intergulf Development, LLC. v. Superior Court (Interstate Fire & Casualty Company), __ Cal.App.4^th __, 2010 WL 1052745 (March 24, 2010). In Intergrulf, the court ruled that the insured may proceed first to a jury trial, and, if successful, recover contract and tort damages against the insurer.

The Duty to Defend Under California Law

Under California law, a liability insurer must defend its insured if the underlying complaint alleges the insured’s liability for damages potentially covered under the policy or if the complaint might be amended to give rise to a liability that would be covered under the policy.” Montrose Chem. Corp. v. Superior Court, 6 Cal. 4th 287, 299 (1993). The duty to defend arises at the time the insured tenders defense of the third party lawsuit to the insurer. Imposition of an immediate duty to defend is necessary to afford the insured what it is entitled to: the full protection of a defense on its behalf. Montrose Chem. Corp., supra, 6 Cal. 4th at 295; Buss v. Superior Court (Transamerica Ins. Co.), 16 Cal. 4^th 35, 49 (1997) (“To defend meaningfully, the insurer must defend immediately”); 10 Cal. Code Regs., section 2695.7(b). On occasion, an insurer will delay its decision to defend outright, defend under a reservation of rights, or deny coverage altogether while it “investigates” coverage, leaving the insured to its own devices.

An unreasonable delay in paying policy benefits or paying less than the amount due is an actionable withholding of benefits which may constitute a breach of contract, as well as bad faith, giving rise to tort damages. Wilson v. 21st Century Ins. Co., 42 Cal. 4th 713, 720, 723 (2007); Major v. Western Home Ins. Co., 169 Cal. App. 4th 1197, 1209 (2009). The general measure of damages for breach of the duty to defend consists of the insured’s cost of defense in the underlying action, including attorney fees. Major v. Western Home Ins. Co., 130 Cal. App. 4th 1078, 1088-1089 (2005). Breach of the duty to defend also results in the insurer’s forfeiture of the right to control the defense of the action or settlement, including the ability to take advantage of the protections and limitations set forth in Civil Code section 2860. Fuller-Austin Insulation Co. v. Highlands Ins. Co. 135 Cal. App. 4th 958, 984 (2006); Atmel Corp. v. St. Paul Fire & Marine Ins. Co., 426 F.Supp. 2d 1039, 1047 (N.D. Cal. 2005).

An Insurer’s Right to Invoke Civil Code Section 2860 Fee Arbitration

Under Civil Code section 2860, when a liability insurer reserves its rights to contest coverage for a third party’s suit against its insured, and defense counsel could manipulate the suit in a way that could impair the insured’s coverage, section 2860 requires the insurer to pay for independent counsel to defend the suit. For example, defense counsel may be in a position to hire expert witnesses with particular perspectives, and guide their testimony on issues such as when damage occurred or whether particular damage was expected or intended—steering claims in or out of coverage. Notably, section 2860(c) limits the hourly rates that the insurer must pay independent counsel, and requires the insured to submit any fee dispute to binding arbitration.

An Insurer’s Unreasonable Delay Forfeits its Right to Invoke Civil Code Section 2860

In Intergulf, Intergulf developed a condominium project in San Diego, California. Intergulf was an additional insured on policies issued to one of its subcontractors by Interstate Fire & Casualty Company, a division of Fireman’s Fund Insurance Company. The policies provided that Interstate had the right and duty to defend any lawsuit seeking damages because of property damage. While Interstate’s policies were in effect, the homeowners association sued Intergulf for alleged construction defects.

Intergulf promptly tendered its defense to Interstate. Two weeks later, Interstate responded, not with an acknowledgment of its defense obligation, but by requesting information and reserving all of its rights. Interstate wrote that, if it determined it had a duty to participate in Intergulf’s defense, it would impose “litigation handling guidelines,” and it would typically not pay hourly rates of more than $ 150 for partners, $135 for associates, and $ 75 for paralegals. Intergulf defended with its own counsel—Luce, Forward, Hamilton & Scripps, LLP—billing at a blended rate of $250 per hour.

Seven months later, Interstate finally informed Intergulf that Interstate recognized a “potential” for a defense obligation, but did not actually acknowledge either a duty to defend or coverage. Interstate offered to “participate” in the defense of Intergulf through the firm of Wood, Smith Henning & Berman. Intergulf objected that Interstate’s reservation of rights created a conflict of interest for the Wood Smith firm, and demanded the appointment of its own independent counsel under section 2860.

Intergulf then asked Interstate to reimburse its out-of-pocket defense fees and costs. No response. About a month later, Intergulf asked again. No response. Approximately one year after it had tendered its defense, Intergulf had neither a commitment to defend with conflict-free counsel nor any reimbursement for outstanding defense fees and costs from Interstate. Intergulf then sued Interstate for breach of the duty to defend, bad faith, and declaratory relief. Two months after Intergulf filed suit, Interstate made a first payment of approximately $ 140,000; nine months later, Interstate made a second payment of approximately $ 98,000.

Five weeks before the scheduled trial, Interstate filed a petition to compel arbitration of what it characterized as a section 2860 fee dispute. Intergulf responded that the case was about the contract and tort damages that Interstate owed for breaching its duty to defend—not about a fee dispute. It argued that because the questions of Interstate’s duty to defend, conflict of interest, and bad faith had not been resolved, Interstate did not satisfy the prerequisites for arbitration under section 2860(c). The trial court, however, granted Interstate’s petition to compel arbitration and continued the trial, pending completion of arbitration.

Intergulf challenged the trial court’s ruling by filing a petition for writ of mandate. The appellate court summarily denied the petition. The Supreme Court granted Intergulf’s petition for review and transferred the matter back to the appellate court with directions to vacate the order denying mandate and issue an order to show cause why the relief sought should not be granted.

The appellate court agreed with Intergulf that the gravamen of the complaint was bad faith and breach of contract, not a dispute over the amount Interstate should pay independent counsel under section 2860(c). By filing the action for breach of contract, bad faith, and declaratory relief, Intergulf gave Interstate notice that it was treating Interstate’s failure to acknowledge Intergulf’s right to independent counsel and delay in paying policy benefits as a total breach of the duty to defend. Intergulf at *2-3, citing Coughlin v. Blair, 41 Cal. 2d 587, 599 (1953) (filing suit gave defendant notice that plaintiff viewed its failure to perform as a total breach of contract); and Sackett v. Spindler, 248 Cal. App. 2d 220, 229-230 (1967)(seller could treat persistent delay in payment for stock as total breach of the purchase agreement).

Intergulf’s entitlement to damages for breach of contract and bad faith turned on (i) whether Interstate owed Intergulf a duty to defend in the first instance; and (ii) whether Interstate breached that duty by failing to defend Intergulf “immediately” and “entirely” on tender of the defense. Intergulf at *3, citing Buss v. Superior Court, supra, 16 Cal. 4th at 49; and Montrose Chemical Corp., supra, 6 Cal. 4th at 295. Neither of these questions had been resolved at the time the court granted Interstate’s petition to compel binding arbitration of the purported fee dispute pursuant to section 2860(c).

As the appellate court noted, ordering fee arbitration under section 2860 under these circumstances puts the cart before the horse. If Intergulf proves that Interstate breached the duty to defend or committed bad faith by failing to acknowledge Intergulf’s right to independent counsel or failing to immediately and fully fund its defense, Interstate forfeits its right to limit defense fees and costs under section 2860(c) fee arbitration. Instead, a jury could award contract and tort damages in the trial court. Intergulf at *4. The appellate court issued a peremptory writ of mandate directing the trial court to vacate its order granting Interstate’s petition to compel arbitration under section 2860(c), and to enter an order denying the petition to compel arbitration.

Sound Public Policy

The appellate court’s decision is based on sound public policy. If an insurer could delay a full and immediate defense for its insured, and then run for cover under section 2860’s rate limits and binding arbitration, it would have an incentive to fabricate a Cumis conflict, comforted by the knowledge that the attorney fee element of its insured’s damages would be limited by Cumis rates, claim management protocols, and binding arbitration, instead of being tried to a jury. The insured’s right to have a jury determine breach and damages is fundamental to enforcing the insurer’s duty to provide a full and immediate defense.

Dispute Between Securities’ Brokers Not Subject to FINRA Arbitration

Several insurers who act as broker-dealers in connection with the sale of “securities” find themselves litigating in Financial Industry Regulatory Authority (“FINRA”) (formerly NASD) arbitrations when disputes arise. Sometimes, they prefer not to litigate in a FINRA forum under its rules. A very recent California Court of Appeals case discussed the types of disputes that are not subject to FINRA arbitration.

In Valentine Capital Asset Management, Inc. v. Agahi, 174 Cal. App. 4th 606 (2009), the court held that a dispute between securities’ brokers was not subject to arbitration pursuant to FINRA rules because the dispute did not relate to the brokers’ activities as members of FINRA-associated firms.

Valentine was the founder and president of Valentine Capital Asset Management, Inc. (“VCAM”) and Valentine Wealth Management, Inc. (“VWM”), neither of which was a member of FINRA.

Agahi, Luippold and Ortale worked for VCAM and VWM. When they left, Agahi formed a competing firm. Luippold and Ortale joined him at that firm and they allegedly took with them the VCAM and VWM client databases. Valentine sued Agahi, Luippold and Ortale (“defendants”) for misappropriation of trade secrets and other causes of action. Defendants moved to compel arbitration, arguing that because they were all members of FINRA, their dispute was subject to mandatory arbitration under FINRA’s arbitration clause. Valentine opposed the defendants’ motion, contending essentially that the defendants had waived their right to arbitrate and that the disputes in the litigation were not subject to FINRA arbitration.

The trial court denied the motion to compel arbitration, finding that FINRA was inapplicable because the parties’ dispute did not arise out of their business activities as FINRA members. The Court of Appeal affirmed.

The Court first explained that written arbitration provisions in interstate commercial transactions are enforceable under the FAA and that the FAA therefore applied to determine the scope of arbitration provisions in contracts with FINRA-member firms. Before engaging in activities as a registered representative for a FINRA-member firm, all registered representatives of broker-dealers, investment advisors, and securities issuers must sign a “Uniform Application for Securities Industry Registration or Transfer,” commonly referred to as Form U-4. See McManus v. CIBC World Markets Corp., 109 Cal. App. 4th 76, 88, fn. 3 (2003). Form U-4 contains an arbitration provision. By signing this form, Valentine and the defendants agreed to arbitrate every dispute required to be arbitrated under FINRA rules.

Noting that arbitration of a dispute between associated persons is required under FINRA Rule 13200 only “if the dispute arises out of the business activities of a member or an associated person . . .,” the court stated:

[T]he phrase ‘business activities of … an associated person’ must have some limitation and cannot include the activities of every possible business enterprise in which an individual, who happens to be an ‘associated person,’ might be engaged. The mandate to arbitrate disputes arising out of ‘business activities of … an associated person,’ reasonably read, must require arbitration of disputes only if they arise out of the business activities of an individual as an associated person of a FINRA member.

The court held that there was no allegation that any of the parties were acting for any FINRA-member firm or as an associated person and no relation was alleged between any FINRA-member firm and the work performed for Valentine. Further, the Court determined that none of the purported wrongdoing was alleged to have occurred in the course of the parties’ duties as associated persons with a FINRA-member firm. Instead, it allegedly occurred in connection with investment advisory firms which were not members of FINRA. The disputes thus related to Valentine and defendants, but not to their business activities as associated persons of a FINRA member.