Opinion ID: 2271349
Heading Depth: 2
Heading Rank: 2

Heading: The Arbitration Clauses and the FAA Conflict with the IRLL's Grant of Broad Exclusive Jurisdiction to the Franklin Circuit Court

Text: Enforcement of the arbitration clauses found in the engagement letters between Ernst & Young and AIK Comp conflicts with the IRLL. We are directed by KRS 304.33-010(3) to liberally construe the provisions of the IRLL to effect the purposes stated in KRS 304.33-010(4). KRS 304.33-010(4)(c) expressly states that one of the purposes of the IRLL is the enhanced efficiency and economy of liquidation, through the consolidation of matters relating to the liquidation under the supervision of a single court so as to avoid divergent rulings by a multiplicity of judicial tribunals . . . . (emphasis added). KRS 304.33-040(3)(a) provides that the [Franklin Circuit] court [10] shall have exclusive jurisdiction to entertain, hear, or determine all matters in any way relating to any delinquency proceeding under this subtitle, including, but not limited to, all disputes involving purported assets of the insurer. KRS 304.33-040(3)(b) allows the Franklin Circuit Court to authorize a rehabilitator [11] to seek injunctive or other appropriate relief from other courts, either within this state or without this state, if in the opinion of the [Franklin Circuit] court, this action will be an aid to any delinquency proceeding. Similarly, KRS 304.33-140(2) provides: (2) Upon the issuance of an order directing the executive director to rehabilitate a domestic insurer, the [Franklin Circuit] court shall have exclusive jurisdiction over all matters relating to the rehabilitation, including, but not limited to, the proper scope and application of the provisions of this subtitle to the rehabilitation as well as all interpretation and enforceability of all contracts of insurance to which the insurer is a party. Exclusive jurisdiction over all matters in any way relating to any delinquency proceeding. . . including ... all disputes involving purported assets of the insurer [12] and over all matters relating to the rehabilitation [13] is an extremely broad grant of authority by the General Assembly to the Franklin Circuit Court. Such broadly defined exclusive jurisdiction, coupled with directions for liberal construction, is a very rare, if not unique, provision in Kentucky law. We have on other occasions in another context noted the broad scope of this jurisdictional grant: The subtitle provides Franklin Circuit Court broad discretion as to supervision of the proceedings. KRS 304.33-040 pertains to the exclusiveness of proceedings and states that the court shall have exclusive jurisdiction over all matters relating to the proceeding, including all disputes over assets. The court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of the subtitle. Section (3)(c) states that no provisions in the subtitle shall be construed to preclude the court from, on its own motion, taking any action or making any determination necessary or appropriate to enforce or implement court orders or rules or to prevent an abuse of process. Kentucky Central Life Ins. Co. v. Stephens, 897 S.W.2d 583, 587 (Ky.1995); see also Minor v. Stephens, 898 S.W.2d 71, 80 (Ky.1995). It is evident that an essential goal of the IRLL is to promote consistent rulings in all matters that impact the rehabilitation of an insurance company. We believe that the strong language of KRS 304.33-040(3)(a) and KRS 304.33-140(2) is an unambiguous expression of the General Assembly's intention to achieve that goal by concentrating in the Franklin Circuit Court all matters in any way related to the proceeding to rehabilitate or liquidate an insurance company. The vesting of such jurisdiction in the Franklin Circuit Court, including the broad authority to supervise all issues relating to a rehabilitation, provides a logical and reasonable means of attaining the IRLL's stated purpose of achieving enhanced efficiency and economy of liquidation, through the consolidation of matters relating to the liquidation under the supervision of a single court so as to avoid divergent rulings by a multiplicity of judicial tribunals. KRS 304.33-010(4)(c)). Compelling the enforcement of the arbitration agreements in this case would remove virtually all of the supervisory authority of the Franklin Circuit Court over the adjudication of the Rehabilitator's claims against Ernst & Young and place it in the hands of the arbitrators. Thus, all discovery issues, evidentiary disputes, and determinations of applicable law would be made by the arbitrators, not by the court as the General Assembly intended. Inconsistent and incompatible results are possible if the Rehabilitator's claims against Ernst & Young are resolved by arbitration, while other issues pertaining to the AIK Comp rehabilitation are adjudicated in the Franklin Circuit Court. Piecemeal adjudication and the potential for inconsistent verdicts are what the General Assembly sought to avoid by the IRLL's strong grant of exclusive jurisdiction to the Franklin Circuit Court. Ernst & Young argues that the potential for such inefficiencies is not relevant to the enforceability of valid arbitration agreements, and cites cases that discount such concerns in favor of arbitration. [14] We recognize the validity of the cited authority, but we note that they do not involve arbitration in the context of a proceeding to liquidate or rehabilitate an insurance company, with the extraordinary state interest vested therein; nor, do they involve the strong statutory preference for the resolution of such matters in a specific forum that we find in the IRLL. Ernst & Young also argues KRS 304.33-010(6) does not apply in this case because the Rehabilitator's lawsuit is not a delinquency proceeding. See Nichols v. Vesta Fire Ins. Corp., 56 F.Supp.2d 778 (E.D.Ky. 1999) (holding that an insurance Rehabilitator's breach of contract suit filed against a third-party insurer was merely a garden variety lawsuit, not a delinquency proceeding in which KRS 304.33-010(6) would apply). On this point, we first note that KRS 304.33-010(6)'s subordination of contractual provisions that conflict with the IRLL is not limited to the delinquency proceeding. By the plain language of KRS 304.33-010(6), any contractual provision in conflict with the IRLL is subordinated [i]f there is a delinquency proceeding under this subtitle . . . . (emphasis added). That there is, in fact, a delinquency proceeding in the Franklin Circuit Court regarding AIK Comp cannot be disputed, and as part of that proceeding under KRS 304.33-160(4), the Rehabilitator has been charged to pursue all appropriate legal remedies on behalf of the insurer. Secondly, the federal court in Nichols found that the exclusive jurisdiction granted by KRS 304.33-040 to the Franklin Circuit Court was inapplicable because the claim involved was simply a common law breach of contract action which merely happens to involve an insolvent insurer. Nichols, 56 F.Supp.2d. at 780. [T]he instant action is no more than a garden variety contract suit which happens to involve two insurers. The fact that one is insolvent is irrelevant[.] Id. at 781. Far from being just a coincidental aspect of a garden variety claim, AIK Comp's insolvency was allegedly caused by Ernst & Young's audits which masked AIK Comp's true financial condition. Under the Reorganization Plan approved by the Franklin Circuit Court, the Rehabilitator's claims against Ernst & Young are an essential component of AIK Comp's rehabilitation. Unlike the claims in Nichols, the claims asserted by the Rehabilitator fall squarely within the scope of KRS 304.33-040(3)(a), as matters . . . relating to [a] delinquency proceeding under this subtitle, including. . . all disputes involving purported assets of the insurer, and therefore, under KRS 304.33-010(6) remain within the exclusive jurisdiction of the Franklin Circuit Court. We therefore conclude that the contractual provisions for arbitration under the Federal Arbitration Act are in conflict with the jurisdictional requirements of the IRLL. In reaching this conclusion, we reject Ernst & Young's comparison of that result to the anti-arbitration concept of ouster of jurisdiction, a doctrine discredited in Fite & Warmath Construction Co. v. MYS Corp., 559 S.W.2d 729, 735 (Ky.1977), and Kodak Min. Co. v. Carrs Fork Corp., 669 S.W.2d 917, 921 (Ky.1984). We recognize that when a lawsuit is submitted to arbitration, the trial court technically retains jurisdiction over the proceeding while the issues are arbitrated. But, we also recognize that in such situations, the trial court no longer retains the authority to determine all matters in any way related to the delinquency. KRS 304.33-040(3)(a). When a dispute goes to arbitration, the trial court's broad discretion to decide all issues pertaining to pre-hearing procedures, including discovery, all issues of substantive law, and all evidentiary matters passes to the arbitrator. 4 Am. Jur.2d. Alternative Dispute Resolution, § 157-169 (2007). The trial court's function is constricted to the simple entry of a final judgment enforcing the arbitrator's decision. See DiMercurio v. Sphere Drake, Ins., PLC, 202 F.3d 71, 77 (1st Cir.2000) (holding that arbitration agreements do not divest courts of jurisdiction, though they prevent courts from resolving the merits of arbitrable disputes.) Only if the arbitrator's decision is alleged to have been tainted by fraud or favoritism does the trial court have the ability to intercede. See Wall Street Associates, L.P. v. Becker Paribas Inc., 27 F.3d 845, 849 (2d Cir.1994)(citing the Federal Arbitration Act, 9 U.S.C. § 10); 3D Enterprises Contracting Corp. v. Lexington-Fayette Urban County Government, 134 S.W.3d 558, 561 (Ky.2004) (citing KRS 417.160 of Kentucky's Uniform Arbitration Act). Such a substantial reduction of the court's role in a process central to the rehabilitation of an insurance company is inconsistent with our legislature's extensive grant of exclusive jurisdiction to the Franklin Circuit Court. The General Assembly did not intend for that grant of jurisdiction to be overruled by an insurance company's agreement to arbitrate issues critical to the state's interest in the rehabilitation or liquidation of the insurance company. Therefore, we conclude that the third part of the Forsyth test is satisfied because the Federal Arbitration Act's preference for arbitration conflicts with, and impairs, the IRLL's grant of broad and exclusive jurisdiction to the Franklin Circuit Court. In this case, application of the McCarran-Ferguson Act reverse-preempts the Federal Arbitration Act. Pursuant to KRS 304.33-010(6), the federal policy favoring arbitration is subordinated to the state's superior interest in having matters relating to the rehabilitation of an insurance company adjudicated in the Franklin Circuit Court. The Rehabilitator properly chose to initiate her claims against Ernst & Young in the Franklin Circuit Court, and properly declined to submit the matter to arbitration. We affirm the court's order denying Ernst & Young's motion to compel arbitration of the Rehabilitator's claims.