Worldwide: PCC Montana Court ruling examined: AmTrust North America, Inc. v. Pacific Re, Inc., No. 15 Civ. 7505 (CM), 2016 U.S. Dist. LEXIS 44889 (S.D.N.Y. Mar. 25, 2016).

Last Updated: 29 November 2016
Article by Nigel Feetham

I have previously written about the Montana Federal Court judgment concerning a reinsurance dispute between a protected cell company (PCC) and it's reinsured. The case is PAC RE 5-AT v. AMTRUST NORTH AMERICA, INC., No. CV-14-131-BLG-CSO (D. Mont. May 13, 2015). The judgment has received wide coverage in captive insurance journals internationally because it is the first judicial decision where a court has analysed in detail the legal status of a PCC.

Some of the complex factual backdrop of this case is briefly described in a related court judgment as follows: "Plaintiffs allegedly became involved in the reinsurance program believing that, for them, it would be an almost risk- and cost-free venture. See id. 25-27. According to their complaint, plaintiffs agreed to reinsure insurance policies that were underwritten by one of defendants' companies, believing that defendants would in turn reinsure plaintiffs and cover their costs. See id. These benefits were to come, at least in part, from defendants' captive reinsurance company Pacific Re, Inc. and its protected cell Pac Re 5-AT. See id. 6. Plaintiffs contend that defendants mismanaged and undercapitalized Pacific Re and Pac Re 5-AT, which left these entities unable to fulfill their contractual and fiduciary obligations to plaintiffs. See Compl. 9, 24, 29, 63, 81-82. Plaintiffs now seek, among other things, to pierce the corporate veil in order to recoup their losses. See id. 84-89.", per Judge James Cott in AMTRUST NORTH AMERICA, INC. v. SAFEBUILT INSURANCE SERVICES, INC., No. 16-MC-169 (CM)(JLC) (S.D.N.Y. May 16, 2016).

It will be recalled that the PCC reinsurer (Pac Re) filed an action in Montana, before the arbitrators issued a decision, seeking a declaratory judgment that only its cell (5-AT), and not the PCC, was a proper party to the arbitration. The Montana Federal Court held that the PCC was the proper party to the arbitration since a cell does not have separate legal identity. Although this was not a case where the cellular regime was being challenged, Judge Ostby stated that "It is clear that the liabilities and assets of a protected cell are segregated from the other cells and from the PCC", also noting that "the statute does not contemplate that the assets of a protected cell will be used to satisfy the liabilities of any other cell". This is consistent with how PCCs are understood to operate by captive professionals around the world, namely, notwithstanding a cell does not have separate legal personality from the PCC (the company itself), and therefore, absent a statutory provision to the contrary, a cell cannot sue or be sued in its own name, the assets and liabilities of each cell are separate for the purposes of limiting creditor liability to cellular assets.

Following the Montana decision, the arbitration panel issued an interim final order ordering the reinsurer to post collateral to pay for reinsured claims and reimburse the reinsured in third party administrator fees pursuant to the reinsurance agreement. The reinsured brought the present action in the New York Federal Court seeking a confirmation of the award whereas the reinsurer sought to have the award set aside.

The reinsurer, in essence, argued that "the arbitrators made their award in manifest disregard of the law". According to the Court judgment the basis for the challenge was as follows:

The arbitrators had determined that Pac Re (the PCC), not simply the cell in this transaction (5-AT), was properly held liable for amounts due from cell 5-AT to the reinsurer. The arbitrators purported to have applied the decision of Judge Ostby, who held that cell 5-AT was not an independent legal entity and that it could not sue and be sued. Pac Re now argued that the New York Federal Court should not confirm the arbitration award because the arbitrators improperly interpreted Judge Ostby's decision as holding that all of Pac Re's assets (including the assets of other protected cells) could be used to satisfy a judgment arising out of the activities of just one of its protected cells (5-AT), when in fact all Judge Ostby did was hold that cell 5-AT could not sue and be sued in its own name—a ruling that Pac Re believed to be much narrower. Meanwhile, reinsurer argued that the arbitrators got Judge Ostby's ruling exactly right and so their award should be confirmed.

It is worth quoting extensively from the law report. The Court held (per Colleen McMahon, United States District Judge):

"Both parties are missing the mark. The award should indeed be confirmed—because the arbitrators did not act in manifest disregard of the law. That is the only arguable basis available for overturning the award. And I cannot say that the arbitrators manifestly disregarded the applicable law. They may have misinterpreted the applicable law—but this court cannot substitute its judgment for the judgment of the arbitrators on that point.

As noted above, the scope of review of an arbitration award is narrow. The parties contracted to allow non-judges to determine their dispute. But that means they chose to eschew having a court of law decide the questions of law applicable to their case, or rule on the facts in accordance with settled legal principals. Arbitrators are free to make an award that they think is fair, even if a court of law would reach a different result. [...] There is no requirement that arbitrators get the law right. [...] Indeed, an award should be confirmed even if it is contrary to what the court understands the law to be. [...] This court does not sit as a court of appeals with the power to correct errors or misinterpretations of law committed by arbitrators (if, indeed, there have been any in this case, which is a question I do not reach). [...]

In order to vacate for manifest disregard of the law, there must be 'something beyond and different from a mere error in the law or failure on the part of arbitrators to understand and apply the law.' [...]. There must be 'egregious impropriety on the part of the arbitrator ....' [...] Here, the arbitrators plainly applied Judge Ostby's ruling as they understood it to be. They did not disregard it at all. Whether the arbitrators got her ruling right or wrong is of no moment to a court sitting as a purely confirmatory body. Parties who want the law strictly applied to the facts of their cases should not sign arbitration clauses. Only litigating in a court of law guarantees that the law will be applied to resolve a dispute. Parties who choose to by-pass the courts cannot be heard to complain if arbitrators do not reach the result they think a court would have reached. They have made their bed; they must lie in it. And indeed, Judge Ostby so stated: she held that Pac Re would be bound by the results of the arbitration. Pac Re 5-AT, 2015 U.S. Dist. LEXIS 65541, 2015 WL 2383406, at *5. The result of the arbitration is that Pac Re, not just its 5-AT captive cell, must pay AmTrust a whole lot of money."

From my reading of the Montana Court judgment (although admittedly this is not entirely clear) Judge Ostby did not (but nor was she required to) rule on what specific assets of Pac Re under the relevant contract (i.e. whether core and cell, or cell only) attached to the liabilities and just ruled on the question before the Court, namely, who was the proper party to the arbitration proceedings. This appears borne out by the Judge's comment "Although a protected cell has many attributes of independence from the PCC, it remains a part of the PCC, which has the capacity to act on behalf of the protected cell, as in this instance Pacific Re acted on behalf of Cell 5 in agreements at issue. This interpretation gives meaning to the entire statute because the arbitration may consider and apply the statutory attributes of the protected cell's independence." I read from this that the Judge left it for the arbitration to decide this matter (which the arbitrators in effective did, albeit, applying Judge Ostby's ruling as they understood it to be), whilst, importantly for the PCC regime, still making it clear that the liabilities and assets of a protected cell are segregated from the other cells.

The effect of the arbitration decision as confirmed by the New York Federal Court therefore appears to be that that the counter-party would be free to enforce the award against the assets of the "core" (PCC), and not just the cell. The difficulty for Pac Re, of course, is that if the assets of the core and cell are insufficient to pay the liabilities of the arbitration award (i.e. it was unable to post the collateral), presumably the PCC itself could be subject to winding up proceedings.

We can make a number of observations about this judgment.

First, it confirms the courts reluctance to interfere with arbitration decisions given, as stated in the judgment, the parties have contracted to allow non-judges to determine their dispute and there is no requirement that arbitrators should get the law right; therefore they are bound by the arbitration decision and cannot later complain to the court.

Second, PCC promoters will note with interest the judgment's comment: "And indeed, Judge Ostby so stated: she held that Pac Re would be bound by the results of the arbitration. Pac Re 5-AT, 2015 U.S. Dist. LEXIS 65541, 2015 WL 2383406, at *5. The result of the arbitration is that Pac Re, not just its 5-AT captive cell, must pay AmTrust a whole lot of money." It is true that Judge Ostby held that Pac Re would be bound by the arbitration; there is nothing inconsistent here with the status of a protected cell company since as Judge Ostby pointed out cells do not have a separate legal identity and Pac Re had "entered into contracts at issue both on its own and on behalf of the protected cell." But that is not to say that the liability of one cell can be enforced against the assets of other cells, and importantly, neither the judgment of the Montana nor New York Federal Court decide otherwise. In fact, to the extent that there was any suggestion to the contrary by the parties in their pleadings, the New York Federal Court must be taken to have rejected this as "missing the mark". Both judgments therefore implicitly leave the cellular regime intact.

Third, the reinsurance agreement contained an arbitration clause and the parties consented to arbitration in New York, rather than in the state of incorporation of the PCC (Montana).

Fourth, the Court cited, with implicit approval, the passage by Judge Ostby on the legal status of a protected cell company. This augurs well for judicial recognition of the statutory ring-fencing of assets and liabilities of different cells.

Fifth, save as stated above, the decision is of limited precedential value as it is clearly confined to its facts, and given as the Judge pointed out, she was not required to make a decision on any question of law.

Finally, if PCC legislation allows a PCC to contract solely on behalf of a cell with no recourse to the assets of the core and the PCC does properly contract in this manner through the express inclusion of a limited recourse provision in the contract between the parties (i.e. the parties identify the assets which would satisfy any claim incurred by the PCC by reference solely to the cell), then, notwithstanding that in law the party to the contract (and therefore to any proceedings) is the PCC itself, the PCC cellular regime would limit the contracting party's right to enforce any claim against the assets of the core, thereby limiting creditor liability to the relevant cell's assets. Assuming parties so contracted, in the event of a judgment or arbitration award being made against "the PCC", the rights of enforcement against the PCC would be limited in recourse against the assets of the specified cell.

Can we learn anything from this case? Most certainly. First, when it comes to PCCs, contracting parties should avoid arbitration. Indeed, PCCs give rise to very complex questions of law and any such disputes are better suited to a court of law than arbitration which is intended to be non-legalistic. Second, to protect the PCC (the corporate entity) from insolvency risk as the contracting party to a contract, the PCC would be well advised to put in place clear contractual language into the contracts in the form of 'risk mitigation clauses' (e.g. cell limitation/limited recourse and local governing law); not to do so could expose the PCC itself. The various mitigation technics are explained in a memorandum published recently. Third, in the case of a contractual dispute, the PCC should always seek to litigate locally (i.e. disputes - arbitration or court proceedings - should be litigated in the jurisdiction of the PCC).

The New York Federal Court case is AmTrust North America, Inc. v. Pacific Re, Inc., No. 15 Civ. 7505 (CM), 2016 U.S. Dist. LEXIS 44889 (S.D.N.Y. Mar. 25, 2016). It is note that the Southern District of New York is one of the most influential federal district courts in the US, with the New York financial centre falling within its jurisdiction.

Nigel Feetham is a senior partner at Gibraltar law firm Hassans and the co-author, with Grant Jones, of "Protected Cell Companies: a Guide to their Implementation and Use" (Spiramus Press, 2010). He is also a Visiting Professor of law at Nottingham Trent University.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Nigel Feetham
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