INSIDE THIS ISSUE
First-Party Coverage For Environmental Claims: Limited To Policy Coverage Period
A Long-Tail Property Insurance Claim: Payment To Mortgagee Questioned Sixteen Years Later
In Personam Jurisdiction:
Union Indemnity: A $48 Million Settlement Wipes Out $200 Million in Reinsurance
IN MEMORIAM
INSERT - - "Innocent" Loss Payees Victims
of Insured's Misrepresentations
FIRST-PARTY COVERAGE FOR ENVIRONMENTAL CLAIMS: LIMITED TO POLICY COVERAGE PERIOD
(MC&W acted as lead trial counsel for the first-party insurers)
The Superior Court of the State of Washington was recently the forum for the trial of a landmark environmental suit under traditional first-party property insurance policies. The Aluminum Company of America ("Alcoa") commenced the action for alleged environmental contamination of soil and groundwater at thirty-five of its manufacturing facilities, naming as defendants its property carriers as well as its liability ("CGL") insurers.
Many of the CGL policies contained pollution exclusions, and those insurers were dismissed from the action early on. Those CGL insurers whose policies did not contain the exclusions, but who were faced with precedential case law that did not bode well for them, settled soon after. The first-party policies, which traditionally have not been the target of environmental contamination claims, contained no pollution exclusions. Once the CGL insurers had been dismissed from or settled out of the case, Alcoa, ignoring traditional distinctions between first- and third-party coverage, quickly deployed every available resource to seek reimbursement under its first-party property policies.
One of the first issues to be resolved in the litigation was whether any of the property policies, which had been issued over an eight-year period, had been triggered by Alcoa's contamination claims. In ruling on a series of threshold motions and cross-motions, the court adopted the "multiple trigger" theory of coverage. This multiple trigger theory had the potential to increase the property insurers' exposure exponentially by presenting three separate bases upon which Alcoa could rely to show coverage during any given policy period.
In addition to the difficulties posed by the multiple trigger theory, the property insurers had to contend with the fact that many of the policy terms and conditions that provided a basis for the insurers' defense were not contained in the manuscript policy forms. Instead, conditions such as the suit limitation and notice provisions were contained in policy jackets that were issued with many of the policies but that, owing largely to the passage of time, were missing or partially missing from the brokers' files.
If it could be shown that the jackets were part of the policies, Alcoa's claims under those policies would be vulnerable to dismissal on the basis of the suit limitation provision. A first stage of the trial was therefore conducted to determine whether the jackets had been received by the brokers, whether the brokers were acting as Alcoa's agents, and whether it was reasonable for Alcoa or its agents to believe that the policy jackets they received were not part of Alcoa's policies. The jury found that the brokers, acting on Alcoa's behalf, did in fact receive jackets for many of the first-party policies, and that it was not reasonable for Alcoa or its agents to believe the conditions contained in the jackets were not part of the policies.
Once the jury had rendered this verdict, the court considered briefing by the parties as to when Alcoa had to commence its lawsuit. Most of the jackets provided that suit had to be brought within twelve (or twenty-four) months from discovery of the damage that gave rise to the claim. Alcoa argued that the suit limitation period began to run only after denial of the claim. Ultimately, the court ruled as a matter of law that suit limitation provisions contained in the jackets barred legal actions commenced after the expiration of the contractual limitations period. At the same time, however, the court required the property insurers to prove the dates by which Alcoa became aware that its claims would exceed the implicated policies' deductible amounts before invoking the suit limitation provision.
At the completion of the initial stage of the Alcoa trial, the primary issues that remained to be resolved centered around the questions of causation, fortuity, and timing of the loss; the timeliness of notice provided to Alcoa's insurers; whether there had been material misrepresentations made by the insured in procuring the policy; and the allocation of costs to repair property damage. After three months of trial, and ten weeks of jury deliberations, a partial verdict was rendered, leaving a number of unresolved questions. Many of these unanswered questions were subsequently decided by the court.
The policies in question provided coverage for each "occurrence," defined as a loss "arising out of one event or common cause." In order to determine how many occurrences were included in Alcoa's claim and thus how many deductibles Alcoa would be required to pay, the jury was asked to identify the cause(s) of the contamination for which Alcoa sought coverage. When the jury was unable to determine what caused the contamination at all of the areas at issue, Alcoa moved for a directed verdict, arguing that the release from each identified area at the sites constituted a separate proximate cause.
In attempting to define a common cause, the court noted that commonalities in remote causes of the loss, such as the operation of the aluminum manufacturing facility at all of Alcoa's plants, would not constitute a single, common cause for the purpose of determining the number of occurrences. Rather, the court found that the existence of numerous intervening acts or omissions that could result in contamination (or prevention of contamination) warranted a more restrictive definition of the term.
Using as a model one of the three test sites, the court held that the occurrences for which Alcoa was seeking coverage under the first-party policies were caused either by the escape from containment units (e.g., lagoons, landfills, etc.) of wastes disposed of on-site or by leakage from the manufacturing operations. The court concluded from this that there were two separate occurrences for which coverage was being sought and hence two deductibles would be applied to the property damage claims at each site.
It is interesting to note that in the Alcoa case, the insured, seeking to maximize coverage, argued that releases from each identified area constituted a separate proximate cause, a view at odds with what the court found the insured had intended when it included the common cause language in the policies' occurrence provision: to broaden coverage by limiting the number of deductibles that could be applied.
Here, however, many of Alcoa's claims were barred by the suit limitation provisions, so that lumping claims together as one occurrence would not broaden coverage; instead, the result was the dismissal of additional claims which, although not individually barred under the suit limitation clause, had been linked to areas that were.
The jury's inability to come to grips with the facts relevant to resolving the causation issue illustrates the difficulties that face first-party insurers when they are forced to respond to environmental coverage claims. Because a first-party policy does not cover losses that occurred before or after the effective dates of the policy, establishing what caused the loss -- and when -- becomes critical to any coverage dispute.
Environmental clean-up costs are frequently incurred long after the moment of contamination. In the Alcoa case, not only did the insured seek coverage for clean-up costs incurred at various times, but the contamination itself happened years before any claim was made, and in many instances decades before Alcoa's first-party policies incepted, making a determination of the cause that much more difficult.
In addition to grappling with the unresolved issues raised by the causation question, the court also dealt with the plaintiffs' motion for a directed verdict with respect to allocation of Alcoa's costs. On this motion, the insured again sought to maximize coverage by taking the position that its property damage was indivisible by policy year, and that each insurer should therefore be held jointly and severally liable for the entire loss up to policy limits.
Relying on the policy language, the parties' intent, and the "reasonable expectations" standard, the court acknowledged the critical distinctions between first- and third-party insurance, and held that the insurers were obligated to pay only for the repair of those damages occurring during their respective policy periods. The distinctions between property damage claims and liability claims are of course well recognized, but the dearth of first-party environmental case law has led courts dealing with such cases in the first-party context to look to third-party cases for guidance. The Alcoa court rejected such an approach in its allocation decision and specifically distinguished the Alcoa case from cases involving asbestos-related bodily injury. The court observed that the myriad physiological problems caused by asbestos inhalation are predictable and may bear no relation to the length of exposure to asbestos or the number of asbestos fibers inhaled, whereas by way of contrast the environmental contamination area or concentration depends directly on how much of a particular contaminant is discharged.
Thus, where Alcoa's damages resulted from a manufacturing process or from the operation of a waste containment unit, the damages claimed were divided by the number of years during which the process or containment unit was in operation. The liability for the resulting yearly allotment was then distributed among the insurers on the risk for that year, subject to the court's prior or subsequent decisions regarding coverage. For example, if a waste management unit incurred damage over the course of its twenty-five year existence for a total of $5,000,000 the damages allocated to each policy year would be only $200,000 (subject to the deductible for each occurrence). The court also ruled that if the damages were in fact found to be indivisible at some later date, a pro rata allocation rather than joint and several liability would still be appropriate.
Before the jury's verdict, the court's post-trial rulings, and the eventual judgment, it had already become evident that insurers and reinsurers alike could be forced to reckon with multi-million dollar claims brought many years after damage occurred or was discovered, and even well after remediation had taken place. Indeed, even insurers who believed they were protected from such delayed claims by suit limitation and notice provisions could not be sure that policy language could be proven or enforced. The trial court's rulings suggest that even where an insured is permitted to maintain a coverage action on its policies after protracted delays, first-party insurers should not be held liable for damages occurring outside the period for which their policies were in effect.
The Alcoa court has, however, certified its judgment as final and appealable. How each of these issues will be resolved on appeal remains to be seen.
A Long-Tail Property Insurance Claim: Payment To Mortgagee Questioned Sixteen Years Later
(MC&W represented the insurer in this case)
After a several week long trial of a case brought against an insurance company which in 1981 paid a claim to a mortgagee, a New York County Supreme Court jury has finally determined something that seemed to be obvious to most insurance lawyers and some judges but that required sixteen years of litigation to resolve: Is an obligation by an insurance company to pay under its policy for covered fire damage to an apartment building complex a "contract affecting real property"?
In the case of Tierra Properties v. A. I. Lloyd's Insurance Company, the insurer maintained that such an obligation was a contract affecting real property. The named insured, ironically, claimed it was not.
The insurance policy in question insured a Texas apartment complex against all risk of loss. The policy also provided that any loss would be payable to the complex's owner's mortgagee (a division of the Chase Bank) as that mortgagee's interest may appear at the time of loss. The mortgage instruments themselves (which are called "Deeds of Trusts" in Texas) authorized the mortgagee to settle and adjust any insurance claims and use the proceeds to repair the premises or to reduce the amount of mortgage debt.
A portion of the insured premises was destroyed by fire back in 1979. Shortly after the fire, the owner (the named insured) went into bankruptcy, the primary creditor being the mortgagee.
As it turned out, the apartment complex had never been finished. The contractors had stopped doing work because they were not being paid. The mortgage loan, which was a construction loan, was in default. The project "needed" a fire and there were many suspicions about the origin, but arson was never proved and thus did not become an issue.
In the Texas Bankruptcy Court, the mortgagee sought permission to foreclose on its mortgages. That was held in abeyance, however, while the parties tried to work out a plan that would resolve the bankruptcy without need of foreclosure. A plan ultimately was worked out, and the Texas Bankruptcy Court signed an "Order of Confirmation" which directed, among other things, that the Trustee in Bankruptcy convey to the mortgagee's designee the deed to the apartment complex and various other described items and "...any other contracts affecting real property or the fixtures and personal property..."
Subsequently, the Trustee in Bankruptcy did in fact deed over the property as required by the Bankruptcy Court's order of confirmation. The insurance company paid insurance proceeds to the mortgagee, which had became the owner of the property, and the named insured was discharged from bankruptcy.
The discharged bankrupt then brought a lawsuit in New York against the insurance company claiming that the insurance company should not have paid the mortgagee. Rather, claimed the discharged bankrupt, it was the intent of the Bankruptcy Court order for the mortgagee to obtain the fire damaged property; for the mortgagee to pay additional money to materialmen so that they would be willing to complete construction on the property; for the mortgagee to fund the repair of the fire damaged property; and for the discharged bankrupt to pocket the insurance proceeds and walk away with those proceeds.
A Justice of the Supreme Court in New York County had granted summary judgment dismissing the complaint and holding that she could not find a better example of a "contract affecting real property" than the insurance on that real property. The Appellate Division of the Supreme Court, First Department, however, by a vote of 4 to 1, found that the phrase from the Bankruptcy Court order "contracts affecting real property" was ambiguous since the word insurance nowhere appeared in the order. The Appellate Division directed a trial by jury on the intent of the parties.
A parade of witnesses from Texas came to New York to testify about transactions that had taken place sixteen years earlier. A jury rendered a verdict for the insurer, stating that the insurer, indeed, did not have to pay twice and obviously agreeing with the initial trial judge (who now happens to sit on New York's Court of Appeals) that nothing could be more a contract affecting real property than the insurance on that property.
IN PERSONAM JURISDICTION:
Iowa District Court finds that a foreign manufacturer's placing of its product into the stream of commerce in the United States is insufficient to satisfy the due process requirement of minimum contacts
(MC&W represented the foreign manufacturer's liability insurer in this case)
In Mark and Julie Vandelune v. 4B Elevator Components, and Synatel Instrumentation Ltd., No. C95-3087 (N.D. Iowa 1997), the court granted Synatel's motion to dismiss the complaint for lack of personal jurisdiction even though Synatel had placed its product into the stream of commerce and was aware that it could end up in the forum state, Iowa.
Plaintiffs Mark and Julie Vandelune brought causes of action based upon strict liability, breach of implied warranty, negligence, res ipsa loquitur, and breach of express warranty against the defendants Synatel and 4B for injuries resulting from an explosion of a grain elevator at Mark Vandelune's place of employment, the Consolidated Cooperative Inc. in Gowrie, Iowa. The explosion, which resulted in severe personal injuries to Mark Vandelune, was allegedly caused by a defective speed monitor manufactured by Synatel in England.
The speed monitor, the M-700, was manufactured by Synatel according to the specifications supplied by its English customer, Braime. Braime's manufacturing specifications required that Synatel include various features in the product aimed at the American market and that the M-700 would be labeled as a 4B product. 4B is Braime's United States distributor. Its offices are in Illinois with distribution throughout the mid-West. Plaintiffs are residents of Iowa. Synatel is an English corporation organized and operating under the laws of England. Synatel has no offices in the United States, nor does it advertise, solicit business, or otherwise maintain a presence in Iowa.
In addition to manufacturing the M-700 for Braime, Synatel also participated in drafting the technical brochure with which Synatel packaged the product. Synatel manufactured about 1,200 M-700s per year for Braime, and the bulk of them ended up in the United States.
On the basis of these facts, plaintiffs contended that Synatel's manufacturing arrangement with Braime was tantamount to a joint marketing and development deal for the M-700 between Synatel and 4B/Braime, and therefore Synatel had fair warning that it could be haled into a U.S. court. In support of the contention, plaintiffs relied upon evidence obtained in the limited discovery ordered by the court that Synatel's director had met with 4B's employees in the U.S. on four occasions and that 4B personnel had visited Synatel's manufacturing plant in the United Kingdom. Additionally, plaintiffs attempted to bolster the joint marketing theory by asserting that Synatel was in charge of the United States Factory Mutual testing for the M-700 and by highlighting the fact that the M-700 was an "Americanized" version of a Synatel speed monitor product (the Rotamatic) which Synatel manufactured and sold extensively in Europe. Essentially, plaintiffs asserted that the M-700 was Synatel's attempt to exploit the Iowa grain elevator market and that the product indeed had a significant impact upon the Iowa market.
Although the court in Synatel acknowledged that Iowa's long-arm statute is narrowly construed and not intended to go to the full extent of constitutional authority, the court held that the plaintiffs satisfied the requirements of the statute. The court's ruling was based on the plaintiffs' contention that Synatel committed a tort in whole or in part in Iowa because Mark Vandelune was injured by the explosion in that state. The Synatel court noted that the Iowa Supreme Court has held that if an injury from a defective product arises in Iowa, then the alleged tort giving rise to the injury is deemed committed in Iowa within the meaning of the Iowa long-arm statute. See Section 617.3 of the Iowa code and Anderson v. National Presto Industries, Inc., 257 Iowa 911, 135 N.W.2d 639 (1965).
Even though plaintiffs satisfied the requirements of Iowa's long-arm statute, however, they were unable to make a prima facie showing of jurisdiction under the due process constitutional analysis.
Relying upon the plurality opinion by the United States Supreme Court in Asahi Metal Industry Company, Ltd. v. Superior Court of California, 480 U.S. 102, 111 (1987), the court concluded that the plaintiffs presented no evidence that Synatel purposely availed itself of the laws and protections of the state of Iowa such that it should reasonably expect to be haled into court there. In Asahi, the Supreme Court held that placing a product into the "stream of commerce" with an awareness that it would eventually end up in a given place is not a sufficient basis for personal jurisdiction.
Relying on Asahi and several concurring Eighth Circuit opinions, the court in Synatel concluded that Synatel's contacts with Iowa were in fact "random, fortuitous, or attenuated" notwithstanding that Synatel manufactured the M-700 according to specifications for the United States market and indeed knew that its product would be sold in the United States, and possibly in the mid-West. The complaint was accordingly dismissed as against Synatel.
UNION INDEMNITY: A $48 MILLION SETTLEMENT WIPES OUT $200 MILLION IN REINSURANCE
A Supreme Court Justice's refusal to allow Union Indemnity's liquidator to "renege on its court-submitted evidence" and use "quasi-official assertions as both a sword and shield" has cost Union Indemnity's liquidator $200 million in reinsurance recoverables. Michigan National Bank-Oakland v. American Centennial, slip op. no. 243, November 14, 1996. The Michigan National decision is the last chapter in a story that began shortly after Union Indemnity was liquidated. The denouement, however, illustrates a couple of points: (1) when different outside counsel ride off on behalf of the same client, both the client and innocent bystanders may wind up victims in their "cross-fire;" and (2) courts that once almost apologetically addressed principles of reinsurance law now have a body of case law to rely on in resolving reinsurance disputes and are beginning to analyze and reason from their earlier decisions to resolve litigated reinsurance disputes.
Background
Frank B. Hall owned Union Indemnity Insurance Company. On March 25, 1985 the Superintendent of Insurance obtained an order from the Supreme Court, New York County, liquidating the company. Liquidated insurers are assigned to a Supreme Court Justice to oversee the estate. Justice Ira Gammerman was assigned the Union Indemnity liquidation.
Union Indemnity issued surety bonds. Michigan National Bank Oakland (Michigan) was the beneficiary on one of these bonds, which had been issued to an investment company. New York law bars any direct action against the Liquidator of an insolvent New York insurer. Therefore, in September 1985 Michigan National sued several of Union Indemnity's reinsurers, the first of which in an alphabetical listing was American Centennial Insurance Company, to recover on the bond.
The Liquidator intervened in the suit against Union Indemnity's reinsurers on the ground that the reinsurance proceeds on the bond belonged to the entire estate, not any particular beneficiary on the bond. The reinsurers, however, went one step further. They counter-claimed alleging that the reinsurance agreements themselves were void because they had been procured by fraud. The reinsurers alleged that Hall had (1) operated Union Indemnity for "improper purposes," i.e., as a "loss leader," not an independent insurer; and (2) had "failed to disclose its insolvency to the reinsurers."
Soon thereafter, the Liquidator sued Hall, Union Indemnity's parent Corporation, Union Indemnity's officers and directors, and its outside auditors. The Liquidator alleged mismanagement, breach of fiduciary duties, and malpractice. The reinsurers then brought a separate action against the Hall defendants on the same grounds. The reinsurers' action was then consolidated with the Liquidator's suit.
The Lawyers' Affidavits
Hall and Union Indemnity's auditors and D&O insurers fought back. They moved to dismiss the Liquidators' and reinsurers' complaint for failure to plead fraud with specificity. Two of the Liquidator's outside attorneys in the fraud action submitted affidavits opposing the motion. Outside counsel attached to their affidavits additional affidavits and documents taken from Union Indemnity records. These affidavits and annexed exhibits were submitted to support the allegations that Hall had actively participated in a scheme to defraud.
The Liquidator prevailed on the motion and the trial court denied the motion to dismiss. The First Department affirmed. 149 A.D.2d 165. In 1989 the parties settled the case against Hall. Hall and its D&O insurers agreed to pay $48 million in a structured settlement that required the Liquidation court's approval. Judge Gammerman, however, delayed approving the settlement until the reinsurance dispute was resolved.
The Reinsurers Seek Rescission
In the meantime, the reinsurers, relying on the attorneys' affidavits submitted in the Hall case, moved for summary judgment and rescission of their contracts. The reinsurers attached the affidavits of the two attorneys in the Hall case as "informal judicial admissions" regarding fraud and failure to disclose material facts.
The Liquidator opposed the motion by submitting additional and different affidavits. This time the Liquidator obtained affidavits from Union Indemnity's former president and its former board chairman. They both swore that Hall operated Union as an independent insurance company separate for Hall. The Liquidator also submitted affidavits from one of Union's former auditors swearing that Hall operated Union as an independent insurance company.
The Liquidator argued that because these affidavits contradicted the affidavits submitted by its outside counsel in the Hall case, the latter could not be conclusive. In addition, the Liquidator argued that the attorneys' affidavits in Hall should be disregarded - or given less weight - because they were not based on firsthand knowledge.
Summary Judgment
Justice Gammerman, who had overseen Union's liquidation from the outset and had by now been dealing with the estate for more than a decade, ruled that the attorneys' affidavits were "informal judicial admissions." 1996 WL 676194, * 2. Justice Gammerman granted the reinsurers' motion for summary judgment and rescinded the reinsurance agreements.
The trial court first found that it was "evident" from the attorneys' affidavits in Hall that: there had been material omissions as well as misrepresentations; Union's officers and directors were aware of the operations and financial condition of the company; and a conscious plan was in operation to utilize Union for Hall's purposes and not run it as an independent entity. 1996 WL 67194 * 2.
The court also relied on the Liquidator's concession that had the reinsurers been aware of Union's insolvency they "certainly would not have underwritten the sum encompassed by reinsuring the bankrupt company." Id.
The Liquidator moved for renewal and reargument. In 1992, Justice Gammerman adhered to the grant of summary judgment. The court, however, did modify its ruling by barring the reinsurers' counterclaim for rescission. The court found that this counterclaim violated the liquidation order provision that bars claims or counterclaims against the Liquidator. Nevertheless, the trial court "functionally rescinded" the treaties by finding that the reinsurers' had proven their affirmative defense of fraud, "thus rending (the treaties) void."
The Appellate Division again affirmed. 200 A.D.2d 99. The Liquidator sought leave to appeal to the Court of Appeals, but New York's highest court refused to accept the appeal because the trial court's order was not final. The order left unresolved several issues, including the Liquidator's demand for a return of premium if the treaties were to be voided ab initio.
On remand, Judge Gammerman severed the demand for return of reinsurance premium and dismissed the Liquidator's claims for reinsurance proceeds. The Appellate Division affirmed once more and the Court of Appeals finally agreed to hear the Liquidator's appeal.
Albany Arguments
In the Court of Appeals, the Liquidator advanced two arguments: (1) the trial court misapplied the doctrine of informal judicial admissions by admitting into evidence in the reinsurance suit admissions made in the Hall action; and (2) even if the trial court correctly admitted the attorneys' affidavits, New York's liquidation statute is the only remedy available in an insolvency proceeding and thus precluded the "remedy of rescission." Michigan, as beneficiary on the surety bond, argued that the informal judicial admission doctrine should not be used against it, an entity that did not participate in either action. Michigan also argued that even if the reinsurers had been misled, this should not void reinsurance contracts entered into for its benefit.
New York's leading text on evidence defines an informal judicial admission as facts "incidentally admitted" either during a trial or in "some other judicial proceeding." A formal judicial admission, in one case, e.g., an answer or an interrogatory, can become an "informal judicial admission" in a separate proceeding. Richardson, EVIDENCE ß 8-210, at 529. The affidavits submitted in the suit against Hall could, therefore, become informal judicial admissions in the separate action brought by the reinsurers. The Court of Appeals noted, as did Justice Gammerman, that it made no difference that the admissions in the Hall case were made by counsel on behalf of the Liquidator or that they were contained in affidavits and briefs, as opposed to a pleading.
The Court of Appeals agreed with Justice Gammerman's finding that the Liquidator's attorneys' affidavits and "supportive documentation" in the Hall suit demonstrated that Union's officers and directors made "material omissions and misrepresentations regarding the operations and financial condition of the company..." 1996 WL 676194 * 4. Specifically, the affidavits and "documents attached to them revealed that Hall operated Union as a loss leader," not as an independent entity as required by NYIL ß 1505, 1507.
The Court of Appeals concluded, therefore, that it would be
unseemly, to say the least, to permit the Liquidator to renege on its court-submitted evidence and, in effect, to use quasi-official assertions as both a sword and a shield by simultaneously documenting Union's fraud and failure to disclose its insolvency and yet later trying to deny the relevance and applicability of the same admissions and data in an action involving the reinsurers.
1996 676194 * 4. The Court of Appeals also pointed out that the Liquidator had been given ample opportunity, in both the trial court and the appellate division, to rebut the assertions contained in the affidavits submitted by its outside counsel, but had failed to do so.
Michigan, the beneficiary on the surety bond, argued that it was never involved in the Hall action and never had a chance to cross-examine the parties whose affidavits were now being used against it. The Court of Appeals acknowledged that Michigan was caught in the "procedural crossfire," but found that, as a practical matter, once the reinsurers established their fraud defense, "effecting a void ab initio consequence on the reinsurance treaties," the treaties and the payments due from them "disappeared." The reinsurers were entitled to summary judgment, therefore, against both the ceding company's liquidator and the intended beneficiary of the insurance proceeds.
Rescission - The Proper Remedy
The Court of Appeals then confronted the issue of whether the failure of the ceding company to reveal its insolvency to potential reinsurers "constitute(d) fraud in the inducement," thus warranting rescission. The Liquidator argued that the doctrine of utmost good faith only required that the ceding company reveal information "material to the insured risk." The cedant was not obliged to reveal its insolvency because: (1) this was a "neutral factor" that did not relate to the risks the ceding company was underwriting; and (2) regardless of the company's insolvency, the reinsurers were obliged to pay all the losses reinsured. In an insolvency, the reinsurer would simply pay the liquidator, not the ceding company, but the amount paid would be the same.
The reinsurers countered by arguing that Hall was operating Union as a "loss leader" for Hall's brokerage business. Hall, therefore, was steering poor risks and causing Union to write bond risks not acceptable by underwriting standards. The reinsurers also argued that the only way to keep an insolvent company afloat is to "simply keep writing additional premiums on bad risk situations." Writing "substandard and underpriced risks" constituted a "material fact" that should have been disclosed because the reinsurers' "true risks" were not generating enough premium to justify the "unknown exposure."
The reinsurers also argued that they had no duty to investigate Union's solvency. They further contended that they would not have reinsured an insolvent company because of the requirement imposed by NYIL 1308 which obligates a reinsurer to pay the Liquidator on reinsured claims even if the Liquidator has not yet paid the policyholder.
After a brief description of the nature of reinsurance, Court of Appeals Judge Bellacosa concluded that the duty to disclose was greater in the context of treaty, as opposed to facultative, business because: (1) there is no individual scrutiny of risks; (2) the reinsurer is obligated to accept risks ceded to it; and (3) of the long term relationship between the parties where profitability is "expected" but only determined over an "extended period of time." 1996 WL 676194 * 5 quoting Clark, "Facultative Reinsurance" Reinsuring Individual Policies, Reinsurance, Strain at 117 (1980).
Citing cases dating back to the 1800s, the Court of Appeals noted that the basic obligation of the reinsured is to disclose to prospective reinsurers all "material facts" regarding the original risk prior to liquidation. Having implicitly held that factual insolvency was a material fact that would have voided Union contracts before it was liquidated, the Court held that the same remedy should be available to reinsurers after Union was officially liquidated.
Finally, the court held that reinsurers' defense of fraud was properly asserted against Michigan, the beneficiary on the surety bond. Michigan's ability to proceed against the reinsurers was unusual in that NYIL 4118(a)(1)(A) and the terms of the Michigan contract allowed it a direct right of action against Union's reinsurers. Nevertheless, "inasmuch as the reinsurance treaties (were) ... void, ab initio," Michigan stood in no better position than Union's liquidator.
The Hall settlement had remained on hold throughout the pendency of the appeals of Judge Gammerman's initial order. In Hall the Liquidator had settled with Hall and its D&O insurers for $48 million. The rescission order, however, voided almost $200 million in reinsurance recoverables, thereby pushing the estate's insolvency from $139 million to almost $300 million.
Nevertheless, shortly after the decision, the Liquidator announced that he would go forward with the Hall settlement and ask Judge Gammerman to approve it. Union Indemnity Settlement to Proceed, Business Insurance, Dec. 9, 1990. At a February 6 hearing, Judge Gammerman approved the settlement.
Analysis
Literally within hours of the Union decision, counsel in a reinsurance arbitration cited the case to an arbitration panel in a reinsurance arbitration involving completely unrelated contracts entered into in the 1980s. Counsel argued that Union set the proper standard for rescission in a reinsurance dispute. The Panel was urged to follow Judge Bellarosa's reasoning.
Union, however, is a narrow decision involving admissions concerning how an insurer was operated as a dumping ground for poor risks. And the reinsurers seeking rescission in the Union case had a lot of help. It is a rare case in which attorneys for the cedant provide complete, detailed, and exhibit-laden affidavits swearing in no uncertain terms that the cedant was operated as a "loss leader" by a broker intent on earning commissions and leaving the lousy risks with an insurer that it owned and controlled. Judge Gammerman believed that these "informal judicial admissions" required that the contracts be rescinded.
But does Union add much to the test of what constitutes grounds for rescission, particularly where these arguments are advanced to arbitrators, where the overwhelming majority of reinsurance disputes are still settled? The court puts together its own thumbnail test for rescission but does not rely on: (1) books on insurance and reinsurance; (2) an 1870 U.S. Supreme Court decision involving some marine insurance written in prose that is barely comprehensible; and (3) a Second Circuit case, Christiania Gen. Ins. Corp. v. Great American Ins. Co., 979 F.2d 268, 278 (2d Cir. 1992) and a Court of Appeals decision, Sumitomo, 552 N.Y.S.2d 891, neither of which actually resulted in the rescission of a reinsurance contract and neither of which contained as broad a definition of good faith as is implied in the Union decision.
For example, in Union the Court earlier refers to Christiana when discussing the duty to disclose "material facts" but then quotes secondary authority for the proposition that an "innocent failure" to disclose a "material fact" may void a reinsurance contract and that there can be no "imputed knowledge of facts material to the risk that the reinsurer is asked to assume." Union 1996 WL 676194, * 6 quoting Ostrager & Newman, Handbook on Insurance Coverage Disputes ß 16.03 at 710-11 (8th ed. 1995)
In Christiania, however, the Second Circuit pointed out that not every undisclosed fact warrants the extraordinary remedy of recision. "[T]he party with a duty to disclose must at least have reason to believe the fact not disclosed is material." Christiania, 979 F.2d at 279. The Second Circuit also held that the duty to disclose is not affected by whether the failure is intentional or inadverten;, "rather the duty does not extend to facts of which the reinsured is not, and has no reason to be, aware of a material to the risk." Id. In other words, if a cedant did not consider a particular fact relevant to underwriting of the risk, and the reinsurer did not ask about these facts, "it cannot be said that the failure to disclose such information deprived (the reinsurer) of the same opportunity defendants had to assess the risk." Id.
Ordinarily, a cedant would not be expected to discuss its own solvency. Reinsurers should and customarily do investigate the cedants' solvency and would not necessarily rely on a cedants' representations in this area anyway. Union led to rescission because of the detailed attorneys' affidavits submitted in the Hall case coupled with concessions in both the trial court and the appellate division that "reinsurers would not have underwritten reinsurance for (Union)" had they known about Union's insolvency. 1996 WL 676194 * 5. To this concession the Court added that reinsurers would shy away from an insolvent company because of the requirement that the reinsurer indemnify the liquidator in full, even if the Liquidator (or the relevant guaranty fund) has not yet paid the underlying claim. NYIL 1308.
But Union's insolvency was only half the story. The other half concerned the broker's using Union as a "loss leader" and steering to it difficult-to-place business. These practices come closer to the type of risk-related information that the principle of utmost good faith was aimed at in the first place. If, however, Union had not been liquidated, and if the Liquidators' attorneys had not tripped over themselves in their eagerness to prevail in the suit against Hall, the result might well have been different.
After all, the fact that Hall owned Union was common knowledge at the time the subject reinsurance treaties were negotiated. Shouldn't the possibility that a broker might be tempted to steer poorly underwritten risks to its own insurance company have prompted a question or two about Union's underwriting standards? If an insurer asks a question, the reinsurer has to assume that the cedant believes the information to be material and a false answer may, depending on the circumstances, warrant rescission. Reinsurance remains, however, business "negotiated at arms length by experienced insurance companies," and not a "fiduciary relationship." Christiania, 979 F.2d at 280.
On the other hand, the relationship between cedant and reinsurer should not change with the insolvency so that one standard applies to solvent companies and another for liquidated entities. The Court has lots of authority for the proposition that the Liquidator "stands in the shoes" of the insolvent company and cannot be placed in a better position than the company being liquidated. This reasoning was extended to the principle of offset in the Midland case, and has now been extended to rescission.
The court was silent, however, about the right to arbitrate the very dispute before it. All or most of the contracts at issue in Union contained arbitration clauses. And Judge Gammerman had, at one point, ruled that this dispute should be arbitrated. His decision was later reversed on the basis of another decision that worked its way to the Court of Appeals, Ardra.
In Midland, the Liquidator pointed to Ardra to argue that he indeed did enjoy different rights from the liquidated company and did, in fact, have the right to reject arbitration, even though a solvent cedant could not. The Court buried its response in a footnote and distinguished Ardra on the ground that arbitration involved "remedies," not "substantive right," ignoring the possibility that the remedy can sometimes be more important than a lot of substantive rights in the sense that a choice of forum and the use of industry custom and practice, may, in some cases, lead to entirely different results.
Finally, we note that Union demonstrates how courts are building a body of reinsurance law. In Sumitomo, then Judge Judith Kaye, now Chief Judge Kaye, began her opinion almost apologetically noting that the Court was being asked to
resolve a question of reinsurance law - a field in which differences have often been settled by handshakes and umpires, and pertinent precedents of this court are few in number. Sujitomo at 892.
Six years later, Judge Bellacosa does not even acknowledge that while reinsurance has been around for hundreds of years and literally thousands of disputes have been resolved by arbitration panels relying on industry custom and practice, there are still only a relative handful of reported reinsurance decisions. The court now begins to reason its way to a result using court cases. The cases, however, involve quite different periods of time and different kinds of contacts - facultative, quota share, excess of loss - all of which involve different types of underwriting involvement and inquiry. These differences are not taken into account.
This, however, is how courts work. "One precedent creates another. They soon accumulate, and constitute law." Junius, Letters (1772). Now we see the court cases being used in lengthy briefs submitted to arbitration panels, who are permitted under the terms of the contracts before them to ignore the "strict rule of law" and apply custom and practice and equitable principles to arrive at a just result. It's hard to see where this cross-pollenization is taking us, except that we are moving further away from reinsurance as a "field where differences have often been settled by handshakes and umpires" and "pertinent precedents are few in number."
IN MEMORIAM
ARTHUR NIELS BROOK 1933 - 1997
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Our partner, colleague, and above all friend, Arthur Brook, died suddenly on July 30, 1997.
Arthur had been part of our world since 1966. Those of our readers who knew him recognize in this photograph the remarkable synthesis of zestful enthusiasm, wry humor, and mellow skepticism that characterized his approach to life. His intellect was large but his demeanor modest.
Most of all, Arthur had passion. Whether planning his strategy for a trial or exulting over the quality of a new espresso machine, managing a friend's political campaign or comparing the styles of different tenors in his favorite aria from Il Trovatore, instructing young lawyers in jury selection techniques or bemoaning the erosion of old-fashioned grammatical English, deposing an expert witness or learning in middle age to speak Italian, Arthur threw himself into everything he did with gusto bordering on abandon.
His warmth was contagious and embraced us all. His joie de vivre illuminated our firm and our lives.
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