Summary
objecting that calculation of Reserves did not consider increases in benefit payments
Summary of this case from E*TRADE Financial Corp. v. Deutsche Bank AGOpinion
01 Civ. 2469 (JSM)
July 9, 2001
For Petitioner Donald F. Luke Clifford Chance Rodgers Wells LLP New York, New York
For Respondents Stephen S. Hart Alston Bird LLP New York, New York
OPINION and ORDER
John Hancock Life Insurance Company ("John Hancock" or "Petitioner") moves to compel arbitration of an objection it raised in regard to certain calculations that were made as part of its purchase of an individual long-term care business from the Fortis Insurance Companies (collectively "Fortis" or "Respondent"). Fortis cross-claims for a declaratory judgment that the objection Hancock raises is non-arbitrable because it is time-barred under the parties' contract of sale. For the reasons set forth below, John Hancock's petition to compel arbitration is denied, and Fortis's cross-claim for a declaratory judgment is granted.
BACKGROUND
In January 2000, the parties entered into an Asset Purchase Agreement (the "Agreement") pursuant to which John Hancock purchased Fortis's individual long-term care business. (DaSilva Decl. Ex. 1.) As part of the transaction, Fortis was required to pay John Hancock the equivalent of the amount represented by the statutory insurance reserves (the "Reserves") on the Closing date. Prior to the Closing, Fortis estimated the amount of the Reserves using information that pre-dated the Closing by two months. The Agreement provided that after the transaction of sale was complete, the parties would agree on the actual amount of the Reserves according to the procedures outlined in a provision of the Agreement called the "Post-Closing Adjustment." (DaSilva Decl. Ex. 1, § 2.6.)The Post-Closing Adjustment required that Fortis deliver a "Post-Closing Reserve Statement" to John Hancock within twenty business days after the Closing, which calculated the actual amount of the Reserves using information as of the date of the Closing. This Statement was duly delivered on March 29, 2000. Pursuant to the Agreement, John Hancock then had ninety days to review and evaluate the Post-Closing Reserve Statement. Within that ninety day period, John Hancock was required to notify [Fortis] in writing of any objections to the Post-Closing Reserve Statement . . . stating in reasonable detail the basis for any such objections." (DaSilva Decl. Ex. 1, § 2.6(c).) John Hancock discovered three such objections, and accordingly delivered to Fortis a "Buyer's Objection Notice" detailing the bases of those objections on June 23, 2000. (DaSilva Decl. Ex. 3.)
The objection relevant to this action involves an alleged understatement by Fortis of the Reserves with respect to about half of the long-term insurance policies containing automatic benefit increase riders (the "ABI Objection"). ABIs account for increased benefit payments to policy-holders over time resulting from the likelihood that expenses in the future will be greater than those in the present, for example, the cost of a nursing home stay. Such increased benefit payments are "reserved" for now because they will be paid in the future. In its Buyer's Objection Notice, John Hancock gave as the basis of its objection the fact that the Reserves as calculated by Fortis did not take into account the fact that benefit payments continue to increase after a claim is made and while the policy-holder remains "on claim," or continues to draw benefits for the claim. (DaSilva Decl. Ex. 3.) John Hancock's Objection Notice stated that the dollar value of the miscalculation was $4,471,097.00.
Pursuant to the Post-Closing Adjustment, if the parties were unable to amicably agree on a resolution of the buyer's objections within twenty days after delivery of the Buyer's Objection Notice, they were required to submit the matter to a neutral actuary (the "Arbitrator"). (DaSilva Decl. Ex. 1, § 2.6(c).) Should the matter proceed to arbitration, the Agreement provided that the Arbitrator would "review the basis upon which Parent computed the Reserves as set forth in the Post-Closing Reserve Statement," and that the costs of arbitration would be allocated between the parties "in accordance with . . . the relative merits of Buyer's and Parent's proposals in respect of the disputed items." On July 14, 2000, the parties agreed to extend "the period to resolve the issues set forth in [the] Objection Notice" until August 25, 2000 (the "July Extension Letter"). (DaSilva Decl. Ex. 4.)
In its Buyer's Objection Notice, John Hancock calculated the dollar amount of the ABI Objection using a mathematical formula that Fortis had used to estimate the cost of benefit increases when it set its premium rates for a certain series of long-term policies (the "4060 Series"). (DaSilva Decl. Ex. 3, MR Report.) Thus, John Hancock's objection was that Fortis had failed to apply that formula to account for the benefit increases in the relevant long-term policies. In late July 2000, John Hancock concluded that in its opinion, that mathematical formula was incorrect and on July 31, 2000, it notified Fortis of this contention. (DaSilva Decl. Ex. 5.) After John Hancock and its actuaries developed what they considered to be a more accurate method of calculating the guaranteed benefits on long-term policies, they concluded that the actual understatement of the Reserves was approximately $11 million, not $4 million. On August 17, 2000, John Hancock submitted this re-calculation to Fortis (the "August Information"). (DaSilva Decl. Ex. 6.)
Needless to say, the ABI objection remained unresolved on August 25, 2000, and the parties are therefore required to submit the matter to an Arbitrator. The present dispute arises as a result of John Hancock's submission of the revised dollar amount for its ABI Objection in August 2000. Fortis argues that the revision constitutes a new objection that is untimely under the terms of the Agreement, which required that all objections be lodged by the buyer within ninety days of receipt of the Post Closing Reserve Statement. John Hancock argues that the new dollar amount was simply a re-quantification of an existing objection, and therefore can properly be considered by the Arbitrator in resolving the ABI Objection.
DISCUSSION
The parties do not dispute that a valid arbitration clause exists for the purpose of resolving disputes over the amount of the Reserves, nor do they dispute the fact that the objections lodged in the Buyer's Objection Notice are timely and properly arbitrable. The issue before the Court involves a straightforward question of contract interpretation, requiring an analysis of the contractual language and the parties' intent in order to ascertain whether the August Information falls within the scope of the arbitration provision. The parties agree that this question is one of law for the Court to decide, and they do not argue that the arbitrator should be the one to rule on the arbitrability of the August objection. See Painewebber Inc. v. Bybyk, 81 F.3d 1193, 1198-99 (2d Cir. 1996)
Although the arguments on each side have some merit, two facts conclusively establish that the August Information is beyond the scope of the arbitration provision. First, the Agreement requires that the Buyer's Objection Notice set forth "in reasonable detail the basis for any such objections" (DaSilva Decl. Ex. 1, § 2.6(c) (emphasis added)), and limits the parties' negotiations to objections raised in the Buyer's Notice. Second, the August Information was not merely a re-quantification of the existing ABI Objection based on some mathematical error in John Hancock's initial calculation or a mistake as to the number of policies at issue, but asserted an entirely new basis for objecting to the reserve calculation, i.e., that the "load" factor used by Fortis was erroneous and that the ABIs should be calculated based on a new formula developed by John Hancock. However, the July Extension Letter only extended the time for the parties to "resolve the issues set forth in [the] Objection Notice." Neither the Extension Letter nor the Agreement gave John Hancock the right to change the basis upon which it objected to the calculation of the Reserves after the ninety-day period expired.
The Agreement laid out a methodical process by which John Hancock would state the basis of its objections to the Post Closing Reserve Statement and pursuant to which the parties would resolve those objections. Crucial to this methodical process were explicit time periods in which the parties would perform certain acts, the obvious purpose of which was to expeditiously conclude the purchase transaction. Accordingly, the Agreement required that within ninety days of receipt of the Post-Closing Reserve Statement, John Hancock would state the basis of its objections to the Reserve calculations in reasonable detail, and that a failure by the parties to resolve those objections would result in submission of the matter to the Arbitrator. Although the language of the arbitration provision appears at first glance to give the arbitrator broad license in reviewing the basis upon which the Reserves were calculated, which would imply that the Arbitrator could consider any and all relevant information at the time of arbitration in re-calculating the Reserves, counsel for John Hancock conceded at oral argument that the intention of the provision was that the Arbitrator consider only the issues raised in the Buyer's Objection Notice.
In order to bring the August objection within the purview of the arbitration clause, John Hancock argues that it was not a new objection, but rather a supplement to an existing objection. Thus, John Hancock asserts that the August notice served only to re-quantify the amount owed under the existing ABI objection. To this end, John Hancock strenuously argues that the Agreement does not require that objections be quantified into dollar amounts, and that John Hancock provided a cash estimate of the ABI Objection in its Buyer's Objection Notice solely for the purpose of proving to Fortis that the objection was legitimate.
The problem with John Hancock's argument is that it ignores the fact that its new objection relies on an entirely different basis for challenging the calculation of the Reserves than was set forth in its original objection. The quantification that John Hancock provided in its Buyer's Objection Notice was the direct result of the objection it raised, which was that in its calculation of the Reserves, Fortis had failed to apply to the relevant policies the formula used in pricing its 4060 Series policies in order to account for the increased benefit payments that accrue once a policy-holder goes on claim. Thus, John Hancock protested that the failure to apply the formula consistently resulted in an understatement in the very precise amount of $4,471,097.00.
Any objections raised pursuant to this provision of the Agreement necessarily relate to a miscalculation of the dollar amount of the Reserves. Indeed, in this context "objection" equates to "miscalculation." While it is true that quantification of an objection was not explicitly required by the Agreement, the very nature of the objection requires reference to a miscalculation that resulted in John Hancock receiving less money in cash from Fortis than it should have.Cf. Philips v. Newell Co., No. 96 Civ. 9153, 1997 WL 181191, at *4 (S.D.N Y Apr. 15, 1997), aff'd 118 F.3d 972 (2d Cir. 1997).
The language in the actuarial report accompanying the Buyer's Objection Notice stated: "Fortis included a load for the ABI rider claim costs in the pricing of the 4060 series to recognize this additional cost. Excluding this load from the valuation morbidity is inconsistent with the pricing for the 4060 series. . . . The impact of including FLTC's load estimate to the valuation morbidity of all form series on the statutory policy reserves is $4,471.097." (Da Silva Decl. Ex. 3, MR Report.)
In contrast, the August Information sought to apply an entirely different mathematical formula in order to alter the benefit calculations at issue; thus, the basis for the objection became not that Fortis had failed to apply its 4060 series formula to account for continued benefit increases once a claim is made, but that it had used an erroneous formula in pricing the 4060 series and that John Hancock's new formula should be used to calculate the Reserves. As a result, John Hancock sought to recover $11 million in understated Reserves, rather than $4 million. Because this revision of the Buyer's Objection Notice was not only quantitatively different, but qualitatively different, it was submitted beyond the permissible time for lodging an objection and does not come within the contractual scope of the controversy to be submitted to the arbitrator.
John Hancock's argument that it was entitled to change the basis of its objection after the ninety-day period expired is not only inconsistent with the language of the Agreement, it is also inconsistent with the structure of the dispute-resolution provision of the Agreement. Once an objection was lodged by John Hancock, Fortis was free to accept or reject John Hancock's assertion of the error in the Reserves, or to offer its own quantification of the error in an attempt to negotiate a compromise. At oral argument, John Hancock conceded that if the parties had come to an agreement before John Hancock discovered the allegedly erroneous mathematical formula, and had Fortis then paid the agreed amount, John Hancock would have been precluded from raising any further objections or recalculations, no matter what it later discovered regarding the Reserves calculations. Since the very purpose of the Buyer's Objection Notice was to provide Fortis with fair notice of the basis of an existing objection so that it could choose to either negotiate a settlement or seek arbitration, the parties could not have intended for John Hancock to have the right to change the basis for its objection after the ninety-day period had expired.
Additional support for the view that the parties intended that the Arbitrator consider only the basis for the objection stated in the Buyer's Objection Notice is found in the fact that the Agreement provides that the costs of arbitration will be assessed according to the merits of the parties' submissions regarding the "disputed items." Logically, those "items" can only be the objections timely raised in the Buyer's Objection Notice.
Accordingly, the August Information pertaining to the new formula that John Hancock contends should be used in calculating the dollar amount of the ABI Objection constituted a "new objection" that is time-barred under the terms of the Agreement. As a result, the Arbitrator may properly consider only those objections timely raised in the Buyer's Objection Notice.
CONCLUSION
Petitioner's motion to compel arbitration is denied. Respondent's cross-claim for a declaratory judgment is granted. The Arbitrator is directed to consider only the objections raised in the Buyer's Objection Notice in resolving the parties' dispute over the Reserve calculations.
SO ORDERED.