Sphere Drake Insur v. All American Insur ( 2001 )

In the
United States Court of Appeals
For the Seventh Circuit
No. 00-2102
Sphere Drake Insurance Limited, formerly
known as Odyssey Re (London) Limited,
Plaintiff-Appellee,
v.
All American Insurance Company,
Defendant-Appellant.
Appeal from the United States District Court
for the Northern District of Illinois, Eastern Division.
No. 99 C 4573--William T. Hart, Judge.
Argued November 7, 2000--Decided July 3, 2001
Before Bauer, Coffey, and Easterbrook,
Circuit Judges.
Easterbrook, Circuit Judge. Who pays
losses incurred on seven insurance
policies is a subject of dispute. All
American Insurance underwrote the
policies. Contracts apparently
representing the agreement of Sphere
Drake Insurance to reinsure these risks
are in All American’s files--but Sphere
Drake denies that it has agreed to any
such reinsurance. A broker called Euro
International Underwriting ("eiu") wrote
the reinsurance on Sphere Drake’s behalf.
eiu had actual authority to represent
Sphere Drake, but only up to an annual
limit of risks. According to Sphere
Drake, eiu exceeded this limit when
agreeing to reinsure All American’s
policies. Moreover, Sphere Drake
contends, All American knew that eiu had
gone over the top, so that eiu had neither
actual nor apparent authority. The
parties appear to agree that if this
defense prevails then Sphere Drake need
not pay; they also agree on the extent of
Sphere Drake’s liability if eiu had power
to bind it. What they do not agree on is
which tribunal has the authority to
decide the extent of eiu’s authority as
Sphere Drake’s agent.
Sphere Drake wants the dispute resolved
in court--federal court in particular,
because the parties are of diverse
nationalities. See 28 U.S.C.
sec.1332(a)(2). All American contends
that the parties have agreed to
arbitrate. It relies on the language in
the short form agreements (called slip
policies) that eiu signed. The parties
concentrate on one particular slip
policy, which agrees to reinsure workers’
compensation risks. We reproduce the bulk
of the slip policy:
CLASS:
To indemnify the Reinsured in respect of
their participation on the Unicare
Insurance Company, Workers Compensation
Excess of Loss Reinsurance contract.
EXCLUSIONS: Employers Liability (Section
B of Workers’ Compensation Act). In all
other respects to follow the original
contract in every respect. . . .
GENERAL CONDITIONS:
This Reinsurance is to pay as may be
paid, and to follow all terms clauses and
conditions on the original contract as
detailed under the CLASS section of this
Reinsurance.
Several Liability Notice (Reinsurance)
LSW 1001.
This contract of Reinsurance shall be
governed by and construed in accordance
with the law of the state of Illinois,
U.S.A. under the jurisdiction of the
courts of the state of Illinois, U.S.A.
The Arbitration contract shall also be
governed by the law and jurisdiction of
the state of Illinois, U.S.A.
WORDING:
Agree to sign slip policy.
This acceptance slip constitutes the
Policy for all purposes; however, a
formal Policy, in substitution for this
Slip Policy or any declaration hereunder,
will be issued at any time at the request
of the (Re-) Insured or any other
Underwriters hereon.
All American contends that this policy
contains two arbitration clauses. First,
the last paragraph of the "General
Conditions" section says that "[t]he
Arbitration contract shall also be
governed by the law and jurisdiction of
the state of Illinois, U.S.A." This use
of the definite article, All American
insists, establishes that Sphere Drake
has agreed to arbitrate. Second, the
initial paragraph of "General Conditions"
says that the reinsurance follows "all
terms clauses and conditions on the
original contract"; because the Unicare
policy has an arbitration clause, this
follow-form slip policy also requires
arbitration. Sphere Drake disputes both
of these contentions and adds a defense:
even if eiu plastered the papers with
arbitration clauses that can’t kick
Sphere Drake out of court on the question
whether eiu was its agent. To arbitrate
the agency issue, Sphere Drake insists,
would be circular, for arbitration is
proper if and only if eiu indeed could
bind Sphere Drake.
The district court ruled in Sphere
Drake’s favor by interpreting the text of
the slip policy not to provide for
arbitration. The last subparagraph is a
choice-of-law clause and not an
arbitration clause, the judge held; any
requirement to arbitrate must be found
elsewhere. And the initial subparagraph
does not incorporate the Unicare policy’s
arbitration provision, according to the
judge, because it follows only the
"clauses and conditions on the original
contract as detailed under the CLASS
section of this Reinsurance." No
arbitration language appears in the
"Class" section, so Sphere Drake cannot
be required to arbitrate. The court not
only denied All American’s motion to
require arbitration but also enjoined All
American from proceeding with
arbitration. All American appeals, as 9
U.S.C. sec.16(a)(1)(B) and (a)(2) permit.
The district court read the first
subparagraph of the "General Conditions"
section as if it said that the
reinsurance will "follow all terms
clauses and conditions . . . detailed
under the CLASS section of this
Reinsurance." If this redacted version,
deleting "on the original contract as,"
is the best understanding, then the
district court’s conclusion follows. The
competing way to read this clause is that
the reinsurance will "follow all terms
clauses and conditions on (the original
contract as detailed under the CLASS
section of this Reinsurance)." We have
added parentheses to show the grouping
All American prefers: the reinsurance
follows the terms and conditions of the
contract referenced in the "Class"
section, not just the terms referenced in
the "Class" section.
All American’s reading is more
plausible, and not just on the technical
ground that it avoids the effective
deletion of five words from the contract.
It is more plausible because the
"Exclusions" section provides that the
slip policy follows the underlying
contract "in every respect" except the
one mentioned specifically. This is
essential to any follow-form policy. The
"Class" section cannot be the source of
all terms of the agreement; it does not
mention any terms. Thus if the "General
Conditions" section requires the
reinsurance to follow only the terms
specified in the "Class" section, the
whole reinsurance arrangement is
uprooted. A follow-form policy must have
a form, which is to say that form’s
terms, to follow; yet the district court
read this slip policy to be term-and-
condition free. What then does it
reinsure? What risks are covered? When
must claims be filed? Who defends the
suits? These questions can be answered
only if the slip policy adopts the
underlying policy’s terms. Here, as in
Progressive Casualty Insurance Co. v.
C.A. Reaseguradora Nacional De Venezuela,
991 F.2d 42 (2d Cir. 1993), a follow-form
reinsurance agreement logically includes
an arbitration agreement in the
underlying contract. This understanding
could be overridden, but this slip
policy’s "Exclusions" section does not
displace the arbitration clause.
Having concluded that the "General
Conditions" section incorporates the
arbitration agreement in the Unicare pol
icy, we can bypass other disputes and cut
straight to the question whether eiu’s
authority is arbitrable. Recall that
Sphere Drake and All American would not
ask the arbitrator to resolve anything
except whether they have a reinsurance
agreement in the first place--a question
that depends entirely on eiu’s authority
to bind Sphere Drake. This dispute seems
to us covered by the principle that
courts, rather than arbitrators, usually
determine whether the parties have agreed
to arbitrate. See First Options of
Chicago, Inc. v. Kaplan, 514 U.S. 938(1995); AT&T Technologies, Inc. v.
Communications Workers, 475 U.S. 643(1986). This is why four federal judges
have parsed the "General Conditions"
section to determine whether the slip
policy agrees to private dispute
resolution; likewise judges must
determine whether Sphere Drake agreed to
the slip policy. It is a shortcut to say
that "the slip policy agrees" to
something; pieces of paper don’t "agree"
to do things. eiu agreed to the slip
policy, but whether eiu spoke for Sphere
Drake is debated. If All American
produced a policy purportedly signed by
Sphere Drake’s CEO, but evidence showed
that a clerk at All American had forged
the signature, then Sphere Drake would
not have to arbitrate (or pay), see
Chastain v. Robinson-Humphrey Co., 957
F.2d 851 (11th Cir. 1992); why would it
be different if eiu lacked authority to
speak for Sphere Drake? Section 2 of the
Federal Arbitration Act, 9 U.S.C. sec.2,
says that an arbitration agreement "shall
be valid, irrevocable, and enforceable,
save upon such grounds as exist at law or
in equity for the revocation of any
contract." An agent’s lack of authority
is a ground that prevents the enforcement
"of any contract"; does it not follow
that judges must determine whether the
agent had authority?
According to All American, Prima Paint
Corp. v. Flood & Conklin Mfg. Co., 388
U.S. 395 (1967), supplies a negative
answer. Prima Paint holds that, unless
the arbitration clause excludes such
disputes, an arbitrator resolves a claim
of fraud in the inducement. This means,
All American believes, that all disputes
about contract formation go to
arbitrators; only disputes about the
scope of arbitration clauses (as in AT&T
Technologies) are resolved in advance by
courts. That is, we suppose, a possible
reading of Prima Paint, which sits
uneasily alongside AT&T Technologies and
First Options. But it is not a plausible
reading, for it would disregard the
principle that arbitration is
contractual. Unless the parties agree
otherwise, they are entitled to have
courts resolve their disputes. The
parties in Prima Paint did agree
otherwise and promised to have the
arbitrator resolve "[a]ny controversy or
claim arising out of or relating to this
Agreement" (emphasis added), the broadest
possible clause. Whether one party
defrauded another during the negotiations
for the agreement "related to" that
agreement. There was no doubt that the
arbitration agreement (and the contract
of which it was a part) had been signed;
both sides knew what they were getting. A
claim of fraud in the inducement--which
boils down to "we wouldn’t have signed
this contract had we known the full truth
about our trading partner"--supposes that
the unhappy party did agree, but now
wishes it hadn’t. If a claim of "we wish
we hadn’t agreed" could be litigated,
even when the arbitration clause is so
broad, this would move a good portion of
contract disputes back to court and
defeat this part of the agreement at the
outset, for it is easy to cry fraud.
Prima Paint thought it important that no
one argued that the arbitration clause
was itself the result of fraud; that
enabled an arbitrator to resolve defenses
to enforcement of the contract without
calling into question the arbitrator’s
own authority to act.
Fraud in the inducement does not negate
the fact that the parties actually
reached an agreement. That’s what was
critical in Prima Paint. But whether
there was any agreement is a distinct
question. Chastain sensibly holds a claim
of forgery must be resolved by a court. A
person whose signature was forged has
never agreed to anything. Likewise with a
person whose name was written on a
contract by a faithless agent who lacked
authority to make that commitment. This
is not a defense to enforcement, as in
Prima Paint; it is a situation in which
no contract came into being; and as
arbitration depends on a valid contract
an argument that the contract does not
exist can’t logically be resolved by the
arbitrator (unless the parties agree to
arbitrate this issue after the dispute
arises). It was possible to arbitrate in
Prima Paint without circularity; in
forgery and agency cases, by contrast,
the arbitrator’s authority to resolve the
dispute would depend on one particular
answer to that very dispute. Only a court
can break that circle. Disputes about the
adequacy of consideration (or some other
formation issues) would be closer
questions, for a contract without
consideration represents an agreement.
Lack of consideration has historically
made the promise unenforceable in court,
but parties may be able to create
contracts that the public tribunals do
not enforce yet private tribunals will
enforce. Nonetheless, we have held, a
claim of missing consideration will be
heard by a court and, if the agreement is
not supported by consideration, the
dispute will not be sent to arbitration.
Gibson v. Neighborhood Health Clinics,
Inc., 121 F.3d 1126 (7th Cir. 1997). If
this is so, then the treatment of a
contract signed by a person who lacks
authority follows directly.
Many appellate courts have held that the
judiciary rather than an arbitrator
decides whether a contract came into
being. See, e.g., Sandvik AB v. Advent
International Corp., 220 F.3d 99, 105-09
(3d Cir. 2000); N&D Fashions, Inc. v. DHJ
Industries, Inc., 548 F.2d 722, 729 (8th
Cir. 1976); Three Valleys Municipal Water
District v. E.F. Hutton & Co., 925 F.2d
1136, 1139-42 (9th Cir. 1991); Chastain,
supra. Most of these decisions involve
the same question as our case: whether a
dispute about an agent’s authority to
bind the principal to the contract is
arbitrable. Every appellate court that
has addressed this question has answered
"no, unless. . .". The "unless" clause
reflects the fact that parties may agree
separately to arbitrate disputes about
whether they have agreed to the
contract’s substantive promises. See
First Options, 514 U.S. at 943. The
approach of Sandvik and its predecessors
is sound, for a person who has not
consented (or authorized an agent to do
so on his behalf) can’t be packed off to
a private forum. Courts have jurisdiction
to determine their jurisdiction not only
out of necessity (how else would
jurisdictional disputes be resolved?) but
also because their authority depends on
statutes rather than the parties’
permission. Arbitrators lack a comparable
authority to determine their own
authority because there is a non-circular
alternative (the judiciary) and because
the parties do control the existence and
limits of an arbitrator’s power. No
contract, no power.
Nonetheless, All American contends,
Colfax Envelope Corp. v. Chicago Graphic
Communications Union, 20 F.3d 750 (7th
Cir. 1994), commits this circuit to a
minority position. If indeed Colfax held
that arbitrators resolve all disputes
about contract formation, it would be
incompatible with Gibson and much
authority elsewhere, and we would be
inclined to reconsider our position to
eliminate the intra-circuit conflict and
avoid being an outlier. See United States
v. Carlos-Colmenares, No. 00-3632 (7th
Cir. June 7, 2001). But Colfax held no
such thing. It concluded that when both
parties sign a contract that appears to
be definitive, and contains an
unmistakable arbitration clause, a
dispute about whether the substantive
promises are too uncertain to be
enforceable is for the arbitrator; if
they have agreed on nothing else, we held
in Colfax, they have agreed to arbitrate.
Many a contract conceals an ambiguity,
and sometimes the ambiguity is so
important to the bargain that the
promises are deemed unenforceable.
(Colfax gave as an example the famous
Raffles v. Wichelhaus, 2 H. & C. 906, 159
Eng. Rep. 375 (Ex. 1864), where the
parties made a contract for the delivery
of a shipment of cotton from Bombay to
England on the ship Peerless--but,
unbeknownst to each, the other had in
mind a different ship of that name.) When
there is no sound basis for choosing
between competing understandings, neither
party is bound. But in cases such as
Colfax and Raffles both parties thought
that they had made and received
enforceable promises, and in Colfax they
also had agreed to arbitrate. Whether an
extrinsic ambiguity is so vital as to
preclude enforcement is exactly the sort
of question that an arbitrator is
supposed to handle; putting such matters
in the hands of specialists rather than
judges or jurors is one attraction of
arbitration. Colfax added that things
would be otherwise if even the rudiments
of agreement were missing. To avoid
arbitration, we wrote, "[t]he party must
show that the arbitration clause itself,
which is to say the parties’ agreement to
arbitrate any disputes over the contract
that might arise, is vitiated by fraud,
or lack of consideration or assent, as in
Three Valleys Municipal Water District v.
E.F. Hutton & Co., 925 F.2d 1136, 1140
(9th Cir. 1991); that in short the
parties never agreed to arbitrate their
disputes." 20 F.3d at 754. The holding of
Three Valleys, which Colfax cited with
approval, is that courts decide whether a
purported agent had the authority to
commit its principal to the contract. Cf.
Harter v. Iowa Grain Co., 220 F.3d 544,
550 (7th Cir. 2000) (courts decide
whether contract with arbitration clause
is invalid root and branch as a violation
of federal law). So this circuit is not
out on a limb.
Sphere Drake may be required to
arbitrate if and only if eiu had authority
to bind it to these reinsurance
contracts. If eiu did have authority, then
there appears to be no further dispute
that needs to be resolved, by judge or
arbitrator. Accordingly, the judgment is
affirmed (there will be no arbitration
unless some additional issue for private
dispute resolution surfaces later in the
case) and the case is remanded with
instructions to resolve the parties’ only
real dispute: the extent of eiu’s
authority.