The ALI Adopts Significant Portions of the ‘Restatement of the Law of Liability Insurance’
The American Law Institute (ALI) is the preeminent
self-governing lawful organization in the United States producing learned
work in the lawful field, including its “Restatement of the Law” treatises
which are meant to report to practitioners on general principles of common law.
The ALI entered the field of insurance law for the first time in 2010, when the
ALI initiated its Insurance Law project, ultimately leading to the progress of
the Restatement of the Law of Liability Insurance. The ALI’s Insurance Law
project took a significant step forward in May 2016, when it’s association
voted to approve Chapters 1 and 2 of the Restatement of the Law of Liability
Insurance.
The significance of the development of the Restatement of
the Law of Liability Insurance cannot be overstated given the enormous
influence of the ALI in the legal field. According to ALI statistics, the U.S.
Supreme Court relied on the ALI’s Restatements or similar projects in 15 cases
during its 2013-14 term, and state and federal courts have cited to the ALI’s
publications roughly 200,000 times since the ALI was founded in 1923. As a
result, the ALI’s Restatement of the Law of Liability Insurance will certainly
have a profound impact on the development of insurance law. This article will
set forth a brief history and overview of the ALI’s Insurance Law project, and
then discuss some of the more significant insurance law principles and
positions adopted to date by the ALI in the Restatement of the Law of Liability
Insurance.
A Brief History and Overview of the ALI’s Insurance Law
Project
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The ALI’s Insurance Law project was first introduced in 2010
as the “Principles of the Law of Liability Insurance” project. in accordance
with the ALI, its “Principles” projects “express the law as it should be, which
may or may not reflect the law as it is.” However, in October 2014, the ALI
converted the “Principles” project into a “Restatement” project—a move that
substantially magnified the project’s significance and influence because
Restatements of the Law are usually regarded as clear formulations of common
law, and are often cited by courts and attorneys as support for their
positions.
As stated in the ALI Style Manual, the Restatements seek to
set forth “clear formulations of common law . . . as it presently stands or
might appropriately be stated by a court.” However, given the unsettled nature
of various insurance law issues in many jurisdictions, as well as competing
rules adopted by different jurisdictions, the goal of setting forth “clear
formulations of common law” is often more easily stated than talented.
An Overview of the Restatement of the Law of Liability
Insurance
The Restatement of the Law of Liability Insurance will
ultimately consist of four chapters. Chapter 1 is titled “Basic Liability
Insurance Contract Rules” and contains three major topics: interpretation,
waiver and estoppel and parody. Chapter 2 is titled “organization of
Potentially Insured Liability Claims” and contains three major topics: defense,
settlement and cooperation. Chapter 3 is titled “General Principles Regarding
the Risks Insured” and contains three major topics: coverage provisions (i.e.
insuring clauses and exclusions); situation; and the application of limits,
deductibles and retentions (i.e. number of occurrences and allocation).
Although not yet drafted, it is anticipated that Chapter 4 will address
enforceability, remedies (including claims for bad faith) and broker liability.
In May 2016, the ALI’s membership voted to approve Chapters
1 and 2 of the Restatement of the Law of Liability Insurance (comprised of
Sections 1 through 30) subject to editorial privilege. It is anticipated that
the drafting of Chapters 3 and 4 will continue throughout 2016, and will be
presented to the ALI membership for approval at the 2017 Annual Meeting. The
first two chapters of the summary of the Law of Liability Insurance which have
been approved by the ALI, include several legal issues frequently faced by
insurance professionals, including policy interpretation, waiver and estoppels,
and the duty to defend.
The “Plain Meaning Presumption Rule” to rule Interpretation
With regard to the most basic insurance law issue—the
interpretation of the rule itself—Section 3 of the Restatement generally adopts
the majority rule that “[a]n insurance rule term is interpreted according to
its plain meaning.” However, the Restatement includes a significant exception
to the “plain meaning” rule where “extrinsic evidence shows that a reasonable
person in the policyholders’ position would give the term a different meaning.”
As a end result, the Restatement states that even where a policy term “is
unambiguous on its face . . . extrinsic evidence may be used to show that the
term has a different meaning in context.” In making this determination, the
Restatement provides that “the court necessarily expands its view to consider
the circumstances”, including the characteristics of the policyholder with better
or lesser experience in the insurance market.
The “plain meaning presumption rule” adopted by the
Restatement is at odds with the majority rule in most jurisdictions that an
insurance policy is subject to general rules of contract construction and must
be construed according to its plain terms when the policy is unambiguous. In
fact, prior to the final vote on Chapters 1 plus 2 of the Restatement, a motion
was brought by an ALI member to reinstate the “plain meaning presumption rule”
with the traditional “plain meaning rule”. However, this motion was defeated
despite concerns raised by several judges that the “plain meaning presumption
rule” adopted by the ALI would cause confusion. It is anticipated that the
approach to policy interpretation adopted by the Restatement will lead to
greater uncertainty in the interpretation of standard coverage forms and higher
costs in resolving insurance coverage disputes because courts will often be
called upon to interpret coverage forms in light of extrinsic evidence rather
than the plain speech of the coverage form at issue.
The “Complaint-Allegation” Rule
With regard to the obligation to defend, Section 13 of the
Restatement addresses a dilemma frequently faced by insurers when undisputed
facts known by the insurer—but not within the four corners of the
complaint—would validate a denial of reporting. In addressing this issue, the
Restatement generally adopts the “complaint-allegation” rule, which provides
that an insurer’s obligation to defend is governed solely by the facts alleged
in the complaint, although an insurer also has a duty to defend if the insurer
knows or reasonably should know of information beyond the allegations of the
complaint that would give rise to a duty to defend. The Restatement carves out
three narrow exceptions to the “complaint-allegation” rule and permits an
insurer to rely upon facts outside of the complaint to deny a duty to defend
when such facts relate to whether: (1) a being or entity is insured under the
policy, (2) a vehicle is covered under the rule, or (3) notice was timely under
a “claims made” rule.
Section 13 was the subject of substantial discuss during the
ALI’s vote on Chapters 1 and 2 of the Restatement. In fact, the unique version
of Section 13 presented prior to the vote allowed the use of information beyond
the pleadings to keep away from a obligation to defend when such truth have no
bearing on the truth alleged in the complaint. However, despite the fact that
this more general rule has been adopted by most courts that have addressed the
issue, policyholder representatives among the ALI membership successfully moved
to modify the language of Section 13 to permit the use of extrinsic evidence
only under the three narrow exceptions outlined above. The correspondents
responsible for drafting the Restatement have agreed to consider other possible
exceptions where courts have allowed the use of extrinsic evidence; however, to
date, the version of Section 13 adopted by the ALI includes only the three
exceptions outlined above.
It is impossible to identify every possible state of affairs
in which an insurer should be able to rely upon information outside of the
allegations of the complaint to decline a duty to defend. In fact, under the
“notice” pleading rules applied in most jurisdictions, the complaint often
omits facts that may brunt a fundamental issue of coverage because such truth
have no bearing on the merits of the underlying case, such as whether the
events giving rise to the claim occurred during the policy period or whether
the incident occurred outside of the coverage territory as defined by the
policy. For example, in long-tail exposure claims, triggering dates are rarely
included in the pleadings, and are often omitted intentionally by plaintiff’s
counsel in an effort to trigger as many policies as possible. As a result, the
Restatement’s limitation of the use of evidence outside of the complaint to the
three narrow exceptions discussed above could require insurers to defend claims
for which there is clearly no coverage based upon undisputed facts.
Consequences of Breach of obligation to Defend
The majority of jurisdictions that have addressed the issue
have held that an insurer does not automatically forfeit its coverage defenses
if it is found to have wrongfully breached its duty to defend. This majority of
courts has declined to impose an automatic indemnity penalty because such a
rule would be overbroad, unfairly punitive and interfere with the parties’
contractual rights. A minority of courts have held that an insurer that
wrongfully breaches its duty to defend does automatically forfeit its coverage
defenses on the theory that any other rule would allow insurers to convert a
“duty-to-defend” rule into an “after-the-fact defense-cost-reimbursement”
policy.
The Restatement rejects both the majority rule and the
minority rule in favor of a “middle ground” come near. Section 19 provides that
an insurer that breaches the duty to defend a legal action loses the right to competition
coverage for the action, but only if the insurer breaches the duty to defend
“without a reasonable basis.” The Comments to the Restatement indicate that the
“reasonable basis” standard is satisfied “when there is a sufficient basis in
the law for taking that legal position” such that “a reasonable insurer would
take [the legal position] under the circumstances.”
This “reasonable basis” rule may have been appropriate if
the ALI’s Insurance Law project had remained a “Principles” plan, which
“express the law as [the ALI believes] it should be, which may or may not
reflect the law as it is.” However, in adopting the “reasonable basis” rule,
the ALI Reporters have exceeded the stated purpose of a “Restatement” project,
which is to set forth “clear formulations of common law . . . as it presently
stands or might appropriately be stated by a court.”
end
The Restatements are greatly regarded by judges, who will
often turn to the Restatements for guidance when their state appellate courts
have not yet addressed a particular legal issue. Accordingly, as the
Restatement of the Law of Liability Insurance continues to develop, it will
have a significant impact on those who address insurance law issues on a every
day basis. In fact, the ALI Style Manual acknowledges that the Restatements at
times seek to “effect changes in the law” in order to “make the law better
adapted to the needs of life.” As a result, it will be important to monitor the
ALI’s progress as it continues to develop the rewording of the Law of Liability
Insurance, particularly as the ALI adopts rules in unsettled or novel areas of
insurance law. The advisers and members consultative group for the ALI’s
Insurance Law project are slated to meet again in October 2016, to go on their talk
about and work on Chapters 3 and 4.
