In State Farm General Insurance Co. v. Watts Regulator Co. (No. B271236, filed 11/30/17), a California appeals court held that a manufacturer could not compel intercompany arbitration of an insurer’s subrogation claim, because the manufacturer was bound by changes to the arbitration company’s agreement that excluded products liability claims from mandatory arbitration.
In Watts, both State Farm and Watts, a manufacturer of backflow preventers and other plumbing products, were members of Arbitration Forums, Inc. (“AF”), a provider of intercompany arbitration services for insurers and self-insured companies. Members of AF are required to sign its “Property Subrogation Arbitration Agreement,” which provides that signatory companies must forego litigation and submit any personal, commercial, or self-insured property subrogation claims, up to $100,000, to intercompany arbitration.
Among others, the agreement authorized AF to make appropriate Rules and Regulations for the presentation and determination of controversies by way of arbitration. In November 2014, AF issued a bulletin advising its members that effective January 1, 2015 the arbitration agreement would be changed such that: “No company shall be required, without its written consent, to arbitrate any claim or suit if: (i) it is a product liability claim arising from an alleged defective product.”
State Farm paid out on a claim for residential water damage occurring in 2012, and in March 2016 sued Watts in subrogation alleging causes of action for negligence, strict products liability and breach of implied warranties. Watts responded by moving to compel arbitration, contending that the parties had been members of AF before the change, and the terms of the arbitration agreement applicable at the time the claim arose governed because Watts had a “vested right to arbitration.”
The trial and appeals courts disagreed. While acknowledging that arbitration agreements are favored, the Watts court cited a number of reasons supporting the denial. The court pointed out that this was not a typical arbitration agreement in which the parties have contracted directly with each other to arbitrate, but had each acted independently to agree to arbitrate certain types of claims. In addition, the agreement authorized AF to set rules, and those rules specified limits on arbitrable issues, but neither the agreement nor the rules contained any restriction on AF’s authority to make changes. “All [of which] leads us to conclude that neither of the parties had any power to determine the terms of the AF arbitration agreement; they could only decide, as they did, whether to assent to terms set by AF, and if they did not, they were free to withdraw.”
The court rejected Watts’ retroactivity argument based on Avery v. Integrated Healthcare Holdings, Inc. (2013) 218 Cal.App.4th 50, which held that the implied covenant of good faith and fair dealing prevents employers from applying new ADR processes to claims that accrue before the employer changes its employee handbook. The Watts court stated that “We agree with the Avery principle, but it has no application here. This is not a case where one party unilaterally changed its agreement with another party. It is a case where a third party, AF, set the terms of the agreement, and made a ‘unilateral’ change, effective on a future date and with advance notice to the parties, both of whom were free to withdraw from the agreement yet neither of whom withdrew. The implied covenant of good faith and fair dealing is not implicated in this case. Defendant’s repeated assertion of a ‘vested right’ to arbitration of product liability claims that accrued before January 1, 2015, fails for the same reasons.”
The Watts court also rejected a claim of judicial estoppel based on a Tennessee claim where State Farm had allegedly consented to arbitrate a products claim after the change to the arbitration agreement, saying that it did not meet the test for judicial estoppel: “There is no ‘unfair strategy’ in consenting to arbitration in one case and not in another. Nor did plaintiff ‘gain an advantage’ by consenting to arbitration in one case and then ‘seek a second advantage’ by not doing so in another.  Moreover, there is no showing plaintiff has taken incompatible positions. The one-page order defendant cites does not show the facts in the Tennessee matter.”
The Watts court likewise dismissed an illusory contract argument saying that “neither party has withdrawn from the AF arbitration agreement as amended. There was, and still is, until either party withdraws, an obligation to arbitrate property subrogation claims not involving products liability, in accordance with the rules and other exclusions set by AF. The fact that product liability claims are no longer subject to compulsory arbitration does not make the agreement illusory.”
Finally, the court rejected Watts’ claim of ambiguity and argument that the court should have excluded evidence of the November 2014 bulletin announcing the change to the arbitration agreement, saying: “We are aware of no principle preventing the consideration of extrinsic evidence to determine the meaning of an agreement.”
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