Australia: Insurance Arbitration: How to Make it Effective in Resolving your Dispute

• Insurance arbitration is a useful tool but it comes with its own special features.

Arbitration is a common method of dispute resolution in the insurance industry, particularly in relation to reinsurance disputes. This is despite the existence of legislation restricting the use of arbitration as a dispute resolution mechanism.

In this article we briefly outline the relevant restrictions and identify a few matters (among many) to look out for if involved in an insurance arbitration.

The use of compulsory arbitration clauses in contracts of direct insurance is curtailed by section 43(1) of the Insurance Contracts Act 1984 (Cth). The Insurance Contracts Act does not apply to reinsurance.

Section 43 provides that any provisions which have the effect of requiring or authorising the insured to submit to arbitration are void. Accordingly, an insurer cannot restrict an insured's ability to initiate court proceedings. The rationale behind this fetter on compulsory arbitration was that compulsory arbitration was considered to have the potential to result in increased costs, delays in payment and even the avoidance of claims by insurers.

However, it is important to note that pursuant to subsection 43(2) of the Insurance Contracts Act parties may still agree to submit a dispute to arbitration once the dispute has arisen. Such an agreement is not prohibited as it is seen to be the product of an informed choice made by both the insurer and the insured. Arbitration of direct insurance disputes therefore remains commonplace, particularly where large commercial insureds are concerned.

In addition, the Insurance Contracts Act does not prohibit parties from agreeing on the terms by which they may submit a dispute to arbitration. Nor does it necessarily affect an optional arbitration provision, which can constitute a valid agreement to arbitrate (PMT Partners Pty Ltd (in liq) v Australian National Parks and Wildlife Service (1995) 131 ALR 377; Hadchiti v NRMA Insurance Ltd (unreported, NSW Sup Ct, Giles J, 7 February 1992)).

The rather obscure Insurance Act 1902 (NSW) also invalidates compulsory arbitration clauses in general insurance contracts (as opposed to life insurance). Section 19 provides that an insured is not bound by a provision in a contract of insurance that requires submission to arbitration. Unlike the Insurance Contracts Act, the Insurance Act also applies to contracts of reinsurance. However, it also provides that an agreement to submit the dispute to arbitration made after the dispute has arisen is valid.

Comparable legislation has been enacted in each of the other States restricting the use of compulsory arbitration clauses as conditions precedent to the commencement of legal proceedings.

However, to the extent State legislation conflicts with any Commonwealth legislation the Commonwealth legislation prevails. Accordingly, in John Kaldor Fabricmaker Pty Ltd v Mitchell Cotts Freight (Australia) Pty Ltd (1989) 18 NSWLR 72), where section 19 came into conflict with section 7(2) of the International Arbitration Act 1974 (Cth) (which mandates arbitration), it was held that the International Arbitration Act took precedence and the parties were required to submit to arbitration.

Given the provisions of the Insurance Contracts Act, arbitration clauses are rare in contracts of direct insurance. Examples of insurance arbitration clauses therefore generally occur in the context of reinsurance.

A compulsory arbitration clause in a reinsurance treaty generally stipulates at what stage of the dispute resolution process arbitration will become mandatory. For example, a clause may specify that if a dispute cannot be resolved by negotiation then it must then be referred to arbitration. Compulsory arbitration clauses commonly stipulate that arbitration must be conducted in accordance with and subject to the Institute of Arbitrators Rules for the Conduct of Commercial Arbitrations or those rules set out by the United Nations Commission on International Trade Law (UNCITRAL).

The arbitration clause also frequently sets out certain additional rules that must be followed. Such rules may stipulate how many arbitrators should be appointed (usually three), what expertise and background they should have, that each party must be responsible for the costs of the arbitration and that the decision of the arbitrator(s) is binding. It is common in reinsurance arbitration for the arbitrators to be industry participants who are not lawyers who have long experience of the reinsurance sector. As with commodity arbitrations, such arbitrators are often balanced on a three member tribunal by a chairman who is a lawyer.

An important aspect of many reinsurance treaty arbitration clauses is the rule that arbitrators may "dispense with judicial formality". This rule often states that arbitrators should have regard to customary practice in the insurance industry rather than strict legal interpretation of the terms of the agreement.

While this rule seems like a simple requirement, it poses some practical problems. For example:

• What exactly does it mean to "dispense with formality"?
• Who determines what customary practice is in the insurance industry?
• To what extent is it acceptable to disregard strict legal interpretations?
• How will this be viewed if the arbitrator's findings are subject to judicial control (eg. where a court has the power to review an award for errors of law, whether an arbitrator's decision is in line with industry practice)?

It is vital that these factors be taken into account when drafting the compulsory arbitration clause in a reinsurance treaty and when carrying out arbitration. The effect of dispensing with formality can leave an unsuccessful party with limited (or no) options for challenging the decision. This is exacerbated if the arbitrator is not required to publish reasons for the decision. Parties need to consider carefully at the time of agreeing to arbitration whether the arbitration agreement needs to be amended to take these factors into consideration.

It is often the choice of arbitrator that will have the biggest impact on the arbitration process. There are several important factors that need to be taken into account when appointing an arbitrator:

• The arbitrator must be impartial and independent of the parties.
• The arbitrator should have suitable qualifications and experience in order to be capable of addressing the dispute. An arbitrator may need to have a background in a particular area of law or in relation to a particular aspect of the insurance industry.
• The arbitrator must be capable of effectively managing the proceedings. The arbitrator must be willing to take control of the matter when necessary and to hand down orders when appropriate.

The practical implication of these requirements is that it is often quite a challenge to find an arbitrator who has a suitable background and expertise and is also impartial to the proceedings. Convergence and job changing in the insurance industry can mean that all suitable arbitrators have at some stage been involved with one or more of the parties. This can at times necessitate the appointment of international experts.

It is important that there are means by which these difficulties can be avoided. When drafting an arbitration clause the authority to appoint an arbitrator can be delegated to an independent body such as the Insurance Council of Australia or the Australian Centre for International Arbitration (ACICA).

These are just some of the issues faced in the context of insurance arbitration. Arbitration remains a useful dispute resolution tool, particularly as it gives the parties greater control over the level of formality required and the person(s) adjudicating the dispute. If managed adequately, with an eye on the issues outlined above, arbitration has the potential to significantly streamline the resolution of insurance disputes.

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.