Arbitration: Seventh Circuit Reviews District Court Dismissal under the FRCP (Web)

In Continental Casualty Co. v. American National Insurance Co., No. 04-1615

(7th Cir. Aug. 5, 2005)(available at www.ca7.uscourts.gov/tmp/L70TMU8Z.pdf), the Seventh U.S. Circuit Court of Appeals held that when parties have agreed to submit a dispute to arbitration and have designated a forum, the district court may dismiss the action for improper venue under Federal Rule of Civil Procedure 12(b)(3), rather than under Rule 12(b)(1) for lack of subject matter jurisdiction or under Rule 12(b)(6) for failure to state a claim upon which relief can be granted.

Continental Casualty Co. highlights a split among the Circuit Courts: The Sixth Circuit and the Federal Circuit have dismissed similar cases under Rule 12(b)(1), while Third Circuit decisions have applied Rule 12(b)(6) to similar sets of facts. The distinction is significant because appellate courts will draw all inferences in favor of the plaintiff on a 12(b)(6) motion, but will grant greater deference to the district court on a 12(b)(1) motion.

Continental Casualty Co. deals with a reinsurance dispute between two companies, Continental Casualty Co. (Continental) and American National Insurance Co. (Anico). Both companies were participants in a reinsurance pool managed by another insurance company, IOA Re. In 2000, Continental communicated its decision to terminate its Participation Agreement with the insurance pool to IOA Re, but failed to communicate its decision to the reinsurance pool’s other members. In 2001, Anico and IOA Re executed a Quota Share Contract. Subsequently, Anico sought indemnification from Continental under the Quota Share Contract.

Continental sought a declaratory judgment that it had no duty to indemnify Anico under either (1) its original Participation Agreement with IOA Re to contribute to the reinsurance pool or (2) the Quota Share Contract between Anico and IOA Re. Both the Participation Agreement and the Quota Share Contract contained arbitration clauses.

In response, Anico filed a motion to dismiss Continental’s complaint. The Northern District of Illinois granted Anico’s motion, holding that IOA Re had apparent authority to bind Continental to the Quota Share Contract and that the original agreement between IOA Re and Continental required the parties to arbitrate their disputes.

After the Seventh Circuit determined that the Participation Agreement required Continental to resolve any disputes related to the reinsurance pool through arbitration, the appellate court considered the appropriate basis for dismissal.

Anico argued that dismissal was appropriate under Rule 12(b)(1) for lack of subject matter jurisdiction. The “jurisdictional theory” posits that once parties have agreed to arbitrate a dispute, the district court, at least temporarily, no longer has the authority to resolve arbitrable claims. This line of reasoning stems from a Third Circuit decision that analogized a motion to stay pending arbitration to an assertion that the district court lacked subject-matter jurisdiction--a Rule 12(b)(1) assertion. See Evans v. Hudson Coal Co., 165 F.2d 970, 972 (3d Cir. 1948). The Federal Circuit, the Sixth Circuit, and some cases from Illinois federal district courts have also treated similar motions to dismiss under Rule 12(b)(1).

In contrast, Continental advocated that the Seventh Circuit consider Anico’s motion as a motion to dismiss under Rule 12(b)(6), for failure to state upon which relief can be granted. Recently, the Third Circuit appears to have adopted this view in lieu of the earlier jurisdictional theory articulated in Evans. See, e.g., Lloyd v. Hovensa LLC, 369 F.3d 263, 272 (3d Cir. 2004); Nationwide Ins. Co. of Columbus v. Patterson, 953 F.2d 44, 45 n.1 (3d Cir. 1991). If the Seventh Circuit adopted Continental’s argument, the district court’s decision to dismiss would be likely vacated because it considered matters beyond the scope of the pleading in its opinion.

The Seventh Circuit ultimately rejected both lines of reasoning: “We need not--indeed we cannot--choose between the competing characterizations offered by the parties. We think it is clear that…the district court proceeded under Rule 12(b)(3)--improper venue--when it disposed of this case.” Since the court determined that the arbitration clauses were enforceable, it upheld the dismissal from the Northern District of Illinois, in light of the fact that the court was not the chosen forum for the arbitration.

The Seventh Circuit stated that the proper course of action when a party seeks to invoke an arbitration clause is to stay the proceedings pending arbitration, rather than to dismiss outright. See, e.g., Tice v. American Airlines Inc., 299 F.3d 313, 318 (7th Cir. 2002). The appeals court, however, found that the district court did not exceed the scope of its authority when it dismissed Continental’s action for improper venue under Rule 12(b)(3).

–By Eric Laufgraben, Associate, Dewey Ballantine LLP