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April 21, 2015 Articles

Coverage You Can Count On?

By Raymond A. Garcia

In complex commercial disputes where insurance or surety companies are involved, the effectiveness of alternative dispute resolution processes (ADR) is directly related to the ability to require all the necessary parties to participate in the ADR process or be bound by the result. Many complex transactions impose ADR on the contracting parties, but the utility of ADR is often frustrated because not all interested parties are bound by contract or compelled by statute to participate in the process. Once a dispute arises, interested parties often agree to mediate, but refuse to arbitrate. In a common scenario, a surety will contend that it is not bound by the underlying contract arbitration provisions, and then, after its principal suffers an adverse arbitration result, contend the surety can re-litigate the entire matter because it was not bound by the arbitration award.     

For purposes of this article, the reference to ADR includes mediation and arbitration. Mediation is the effort to resolve a dispute with a structured negotiation, managed by a neutral who is usually chosen by the parties to the dispute. The process is purely voluntary and not binding. Arbitration is a more formal process during which one or more arbitrators selected by parties hear evidence and render a binding award resolving their dispute. In many industries, ADR is governed by standard forms that prescribe the arbitration process either in detail or by reference to existing procedures administered by a recognized ADR service provider.

A Final Arbitration Award Against Some Parties May Not Bind All Parties
In a recent case, a retired judge sitting in a New York Supreme Court as a judicial hearing officer (JHO) was tasked with determining the amount of damages that should be awarded against two sureties after an arbitration award was issued against the principal of the payment bond. The JHO remarked that it seemed like bad lawyering that the sureties could not automatically be held responsible for the entire amount of the arbitration award against the principal. The sureties contended they were not parties to the arbitration, and therefore, not bound by the award. The judge was surprised that the sureties were not in the arbitration with the principal. He asked, rhetorically, why anyone would put themselves in the position to have to try the case on damages twice.

The project at issue was commenced in December 2003. Litigation started in June 2007. The arbitration award was confirmed by a court in December 2013. In May 2014, confronted with the confirmed award, a New York Supreme Court partially granted a Motion for Summary Judgment and found that the sureties should be bound by the liability decision in the arbitration, but not the damage award, and that some of the items included in the arbitration award did not seem like they were recoverable under the payment bond. The sureties appealed and argued that they were not allowed into the arbitration, nor parties to the underlying contract, and should not be bound by any decision the arbitrators made. It was stipulated that the scope and nature of the obligation under the sureties' payment bonds had not been decided by the arbitrators. Nevertheless, the bond claimant, the principal's subcontractor, contended that the sureties should be bound in all respects by the arbitration award.

Collateral Estoppel and the Surety
New York law applicable to the case was very clear on the scope of collateral estoppel and its application to the dispute with the sureties. The appellate court decided that the sureties and the bond principal were in privity, and thus, the sureties were bound by the arbitrator's decisions on any issues actually resolved during the arbitration, regardless of whether they ever had a chance to participate in the arbitration. The key issue then became what issues were actually resolved in the arbitration.

It is often difficult to determine what issues were resolved during arbitration because arbitrators generally are not required to issue written decisions explaining the basis for their awards. In the New York case, it was clear from the written award and the record before the arbitrators that the scope and extent of the sureties' obligation under the payment bond was not decided during the arbitration. The obligation of the general contractor to make payment to a subcontractor bond claimant was not the same as the sureties' obligation under the bond. The arbitrator only had heard evidence on the principal's liability to the bond claimant. As a result, the obligation of the sureties to the bond claimant was not decided in the arbitration.

In two First Department cases and one Second Department case, the courts decided that only those issues resolved by the arbitrators that affected the responsibility of the bonding company would bind the bonding company and could not be re-litigated. But none of the reported decisions actually preclude the bonding companies from contesting the damages awarded against the bond principals in the underlying arbitrations. See Azevedo & Boyle Contracting Inc v. J. Greaney Construction Corp. (285 A.D.2d 571 [2nd Dept 2001]); Sette-Juliano Contracting Corp. v. Aetna Casualty and Surety Company (246 A.D.2d 142 [1st Dept 1998]); andQDR Consultants and Development Corp. v. Colonia Insurance Co. (251 A.D.2d 641 [1st Dept 1998]).

General Liability Policies Differ from Surety
In cases involving general liability policies, the trigger to the insurer's liability is an allegation of injury caused by negligent conduct. The insurer's exposure may not solely be determined by collateral estoppel, but rather could depend on the terms of the insurance policy. See Travelers Casualty and Surety Company of America v. Netherlands Insurance Co., 312 Conn. 714, 95 A.3d 1031 (2014). In such scenarios, the insurer could find itself defending the assertion of an award from an arbitration held under a contract which required the parties to have insurance for certain kinds of injuries. Yet, the insurer may not have had the opportunity to participate in the arbitration or may have opted not to participate. These situations may spawn coverage disputes as well as attempts by the insureds to shift losses to potential indemnitors who caused the underlying injury.

The coverage disputes will require the use of several lawyers, each of whom has a different responsibility. For example, one lawyer may be responsible for asserting coverage. One may be responsible for defending the underlying claims on the merits. One may represent the insured and one may represent the insurer. The coverage question may not be subject to an ADR process while the underlying claims may be subject to an ADR process. Then there may be an overlay of notice requirements or limitations on the time within which parties can seek to assert claims. For example, it is possible that one party who may be entitled to insurance purchased by others may lose the right to assert its right to coverage because proper notice was not provided or the insurer was not given an adequate chance to defend.

The critical element in all these scenarios is the scope of the obligation to participate in the ADR process set forth in the underlying contracts. To enjoy the full benefit of insurance coverage, efforts need to be made either to have the insurer agree to participate in the ADR process when the policy is purchased, or to have the bonds incorporate the underlying contract, thus binding the sureties to participate in the ADR process or be bound by the result even if the surety chooses not to participate.

Keywords: alternative dispute resolution, litigation, insurance commercial dispute, mediation, damage award, collateral estoppel