(1) Insurance policy interpretation is the process of determining the meaning of the terms of an insurance policy. Whether those terms as so interpreted are enforceable is determined by reference to other legal rules.

  (2) Insurance policy interpretation is a question of law.

  (3) Except as this Restatement or applicable law otherwise provides, the ordinary rules of contract interpretation apply to the interpretation of liability insurance policies.

Comment:

a. Scope. Interpretation is the first substantive topic of this Restatement because of its importance for insurance coverage. Most of the parties’ rights and obligations under an insurance policy are set forth in the policy. Courts primarily determine those rights and obligations by interpreting the terms in that policy. This Restatement takes a textualist, or linguistic, approach to interpretation. In interpreting insurance policy terms, courts are bound by the words in the policy. Insurance policy terms must be given meanings to which the words in the policy are reasonably susceptible. Courts may in certain circumstances impose terms on the parties that contravene the language in insurance policies, or refuse to enforce terms in policies, but such decisions are not properly regarded as interpretation.

b. A question of law. The interpretation of an insurance policy is a question of law, even when interpretation involves the consideration of evidence beyond the insurance policy. Interpreting an insurance policy term ordinarily does not present questions of fact. Judicial decisions regarding the interpretation of standard-form terms provide guidance regarding the application of the terms in other cases. Judicial decisions are subject to de novo review on appeal and provide stare decisis. They provide reasons that the parties can understand and that participants in the insurance market can use to predict future decisions. Such guidance is a public benefit that is not provided by jury decisions. On rare occasions, there may be a pure question of fact relating to interpretation of an insurance policy, such as a factual dispute regarding what happened during negotiations or course of performance that bears upon the meaning that a reasonable person in the policyholder’s position would ascribe to a term, especially regarding a non-standard-form term, but, ordinarily, the application of extrinsic evidence to determine the meaning of a term is a question of law for the court to determine. If there is such a question of fact, the court could instruct the jury on the legal consequences of the possible alternative findings of fact; alternatively, the jury could be asked to provide a special verdict with its findings of fact that the court would then use to resolve the coverage dispute.

  Illustrations:

  1. An adjoining property owner files a tort action against an automobile service station that is insured under a commercial general-liability insurance policy. The complaint alleges that toxic chemicals, released on a gradual basis from the service station over a long period of time, have contaminated the plaintiff’s property. The service station’s liability insurance policy contains a standard-form pollution exclusion that excludes coverage of liability for harm arising out of the discharge, dispersal, or release of toxic chemicals and other designated substances, with an exception for a discharge that is “sudden and accidental.” The insurer agrees to defend the legal action but reserves the right to deny coverage based on the pollution exclusion.

The insurer contends that “sudden and accidental” includes a temporal requirement, such that liability arising out of gradual releases that take place over a long period of time is not covered. The service station counters that the exclusion is ambiguous. It argues that the exclusion, read in the context of this claim, reasonably could mean “unexpected and accidental.” Whether the exclusion has a single reasonable meaning in the context of the claim, as defined in § 3(2), is a question of law for the court. If the court determines that the exclusion is ambiguous as defined in § 4(1), the service station then may proffer extrinsic evidence including the drafting history of the pollution exclusion, administrative-agency filings made by the insurance industry, and other circumstances surrounding the drafting and approval of the exclusion, which, the service station contends, contradict the interpretation proffered by the insurer. The interpretation of the pollution exclusion in these circumstances, which is made under § 4(2), is a question of law for the court, whether or not it considers the extrinsic evidence.

  2. A medical-records-processing business is sued for negligently overcharging for copies. The business is insured under a liability insurance policy that provides coverage for liability arising out of “any actual or alleged negligent act or omission committed in the rendering or failure to render the Professional Services stated in the Declarations.” The declarations of the policy define the term “professional services” as “Medical Records Processor,” a definition that was specially inserted into the declarations in the course of negotiations for the policy. The insurer denies coverage for the legal action on the ground that charging for copies is not a “professional service” that involves a specialized skill that distinguishes a particular occupation from another occupation. The records processor files a breach-of-contract action alleging that documents and discussions from the parties’ negotiation of the policy demonstrate that the parties intended the definition of “professional services” to include all of the essential components of the medical-records-processing business, including the determination of the fees to be charged, without regard to whether any particular component could also be regarded as an ordinary commercial activity. Determining what occurred during the negotiation of this term presents a question of fact that, if disputed and relevant to determining the meaning that a reasonable person in the policyholder’s position would ascribe to the term, is appropriate for resolution by the trier of fact.

c. Objectives of liability-insurance-policy interpretation. The appellate oversight and public guidance provided by judicial decisions interpreting liability insurance policies promote the objectives of liability-insurance-policy interpretation. These objectives include: effecting the dominant protective purpose of insurance; facilitating the resolution of insurance-coverage disputes and the payment of covered claims; encouraging the accurate description of insurance policies by insurers and their agents; and providing clear guidance on the meaning of insurance policy terms in order to promote, among other benefits, fair and efficient insurance pricing, underwriting, and claims management. These objectives provide guidance for the interpretation of insurance policies.

d. The importance of consistent meanings of standard-form insurance policy terms. Insurance policies generally are standard-form contracts sold on a mass-market basis. This is universally the case for personal-lines insurance policies sold to individuals, such as personal-automobile and homeowner’s insurance (the liability-coverage parts of which are the most widely distributed forms of liability insurance coverage in the United States). Even in the commercial insurance market, the vast majority of insurance policies are standard-form contracts. A prospective policyholder generally is able to customize the coverage only by selecting among the forms offered by the insurer. Adjudication of the meaning of a standard-form term in one case has consequences for the scope of the risks insured under all similar policies. Interpretive rules that give the same meaning to an insurance policy term in all contexts facilitate the orderly operation of the insurance market and, accordingly, are preferred. Although it is unlikely that most consumers are directly aware of the results of adjudication, those results inform insurers and insurance intermediaries in the pricing and marketing of insurance policies.

To the extent that this process results in clearly worded, understandable insurance policies, those policies may in some cases provide useful information to consumers in the purchasing process, although it must be noted that current practices in the consumer-insurance market make it unlikely that a consumer will receive a complete copy of a liability insurance policy before purchase. It is not assumed or expected that consumers ordinarily read their insurance policies, nor that legal rules can do very much to change consumer behavior in that regard.

e. Financial responsibility. Liability insurance coverage often sets practical boundaries on the ability to enforce liability. Individuals and firms frequently are obligated to purchase liability insurance, either as a matter of statutory law or contract, in order that they will be able to compensate third parties whom they injure through breach of a legal duty. This financial-responsibility objective informs and stimulates demand for liability insurance and, therefore, is part of the justification for the traditional insurance-law approach to insurance policy interpretation. This objective does not mean, however, that insurance policy terms should be given strained or unreasonable meanings in order to provide compensation to injured parties.

f. Interpretation and application. Once the court determines the meaning of an insurance policy term, the term is then applied to the claim to determine, for example, whether the claim is covered. In many cases the facts relevant to a coverage determination are not in question and, thus, there will be no need for a trial. In other cases there is a factual dispute regarding some aspect of the claim such that interpretation of the insurance policy is not sufficient to make the coverage determination. In those cases, the trier of fact applies the term to the claim. If the trier of fact is a jury, the court instructs it on the meaning of the insurance policy term.

  Illustration:

  3. Same facts as Illustration 1, except that the service station also contends that some or all of the toxic chemicals were released as a result of specific accidents that occurred at discrete moments. If the court determines that “sudden and accidental” includes a temporal component, questions such as whether these releases were accidental, whether they occurred at discrete moments and, if so, how much of the damage is attributable to them are questions of application that, if disputed, are for the jury to determine based on instructions from the court regarding the meaning of “sudden and accidental.”

g. Construction and interpretation. Construction is sometimes distinguished from interpretation, with construction referring to the process of determining the legal effect of the terms in the contract, and interpretation referring to the process of determining the meaning of the document that sets forth the terms of a contract. In most insurance cases, construction collapses into interpretation. The insurance policy is almost always regarded as setting forth all of the terms of the insurance contract, except for terms that are implied in law, such as the duty of good faith and fair dealing, or a term that is implied in law in the contract unless the parties specify a contrary term (commonly referred to as a default term). The legal effect of an insurance policy term ordinarily is the same as its meaning. In the event that an insurance policy does not contain a term to which the parties agreed, the contract-law doctrine of reformation will supply that term, which is then subject to interpretation. The rules stated in this interpretation Topic do not affect any of the legal rules regarding the enforceability of insurance policy terms (such as unconscionability or prohibitions on terms that are against public policy).

h. Relationship to contract law. Although the rules of insurance policy interpretation may be understood as a subset of the general law of contracts, the insurance context is sufficiently different from those that inform the general contract-law paradigm that insurance-policy-interpretation rules are properly considered to be distinct from general contract-interpretation rules in some respects. The vast majority of insurance policies are standard-form, mass-market products; they are not negotiated agreements as to which the purchasers can be understood to have a well-developed intent. All insurance contracts are aleatory, meaning that the policyholder pays for the insurer’s promise to perform in the future, based on the occurrence of an event that is uncertain at the time of purchase, and following the occurrence of which it is too late for the policyholder to take other meaningful steps to obtain the purchased protection. Moreover, the insurance business represents one of the most important, longstanding, and self-conscious efforts to harness private markets to promote the public good. Of course there are other kinds of contracts that share some or all of these features, but there are few, if any, other kinds of contracts with these features that are so deeply entwined with the civil-justice system and so commonly before the courts that an analytically distinct set of common-law doctrines could have developed from this process, as is the case with the common law of insurance.

i. Administrative approval of insurance policy forms. Statutory law commonly requires insurers to obtain approval of a standard-form insurance policy (including the revision of a term in the policy) or other standard form from a designated insurance regulatory agency before using the policy or form in the market. Such statutory law may in some circumstances have significance for the enforceability of terms in insurance policies. However, the mere approval or non-approval of an insurance policy or other form has no significance for the meaning of the terms in the policy or form (though materials submitted to the administrative agency may be relevant extrinsic evidence of meaning in the event that extrinsic evidence may be considered). For example, the fact that the appropriate administrative agency approved a policy form has no bearing on whether a term in the policy has a plain meaning or is ambiguous. The primacy of the courts in the interpretation of the terms of an insurance policy follows from the legal status of insurance policies as contracts. In approving an insurance policy form, insurance administrative agencies generally do not issue legally definitive rulings or other statements regarding the meaning of terms in the policy.

(1) If an insurance policy term has a plain meaning when applied to the facts of the claim at issue, the term is interpreted according to that meaning.

  (2) The plain meaning of an insurance policy term is the single meaning to which the language of the term is reasonably susceptible when applied to facts of the claim at issue in the context of the entire insurance policy.

  (3) If a term does not have a plain meaning as defined in subsection (2), that term is ambiguous and is interpreted as specified in § 4.

Comment:

a. The two traditional approaches to interpretation. There are two main approaches to the interpretation of contracts that find support in the common law of insurance: the contextual approach and the plain-meaning approach. Under the contextual approach, which was adopted in the Restatement Second of Contracts, courts interpret insurance policy terms in light of all the circumstances surrounding the drafting, negotiation, and performance of the insurance policy. Under the plain-meaning approach, which is typically followed in insurance law, courts interpret an insurance policy term on the basis of its plain meaning, if it has one. Regardless of approach, however, courts generally employ the ordinary rules of contract interpretation in insurance cases. See § 2(3) (“Except as this Restatement or applicable law otherwise provides, the ordinary rules of contract interpretation apply to the interpretation of liability insurance policies”).

This Section does not follow the Restatement Second of Contracts contextual rule because a substantial majority of courts in insurance cases have adopted a plain-meaning rule. Moreover, because of the mass-market nature of liability insurance, there is value in a rule that rewards and encourages the drafting of insurance policy terms that have a plain meaning. The plain-meaning appproach promotes consistency of interpretation of insurance policies using the same language in similar contexts, giving the parties to standardized insurance policies greater confidence that they will be uniformly enforced.

b. Generally accepted sources of plain meaning. Generally accepted external sources of meaning that courts consult when determining the plain meaning of an insurance policy term include: dictionaries, court decisions, statutes and regulations, and secondary legal authority such as treatises and law-review articles. Such external sources of meaning are not “extrinsic evidence,” except in limited circumstances discussed below. Rather, they are legal authorities that courts consult when determining the plain meaning of an insurance policy term, which is a legal question. However, when sources such as treatises and law-review articles are relied upon for an evidentiary purpose—namely, to prove the existence of an empirical fact—then their use would be subject to the liability-insurance-law standards concerning extrinsic evidence, see § 4, Comments b and c, in addition to any applicable rules of evidence, such as rules concerning the admission of hearsay and judicial notice.

c. Custom, practice, and usage. Some courts that follow a plain-meaning rule also consider custom, practice, and usage when determining the plain meaning of insurance policies entered into between parties who can reasonably be expected to have transacted with knowledge of that custom, practice, or usage. The plain-meaning rule adopted in this Section follows this approach, which recognizes that informed insurance-market participants conduct their business in light of custom, practice, and usage in the insurance market and in the trade or business being insured. Custom, practice, and usage therefore can inform the court’s determination of the objective meaning of insurance policy terms in the relevant market, as distinguished from the specific or subjective intent or understanding of a particular party. Efforts to ensure that insurance policy terms are interpreted in a manner that is consistent with relevant custom, practice, and usage promote certainty in the insurance market. Moreover, in jurisdictions in which the meaning of an ambiguous term is a question for the jury, consideration of custom, practice, and usage at the plain-meaning stage of the analysis can help the court determine whether the meaning is plain in the relevant trade or under common insurance usage, and thereby allow the court to determine the meaning of the term on summary judgment.

Consideration of custom, practice, and usage at the plain-meaning stage does not, however, open the door to extrinsic evidence of the parties’ specific or subjective intent or understanding regarding the insurance policy, such as drafting history, course of dealing, or precontractual negotiations. Rather, custom, practice, and usage refer only to aspects of the insurance market or the trade or business being insured that are so widely known as to form a shared backdrop against which an insurance policy is reasonably understood to have been written and executed. In that regard, it is important to note that the term “extrinsic evidence” does not include all sources of meaning that are external to the policy. The facts of the claim at issue are external to the policy, as are custom, practice, and usage. Yet, all courts that follow the plain-meaning rule permit consideration of claim facts and some of those courts also permit consideration of trade custom, practice, and usage when determining whether a term has a plain meaning and, if so, what that meaning is.

While courts do not generally conduct a cost-benefit analysis when considering whether to permit consideration of custom, practice, and usage at the plain-meaning stage of the analysis, the costs of considering these sources of meaning should generally be low because, by definition, a custom, practice, or usage will be widely known in the insurance market, or in the trade or business being insured, and, thus, capable of being documented and presented to the court without burdensome discovery. There should be no need to take discovery to discern, prima facie, the existence of a custom, practice, or usage. Each party should be knowledgeable of custom, practice, and usage in its own trade or business; insurers should have access to information outside of discovery regarding custom, practice, and usages in the trades or businesses that they insure; and insureds should have access outside of discovery to insurance brokers and others with knowledge of the insurance industry. Discovery necessary to impeach an opposing party’s evidence is a matter that trial judges have the capacity to manage. Further, courts following the plain-meaning rule stated in this Section may develop diverse approaches to the sources of information they are willing to consider in identifying a relevant custom, practice, or usage. Courts concerned with the potential costs of factfinding at the plain-meaning stage could exercise discretion, for example, to refuse to allow expert evidence, yet could be willing to consider custom, practice, or usage of which judicial notice properly may be taken. Courts also could elect to permit parties to seek discovery limited to securing stipulations or admissions regarding the existence of a relevant custom, practice, or usage. In other instances, a court might determine that limited expert discovery on the issue of a custom, practice, or usage would provide needed context to determine whether a plain meaning exists. In all circumstances, custom, practice, and usage may be used against only a party who can reasonably be charged with knowledge of that custom, practice, or usage. Thus, for example, if there is a special, insurance-trade understanding of a term, and if the policyholder is an organization that would reasonably be expected to be aware of that trade understanding, then the term should ordinarily be given that meaning.

  Illustrations:

  1. A stock exchange is sued by a class of retail investors for actions taken in connection with a troubled initial public offering. The exchange’s directors’ and officers’ (D&O) insurer denies coverage based on a professional-services exclusion in the policy that excludes coverage for any claim “by or on behalf of a customer or client of the” exchange. The exchange’s errors and omissions (E&O) insurer agrees to pay its policy limits toward settlement of the class action. After settlement of the action, the exchange and its E&O carrier bring an action against the D&O insurer seeking to recover a share of the costs of settlement of the claim, arguing that the exchange’s customers are brokers-dealers, not retail investors. Finding that the usage of the term “customers” in the securities markets is shaped by its usage in federal securities law and reflected in industry usage, the court looks to judicial precedent and to statements by exchange industry leaders to find that retail investors are unambiguously considered “customers” of a stock exchange, and that this usage formed the backdrop against which the policy term would have been understood by reasonable actors in the parties’ positions. Accordingly, the court grants summary judgment for the D&O insurer.

  2. A fuel-delivery company is sued when fuel oil leaks out of a truck while parked overnight. The company seeks coverage from its auto liability insurer, which regularly insures fuel-delivery companies and is familiar with custom and practice in that trade. The insurer denies coverage based on an exclusion for release of pollutants “being stored … upon the covered auto.” The fuel-delivery company brings a breach-of-contract action, on the ground that it had purchased a pollution liability endorsement that provided coverage for damages arising out of the release of pollutants “being transported” by covered vehicles or “otherwise in the course of transit by or on behalf” of the company. It is undisputed that fuel-delivery trucks hold more fuel than typically can be distributed to customers in a single day, and that the trucks customarily are parked overnight in the course of distributing the contents of a tank. The court determines that reasonable actors in the parties’ positions would believe that fuel that is left in a truck while parked overnight between deliveries is “otherwise in the course of transit by” the company, and the court therefore grants summary judgment for the insured.

d. What sources of meaning may not be considered when determining whether a term has a plain meaning. Courts that follow a plain-meaning rule consider the sources of meaning described in Comments b and c when determining whether a term has a plain meaning, but they do not consider precontractual negotiations, course of dealing, or other similar forms of extrinsic evidence that pertain to interactions of the parties regarding the particular insurance contract at issue. These latter sources of meaning may be considered only if the court first makes the threshold determination that the insurance policy term is ambiguous when applied to the facts of the claim at issue. This more restrictive rule reflects a judgment by courts that the additional costs of considering such evidence when making the threshold ambiguity determination (such as the increased costs of discovery and a reduced likelihood that the case will be resolved before discovery) outweigh the benefits of considering such evidence (such as an increase in the accuracy of the court’s assessment of a term’s meaning). Although courts rarely make such a cost-benefit calculation explicitly, the implicit judgment is that the costs will be incurred in many cases, whereas the benefits will be realized in only a small fraction of those cases.

e. Purpose. A policy term that might otherwise be subject to a wide range of meanings can sometimes be given greater precision by reference to the purpose of the term in the context of the policy as a whole. The objective purpose of a standard-form term often can be determined from the sources listed in Comments b and c, in which case the purpose of the policy term can inform the court’s determination of the plain meaning of the term.

f. Determining whether a term has a plain meaning or is ambiguous. An ambiguous policy term is a term that lacks a plain meaning in the context of the claim at issue, i.e., a term that has at least two interpretations to which the language of the term is reasonably susceptible when applied to the facts of the claim in question. See § 4(1). This definition follows the traditional insurance-law approach pursuant to which the competing interpretations need not be equally reasonable for a term to be ambiguous. All that is required is that the language of the policy be reasonably susceptible to the proposed alternative. The concept of ambiguity in insurance law can include what is sometimes called vagueness: a lack of clarity in application that does not easily reduce to multiple competing interpretations. A term that has a plain meaning when applied to one claim may not have a plain meaning when applied to another claim.

  Illustrations:

  3. A policyholder is sued for negligent infliction of emotional distress. The complaint alleges that the distress resulted in headaches, stomach pains, nausea, and body pains. The insurer denies coverage for the suit on the ground that the suit does not seek “damages because of … bodily injury,” as required by the liability insurance policy. The insurance policy defines “bodily injury” as “bodily injury, sickness or disease.” The insurer argues that the suit is for damages because of emotional distress, not because of bodily injury; the alleged aches and pains were a consequence of the emotional distress, and not the basis for the suit. The policyholder argues that the aches and pains are “bodily injury” and that the suit seeks “damages because of … bodily injury”; the plaintiff is using the existence of the aches and pains as evidence of the seriousness of the emotional distress and as a basis for the alleged damages. The court determines that the language of the policy is reasonably susceptible to both interpretations. “Bodily injury” does not have a plain meaning in the context of this suit; it is ambiguous in relation to allegations of emotional injury that produces these physical manifestations.

  4. Same facts as Illustration 3, except the complaint alleges that the distress resulted in “pain and suffering, including humiliation, loss of self-esteem, irritability, and sleeplessness.” The policyholder argues that the suit seeks “damages because of … bodily injury” because irritability and sleeplessness are physical manifestations that demonstrate the seriousness of the emotional distress. The court determines that, when used in a liability insurance policy, the term “bodily injury” is not reasonably susceptible to an interpretation that includes irritability and sleeplessness arising out of the negligent infliction of emotional distress. Thus, the term is not ambiguous when applied to the suit. The suit is not covered.

  5. A tour company is sued for negligence that allegedly caused a patron to drown while snorkeling during an eco-tour excursion in the Florida Keys. The company’s liability insurer agrees to defend the action but reserves the right to deny coverage based on an exclusion for bodily injury to any person “while participating in any sports or athletic activity.” The insurer files a declaratory-judgment action seeking to terminate the defense and then files for summary judgment on the ground that the injury occurred while the patron was “participating in any sports or athletic activity.” The court determines that the term “sports or athletic activity” does not have a plain meaning when applied to death while snorkeling on an eco-tour.

  6. A tour company is sued for negligence that allegedly caused a patron to injure her back while participating in a touch-football game during an eco-tour excursion in Costa Rica. The company’s liability insurer declines to defend the action based on an exclusion for bodily injury to any person “while participating in any sports or athletic activity.” The company files an action alleging that the insurer breached the duty to defend. The court determines that the term “sports or athletic activity” does have a plain meaning when applied to a touch-football game. The suit is not covered.

g. In the context of the entire policy. Other parts of the insurance policy are an important source of guidance regarding the plain meaning of an insurance policy term, particularly when the term contains a word used elsewhere in the policy. It must be recognized, however, that insurance policies may consist of components that evolve over time along different paths, are amended or retained because of understandings that develop in the market and in judicial interpretations, or make explicit rights or obligations that the law would imply in any event. Accordingly, while courts should avoid an interpretation that renders a term meaningless, insurance policies may contain what might be considered redundancies or surplusage. Reading a term in the context of the policy as a whole does not require giving a term an unnaturally restrictive meaning simply because it overlaps with another term in the policy.

h. Relationship to reasonable expectations. The rules stated in this Section and in § 4 are broadly consistent with the principle that insurance policy terms are to be interpreted according to the reasonable expectations of the insured, provided that the understanding of what makes an expectation “reasonable” incorporates the concept of plain meaning. The term “reasonable expectations” is not used in the black letter of this or other Sections because of the wide variation in the way that courts have employed that term. By requiring that the meaning be one to which the words are reasonably susceptible, this Restatement does not follow the strong formulation of the reasonable-expectations doctrine, pursuant to which an insurance policy is to be interpreted according to the reasonable expectations of the insured even if the insurance policy language is to the contrary. So stated, the reasonable-expectations doctrine is not actually a rule of interpretation. Rather, it is a rule regarding the enforceability of terms that are inconsistent with the reasonable expectations of the insured. As stated in § 2, the enforceability of insurance policy terms is governed by legal rules other than those regarding interpretation.

i. The parol-evidence rule. Although the plain-meaning rule applied in insurance-law cases and the parol-evidence rule have underlying conceptual similarities, the two rules are not identical. See Restatement Second, Contracts § 213 (parol-evidence rule).

(1) An insurance policy term is ambiguous if there is more than one meaning to which the language of the term is reasonably susceptible when applied to the facts of the claim at issue in the context of the entire insurance policy.

  (2) When an insurance policy term is ambiguous as defined in subsection (1), the term is interpreted against the party that supplied the term, unless that party persuades the court that a reasonable person in the policyholder’s position would not give the term that interpretation.

Comment:

a. Definition of ambiguity. An ambiguous policy term is a term that has at least two interpretations to which the language of the term is reasonably susceptible when applied to the facts of the claim in question. This definition follows the traditional insurance-law approach pursuant to which the competing interpretations need not be equally reasonable for a term to be ambiguous. All that is required is that the language of the policy be reasonably susceptible to the proposed alternative. The concept of ambiguity in insurance law can include what is sometimes called vagueness: a lack of clarity in application that does not easily reduce to multiple competing interpretations. A term that has a plain meaning when applied to one claim may not have a plain meaning when applied to another claim. See Comment f to § 3.

b. Using external sources of meaning to determine whether a term is ambiguous. Courts that follow a plain-meaning rule may consider the external sources of meaning described in Comments b and c to § 3 when determining whether a term is ambiguous (including custom, practice, and usage in appropriate circumstances), but they may not consider precontractual negotiations, course of dealing, or other similar forms of extrinsic evidence that pertain to interactions of the parties regarding the particular insurance contract at issue. These latter sources of meaning may be considered only if the court first makes the threshold determination that the insurance policy term is ambiguous when applied to the facts of the claim at issue. This more restrictive rule reflects a judgment by courts that the additional costs of considering such evidence when making the threshold ambiguity determination (such as the increased costs of discovery and a reduced likelihood that the case will be resolved before discovery) outweigh the benefits of considering such evidence (such as an increase in the accuracy of the court’s assessment of a term’s meaning). Although courts rarely make such a cost-benefit calculation explicitly, the implicit judgment is that the costs will be incurred in many cases, whereas the benefits will be realized only in a small fraction of those cases.

Courts in some states have articulated a broad “latent ambiguity” rule that, unlike the rule followed in this Section, permits courts to consider a similarly broad range of circumstances at the threshold, ambiguity-determination stage, reasoning that this approach better protects the reasonable expectations of insurance purchasers and that the additional administrative costs are worth incurring as a result. This Restatement does not adopt this latent-ambiguity rule.

c. Using external sources of meaning to resolve an ambiguity. Courts generally agree that, once a court determines that a term is ambiguous, it may consider a wide range of potential sources of meaning in the effort to resolve the ambiguity. Commonly considered sources of meaning include: precontractual negotiations; the parties’ course of performance under the policy at issue; the course of dealing between the parties with regard to other policies; the drafting history of insurance policy terms at issue; documents filed with state administrative agencies regarding an insurance policy or term at issue; other versions of the relevant term available on the market; other forms of insurance available on the market; publications and expert testimony regarding the history, purpose, and function of policy terms and forms of insurance coverage; and publications and expert testimony regarding custom, practice, and usage in the business or trade being insured and in the insurance industry. (Note that custom, practice, and usage can also be a relevant consideration at the initial, plain-meaning stage of interpretation. See § 3, Comments c and d.) Courts differ on whether these types of evidence should be discoverable before the court has determined that the term at issue is ambiguous. Because discoverability implicates civil-procedure concerns that are beyond the scope of this Restatement, this Section does not state a rule regarding discovery of such evidence. Courts agree that a party’s unilateral subjective understanding of an insurance policy term is generally not relevant to the interpretation of the policy. See Comment i.

Because the objective of using these sources of meaning is to understand the meaning that a reasonable person in this policyholder’s position would ascribe to the term, such evidence may be used against an insured only when the policyholder could reasonably be expected to have been aware of it. There are differences among policyholders in this regard based on the knowledge that they reasonably should have regarding the form of insurance in question. For example, a large commercial policyholder that employs a risk manager, uses a broker (who can identify how a term varies from other versions of the term available on the market), has access to counsel (who can identify how the term has been applied by courts), and has purchased similar policies in the past may be considered to have such knowledge and understanding of the meaning of standard-form terms of insurance policies within the insurance trade as could be obtained by these agents through reasonable investigation, commensurate with the risks transferred. By contrast, individual consumer and small commercial policyholders ordinarily would not be expected to have been aware of such specialized meanings.

Extrinsic evidence can likewise be used against the insurer only when the insurer could reasonably be expected to have been aware of it. Insurers are presumed to be sophisticated and knowledgeable about matters of insurance, including the drafting history of standard-form terms, even if the particular insurer involved was not itself involved in the drafting of that term. This presumption is consistent with how contra proferentem is applied, as ambiguous terms in standard-form policies are construed against insurers even if the particular insurer did not supply the term. Some extrinsic evidence—such as prior negotiations and course of dealing between the parties—may go to the intent of both the insurer and the policyholder and may reveal a controlling mutual intent supporting reformation of the policy. See Comment i.

  Illustrations:

  1. Insurer issues a general liability policy to Named Insured that designates “Acme, 123 Main Street” as an additional insured. Acme Logistics, which has been sued in connection with an accident caused by Named Insured, requests coverage under the policy. Insurer denies coverage on the ground that Acme Logistics is not an insured under the policy. In a coverage action, Acme Logistics introduces evidence showing it has had an office at that address for 20 years and, therefore, it is the additional insured under the policy issued by Insurer. Insurer introduces undisputed evidence showing that (a) Acme Products also has an office at that same address, (b) Acme Products has a commercial relationship with Named Insured pursuant to which Named Insured was obligated to obtain liability insurance coverage for Acme Products, and (c) Acme Logistics has no such commercial relationship with Named Insured. The additional-insured term is ambiguous when applied to the facts of the claim for coverage because, on its face, the term could reasonably be read to refer to either of two entities. The court nevertheless issues a judgment for Insurer because the extrinsic evidence shows that no reasonable policyholder would interpret the additional-insured term to refer to Acme Logistics.

  2. An insured restaurant owner is sued by a patron who was injured when a waiter accidentally splashed hot-pepper oil in the patron’s eye. The insurer denies coverage under the pollution exclusion in the policy, which states that the policy “does not apply to … bodily injury or property damage arising out of the actual, alleged, or threatened discharge, dispersal or release or escape of ‘pollutants’ ….” The term “pollutants” is defined in the policy to mean:

Any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste. Waste includes materials to be recycled, reconditioned or reclaimed.

The court determines that the word “irritant” contained in the exclusion is ambiguous when applied to hot-pepper oil, because it is capable of being read narrowly so that it does not include food items spilled on a patron in a restaurant and broadly so that it includes such items. Considering extrinsic evidence indicating that the purpose of the exclusion is to avoid coverage for liability for environmental damage and toxic torts, the court determines that a reasonable policyholder in the restaurant’s position would not interpret the term “irritant” to include hot-pepper oil accidentally splashed in a restaurant patron’s eye.

d. Interpretation against the supplier of the term. The rule that an ambiguous contract term should be interpreted against the party that supplied the term is commonly referred to in insurance-law sources by its Latin name, contra proferentem, which means “against the offeror.” In the context of standard-form insurance policy terms, the insurer is so regularly the party supplying the form that courts often describe the contra proferentem rule as meaning that an ambiguous policy is interpreted in favor of coverage. The standard justification for the contra proferentem rule builds on the idea that the supplier of a term in a contract is generally in the best position to avoid ambiguity in the wording of the term, because the supplier drafted or, at the very least, chose to offer a contract containing that term. This rationale applies especially to situations involving standard-form terms, when one party supplies the terms and the other party either accepts or rejects them but is not given the option of suggesting alternative wording. The contra proferentem rule gives the supplier of the terms the incentive to take all reasonable steps to eliminate ambiguity in the drafting of terms.

It should be noted, however, that the aim of the rule is not the elimination of all ambiguity. Here the analogy to tort law is helpful. Just as it is not possible for the incentive provided by a tort-liability rule to eliminate all possibility of accidents, it is not possible for the incentive provided by a contra proferentem rule to eliminate all possibility of ambiguity. Even insurance policy terms that are relatively simple and clear on their face can become ambiguous when applied to a particular claim. The cost, to insurers and policyholders, of attempting to draft policies that specifically and unambiguously address every conceivable contingency would be prohibitive. Over time, insurance policies would become unacceptably long and, by their very length and complexity, inhibit rather than promote clear meaning. Thus, the contra proferentem rule, even when creating positive drafting incentives, should not be expected to eliminate all ambiguity.

e. Residual risk of unavoidable ambiguity. In addition to creating positive drafting incentives, the contra proferentem rule allocates to the party supplying the term the residual risk of unavoidable ambiguity. This allocation of risk is especially appropriate in the insurance context, when the parties supplying terms generally are insurance companies whose primary function is the spreading of risks. Thus, the risk of unavoidable ambiguity in insurance policy terms is, through the application of the contra proferentem rule, ultimately spread over all policyholders rather than borne by any individual insured. There is also a fairness argument that supports imposing the costs of ambiguity upon the party that benefited from having its preferred term in the insurance policy. This fairness argument applies even when the doctrine works against the insured and, thus, against risk spreading.

f. The mechanical application of the contra proferentem rule. Some courts apply a more mechanical version of the contra proferentem rule, in which the insurer that drafted or supplied the policy always loses whenever a term is found to be facially ambiguous when applied to the claim in question. This mechanical version of the rule is problematic because it sometimes produces outcomes that the policyholder could not have reasonably expected, in circumstances in which the insurer could not reasonably have eliminated the ambiguity. Under the rule in this Section, an insurer has the opportunity to use extrinsic evidence to demonstrate to the court that the coverage-promoting interpretation of an ambiguous term is unreasonable in the circumstances, meaning that a reasonable person in the policyholder’s position would not give the term that interpretation. In addition to being more likely to result in outcomes that are consistent with the reasonable expectations of the policyholder, this approach to contra proferentem is also consistent with what many courts in fact do, by engaging in the analytical effort needed to identify whether the coverage-promoting interpretation is unreasonable in the circumstances.

g. A reasonable person in this policyholder’s position. When the question is plain meaning, the inquiry focuses on identifying the single meaning that a reasonable person would assign to the language if that person had read the term and the insurance policy reasonably carefully. The rule in this Section applies only when the term in question has no single plain meaning when applied to the claim in question; rather, the term is ambiguous. In that case, the question becomes whether the coverage-promoting interpretation is one that a reasonable person in the policyholder’s position would give to the term in the circumstances. The legally relevant circumstances include the observable, objective characteristics of the policyholder that identify the policyholder as a member of a relevant class of insurance purchasers, with greater or lesser experience and expertise in the insurance market (or greater or lesser capacity to obtain expert advice in that regard). Taking these circumstances into account assists the court in arriving at the traditional objective of contract interpretation in general, giving a term in a contract the meaning that a reasonable person would ascribe to it under the circumstances. This tailored objective standard takes into account the level of sophistication and insurance-purchasing experience expected of the party buying the policy, but not that party’s subjective understanding.

It is important to emphasize that the concept of “a reasonable person in this policyholder’s position” is no less a legal construct than the “reasonable person” concept that courts employ when determining the plain meaning. Hence, interpreting an ambiguous insurance policy term in light of the circumstances is ordinarily just as much a question of law as determining the plain meaning of an insurance policy term. The exception would be the unusual situation in which there is an outcome-determinative factual dispute about the circumstances that the court cannot resolve through summary proceedings. A determination that an insurance policy term is ambiguous does not ineluctably lead to the conclusion that the meaning of the term is a question for the trier of fact to determine.

h. No sophisticated-policyholder exception. Some courts have suggested, and some commentators have recommended, that the contra proferentem doctrine not be applied to insurance policies entered into by sophisticated commercial policyholders—for example, large corporations that are represented by counsel. This Section does not endorse the idea of a sophisticated-policyholder exception to the contra proferentem doctrine. By placing the responsibility for residual ambiguity on the party that is most in control of the language of the policy, the contra proferentem rule provides an important incentive to draft terms clearly regardless of the sophistication of the policyholder. The rule that an ambiguous insurance policy term is given the meaning that a reasonable person in the position of the policyholder would give the term takes the sophistication of the policyholder into account, while preserving contra proferentem as the residual decision rule. See Comments d and e.

i. The subjective understanding of the policyholder. Because the meaning of an insurance policy is determined on an objective basis, the subjective understanding of the policyholder ordinarily does not have any significance for the interpretation of an insurance policy term. By definition, the plain meaning of an insurance policy term is independent of any individual person’s situation or understanding. Similarly, the understanding of a reasonable person in this policyholder’s position is an objective determination. This does not mean that subjective knowledge of the policyholder could never have relevance for determining legal rights and duties under an insurance policy. If the court determines that both the policyholder and the insurer subjectively intended a specific meaning of a particular, ambiguous term, that term could be reformed to reflect that shared understanding. Alternatively, a policyholder that expressed that specific meaning to the insurer could be estopped from asserting an alternative meaning, provided that the requirements of § 6 are met. Finally, a policyholder’s actual knowledge of a trade usage or some other circumstance could be taken into account in determining whether that usage or circumstance could be used to resolve the ambiguity in situations in which a reasonable person in that policyholder’s position would not ordinarily possess such knowledge.

j. Purpose. As explained in Comment e to § 3, a policy term that might otherwise be subject to a wide range of meanings can sometimes be given greater precision by reference to the purpose of the term in the context of the insurance policy as a whole. When the purpose of a standard-form term can be determined from the sources listed in Comments b and c to § 3, that purpose can inform the court’s determination of the plain meaning of the policy term. Purpose is also an important consideration when a term is ambiguous. Considering the objective purpose of an insurance policy term may help a court determine that one or more of the proposed meanings of the term is unreasonable in the circumstances.

k. When a term could have been more clearly drafted. In determining the meaning of an ambiguous term, it is appropriate to consider the difficulty of redrafting the insurance policy to more plainly express the meaning urged by the drafting party, ordinarily the insurer, taking into account that some residual risk of ambiguity is to be expected. The easier it would be for the drafter to state that meaning more plainly, the more likely it is that the other party’s proposed meaning is the meaning that a reasonable policyholder would give to the term. This approach creates an incentive for insurers to draft insurance policy terms that provide clear guidance regarding the scope of the risks insured under their policies. This approach does not apply to the language of a term that is legally mandated to appear in an insurance policy, however, because the insurer does not have the option of redrafting such a term.

  Illustration:

  3. A state environmental-protection agency issues an order requiring the policyholder to remedy hazardous conditions at a waste site. The policyholder requests coverage for these remediation expenses under a liability insurance policy that obligates the insurer “to pay on behalf of the insured all sums which the insured shall become legally obligated to pay as damages because of … property damage to which this insurance applies, caused by an occurrence.” The term “damages” is not defined in the policy. The insurer denies coverage on the ground that the obligation to incur remediation expenses does not constitute an obligation to pay “damages.” The insurer asserts that the term “sums which the insured shall become legally obligated to pay as damages,” when used in the liability insurance policy, refers to amounts paid as monetary compensation for injuries to third parties and not to amounts paid to comply with injunctive orders such as the remediation order at issue. The policyholder files a breach-of-contract action against the insurer, alleging that the legal action should be covered because the term “damages” can reasonably be interpreted to cover any legal action asserted against the insured arising out of property damage that requires the expenditure of money, regardless of whether the action can be characterized as legal or equitable in nature. In determining the meaning of the term “damages,” the court should take into account the fact that the term is not defined in the policy and that the insurer could have included a definition that incorporated the distinction between legal and equitable remedies urged by the insurer.

l. When a policyholder requests an insurer to use a different standard-form term available in the market. Commercial liability insurers compete, among other ways, on the basis of their willingness to match terms provided by other insurers in the market. A standard-form insurance policy term should not ordinarily have a different meaning depending on which party supplied or requested the term for use in the insurance policy in question, because the insurance market benefits when an insurance policy term develops a uniform meaning. Moreover, when an insurer competes for business, in whole or in part, on the basis of its willingness to match a policy term offered by another insurer, it would be unreasonable for the insurer to later assert that it can give that term a different meaning than the term would have in a policy purchased from the insurer that drafted the term.

Thus, for example, the fact that a policyholder requested that one insurer use a standard-form term taken from an insurance policy drafted by another insurer should not as a matter of course result in the application of the contra proferentem rule against the policyholder in the event of a dispute regarding the meaning of that term. Doing so in every such case would defeat the purpose of the inclusion of such terms in insurance policies, which is to obtain the coverage that the terms are understood in the insurance market to provide. Although it is possible that the replacement of the insurer’s ordinary term in an insurance policy with another standard-form term could produce an ambiguity in some circumstances, the insurer ordinarily will have more experience with and a better understanding of the policy than the policyholder and, thus, is in a better position to anticipate and avoid such ambiguity. This is the primary justification for the contra proferentem rule.

When a policyholder assembles an insurance policy out of standard-form terms that are not ordinarily combined in a single policy, however, any ambiguities resulting from the combination of those terms can fairly be attributed to the policyholder, who should be regarded as the drafter or supplier of the policy. If a policyholder requests an insurer to use a standard-form term that the insurer does not ordinarily use, the parties can choose to apply the ordinary contract-law contra proferentem rule to that term, pursuant to which the term would be interpreted against the policyholder. To avoid dispute, the parties’ intention to adopt such a different interpretive rule for a standard-form term selected by the policyholder should be incorporated in the endorsement to the insurance policy or in another writing clearly assented to by the parties. In no event should the contra proferentem rule be applied against an insured unless the policyholder in fact drafted or supplied the term. With respect to a term that is created for a specific policy, the doctrine of contra proferentem applies against whichever party, if either, created the term. If the term was jointly created (such as if one party modified a term supplied by another), then the rule of contra proferentem would not apply against either party.

While courts have not explicitly recognized this rule, neither have they rejected it. For example, the fact that the traditional practice in certain markets is for the broker to assemble the form using standard terms available in the market and present it to the underwriters for approval does not ordinarily change the rule that ambiguities are interpreted in favor of the policyholder. The circumstances in which courts have interpreted a policy provision against an insured are ones in which the provision was drafted by the policyholder or its broker.

  Illustrations:

  4. A D&O liability insurance policy issued to a publicly traded corporation contains an endorsement that, at the policyholder’s request, replaces the “prior and pending litigation” exclusion in the insurer’s standard policy with a version of the exclusion taken from a standard policy sold by another company. Neither the liability insurance policy, nor any communication between the parties in relation to this insurance policy, refers to rules regarding how to interpret the policy. The prior-and-pending-litigation exclusion in this policy is a standard-form term that is interpreted as if it were supplied by the insurer.

  5. Same facts as Illustration 4, except that, at the insurer’s request, the endorsement requested by the policyholder is amended to contain the following term:

The terms of this endorsement are included in the Policy at the request of the Named Insured. The Named Insured is deemed to be the drafter of the terms of this endorsement, which are subject to the general contract-law rule of interpretation against the drafter in the event of ambiguity.

The endorsement is to be interpreted according to this term. Because the policyholder supplied the endorsement, the parties were free to contract so that the ordinary contra proferentem rule would be applied against the policyholder.

m. Relationship to reasonable expectations. See Comment h to § 3.

Restatement of the Law of Liability Insurance § 31 (2019)

Restatement of the Law - Liability Insurance | June 2021 Update

Restatement of the Law of Liability Insurance

Chapter 3. General Principles Regarding the Risks Insured

Topic 1. Coverage

• 31 Insuring Clauses

^Comment:

^{Reporters’ Note}

• (1) An “insuring clause” is a term in a liability insurance policy that grants insurance coverage.
• (2) Whether a term in a liability insurance policy is an insuring clause does not depend on where the term is in the policy or the label associated with the term in the policy.
• (3) Insuring clauses are interpreted broadly.

Comment:

1. a. Classification of a term as an insuring clause is to be made on a functional rather than a formal basis. In contemporary liability insurance policies, insuring clauses most commonly appear in sections of the policy with the label “insuring agreement” or similar labels, but they also appear in other parts of a liability insurance policy.

34. b. Insuring agreements. Contemporary insurance policies commonly contain a section labeled “insuring agreement” that specifies what will be covered under the policy provided that all of the conditions in the policy are met and no exclusions apply. Insuring agreements always contain insuring clauses, but they may also contain exclusions and conditions. An exclusion or condition that appears in an insuring agreement is subject to the ordinary rules governing exclusions and conditions. See §§ 32 and 34.

1. c. Insuring clauses in endorsements. Contemporary insurance policies commonly consist of one or more standard-form parts that could function as complete insurance policies, along with additional parts, known as “endorsements,” that modify the coverage. Typically, the endorsements are also standard forms. Whether a term in an endorsement is an insuring clause, an exclusion, a condition, or none of these is to be determined on the same basis as if it were in the main body of the policy.

32. d. Exception clauses in exclusions. Contemporary insurance policies commonly contain a section labeled “exclusions” that includes a set of terms that restrict the coverage that otherwise would be provided by the policy. See 32. Exclusions may contain exceptions that narrow the application of the exclusion. Such exceptions operate only to narrow the exclusions in which they appear, not to expand coverage beyond that stated by other insuring clauses in the policy. See § 32(5).

4. e. Relation between broad interpretation of insuring clauses and contra proferentem. Judicial opinions issued in insurance-coverage cases commonly state that grants of coverage are to be interpreted broadly. This statement does not represent an independent, analytically distinct canon of construction but rather an application of the ordinary insurance policy interpretation rules stated in §§ 3 and 4.

1. f. Burden of proof. The insured bears the burden of proving that a claim falls within the scope of an insuring clause in the policy. This is the prevailing legal rule.

Reporters’ Note

16. Purpose.Appleman notes that an “insuring clause … sets forth the basic scope of the insured risk and represents the requirements that must be satisfied for a covered loss to be present.” 3 PAUL E.B. GLAD, WILLIAM T. BARKER & MICHAEL BARNES, NEW APPLEMAN ON INSURANCE LIBRARY EDITION§ 16.09[1][c] (Jeffrey E. Thomas & Francis J. Mootz, III eds., Lexis 2017). See, e.g., Liberty Nat’l Enters., L.P. v. Chi. Title Ins. Co., 217 Cal. App. 4th 62, 77 (2013) (“Before considering whether any exclusions apply, we examine the insuring clause to determine whether coverage exists at all.”).

1. Insuring agreements.See, e.g., Clemco Indus. v. Commercial Union Ins. Co., 665 F. Supp. 816, 820 (N.D. Cal. 1987) (applying California law) (“The placement of the phrase, however, in no way changed the effect or character of the phrase; ‘expected or intended’ remained an exclusion of the coverage grant by the very operation of its terms.”).

1. Insuring clauses in endorsements.See, e.g., 2 STEVEN PLITT, DANIEL MALDONADO, JOSHUA D. ROGERS & JORDAN R. PLITT, COUCH ON INSURANCE § 21:21 (3d ed. 2017) (“Endorsements, riders, marginal references, and other similar writings are a part of the contract of insurance and are to be read and construed with the policy proper.”). See also Haynes v. Farmers Ins. Exch., 89 P.3d 381, 385 (Cal. 2004) (citation omitted) (“Coverage may be limited by a valid endorsement and, if a conflict exists between the main body of the policy and an endorsement, the endorsement prevails.”); Adams v. Explorer Ins. Co., 107 Cal. App. 4th 438, 451 (2003) (“[A]n endorsement is an amendment to or modification of an existing policy of insurance. It is not a separate contract of insurance. Standing alone, an endorsement means nothing.”); Hart Constr. Co. v. Am. Family Mut. Ins. Co., 514 N.W.2d 384, 391 (N.D. 1994) (“When there is a conflict between the provisions of an insurance policy and an attached endorsement, the provisions of the endorsement prevail.”).

1. Exception clauses in exclusions.See § 32, Reporters’ Note to Comment f.

1. Relation between broad interpretation of insuring clauses and contra proferentem.See La. Civ. Code Ann. art. 2056 (2018) (“In case of doubt that cannot be otherwise resolved, a provision in a contract must be interpreted against the party who furnished its text. A contract executed in a standard form of one party must be interpreted, in case of doubt, in favor of the other party.”); Miller v. Cont’l Ins. Co., 358 N.E.2d 258, 260 (N.Y. 1976) (“The hornbook rule [states] that policies of insurance, drawn as they ordinarily are by the insurer, are to be liberally construed in favor of the insured”); Richards v. Standard Accident Ins. Co., 200 P. 1017, 1020 (Utah 1921) (“[I]nsurance policies should be construed liberally in favor of the insured and their beneficiaries so as to promote and not defeat the purpose of insurance.”). See also Uniroyal, Inc. v. Home Ins. Co., 707 F. Supp. 1368, 1376 (E.D.N.Y. 1988) (applying New York law) (citations omitted) (“At this stage, ‘after it has exhausted every effort to derive the meaning of the terms that accurately reflects the intent of the parties,’ the court must follow the rule of contra proferentem to construe any ambiguity against the insurer as drafter.”). For a discussion of how the maxim of construing an insuring clause broadly represents an application of the ambiguity principle, see Woodson v. Manhattan Life Ins. Co. of New York, N.Y., 743 S.W.2d 835 (Ky. 1987).

Restatement of the Law - Liability Insurance © 2012-2021 American Law Institute. Reproduced with permission. Other editorial enhancements © Thomson Reuters.

Restatement of the Law of Liability Insurance § 32 (2019)

Restatement of the Law - Liability Insurance | June 2021 Update

Restatement of the Law of Liability Insurance

Chapter 3. General Principles Regarding the Risks Insured

Topic 1. Coverage

• 32 Exclusions

^Comment:

^{Reporters’ Note}

^{Case Citations - by Jurisdiction}

• (1) An “exclusion” is a term in an insurance policy that identifies a category of claims that are not covered by the policy.
• (2) Whether a term in an insurance policy is an exclusion does not depend on where the term is in the policy or the label associated with the term in the policy.
• (3) Exclusions are interpreted narrowly.
• (4) Unless otherwise stated in the insurance policy, words in an exclusion regarding the expectation or intent of the insured refer to the subjective state of mind of the insured.
• (5) An exception to an exclusion narrows the application of the exclusion; the exception does not grant coverage beyond that provided in the insuring clauses.

Comment:

1. a. Exclusions can appear anywhere in an insurance policy. Insurance law takes a functional approach to determine whether an insurance policy term is an exclusion. Under the prevailing conventions of insurance policy drafting, exclusions typically appear in a part of the insurance policy with the specific heading “Exclusions.” But exclusions can appear in almost any part of an insurance policy: the insuring agreement, the definitions section, endorsements, and even in the conditions section.

• Illustration:

1. The 1966 edition of the Commercial General Liability Insurance policy defines “occurrence” as follows:

• “occurrence” means an accident, including injurious exposure to conditions, which results, during the policy period, in bodily injury or property damage neither expected nor intended from the standpoint of the insured.
•  
• The clause “neither expected nor intended from the standpoint of the insured” is an exclusion despite the fact that it is included in a term that is contained in a section of the policy labeled “Definitions” and not in the section of the policy labeled “Exclusions.”
•  

4. b. Courts regularly state that exclusions in insurance policies are to be interpreted narrowly. This statement does not represent an independent, analytically distinct canon of construction but rather an application of the ordinary insurance policy interpretation rules stated in §§ 3 and 4.

1. c. Severability of exclusions. Liability insurance policies often contain exclusions whose application depends upon specified conduct of the insured that serves as the basis for the alleged liability. Examples include exclusions for liability arising out of expected-or-intended injury, criminal or malicious acts, the use of intoxicating substances, sexual molestation, corporal punishment, physical or mental abuse, fraud, wrongful profit or advantage, and knowing violation of rights. The default rule is that such exclusions are severable, meaning that they apply only to insureds whose conduct meets the requirements of the exclusion. This rule is an application of the general rule regarding the narrow interpretation of exclusions. In addition, this rule reflects the underlying purposes of such exclusions: limiting the impact of liability insurance on incentives to engage in highly wrongful conduct, and preventing those who in fact engage in such conduct from drawing on the resources of those in the insurance pool. Applying these exclusions to insureds who did not engage in the wrongful conduct does not promote these purposes of the exclusions. Because these insureds did not engage in the wrongful conduct, there is less concern that the presence of insurance changed their incentives to engage in that conduct, nor is there the same concern about using the resources of the insurance pool on their behalf.

1. d. The default rule in favor of a subjective standard for expectation and intent. Many liability insurance policies contain an exclusion for legal actions arising out of injuries that are “expected or intended from the standpoint of the insured.” Courts have articulated different standards governing the application of this expected-or-intended exclusion. This Section follows the subjective standard that is the majority rule, while making clear that this standard is a default rule. Under the subjective standard, an insured intends harm when such harm is the object of the insured’s action, and an insured expects harm when the insured foresees that harm is practically certain to occur as the result of the insured’s intentional act, even if that harm was not the object of the action. This default rule is an application of the general rule in favor of the narrow interpretation of exclusions. Because the traditional expected-or-intended exclusion is silent regarding the subjective or objective nature of the standard, it is ambiguous in that regard. As demonstrated by the many judicial opinions adopting the subjective standard as the proper interpretation of the expected-or-intended exclusion, the subjective standard is a reasonable interpretation of the exclusion. Of course, subjective intent can be determined only on the basis of objective evidence, as even an insured’s admission of intent to harm is subject to cross-examination and the jury’s assessment of credibility. Moreover, courts at times have determined that subjective intent to harm can be inferred as a matter of law, for example in cases involving sexual abuse. Subject to any restrictions that may be imposed on public-policy or other grounds through the procedures governing the approval of liability-insurance-policy forms, insurers may draft around the subjective standard (as has occurred through the criminal-acts exclusion now included in many homeowner’s insurance policies).

• Illustrations:

2. Insured fires a .22 caliber rifle high and away from A, B, and C, who are 200 yards away, intending to scare them away from stealing his watermelons. One of the shots hits C. C files a tort action against Insured alleging that Insured negligently injured C. Insured has a standard homeowner’s insurance policy that excludes coverage for suits arising out of bodily injury that is expected or intended from the standpoint of the insured. Insurer defends the action, properly reserving the right to deny coverage on the basis of the exclusion. The judgment entered in the action against Insured is not excluded by the expected-or-intended exclusion because the Insured did not expect or intend the injury.

3. Insured kicks A from behind, believing that person to be his wife. A is not in fact his wife. A brings a tort action against Insured alleging that Insured negligently injured A. Insured has a standard homeowner’s insurance policy that excludes coverage for suits arising out of bodily injury that is expected or intended from the standpoint of the insured. Insurer defends the action, properly reserving the right to deny coverage on the basis of the exclusion. The judgment entered in the action against Insured is excluded by the expected-or-intended exclusion because Insured intended to injure A even though he was mistaken about the identity of A.

4. Manager deliberately fires a worker and intentionally discriminated on the basis of age, causing emotional distress that is sufficiently severe that it leads to bodily injury. The fired worker files suit against Manager’s Company, which has a standard commercial general-liability insurance policy that excludes coverage for suits arising out of bodily injury that is expected or intended from the standpoint of the insured. The suit is not excluded by the expected-or-intended exclusion because Manager did not expect or intend to cause bodily injury.

1. e. Burden of proof. The insurer bears the burden of proving that a claim falls within the scope of an exclusion in the policy. This is the prevailing legal rule. This burden of proof reflects the basic structure of liability insurance policies, which generally contain a relatively broad grant of coverage and a set of narrower exclusions from coverage. Each exclusion represents an insurer’s efforts to identify a class of claims that differs in some material way from the broad class of claims that are covered by the policy. It is the insurer that has identified the excluded classes of claims and will benefit from being able to place a specific claim into an excluded class. Thus, assigning the insurer the burden of proving that the claim fits into the exclusion is appropriate.

1. f. An exception to an exclusion. The rule in subsection (5) regarding exceptions to exclusions is a straightforward application of logic to the interpretation of a liability insurance policy. An exception to an exclusion narrows the application of the exclusion; it does not extend the coverage provided by the insuring clauses in the policy. See also 31, Comment d.

Reporters’ Note

1. Exclusions can appear anywhere in an insurance policy.See, e.g., Borough of Moosic v. Darwin Nat’l Assurance Co., 556 F. App’x 92, 97 (3d Cir. 2014) (applying Pennsylvania law) (“While the Related Claims provision appears in the section titled ‘Conditions,’ rather than the section titled ‘Exclusions,’ the location of the provision in the policy is not determinative.”); Stonewall Ins. Co. v. Asbestos Claims Mgmt. Corp., 73 F.3d 1178, 1205 (2d Cir. 1995) (applying New York law) (“[U]nder New York law, the exclusionary effect of policy language, not its placement, controls allocation of the burden of proof.”), op. modified on other grounds, 85 F.3d 49 (2d Cir. 1996); United Pac. Ins. Co. v. McGuire Co., 281 Cal. Rptr. 375, 378 (Ct. App. 1991) (“It does not matter that the [provision limiting coverage] appears in the ‘definitions’ section of the policy rather than the ‘exclusions’ section; in either case it performs the function of an exclusion.”); Jones v. Philip Atkins Constr. Co., 371 N.W.2d 508, 512 (Mich. Ct. App. 1985) (holding that an exclusion that appeared on a separate endorsement to the policy barred coverage for plaintiff’s injuries).

1. Interpretation.Courts regularly state that exclusions should be narrowly construed. See, e.g., Gore Design Completions, Ltd. v. Hartford Fire Ins. Co., 538 F.3d 365, 370 (5th Cir. 2008) (applying Texas law) (“Exclusions are narrowly construed.”); An-son Corp. v. Holland-Am. Ins. Co., 767 F.2d 700, 703 (10th Cir. 1985) (applying Oklahoma law) (“An insurance policy’s words of exclusion are to be narrowly viewed.” (citing Conner v. Transamerica Ins. Co., 496 P.2d 770, 774 (Okla. 1972))); First Ins. Co. of Haw., Ltd. v. Contl. Cas. Co., 466 F.2d 807, 809 (9th Cir. 1972) (applying Hawai’i law) (“Insurance exclusions are narrowly construed against the insurer.”); Reserve Ins. Co. v. Pisciotta, 640 P.2d 764, 770 (Cal. 1982) (holding that the policy’s family exclusion did not apply by reasoning that “[b]ecause the word ‘family’ is susceptible of several reasonable definitions, the most appropriate resolution is to construe the term narrowly, i.e., in favor of the insured.”); Eyler v. Nationwide Mut. Fire Ins. Co., 824 S.W.2d 855, 859 (Ky. 1992) (“Kentucky law is crystal clear that exclusions are to be narrowly interpreted”); Snell v. Stein, 259 So. 2d 876, 879 (La. 1972) (citation omitted) (“Construing the exclusionary clause strictly, as we must, … we cannot conclude it applies here.”); Seaboard Sur. Co. v. Gillette Co., 476 N.E.2d 272, 275 (N.Y. 1984) (“[Exclusions] are to be accorded a strict and narrow construction.”); 7A STEVEN PLITT, DANIEL MALDONADO, JOSHUA D. ROGERS & JORDAN R. PLITT, COUCH ON INSURANCE § 108:6 (3d ed. 2017) (“[E]xclusions from coverage in insurance policies are to be strictly construed.”).

1. Severability of exclusions.See generally 7A STEVEN PLITT, DANIEL MALDONADO, JOSHUA D. ROGERS & JORDAN R. PLITT, COUCH ON INSURANCE § 103:37 (3d ed. 2017) (“Liability insurance policies employ any number of exclusions that attempt to describe certain types of behavior, liability for the consequences of which the insurer intends to exclude from coverage.”). For cases determining the applicability of exclusions by examining whether the insured engaged in the excluded conduct, see, e.g., Aetna Cas. and Sur. Co. v. Dow Chem. Co., 28 F. Supp. 2d 421, 431 (E.D. Mich. 1998) (applying Michigan law) (“It should also be noted that it is important to focus on whether the insured engaged in culpable conduct in order to enforce the important public policies at issue.”); Arenson v. Nat’l Auto. & Cas. Ins. Co., 286 P.2d 816, 818 (Cal. 1955) (concluding that an intentional-act exclusion did not exclude coverage for parents for intentional act of vandalism committed by son, who also was an insured under policy); Catholic Diocese of Dodge City v. Raymer, 840 P.2d 456, 462 (Kan. 1992) (holding that the intentional-act exclusion did not apply to parents who had been found to have been negligent in supervising their minor child); Worcester Mut. Ins. Co. v. Marnell, 496 N.E.2d 158, 160–161 (Mass. 1986) (finding that severability clause in policy created separate insurable interests and did not exclude parents from coverage for damage caused by son, who was also an insured under the policy). For cases holding that a policy’s exclusion applies only if it applies with respect to the specific insured seeking coverage, see, e.g., Float–Away Door Co. v. Cont’l Cas. Co., 372 F.2d 701 (5th Cir. 1966) (applying Georgia law); Phoenix Assurance Co. v. Hartford Ins. Co., 488 P.2d 206 (Colo. App. 1971); Shelby Mut. Ins. Co. v. Schuitema, 183 So. 2d 571 (Fla. Dist. Ct. App. 1966), aff’d per curiam, 193 So. 2d 435 (Fla. 1967); Pa. Nat’l Mut. Cas. Ins. Co. v. Bierman, 292 A.2d 674 (Md. 1972); Am. Nat’l Fire Ins. Co. v. Estate of Fournelle, 472 N.W.2d 292 (Minn. 1991); Travelers Ins. Co. v. Auto–Owners Ins. Co., 203 N.E.2d 846 (Ohio Ct. App. 1964); Commercial Standard Ins. Co. v. Am. Gen. Ins. Co., 455 S.W.2d 714 (Tex. 1970); Bankers & Shippers Ins. Co. v. U.S. Fire Ins. Co., 224 S.E.2d 312 (Va. 1976).

In general, the reasoning in the severability cases employs an ambiguity-centric analysis that is consistent with a default-rule approach. The following statement from the Kansas Supreme Court in Catholic Diocese of Dodge City v. Raymer is representative:

In Kansas, the general rule is that exceptions, limitations, and exclusions to insuring agreements require a narrow construction on the theory that the insurer, having affirmatively expressed coverage through broad promises, assumes a duty to define any limitations on that coverage in clear and explicit terms.

840 P.2d 456, 462 (Kan. 1992). Dicta from the Massachusetts Supreme Judicial Court in Worcester Mut. Ins. Co. v. Marnell suggests that, at least in the homeowner’s-insurance context, severability may be a mandatory rule, not just a default rule:

Finally, our decision is in keeping with the long-standing rule of construction that the favored interpretation of an insurance policy is one which “best effectuates the main manifested design of the parties.” [citation omitted] Clearly, the manifest design of homeowners’ insurance is to protect homeowners from risks associated with the home and activities related to the home. Contrary to the position taken by Worcester Mutual, negligent supervision, unlike negligent entrustment, is a theory of recovery that is separate and distinct from the use or operation of an automobile. Thus, the negligent supervision theory advanced by Alioto and the cause of action pertaining to the negligent failure of the Marnells to prevent their son from drinking relate only to activities that are alleged to have taken place within the Marnells’ home. Therefore, the Marnells could reasonably expect to be protected by their homeowners’ policy in an action based on those activities.

496 N.E.2d 158, 161 (Mass. 1986).

1. The default rule in favor of a subjective standard for expectation and intent.The expected-or-intended exclusion originally appeared as part of the definition of occurrence, as part of the shift from accident- to occurrence-based coverage, see Donald F. Farbstein & Francis J. Stillman, Insurance for the Commission of Intentional Torts, 20 HASTINGS L.J. 1219, 1220–1221 & 1236–1237 (1969) (describing the two ambiguities of the term “accident” in relation to gradual events and the perspective from which to consider whether an event is accidental and explaining that “[b]y replacing the term ‘accident’ with that of ‘occurrence,’ and by supplying the definition [of occurrence] quoted above, the new policy seeks to eliminate the major ambiguities noted earlier”). The formulation for what it means to subjectively expect harms is taken from Shell Oil Co. v. Winterthur Swiss Ins. Co., 15 Cal. Rptr. 2d 815, 835–836 (Ct. App. 1993) (adopting subjective standard for expected):

Our conclusion on the meaning of “expected or intended” is not unique. Patrons–Oxford Mut. Ins. Co. v. Dodge, 426 A.2d [888] 892, [(Me. 1981)] adopted essentially the same interpretation, albeit without examining the words’ ordinary and popular meanings. The court decided that damage “‘… which is either expected or intended from the standpoint of the Insured’” refers only to damage “that the insured in fact subjectively wanted (‘intended’) to be a result of his conduct or in fact subjectively foresaw as practically certain (‘expected’) to be a result of his conduct.” (Ibid., original emphasis.) Similarly, Quincy Mut. Fire Ins. Co. v. Abernathy (1984) 393 Mass. 81, 469 N.E.2d 797, 800, held that “expected” requires a showing that the insured “knew to a substantial certainty” that damage would ensue. “Had the insurer intended a different result, it could have used more appropriate language in the exclusion clause.” (Ibid.)

Most courts have held that liability insurance uses the subjective expected-or-intended standard to determine if an accident took place. See, e.g., City of Johnstown, N.Y. v. Bankers Standard Ins. Co., 877 F.2d 1146, 1150-1151 (2d Cir. 1989) (applying New York law) (citations omitted) (“It is not enough that an insured was warned that damages might ensue from its actions, or that, once warned, an insured decided to take a calculated risk and proceed as before. Recovery will be barred only if the insured intended the damages, or if it can be said that the damages were, in a broader sense, ‘intended’ by the insured because the insured knew that the damages would flow directly and immediately from its intentional act. In those instances, coverage is precluded because the damages are not ‘accidental.’”); Brooklyn Law School v. Aetna Cas. & Sur. Co., 849 F.2d 788, 789 (2d Cir. 1988) (applying New York law) (citations omitted) (“Ordinary negligence does not constitute an intention to cause damage; neither does a calculated risk amount to an expectation of damage. To deny coverage, then, the fact finder must find that the insured intended to cause damage.”); Hecla Mining Co. v. N.H. Ins. Co., 811 P.2d 1083, 1088 (Colo. 1991) (citations omitted):

[W]hat make injuries or damages expected or intended rather than accidental are the knowledge and intent of the insured. It is not enough that an insured was warned that damages might ensue from its actions, or that, once warned, an insured decided to take a calculated risk and proceed as before. Recovery will be barred only if the insured intended the damages, or if it can be said that the damages were, in a broader sense, “intended” by the insured because the insured knew that the damages would flow directly and immediately from its intentional act.

SL Indus. Inc. v. Am. Motorists Ins. Co., 607 A.2d 1266, 1278 (N.J. 1992):

[If the insured] subjectively intends or expects to cause some sort of injury, that intent will generally preclude coverage. If there is evidence that the extent of the injuries was improbable, however, then the court must inquire as to whether the insured subjectively intended or expected to cause that injury. Lacking that intent, the injury was “accidental” and coverage will be provided.

Cf. Shell Oil Co. v. Winterthur Swiss Ins. Co., 15 Cal. Rptr. 2d 815 (Ct. App. 1993) (adopting subjective standard for expected); State Farm Fire & Cas. Co. v. CTC Dev. Corp., 720 So. 2d 1072, 1076 (Fla. 1998) (“Uzdevenes did not expect or intend for damages to result from his act of constructing the home. He did not openly defy the setback requirements; he mistakenly believed that he had received a variance for the construction. Therefore, the fact that he intentionally constructed the house knowing that it was outside of the setback line does not preclude a finding of coverage under his liability policy for this ‘occurrence.’”); S. Macomb Disposal Auth. v. Am. Ins. Co., 572 N.W.2d 686, 696 (Mich. Ct. App. 1997) (citation omitted) (“[T]he subjective test applies where an insurance policy uses the term ‘accident’ but is otherwise silent with respect to from whose perspective the event is to be deemed an accident.”); Am. Family Ins. Co. v. Walser, 628 N.W.2d 605, 612 (Minn. 2001) (citation omitted) (“[W]here there is specific intent to cause injury, conduct is intentional for purposes of an intentional act exclusion, and not accidental for purposes of a coverage provision…. [W]here there is no intent to injure, the incident is an accident, even if the conduct itself was intentional.”); Physicians Ins. Co. of Ohio v. Swanson, 569 N.E.2d 906 (Ohio 1991) (adopting subjective standard); Tennessee Farmers Mut. Ins. Co. v. Evans, 814 S.W.2d 49, 54-55 (Tenn. 1991) (detailing seven approaches taken by courts in construing “expected or intended” provisions). But see City of Carter Lake v. Aetna Cas. & Sur. Co., 604 F.2d 1052, 1058–1059 (8th Cir. 1979) (applying Nebraska law) (“For the purposes of an exclusionary clause in an insurance policy, the word ‘expected’ denotes that the actor knew or should have known that there was a substantial probability that certain consequences will result from his actions.”); Employers Mut. Cas. Co. v. Fisher Builders, Inc., 371 P.3d 375, 379 (Mont. 2016) (finding a purely subjective intent analysis of an “expected or intended” policy exclusion “incomplete” and incorporating an objective “second prong of the analysis”). For an example of a case from a jurisdiction with an objective standard adopting an exception, see Amco Ins. Co. v. Haht, 490 N.W.2d 843, 848 (Iowa 1992) (finding an exception to an intentional tort-like standard in a case in which a young boy killed a friend by throwing a baseball at him).

For authority on the relationship between mental illness and the expected-or-intended exclusion, see, e.g., Globe Am. Cas. Co. v. Lyons, 641 P.2d 251, 254 (Ariz. Ct. App. 1981) (“if [insured] was suffering from mental derangement which deprived her of her capacity to act in accordance with reason and while in that condition acted on an irrational compulsion to drive her vehicle into oncoming traffic, her act was not ‘intentional’”); Prasad v. Allstate Ins. Co., 644 So. 2d 992, 995 (Fla. 1994) (stabbing injury by psychotic brother on his sister was not an “accident”); Rajspic v. Nationwide Mut. Ins. Co., 662 P.2d 534, 536 (Idaho 1983) (comparing the standards for intentional conduct that apply in tort and insurance law, respectively, with respect to insanity); Shelter Mut. Ins. Co. v. Williams, 804 P.2d 1374, 1382 (Kan. 1991) (“We hold that an injury inflicted by an insured who is mentally ill is ‘intentional’ within the meaning of the policy provision excluding coverage for intentional acts of the insured if the insured understands the nature and quality of his acts and intends to cause the injury, even though he is unable to recognize his conduct as wrongful.”); State Farm Fire & Cas. Co. v. Wicka, 474 N.W.2d 324, 331 (Minn. 1991) (“an intent to cause bodily injury requires that the insured possess both cognitive and volitional capacities, either of which may be affected by the insured’s mental illness”); Municipal Mut. Ins. Co. of West Virginia v. Mangus, 443 S.E.2d 455, 458 (W. Va. 1994) (“coverage under an intentional injury exclusion clause in a homeowners insurance policy may be denied when one who commits a criminal act has a minimal awareness of the nature of his act”). See also Catherine A. Salton, Mental Incapacity and Liability Insurance Exclusionary Clauses: The Effect of Insanity Upon Intent, 78 Cal. L. Rev. 1027 (1990) (discussing two lines of authority). On inferred intent, see, e.g., Fire Ins. Exch. v. Abbott, 251 Cal. Rptr. 620, 629 (Ct. App. 1988) (“Most courts … have inferred a specific intent to injure as a matter of law from the fact of sexual misconduct with a minor.”). See also Kenneth S. Abraham, Insurance Law and Regulation: Cases and Materials 538 (5th ed. 2010) (“Sometimes … subjective intent or expectation can be inferred from the circumstances, perhaps even as a matter of law.”); 3-18 Appleman on Insurance § 18.03 (“Many jurisdictions have recognized that the intent to injure, especially when guns or sexual abuse are involved, can be inferred as a matter of law based on the egregious nature of the act involved and the accompanying foreseeability of harm.”). On limiting imputation of intent to a corporation see, e.g., Travelers Indem. Co. v. Bloomington Steel & Supply Co., 718 N.W.2d 888, 895 (Minn. 2006) (holding that under the terms of the insurance policy, intent or knowledge of an agent of the insured corporation would not automatically be imputed to the corporation for the purposes of determining whether bodily injury inflicted by the agent upon a third party was “expected or intended”); RJC Realty Holding Corp. v. Republic Franklin Ins. Co., 808 N.E.2d 1263, 1265-1266 (N.Y. 2004) (knowledge of masseur who had sexually assaulted customer could not be attributed to employer for purposes of “expect or intend” analysis of coverage for liability of employer). For authority enforcing expected or intended exclusions that explicitly adopt an objective standard, see, e.g., Allstate Ins. Co. v. Barnett, 816 F. Supp. 492, 496 (S.D. Ind. 1993) (holding that a provision excluding losses “which may reasonably be expected to result from the intentional or criminal acts of an insured person or which are in fact intended by an insured person” was “clear and unambiguous and provides an objective standard”); Allstate Ins. v. Cruse, 734 F. Supp. 1574, 1581 (M.D. Fla. 1989) (“This Court … finds that the intentional acts exclusion at issue in this case requires the Court to apply an objective standard to [insured’s] intentional acts.”); Allstate Ins. Co. v. Peasley, 932 P.2d 1244, 1247 (Wash. 1997) (excluding losses from “any bodily injury which may reasonably be expected to result from the intentional or criminal acts of an insured person or which are in fact intended by an insured person.”). Cf. Eric S. Knutsen, Fortuity Victims and the Compensation Gap: Re-envisioning Liability Insurance Coverage for Intentional and Criminal Conduct, 21 CONN. INS. L.J. 209, 243 (2014) (proposing that the subjective standard should also be applied to the criminal-acts exclusion). Note that there is a minority rule that holds that an intentional injury committed by a third party is not an “accident” with respect to an insured who is sued for failure to supervise that third party. See, e.g., Farm Bur. Mut. Ins. Co. of Idaho v. Cook, 414 P.3d 1194, 1198 (Idaho 2018).

Illustration 2 is based on the facts in State Farm Mut. Auto. Ins. Co. v. Worthington, 405 F.2d 683 (8th Cir. 1968). Illustration 3 is based on Am. Family Mut. Ins. Co. v. Johnson, 816 P.2d 952 (Colo. 1991).

1. Burden of proof.Courts generally require the insurer to bear the burden of proving that a claim falls within the scope of an exclusion in the policy. See, e.g., Ment Bros. Iron Works Co. v. Interstate Fire & Cas. Co., 702 F.3d 118, 121 (2d Cir. 2012) (applying New York law) (“Under New York law … an insurer bears the burden of proving that an exclusion applies.”); N.H. Ins. Co. v. Martech USA, Inc., 993 F.2d 1195, 1199 (5th Cir. 1993) (applying Texas law) (“[U]nder … Texas law, the burden is on the insurer to prove the applicability of policy exclusions.”); Capital Envtl. Servs., Inc. v. N. River Ins. Co., 536 F. Supp. 2d 633, 640 (E.D. Va. 2008) (applying Virginia law) (citations omitted) (“[T]he insurer bears the burden of proving that any coverage exclusion applies.”); HLTH Corp. v. Clarendon Nat’l Ins. Co., No. 07C-09-102 RRC, 2009 WL 2849779, at *22 (Del. Super. Ct. Aug. 31, 2009), aff’d sub nom. Axis Reinsurance Co. v. HLTH Corp., 993 A.2d 1057 (Del. 2010), as corrected (May 10, 2010) (“Under Delaware law, because the Plaintiffs have established, and the parties do not dispute, that their loss is within the terms of the policies, Defendants, as insurers, bear the burden of establishing that the Prior Notice Exclusion bars coverage.”); Great Am. Ins. Co. v. Gaspard, 608 So. 2d 981, 984 (La. 1992) (“As with any exclusion in an insurance policy, the insurer bears the burden of proving that the intentional injury provision is applicable.”); Int’l Paper Co. v. Cont’l Cas. Co., 320 N.E.2d 619, 622 (N.Y. 1974) (citation omitted) (“The insurer is cloaked with the burden of proving that the incident and claim thereunder came within the exclusions of the policy”); Madison Constr. Co. v. Harleysville Mut. Ins. Co., 735 A.2d 100, 106 (Pa. 1999) (“Where an insurer relies on a policy exclusion as the basis for its denial of coverage and refusal to defend, the insurer has asserted an affirmative defense and, accordingly, bears the burden of proving such defense.”); 17A STEVEN PLITT, DANIEL MALDONADO, JOSHUA D. ROGERS & JORDAN R. PLITT, COUCH ON INSURANCE § 254:12 (3d ed. 2017) (“The insurer bears the burden of proving the applicability of policy exclusions and limitations or other types of affirmative defenses, in order to avoid an adverse judgment after the insured has sustained its burden and made its prima facie case.”).

1. An exception to an exclusion.See, e.g., Sikirica v. Nationwide Ins. Co., 416 F.3d 214, 228 (3d Cir. 2005) (applying Pennsylvania law) (“The Contractual Liability provision broadens the definition of ‘incidental contract’ as used in the exception to the exclusion provision, but it does not extend coverage of the Policy to injury or damages that are not the result of an ‘occurrence’ or ‘accident.’”); Sheehan Constr. Co. v. Cont’l Cas. Co., 935 N.E.2d 160, 162 (Ind. 2010) (citations omitted) (“Exceptions to exclusions narrow the scope of the exclusion and, as a consequence, add back coverage. However, it is the initial broad grant of coverage, not the exception to the exclusion, that ultimately creates (or does not create) the coverage sought.”); Nav-Its, Inc. v. Selective Ins. Co. of Am., 869 A.2d 929, 939 (N.J. 2005) (“We interpret that exception to limit the reach of the pollution clause, i.e. if the environmental pollution occurs within a building within a single forty-eight hour period, and the other conditions are met, then the insured may receive coverage for that environmental pollution claim. Simply put, if the pollution exclusion is not applicable, neither is the exception to the pollution exclusion.”); K & L Homes, Inc. v. Am. Family Mut. Ins. Co., 829 N.W.2d 724, 728 (N.D. 2013) (citation omitted) (“Likewise, although an exception to an exclusion from coverage results in coverage, an exception to an exclusion is incapable of initially providing coverage; rather, an exception may become applicable if, and only if, there is an initial grant of coverage under the policy and the relevant exclusion containing the exception operates to preclude coverage.”). For an example of a court using an exception to an exclusion as a guide to interpretation of coverage, see Panfil v. Nautilus Ins. Co., No. 12 C 6481, 2014 WL 52774, at *2 (N.D. Ill. Jan. 7, 2014), aff’d, 799 F.3d 716 (7th Cir. 2015) (applying Illinois law):

Defendant correctly notes that, under Illinois law, “an exception to an exclusion does not create coverage or provide an additional basis for coverage, but, rather, merely preserves coverage already granted in the insuring provision.” [citation omitted] I do not suggest that this exception to an exclusion has “created” coverage. But by “preserving coverage already granted in the insuring provision,” an exception to an exclusion does offer some indication as to what the policy itself is meant to cover.

See also Architex Ass’n, Inc. v. Scottsdale Ins. Co., 27 So. 3d 1148, 1160 (Miss. 2010) (“The policy exclusions and exceptions thereto can be (and often are) valuable in determining the parameters of coverage, generally, and the meaning of ‘accident’ within the definition of ‘occurrence,’ specifically.”).

Case Citations - by Jurisdiction

________________________________________________________________________________________________________________________________________________________

• ^Me.
• ^N.M.

D.Me.

D.Me.2019. Com. (e) cit. in sup. Insured lawyer and law firm sued insurer, seeking a defense against a class action filed against them by investors who alleged, among other things, that insureds drafted faulty and misleading legal documents and were involved in the improper sale of securities in violation of federal securities laws. This court denied in part insurer’s motion for summary judgment, holding that it had a duty to defend insureds against the class action, notwithstanding the policy’s investment-advice exclusion. The court reasoned, in part, that insurer failed to meet its burden under Restatement of Liability Insurance § 32 of establishing that the investment-advice exclusion applied, because investors did not allege that insureds rendered investment advice to them, or advised them to make an investment or refrain from doing so. Marcus v. Allied World Insurance Company, 384 F.Supp.3d 115, 123.

D.N.M.

D.N.M.2020. Subsecs. (1) and (5) quot. in sup. Insurer that had issued a professional-liability-insurance policy to nonprofit provider of trustee services for disabled individuals sued insured after its CEO pleaded guilty to embezzlement, seeking rescission of the policy, as well as a declaration that it had no duty to defend or indemnify insured against claims arising from CEO’s actions, on the ground that CEO made material misrepresentations in insured’s policy application. This court denied insurer’s motion for summary judgment, but rejected insured’s argument that insurer had the burden to prove that insured knew of CEO’s embezzlement in order to establish a lack of coverage. The court held that the prior-knowledge provision contained in the policy created a condition precedent to coverage under Restatement of Liability Insurance § 34, rather than an exclusion under § 32, such that insured had the burden to show that it had no knowledge of circumstances that were likely to lead to a claim in order to be entitled to coverage. Evanston Insurance Company v. Desert State Life Management, 434 F.Supp.3d 1051, 1098, 1103.

Restatement of the Law - Liability Insurance © 2012-2021 American Law Institute. Reproduced with permission. Other editorial enhancements © Thomson Reuters.

Restatement of the Law of Liability Insurance § 44

Restatment of the Law - Liability Insurance | June 2019 Update

Restatement of the Law of Liability Insurance

Chapter 4. Enforceability and Remedies

Topic 1. Enforceability

§ 44 Implied-in-Law Terms and Restrictions

^Comment:

^{Reporters’ Note}

Comment:

a. Implied-in-law terms generally. This Section contains liability-insurance-law applications of general contract-law rules regarding implied-in-law terms and restrictions. Any authoritative source of positive law may lead to an implied-in-law liability insurance term or restriction. Generally, those sources are statutes, regulations, and the common law. Typically, the applicable statutes and regulations are part of the state insurance code or regulations, but there can be liability insurance requirements in other parts of state statutes or regulations.

b. Terms that are unenforceable on public-policy grounds. Subsection (2) restates for the liability insurance context the general contract-law rule regarding terms that are unenforceable on grounds of public policy. See Restatement Second, Contracts § 178(1). As in that Restatement, the term “legislation” is used in this Section in a broad sense to include any fixed text enacted by a body with authority to promulgate rules, including not only statutes but also constitutions and local ordinances, as well as administrative regulations issued pursuant to them. See Restatement Second, Contracts § 178, Comment a.

c. Terms or coverage contrary to judicially declared public policy. Although it is rare for courts to declare that a term in, or coverage provided by, a liability insurance policy is unenforceable because of a judicially recognized public policy, such examples exist, most commonly in relation to the topics addressed in § 45.

d. Factors to be considered. Under Restatement Second of Contracts § 178, the factors to be considered in weighing the interest in the enforcement of a term are: “(a) the parties’ justified expectations, (b) any forfeiture that would result if enforcement were denied, and (c) any special public interest in the enforcement of the particular term.” The factors to be considered in weighing a public policy against enforcement of a term are: “(a) the strength of that policy as manifested by legislation or judicial decisions, (b) the likelihood that a refusal to enforce the term will further that policy, (c) the seriousness of any misconduct involved and the extent to which it was deliberate, and (d) the directness of the connection between that misconduct and the term.”

e. Effect of violation of a state form-review law. State insurance regulatory codes generally require insurance companies to submit all consumer liability insurance forms and most commercial liability insurance forms to the state insurance department for review before those forms may be used in insurance policies sold in the state. The remedy for violating such requirements is a matter of state administrative law. Remedies include fines and other measures directed at encouraging compliance with these requirements. Courts uniformly enforce a liability insurance policy, or a term in a policy, that has not been subject to a required form-review process, except to the extent that the term is otherwise contrary to public policy. If the insured demonstrates that the form-review process would have resulted in a determination that the term could not lawfully be used in the insurance policy at issue, then the term is contrary to public policy and, thus, subject to the balancing-test analysis stated in subsection (2).

Reporters’ Note

a. Implied-in-law terms generally.For examples of courts refusing to enforce policy terms that conflict with implied-in-law terms, see Nationwide Mut. Ins. Co. v. Aetna Life & Cas. Co., 194 S.E.2d 834, 838 (N.C. 1973) (holding that an auto liability insurance policy’s exclusion purporting to eliminate coverage when a vehicle was used by a person employed or engaged in the automobile business was unenforceable because it conflicted with the mandatory requirements of a statute); Nat’l Cty. Mut. Fire Ins. Co. v. Johnson, 879 S.W.2d 1, 3–5 (Tex. 1993) (holding that an auto liability insurance policy’s household exclusion was void because it conflicted with a statute whose purpose was to ensure that all claims for losses arising out of all vehicles’ operation were covered by insurance). For examples of insurance policies being held to include terms through the operation of law, see Flewellen v. Atlanta Cas. Co., 300 S.E.2d 673, 676 (Ga. 1983) (including $50,000 worth of personal-injury protection in an auto liability insurance policy because a statute required that the policy offer such coverage and that the offer could only be rejected in a manner that had not in fact occurred); Watson v. United Servs. Auto. Ass’n, 566 N.W.2d 683, 692 (Minn. 1997) (holding that a homeowner’s insurance policy’s intentional-loss exclusion “must be reformed to comply with the Minnesota standard fire insurance policy,” such that coverage was excluded only for insureds who themselves intentionally cause a loss, rather than to all innocent people co-insured for that loss as well).

b. Terms that are unenforceable on public-policy grounds.According to the Restatement Second of Contracts § 178 (AM. LAW INST. 1981), public policies that affect the enforcement of contracts are “manifested by legislation or judicial decisions.” “The term ‘legislation’ is used here in the broadest sense to include any fixed text enacted by a body with authority to promulgate rules ….” Id., Comment a. For examples of public policy being supplied by statutes in state insurance codes, see Attorneys Liab. Prot. Soc’y, Inc. v. Ingaldson Fitzgerald, P.C., 370 P.3d 1101 (Alaska 2016); Severs v. Country Mut. Ins. Co., 434 N.E.2d 290 (Ill. 1982); Bishop v. Allstate Ins. Co., 623 S.W.2d 865 (Ky. 1981); Bartell v. Am. Home Assurance Co., 49 P.3d 623 (Mont. 2002). For examples of public policy being supplied by state insurance department regulations, see Diaz v. Progressive Direct Ins. Co., No. CV146047082S, 2015 WL 8487876 (Conn. Super. Ct. Nov. 18, 2015); Liberty Mut. Fire Ins. Co. v. Nat’l Cas. Co., 935 N.Y.S.2d 319 (App. Div. 2011). For examples of public policy affecting the enforceability of liability insurance policies being supplied by noninsurance statutes and regulations, see F.D.I.C. v. Am. Cas. Co. of Reading, Pa., 843 P.2d 1285, 1290 (Colo. 1992) (relying on state banking code); Jones v. Bituminous Cas. Corp., 821 S.W.2d 798, 802 (Ky. 1991) (relying on an administrative regulation that made liability insurance coverage a precondition for obtaining a mining license); Sensebe v. Canal Indem. Co., 58 So. 3d 441, 446–451 (La. 2011) (relying on a motor vehicle and traffic statute); Nat’l Cty. Mut. Fire Ins. Co. v. Johnson, 879 S.W.2d 1, 2–5 (Tex. 1993) (relying on a traffic statute).

c. Terms or coverage contrary to judicially declared public policy.For example, the highest court in New York held that public policy prohibits insurers from indemnifying their insureds for punitive damages, without reference to any statute or regulation. See Hartford Accident & Indem. Co. v. Vill. of Hempstead, 397 N.E.2d 737, 744 (N.Y. 1979). The court explained that it “reach[ed] that conclusion primarily because to allow insurance coverage is totally to defeat the purpose of punitive damages.” Id. Similarly, the Supreme Court of Kansas has held, without reference to any statute or regulation, that “an insurance policy is void as against public policy if its intent is to indemnify the insured against liability for his criminal acts.” Herrman v. Folkerts, 446 P.2d 834, 837 (Kan. 1968) (citing 44 C.J.S. Insurance § 242b, p. 1005). For examples of courts applying a judicially created public policy against coverage for liabilities stemming from intentional harm, see § 45, Reporters’ Note to Comment g.

e. Effect of violation of a state form-review law.For examples of terms being enforced even though they were not submitted for legally required administrative review, see Powell v. Am. Cas. Co. of Reading, Pa., 772 F. Supp. 1188, 1191 (W.D. Okla. 1991) (positing that the Oklahoma legislature would have explicitly declared endorsements issued in violation of the state’s form-review law void if that was the remedy it had intended); Cage v. Litchfield Mut. Ins. Co., 713 A.2d 281, 285 (Conn. Super. Ct. 1997) (“The majority of jurisdictions which have addressed this issue have concluded that the failure to file the policy or endorsement does not render it invalid.”); Penn Am. Ins. Co. v. Miller, 492 S.E.2d 571, 573 (Ga. Ct. App. 1997) (holding that despite lacking approval “no reason exists to invalidate [the endorsement] as a matter of law”); Nat’l Union Fire Ins. Co. of Pittsburgh, Pa. v. Ambassador Grp., Inc., 157 A.D.2d 293, 298 (N.Y. App. Div. 1990) (“The failure of plaintiff to file Endorsement 11 with the New York Superintendent of Insurance for approval would not mandate rejection of its application herein. Failure to file under Insurance Law §§ 2307 and 3102 does not, by itself, void the policy clause, but rather carries its own penalties for non-filing. Further, such clause is void only if the substantive provisions of the clause are inconsistent with other statutes or regulations.”). In Gen. Refractories Co. v. First State Ins. Co., a district court interpreting Pennsylvania law held that the burden was on the policyholder to show that an exclusion that was never submitted for legally required review violated public policy. No. 04-3509, 2012 WL 568936, at *3 (E.D. Pa. Feb. 22, 2012). To meet that burden, the policyholder had “to demonstrate ‘a plain indication of that policy through long governmental practice or statutory enactments, or of obvious ethical or moral standards.’” Id. at *4 (quoting Heller v. Pa. League of Cities & Municipalities, 32 A.3d 1213, 1220–1221 (Pa. 2011)).

Restatement of the Law - Liability Insurance © 2012-2019 American Law Institute. Reproduced with permission. Other editorial enhancements © Thomson Reuters.

Restatement of the Law of Liability Insurance § 45

Restatment of the Law - Liability Insurance | June 2019 Update

Restatement of the Law of Liability Insurance

Chapter 4. Enforceability and Remedies

Topic 1. Enforceability

§ 45 Insurance of Liabilities Involving Aggravated Fault

^Comment:

^{Reporters’ Note}

Comment:

a. Scope. This Section addresses the insurability of defense costs and damages incurred in legal actions involving aggravated fault. Following the example of the Restatement Second of Contracts, the term “legislation” is used here in a broad sense to include any fixed text enacted by a body with authority to promulgate rules, including not only statutes but also constitutions and local ordinances, as well as administrative regulations issued pursuant to them. As subsection (3) makes clear, this Section does not address the question whether an insurance policy contains terms that would provide such coverage. This latter question is one of interpretation that is addressed using the rules of insurance-contract interpretation set forth in §§ 3 and 4. The rules in this Section apply only if the application of the ordinary rules of insurance-contract interpretation determines that the insurance policy provides the coverage in question. A term in an insurance policy excluding such coverage is enforceable.

b. Defense coverage for criminal proceedings. Payment of the costs of defending criminal proceedings brought against an insured is among the forms of defense coverage that are permissible for liability insurers to provide. Whether such defense costs are insured under a liability insurance policy is a question of interpretation. Although there are no public-policy-based restrictions on such defense coverage under prevailing insurance law, this Section recognizes that such restrictions could be imposed by legislation. See § 44. Courts generally hold that such coverage does not violate public policy, among other reasons because such insurance promotes the presumption of innocence and other constitutionally protected aspects of a criminal defense.

c. Defense coverage for uninsurable civil liabilities. Courts also generally enforce liability insurance defense coverage for uninsurable civil actions. The public-policy objections to insurance of certain liabilities are based upon the premise that the insured is liable for the wrong upon which the remedy is based. Defense coverage provides the means for the insured to contest liability, not to avoid the financial consequences of liability actually assessed. Although there are no public-policy-based restrictions on such defense coverage under prevailing insurance law, this Section recognizes that such restrictions could be imposed by legislation. See § 44.

d. Insurability of civil liability arising out of criminal acts. There is no blanket, public-policy-based objection in insurance law to insuring a civil liability that arises out of a criminal act, even in jurisdictions with public-policy-based restrictions on the insurability of certain kinds of liabilities. In such jurisdictions, the insurability of civil liability arising out of a criminal act generally depends on whether the insured intended to injure the victim or whether punitive damages are assessed. To the extent that public-policy-based limits on insurance coverage are based on a concern about moral hazard, the fact that a wrong is also a crime should reduce that concern, because the presence of criminal penalties will increase whatever deterrence is provided by liability.

e. Insurability of vicarious liability. Courts generally permit insurance coverage of liabilities that are assessed vicariously, even in situations in which the liability of the primary actor would be uninsurable in the jurisdiction, for example liability for punitive damages.

f. Insurability of liabilities based on morally offensive acts. There is some old legal authority supporting the proposition that liability insurance law should limit coverage for morally offensive acts, without regard to the presence of applicable exclusions or absence of incentive effects created by insurance, but recent authority is to the contrary. Such a prohibition would have the unfortunate consequence that the victims of some of the most offensive wrongs would be least likely to be able to obtain redress for those wrongs. That such a situation presently exists for certain liabilities because of exclusions in liability insurance policies (exclusions for certain sexual-molestation suits provide a ready example) does not provide a basis for a common-law prohibition of such coverage.

g. Insurability of liability for intentional harm. Insurance law recognizes the potentially deleterious consequences that could result from the incentives created by liability insurance for intentional harm. Because intentional harm is ordinarily under the conscious control of the insured, and because such harm may even be part of the objective of the insured’s wrongful act, insurance of the liabilities arising out of such wrongful acts poses a potential threat to the deterrence and retribution purposes of liability law. Nevertheless, these deterrence- and retribution-based concerns do not support a blanket prohibition on insurance of all liabilities arising out of intentional injuries. In many cases, the presence or absence of insurance has no effect on the behavior of the wrongdoer. The case of an assault that occurs in the heat of passion is an obvious example, but many wrongs are committed without regard for the consequences or the presence or absence of insurance covering the potential liability. Moreover, the presence of liability insurance can promote, rather than hinder, the objectives of tort law, by providing compensation for the victim as well as the means to employ the civil-justice system to name, blame, and shame the defendant. Although there are some state statutes and judicial opinions that state that intentional injuries are not insurable, those statutes and decisions have generally not been tested in relation to liability insurance policies that explicitly provide coverage for intentional torts as described in Comment h.

h. Insurance coverage of liability for intentional harm. The contemporary liability insurance market includes a variety of policy forms that cover intentional common-law or statutory torts, for example: defamation, disparagement, trademark infringement, unfair competition, false imprisonment, employment discrimination, wrongful termination, malicious prosecution, invasion of privacy, and certain statutory violations. Courts regularly enforce insurers’ promises to provide these coverages, even in cases involving intentional injuries, typically without any mention of the tension between these coverages and the traditional public-policy-based concern about insurance for intentional harm. Those relatively few cases that do discuss the insurability issue generally resolve that issue by explaining that providing liability insurance (a) does not undercut the purpose of the underlying liability and (b) promotes the compensation purpose of that liability. Cases enforcing the “final adjudication” clause in certain intentional-harm or misconduct exclusions also result in coverage for liabilities involving intentional harm. The final-adjudication clause in such exclusions generally states that the exclusion applies to a legal action only if there has been final adjudication of the designated misconduct in that legal action. The practical impact of the clause is that even a post-trial settlement of the underlying legal action prevents the exclusion from being applied, because the settlement means that there was no “final adjudication” of the misconduct.

i. Insurability of liability for punitive damages. There is a split in the authority regarding the insurability of liability for punitive damages. The courts in the majority of states that have considered the issue have held that liability for punitive damages is insurable, leaving the question of whether a liability insurance policy provides coverage for punitive damages to the interpretation of the insurance policy. Courts in nearly as many states have held that liability insurance for directly assessed punitive damages contravenes the public policy of the state, in some cases as expressed in legislation and in other cases as a matter of judicially declared public policy.

Courts that prohibit insurance for direct punitive damages provide both deterrence- and retribution-based justifications for this decision. As with insurance of liabilities arising out of intentional injuries, these justifications do not apply with equal force in all cases involving punitive damages. Under the deterrence justification, punitive damages are sometimes necessary to create incentives for parties to take reasonable care to avoid accidents, and insurance could dampen the incentive effect of such awards. However, punitive damages can be assessed in situations in which there is little or no reason to believe that the presence of liability insurance for punitive damages will have any effect on behavior, for example in the drunk-driving context or other contexts in which there are widely known criminal penalties. Under the retributivist justification, punitive damages represent a consequence for highly wrongful conduct, and insurance lessens the sting of that consequence. However, the availability of insurance for punitive damages may promote the retributive objectives of punitive damages, especially when defendants lack the resources to pay a substantial punitive-damages judgment. The availability of insurance against liability for punitive damages helps to motivate the plaintiff to bring an action against the wrongful actor and thereby express the public commitment to the value of persons that is one of the core principles of retribution.

Moreover, a declaration that insuring against liability for punitive damages violates the public policy of a state often turns out to have little or no effect, other than to lead insureds to find the coverage elsewhere. Specifically, large organizations and wealthy individuals can procure, and regularly do procure, insurance that covers direct punitive damages even when those damages are assessed in jurisdictions in which courts have declared that such insurance violates the public policy of the state. Policyholders obtain such insurance by purchasing insurance issued with insurance policy forms that contain favorable choice-of-law and venue clauses and, often, arbitration clauses. Sometimes this insurance is purchased in offshore jurisdictions. This means that a prohibition against insurance for punitive-damages awards primarily affects legal actions brought against individuals and small- to medium-sized businesses, significant numbers of which are likely to be, for practical purposes, judgment proof and, thus, unaffected by whatever incentive effects might in theory result from that insurance.

Reporters’ Note

b. Defense coverage for criminal proceedings.Directors’ and Officers’ liability insurance regularly provides coverage for criminal-defense costs. See Tom Baker & Sean Griffith, The Missing Monitor in Corporate Governance: The Directors’ and Officers’ Liability Insurer, 95 GEO. L.J. 1795, 1805 (2007). For a discussion of criminal-defense coverage provided by the National Rifle Association, see generally Tom Baker, Liability Insurance at the Tort-Crime Boundary, in FAULT LINES: TORT LAW AS CULTURAL PRACTICE (David M. Engel & Michael McCann eds., Stanford U. Press 2009).

c. Defense coverage for uninsurable civil liabilities.See Sean W. Gallagher, The Public Policy Exclusion and Insurance for Intentional Employment Discrimination, 92 MICH. L. REV. 1256, 1261 n.22 (1994) (“Courts are generally willing to enforce insurance to cover defense costs even in cases in which the underlying liability might be uninsurable as a matter of public policy.”). For cases allowing coverage of defense costs, see, e.g., Andover Newton Theological Sch., Inc. v. Cont’l Cas. Co., 930 F.2d 89, 95 (1st Cir. 1991) (applying Massachusetts law) (“Although an argument can be made that a public policy is to some extent subverted by insurance against defense costs, the basic fact is that this is not insurance against liability.”); B&E Convalescent Ctr. v. State Comp. Ins. Fund, 9 Cal. Rptr. 2d 894, 903 (Ct. App. 1992) (“[E]ven though public policy … precludes an insurer from indemnifying an insured in an underlying action the duty to defend still exists so long as the ‘insured reasonably expect[s] the policy to cover the types of acts involved in the underlying suit.’” (quoting Republic Indem. Co. v. Super. Ct., 273 Cal. Rptr. 331, 335 (Ct. App. 1990))).

d. Insurability of civil liability arising out of criminal acts.See generally Tom Baker, Liability Insurance at the Tort-Crime Boundary, in FAULT LINES: TORT LAW AS CULTURAL PRACTICE (David M. Engel & Michael McCann eds., Stanford U. Press 2009). See also Sean W. Gallagher, The Public Policy Exclusion and Insurance for Intentional Employment Discrimination, 92 MICH. L. REV. 1256, 1325 (1994) (“[C]ourts do not necessarily void insurance for civil liability arising out of criminal misconduct, and several courts have even enforced insurance to cover civil liability for criminal sexual assault.”). Careful examination of opinions stating that a liability is uninsurable because it arises out of a criminal act reveals that these cases fall into one of two categories: (1) the insurance policy contains an exclusion for liabilities arising out of criminal acts; (2) the criminal act involved an intentional injury. For cases stating that the insurability of liability arising out of a criminal act depends on whether the insured intended to injure the victim or whether punitive damages are assessed, see, e.g., Penzer v. Transp. Ins. Co., 545 F.3d 1303, 1310–1311 (11th Cir. 2008) (applying Florida law) (explaining that Florida public policy against insuring for intentional misconduct does not apply when liability is not predicated on intent); Nationwide Mut. Ins. Co. v. Machniak, 600 N.E.2d 266, 268 (Ohio Ct. App. 1991) (holding that intentional-injury exclusion did not apply to insured’s conviction for felonious assault because the crime is not statutorily defined as a specific-intent crime); Nielsen v. St. Paul Cos., 583 P.2d 545, 547–548 (Or. 1978) (explaining that the public policy against insurability does not attach to all unlawful acts or even all intentional acts but attaches only in the specific scenario in which the actor’s purpose is to inflict harm).

e. Insurability of vicarious liability.See Sean G. Gallagher, The Public Policy Exclusion and Insurance for Intentional Employment Discrimination, 92 MICH. L. REV. 1256 (1994) (discussing insurance coverage for intentional discrimination by an employee that is imputed to an employer); Catherine M. Sharkey, Revisiting the Noninsurable Costs of Accidents, 64 MD. L. REV. 409 (2005) (discussing insurability of vicariously assessed punitive damages).

f. Insurability of liabilities based on morally offensive acts.See generally Tom Baker, Liability Insurance at the Tort-Crime Boundary, in FAULT LINES: TORT LAW AS CULTURAL PRACTICE (David M. Engel & Michael McCann eds., Stanford U. Press 2009); Mary Coates McNeeley, Illegality as a Factor in Liability Insurance, 41 COLUM. L. REV. 26 (1941). For cases demonstrating a concern for victim compensation, see, e.g., Aetna Life & Cas. Co. (Cas. & Sur. Div.) v. McCabe, 556 F. Supp. 1342, 1353 (E.D. Pa. 1983) (applying Pennsylvania law) (holding that physician’s intentional malpractice would be covered under insurance policy because (1) nothing suggested that the physician bought the insurance in contemplation of committing malpractice, (2) there was no basis to believe denying coverage would have a deterrent effect, and (3) Pennsylvania’s interest in compensating victims of malpractice outweighed Pennsylvania’s recognized interest in deterring intentional torts); Grinnell Mut. Reinsurance Co. v. Jungling, 654 N.W.2d 530, 538, 541 (Iowa 2002) (citations omitted) (noting that the interest in victim compensation was found to “outweigh[ ] the public interest in forcing the willful wrongdoer to pay the consequences of the wrongdoing” and “the ultimate and primary beneficiaries of coverage [for intentional wrongdoing] will be innocent third parties”); Burd v. Sussex Mut. Ins. Co., 267 A.2d 7, 15–16 (N.J. 1970) (noting that the public interest in victim compensation and the insured’s interest in maximum protection under the contract weigh against an overly broad reading of the public-policy exclusion). For cases finding that a liability insurance policy, absent a pertinent exclusion, covers morally offensive acts, see, e.g., Bailer v. Erie Ins. Exch., 687 A.2d 1375, 1376, 1385 (Md. 1997) (finding coverage for an invasion-of-privacy suit when an insured surreptitiously videotaped an au pair while she was showering); Vigilant Ins. Co. v. Kambly, 319 N.W.2d 382, 385 (Mich. Ct. App. 1982) (Finding coverage for malpractice when a doctor induced his patient to engage in a sexual relationship with him as part of her therapy, the court reasoned, “coverage does not allow the wrongdoer unjustly to benefit from his wrong. It is not the insured who will benefit, but the innocent victim who will be provided compensation for her injuries.”); S. Carolina State Budget & Control Bd., Div. of Gen. Servs., Ins. Reserve Fund v. Prince, 403 S.E.2d 643, 647 (S.C. 1991) (determining that it would be unreasonable to exclude coverage for defamation when the insurance policy specifically provided for that coverage). See also Ill. Farmers Ins. Co. v. Keyser, 956 N.E.2d 575, 578 (Ill. App. Ct. 2011) (finding coverage for malicious-prosecution suit because “it is … a fundamental policy in Illinois that when an insured pays a premium and an insurance company accepts it and promises coverage based on the premium paid, the insurer should be required to fulfill its obligation.”).

g. Insurability of liability for intentional harm.For cases finding intentional harm uninsurable, see, e.g., Regence Grp. v. TIG Specialty Ins. Co., 903 F. Supp. 2d 1152, 1161 (D. Or. 2012) (applying Oregon law) (citations omitted) (“Oregon has long recognized the principle that ‘a clause in a contract of insurance purporting to indemnify the insured for damages recovered against him as a consequence of his intentional conduct in inflicting injury upon another is unenforceable by the insured on the ground that to permit recovery would be against public policy.’”); Thomas v. Benchmark Ins. Co., 179 P.3d 421, 425 (Kan. 2008) (citations omitted) (“Kansas public policy prohibits insurance coverage for intentional acts: ‘[A]n individual should not be exempt from the financial consequences of his own intentional injury to another.’”). See also Nat’l Fire Ins. Co. of Hartford v. Lewis, 898 F. Supp. 2d 1132, 1146 (D. Ariz. 2012) (applying Arizona law) (holding that policy provisions extending to intentional acts are prohibited by public policy under Arizona law); Chiquita Brands Int’l, Inc. v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 988 N.E.2d 897, 900 (Ohio Ct. App. 2013) (citations omitted) (“Ohio public policy generally prohibits obtaining insurance to cover damages caused by intentional torts.”). For a discussion of how the justifications for the “public policy exception” are overbroad, see generally Christopher C. French, Debunking the Myth That Insurance Coverage Is Not Available or Allowed for Intentional Torts or Damages, 8 HASTINGS BUS. L.J. 65 (2012). For cases demonstrating a concern for victim compensation, see Reporters’ Note to Comment f. On the difficulty of collecting money from an uninsured defendant, see Steven G. Gilles, The Judgment Proof Society, 63 WASH. & LEE L. REV. 603 (2006).

Note that, for the purposes of the public-policy exception, intent is often defined in a very restrictive manner that severely constrains the scope of the exception. See Nielsen v. St. Paul Cos., 583 P.2d 545, 547–548 (Or. 1978) (explaining that the public policy against insurability does not attach to all unlawful acts or even all intentional acts but attaches only in the specific scenario in which the actor’s purpose is to inflict harm). As a result, actions taken in self-defense, which are intentional but are not taken for the purpose of injuring another, are often covered by insurance policies. See Fire Ins. Exch. v. Berray, 694 P.2d 191, 193 (Ariz. 1984) (citation omitted) (“[A]n act committed in self-defense should not be considered an ‘intentional act’ within the meaning of the exclusion.”). Further, even intentional harm may not fall within the public-policy exclusion if the underlying violation does not require intent. See Penzer v. Transp. Ins. Co., 545 F.3d 1303, 1310–1311 (11th Cir. 2008) (explaining that Florida public policy against insuring intentional misconduct does not apply when liability is not predicated on intent). See also Nationwide Mut. Ins. Co. v. Machniak, 600 N.E.2d 266, 268 (Ohio Ct. App. 1991) (holding that intentional-injury exclusion did not apply to insured’s conviction for felonious assault because the crime is not statutorily defined as a specific-intent crime).

h. Insurance coverage of liability for intentional harm.Couch describes the case law enforcing insurance for intentional torts as follows:

Even though it may be against public policy to insure for an insured’s intentional or willful conduct, some jurisdictions may find coverage for the conduct when the policy language specifically provides coverage for that conduct; a statute allows insurance for intentional conduct; or the court finds that the public interest in having victims compensated for their injuries, outweighs public interest in forcing the willful wrongdoer to pay the consequences of the misconduct.

7 STEVEN PLITT, DANIEL MALDONADO, JOSHUA D. ROGERS & JORDAN R. PLITT, COUCH ON INSURANCE § 101:24 (3d ed. 2017). For cases finding coverage under liability insurance provisions that cover intentional wrongs, see, e.g., Cincinnati Ins. Co. v. Zen Design Grp., Ltd., 329 F.3d 546, 549 (6th Cir. 2003) (applying Michigan law) (enforcing a business liability policy that covered “slander,” “libel,” “misappropriation of advertising ideas or style of doing business,” and “infringement of copyright, title, or slogan.”); North Bank v. Cincinnati Ins. Cos., 125 F.3d 983, 985 (6th Cir. 1997) (applying Michigan law) (finding coverage for employment discrimination under a policy that explicitly covered discrimination); Dixon Distrib. Co. v. Hanover Ins. Co., 641 N.E.2d 395, 402 (Ill. 1994) (concluding that providing coverage for an allegedly intentional wrongful termination did not violate the public policy of Illinois); Ill. Farmers Ins. Co. v. Keyser, 956 N.E.2d 575, 577–579 (Ill. App. Ct. 2011) (finding coverage for malicious prosecution under a homeowner’s policy that explicitly covered “false arrest, imprisonment, malicious prosecution, and detention.”); Bailer v. Erie Ins. Exch., 687 A.2d 1375, 1376–1377 (Md. 1997) (finding coverage for an invasion-of-privacy suit under a personal-catastrophe liability policy); S.C. State Budget & Control Bd., Div. of Gen. Servs., Ins. Reserve Fund v. Prince, 403 S.E.2d 643, 644 (S.C. 1991) (holding that an insurer had a duty to indemnify under a policy that explicitly provided coverage for defamation). For cases finding coverage for intentional conduct and demonstrating a concern for victim compensation, see Reporters’ Note to Comment f.

For sources noting that covering intentionally caused harm does not undercut the purpose of the underlying liability, see, e.g., Yousuf v. Cohlmia, 741 F.3d 31, 41 (10th Cir. 2014) (applying Oklahoma law) (“ANPAC’s policies covering Dr. Cohlmia specifically provide indemnification for certain intentional conduct, and there is no evidence that the availability of insurance coverage induced Dr. Cohlmia to engage in intentional conduct. Furthermore, the interest in compensating an innocent third party, Dr. Yousuf, outweighs the concern that Dr. Cohlmia would unjustly benefit from the coverage.”); N. Bank v. Cincinnati Ins. Cos., 125 F.3d 983, 988 (6th Cir. 1997) (applying Michigan law) (enforcing insurance against intentional discrimination, noting that high premiums, bad publicity for businesses, and the “trauma of litigation” likely eliminated any effect that insurance may have in encouraging an insured to commit intentional torts); St. Paul Fire & Marine Ins. Co. v. Jacobson, 826 F. Supp. 155, 157 (E.D. Va. 1993) (applying Virginia law) (enforcing insurance against intentionally caused harm, noting that the existence of criminal sanctions for the doctor’s behavior served as a greater deterrent than civil liability and that no evidence suggested the presence of insurance encouraged his behavior), aff’d, 48 F.3d 778 (4th Cir. 1995); Aetna Life & Cas. Co. (Cas. & Sur. Div.) v. McCabe, 556 F. Supp. 1342, 1353 (E.D. Pa. 1983) (applying Pennsylvania law) (holding that physician’s intentional malpractice would be covered under insurance policy because (1) nothing suggested that the physician bought the insurance in contemplation of committing malpractice, (2) there was no basis to believe denying coverage would have a deterrent effect, and (3) Pennsylvania’s interest in compensating victims of malpractice outweighed Pennsylvania’s recognized interest in deterring intentional torts); Ill. Farmers Ins. Co. v. Keyser, 956 N.E.2d 575, 579 (Ill. 2011) (“[T]here is nothing inherently unreasonable or inconsistent with Illinois public policy in allowing an individual to insure himself against damages caused by certain intentional acts, except to the extent that the insured wrongdoer may not be the person who recovers the policy proceeds.”). See also Donald F. Farbstein & Francis J. Stillman, Insurance for the Commission of Intentional Torts, 20 HASTINGS L.J. 1219, 1254 (1969) (suggesting that uninsurability could be roughly limited to areas of civil damages intended to deter the wrongdoer rather than compensate the victim); Christopher C. French, Debunking the Myth That Insurance Coverage Is Not Available or Allowed for Intentional Torts or Damages, 8 HASTINGS BUS. L.J. 65, 94 (2012) (noting that other deterrents, including the threat of jail time or concern with injuring oneself, loom much larger than any concern with civil liability that the presence of insurance may alleviate). Cf. Ranger Ins. Co. v. Bal Harbour Club, Inc., 549 So. 2d 1005, 1005–1006 (Fla. 1989) (refusing to enforce insurance coverage for intentional religious discrimination based on a two-part test that would permit insurance for intentional injuries in other contexts: (1) whether the conduct of the insured is the type that will be encouraged by insurance; and (2) whether the purpose of the imposition of liability is to deter wrongdoers or to compensate victims).

On the final-adjudication clause, see, e.g., Pendergest-Holt v. Certain Underwriters at Lloyd’s of London, 600 F.3d 562, 572–573 (5th Cir. 2010) (applying Texas law) (quotations omitted) (“When a D&O policy requires a ‘final adjudication’ to trigger an exclusion, ‘courts have consistently held that the adjudication must occur in the underlying D&O proceeding,’ rather than in a parallel coverage action or other lawsuit…. In contrast, courts have generally imbued ‘in fact’ language with a broader scope than ‘final adjudication,’ holding, for example, that the term requires a final decision on the merits in either the underlying case or a separate coverage case, or an admission by the insured.”); Atl. Permanent Fed. Sav. & Loan Ass’n v. Am. Cas. Co. of Reading, Pa., 670 F. Supp. 168, 172 (E.D. Va. 1986) (applying Virginia law) (“The Court finds that under the Directors and Officers Policy issued by the defendant, the exclusion for the dishonesty of the directors and officers must have been finally adjudicated in the underlying action in order for the defendant to assert it as an exclusion under the policy. The Court is of the opinion that the wording of the exclusion supports this result.”); JOHN H. MATHIAS, JR., MATTHEW M. NEUMEIER, TIMOTHY W. BURNS & JERRY J. BURGDOERFER, DIRECTORS AND OFFICERS LIABILITY: PREVENTION, INSURANCE AND INDEMNIFICATION at § 8.04 (2003) (collecting cases holding that “[i]f the exclusion requires a final adjudication, that adjudication generally must take place in the underlying action for which coverage is sought”); Alan Rutkin & Robert Tugander, Dishonesty and Personal Profit Exclusions As Bars for Coverage for Suits Arising from the Subprime Crisis, 44 TORT TRIAL & INS. PRAC. L.J. 169, 177 (2008) (Courts have tended to hold that the adjudication must take place in the underlying litigation, not in coverage litigation.). For discussion of the practical impact of the final-adjudication language based on field research, see TOM BAKER & SEAN GRIFFITH, ENSURING CORPORATE MISCONDUCT 49 & 187 (2010).

i. Insurability of liability for punitive damages.Some courts refuse on public-policy grounds to enforce contracts that cover punitive damages, while other courts leave the question of liability insurance coverage for all punitive damages, both vicarious and direct, to the insurance contract. See generally BARRY R. OSTRAGER & THOMAS R. NEWMAN, HANDBOOK ON INSURANCE COVERAGE DISPUTES, § 14 Insurance Coverage for Punitive Damages Assessed Against an Insured, and § 14.06 Survey of the Insurability of Punitive Damages in Various Jurisdictions (18th ed. 2016); Catherine M. Sharkey, Revisiting the Noninsurable Costs of Accidents, 64 MD. L. REV. 409 (2005) (discussing jurisdictions’ differing approaches to the insurability of punitive damages, including an appendix with a 50-state survey, and noting how underwriters and insurance brokers have begun to circumvent public-policy objections to insuring punitive damages by including “most favorable venue” language, “a kind of ‘choice-of-law’ provision that specifies, for example, that if an issue arises regarding punitive damages, the carrier will apply the law and public policy of an applicable state with the ‘most favorable’ view of insurance coverage for punitive damages.”). For a discussion of why a deterrence- and retribution-based justification for an implied-in-law exclusion for direct punitive damages is overbroad, see generally Tom Baker, Reconsidering Insurance for Punitive Damages, 1998 WIS. L. REV. 101 (1998). Acknowledgment that the common law is, as a practical matter, unable to prevent the sale or purchase of such insurance could have the salutary effect of prompting action by regulatory authorities, which have greater powers than courts to detect and prevent the sale or purchase of, or payment under, such policies, and greater expertise in the determination of when such insurance is likely to have undesirable consequences.

Restatement of the Law - Liability Insurance © 2012-2019 American Law Institute. Reproduced with permission. Other editorial enhancements © Thomson Reuters.

Restatement of the Law of Liability Insurance § 46

Restatment of the Law - Liability Insurance | June 2019 Update

Restatement of the Law of Liability Insurance

Chapter 4. Enforceability and Remedies

Topic 1. Enforceability

§ 46 Insurance of Known Liabilities

^Comment:

^{Reporters’ Note}

Comment:

a. History and rationale for the known-loss doctrine. This Section addresses the known-loss doctrine, a first-party insurance-law doctrine that was extensively litigated in the context of early 1990s environmental liability-insurance-coverage litigation involving coverage under occurrence-based commercial general-liability insurance policies. Most jurisdictions that have considered the known-loss doctrine in that liability insurance context have adopted the narrow version of the doctrine followed in this Section, but there are only a few reported decisions in which the doctrine serves as the sole ground for decision, and there are nearly as many reported decisions rejecting or raising questions about the doctrine. Two rationales have been proposed for the doctrine: the fortuity principle in insurance law and protecting the insurance pool from policyholders who conceal known losses.

b. The fortuity principle. The fortuity principle reflects the historic and analytical connections between risk and insurance. Historically, insurance institutions developed to provide protection from losses that were contingent or uncertain (referred to in early sources as losses that were subject to chance), and many justifications for the value of insurance focus on how the reduction in financial uncertainty provided by insurance promotes individual and social welfare. From this history has come the idea that fortuity—a synonym for words such as risk, chance, contingency, and uncertainty, all of which have subtly different meanings—is the essence of insurance. That idea has been incorporated in many state statutes that have been drafted for the purpose of identifying the jurisdiction of state insurance departments, although those statutes use the word “contingency” rather than fortuity. But, just as the concept of contingency has proven to provide little guidance to courts regarding boundaries on the jurisdiction of state insurance departments, so, too, has the fortuity principle proven to provide little guidance to courts regarding what liabilities are insurable. As courts have recognized, the degree of fortuity that is required for the insurance market to be able to insure losses is not something that courts are well equipped to determine.

Accordingly, at least in the liability insurance context, most courts have adopted a standard for the known-loss doctrine that represents a very nondemanding application of the fortuity principle. By adopting that standard as a default rule, however, courts have allowed insurers to choose to impose a more demanding fortuity requirement by contract. See § 1(9) (defining “default rule”) and § 1, Comment f (explaining the difference between mandatory and default rules). In addition, because the known-loss doctrine excludes coverage only for an undisclosed, known liability, a policyholder can obtain coverage for a known liability by disclosing it to the insurer in the application or renewal process, subject of course to the insurer’s discretion regarding whether to insure that liability.

c. Rationale for the known-liability standard. There are two competing known-loss standards in the case law. Some courts have applied a broader, known-harm standard that is more common in the first-party insurance context. In the liability insurance context, the more widely applied rule is the narrower, known-liability standard. The known-liability standard better reflects the fortuity principle in the liability insurance context, because the fortuity that the liability insurance market requires is not uncertainty about whether a harm has occurred that might lead to an insured liability, but rather uncertainty about whether there is an insured liability that will reach the level of coverage provided by the insurance policy in question. Even if a harm has already occurred and even if it is foreseeable that the insured will be the subject of a liability action, there remains substantial uncertainty about whether there in fact will be a liability action, whether the plaintiff will succeed in the action, and, if so, for how much and when the judgment will be entered. Liability insurance coverage can be available in some circumstances even when it is a certainty that the insured will be found liable, as long as there is uncertainty about the timing or amount of that liability.

Insurers that wish to avoid coverage for liability arising out of known harms can and do draft their liability insurance policies to exclude that coverage, thereby replacing the known-liability rule followed in this Section with a contractually specified known-harm rule. If insurers are willing to provide coverage for known harms only after evaluating the risk, they can and do ask questions about known harms on their insurance applications to require policyholders to disclose those harms, on pain of losing coverage for misrepresentation.

The known-loss doctrine can produce different results when policyholders have large self-insured retentions than when they have first-dollar coverage. When a policyholder has a large self-insured retention, the known-loss doctrine may not apply to an action involving continuing harm, such as a pollution-liability claim, even if a suit seeking damages attributable to the pollution is filed against the insured prior to the policy period, depending on the amount of potential damages and defense costs and the size of the self-insured retention. By contrast, when a policyholder has first-dollar coverage a suit filed before the policy period regarding harm that the insured knows will continue into the policy period implicates the known-loss doctrine. The touchstone for whether the doctrine applies is substantial certainty that the insured will be subject to liability in an amount that exceeds the deductible or self-insured retention under the policy that is about to be issued.

d. A subjective standard. The known-liability standard is subjective: the known-loss doctrine avoids coverage only if the policyholder knows, prior to the policy period, that it is substantially certain to be held liable in a specific legal action, absent a settlement of that action. The subjective standard best fits the anti-fraud purpose of the known-loss doctrine. As with all subjective standards, this knowledge is capable of proof using circumstantial or other objective evidence, as well as direct evidence of subjective knowledge. Because the subjective-knowledge requirement applies to a specific legal action, the known-loss doctrine does not exclude coverage in a situation in which, because of the nature of the insured’s business, the insured expects to face a particular number of lawsuits in a given year (for example, if the insured manages shopping malls that regularly produce a predictable number of slip and fall claims or the insured owns a fleet of cars that regularly produce a predictable number of auto liability claims). Rather, the doctrine excludes coverage only if the insured is substantially certain, absent settlement, to be held liable to a particular, identified plaintiff or set of plaintiffs.

e. Known defense costs. In considering whether to adopt and how to apply the known-liability rule, courts have focused on the certainty of the insured’s liability in the legal action in question and do not appear to have focused separately on defense costs. Thus, courts have not squarely addressed the circumstance in which a policyholder believes, prior to the policy period, that it is substantially certain to face a legal action that will result in defense costs that would be covered by the policy (if the known-liability rule does not apply), and the policyholder also believes that it will successfully defend the action, such that there will be no liability. Because of the lack of case law on this subject, this Restatement takes no position on the application of the known-liability rule to such situations.

f. Relationship to misrepresentation and concealment doctrine. The known-loss doctrine provides an additional incentive beyond that supplied by the misrepresentation and concealment doctrines for policyholders to disclose known liabilities to their insurers. In contrast to misrepresentation and concealment law, the known-loss doctrine does not require the insurer to prove materiality or reliance. In practice, however, the same result would be reached under both sets of doctrine in most cases, especially if the insurer asked a question in the application process that obligated the policyholder to disclose any known liabilities. Indeed, there are few cases in which the known-loss doctrine provides the sole basis for a decision denying coverage under a liability insurance policy. In most cases, the court’s decision is also based on concealment or fraud.

g. Not a doctrine of legal insurability. The known-loss doctrine obligates policyholders to disclose known liabilities if they want to obtain insurance coverage for those liabilities. The rule does not limit insurers’ freedom to provide insurance of the liabilities so disclosed. Whether a known liability is insurable is a decision for the insurer to make in its discretion.

Reporters’ Note

a. History and rationale for the known-loss doctrine.For cases discussing the history and rationale of the known-loss doctrine, see, e.g., Domtar, Inc. v. Niagara Fire Ins. Co., 563 N.W.2d 724, 737 (Minn. 1997) (citations omitted) (“In this state, ‘known loss’ is a fraud-based defense.”); Ins. Co. of N. Am. v. Kayser-Roth Corp., 770 A.2d 403, 415 (R.I. 2001) (endorsing the view that the known-loss doctrine “is designed to prevent fraud when coverage is sought to be misused to insure a certainty rather than a fortuity” (quoting 3 ERIC MILLS HOLMES, HOLMES’S APPLEMAN ON INSURANCE§ 16.4 (2d ed. 1998))); State v. Hydrite Chem. Co., 695 N.W.2d 816 (Wis. Ct. App. 2005). For examples of courts’ reliance on the fortuity rationale, see Outboard Marine Corp. v. Liberty Mut. Ins. Co., 607 N.E.2d 1204, 1210 (Ill. 1992) (resting the known-loss doctrine on the premise that “[b]y its very nature, insurance is fundamentally based on contingent risks which may or may not occur.”); Gen. Housewares Corp. v. Nat’l Sur. Corp., 741 N.E.2d 408, 414–415 (Ind. Ct. App. 2000) (citing the definition of “insurance” in Black’s Law Dictionary 721 (5th ed. 1979), which states that insurance is “applicable only to some contingency or act to occur in [the] future,” to show that the known-loss doctrine is “inherent to the very concept of insurance.”).

For examples of cases in which the known-loss doctrine serves as the sole ground for decision, see Outboard Marine Corp. v. Liberty Mut. Ins. Co., 607 N.E.2d 1204 (Ill. 1992); SCA Servs., Inc. v. Transp. Ins. Co., 646 N.E.2d 394 (Mass. 1995); Am. Family Mut. Ins. Co. v. Am. Girl, Inc., 673 N.W.2d 65 (Wis. 2004). For examples of cases that reject the known-loss doctrine, see City of Johnstown, N.Y. v. Bankers Standard Ins. Co., 877 F.2d 1146, 1153 (2d Cir. 1989) (predicting that the New York courts would reject the doctrine because it “might well swallow up the more narrow doctrines regarding (1) concealment and misrepresentation, and (2) damages that are ‘expected’ or ‘intended’ by the insured.”); Owens-Corning Fiberglas Corp. v. Am. Centennial Ins. Co., 660 N.E.2d 770, 777–778 (Ohio Ct. C.P. 1995) (explaining that the court is “unwilling to recognize” the doctrine, in part because “the defense that only fortuitous losses are insurable is already provided for in the policy, which states that only an ‘occurrence’ which is neither ‘expected or intended’ will be covered.”).

b. The fortuity principle.The insurance codes of New Mexico and West Virginia provide representative examples of how statutory definitions of insurance incorporate the concept of fortuity: The former defines “insurance” as “a contract whereby one undertakes to pay or indemnify another as to loss from certain specified contingencies or perils, or to pay or grant a specified amount or determinable benefit in connection with ascertainable risk contingencies, or to act as surety,” N.M. Stat. Ann. § 59A-1-5 (West 2018) (emphasis added), and the latter states that “[i]nsurance is a contract whereby one undertakes to indemnify another or to pay a specified amount upon determinable contingencies.” W. Va. Code Ann. § 33-1-1 (West 2018) (emphasis added). Courts occasionally interpret such statutes to mean that insurance policies do not cover known losses. See, e.g., City of Corvallis v. Hartford Accident & Indem. Co., No. 89-294-JU, 1991 WL 523876, at *8 (D. Or. May 30, 1991) (asserting that the known-loss doctrine is “implicit in Oregon’s definition of insurance”); Interstate Fire & Cas. Co. v. Abernathy, 93 So. 3d 352, 358 (Fla. Dist. Ct. App. 2012) (deriving from a statutory definition of insurance that “Florida’s insurance laws embody the fortuity and known loss principles, precluding coverage for losses that have already taken place.”); Henry Modell & Co. v. Gen. Ins. Co. of Trieste & Venice, 193 A.D.2d 412, 412 (N.Y. App. Div. 1993) (citing a statutory definition of insurance for the rule that known losses were not covered by an insurance policy). Significantly, courts have not used the fortuity elements of statutory definitions of insurance as grounds to eliminate coverage for known losses when both parties intended for such coverage to exist.

c. Rationale for the known-liability standard.The known-liability standard for determining the application of the known-loss doctrine has been adopted by more courts than the known-harm standard. See Rohm & Haas Co. v. Cont’l Cas. Co., 781 A.2d 1172, 1182 (Pa. 2001) (Castille, J., dissenting) (calling it “the prevailing standard among those courts recognizing known loss.”); State v. Hydrite Chem. Co., 695 N.W.2d 816, 828 (Wis. Ct. App. 2005) (stating that what this Restatement calls the known-liability standard is “apparently the majority view”). The courts that have adopted the known-liability standard recognize its fidelity to the fortuity principle. As one district court explained:

[T]he occurrence of the event (here, the leak of [pollutants from the insured’s underground storage tanks]) does not destroy the requisite element of statistical uncertainty in the third party liability context, as the relevant events remain to be determined, including: is there any harm to off-site locations; will claims be filed at all; what number of claims will be filed; what sums of money will the claims demand.

UTI Corp. v. Fireman’s Fund Ins. Co., 896 F. Supp. 362, 376 (D.N.J. 1995) (applying Pennsylvania law) (emphasis added).

Similarly, in applying the known-liability standard, the Second Circuit stated:

Though NGC was aware, prior to the inception of many of the policies, that its products risked asbestosis and cancer diseases and had received a large number of claims, it was highly uncertain … as to the prospective number of injuries, the number of claims, the likelihood of successful claims, and the amount of ultimate losses it would be called upon to pay. NGC was fully entitled to replace the uncertainty of its exposure with the precision of insurance premiums and leave it to the insurers’ underwriters to determine the appropriate premiums.

Stonewall Ins. Co. v. Asbestos Claims Mgmt. Corp., 73 F.3d 1178, 1215 (2d Cir. 1995) (applying New York and Texas law) (citations omitted), modified on denial of reh’g, 85 F.3d 49 (2d Cir. 1996). For other courts adopting the known-liability standard for applying the known-loss doctrine, see Stonehenge Eng’g Corp. v. Emp’rs Ins. of Wausau, 201 F.3d 296, 301 (4th Cir. 2000) (applying South Carolina law) (when prior to the inception of the policy period, the policyholder received an inspection report revealing construction defects and a letter threatening legal action, and had been named as a defendant in a lawsuit prior to the policy period, the court held that such notice did not preclude coverage because the evidence existing at the time the policies commenced made liability uncertain); Pittston Co. Ultramar Am. v. Allianz Ins. Co., 124 F.3d 508, 518 (3d Cir. 1997) (applying New Jersey law) (“We think the better rule, and the one likely to be adopted by the New Jersey Supreme Court, is that the known loss doctrine will bar coverage only when the legal liability of the insured is a certainty.”); Columbus Farmers Mkt., LLC v. Farm Family Cas. Ins. Co., No. 05-2087, 2006 WL 3761987, at *11 (D.N.J. Dec. 21, 2006) (applying New Jersey law) (although the policyholder had been subject to raids on its premises and Recording Industry Association of America (“RIAA”) investigations into its activities prior to the policy period, the court held that such notice did not preclude coverage for a lawsuit filed by RIAA members because the policyholder “could not have concluded to any ‘certainty’ that they would be liable” due to uncertainty in the applicable law); Peck v. Pub. Serv. Mut. Ins. Co., 363 F. Supp. 2d 137, 146 & 147 n.6 (D. Conn. 2005) (applying Connecticut law) (when the policyholder had been named as a defendant in the underlying lawsuit prior to the policy period, the court held that coverage was not precluded under the known-loss doctrine because the policyholder was aware only of “potential likely losses,” explicitly disagreeing with case law “from other jurisdictions suggesting that the known loss doctrine applies to a loss for which suit had been filed prior to the effective date of the policy”); UTI Corp. v. Fireman’s Fund Ins. Co., 896 F. Supp. 362, 376 (D.N.J. 1995) (distinguishing first-party cases from the third-party liability insurance context at issue and predicting that the Pennsylvania Supreme Court would require the insurer to prove that “at the time of contracting, there existed certain knowledge of a particular legal liability which would reach the excess layer” at issue); Outboard Marine Corp. v. Liberty Mut. Ins. Co., 607 N.E.2d 1204, 1212 (Ill. 1992) (“[T]he known loss doctrine may be invoked if the insurers demonstrate that OMC knew or had reason to know, at the time it purchased the CGL policy, that there was a substantial probability that loss or liability would ensue due to the PCB contamination for which it is seeking coverage. The question is not whether OMC knew it was discharging a pollutant into the environment, as the insurers and their amici argue. Rather, the relevant question is whether OMC knew or had reason to know that a probable loss or liability would occur due to the PCB contamination alleged in the underlying complaints.”); Westchester Fire Ins. Co. v. G. Heileman Brewing Co., 747 N.E.2d 955, 966 (Ill. App. Ct. 2001) (adopting standard of “substantial probability that loss or liability would result from the conduct for which it seeks coverage.”); Gen. Housewares Corp. v. Nat’l Sur. Corp., 741 N.E.2d 408, 414 (Ind. Ct. App. 2000) (the known-loss doctrine bars coverage only for “substantially certain” liabilities); Atchison, Topeka & Santa Fe Ry. Co. v. Stonewall Ins. Co., 71 P.3d 1097, 1136 (Kan. 2003) (affirming trial-court ruling that “[t]he inquiry was whether Santa Fe knew when it purchased liability policies that there was a substantial probability it would suffer a known loss exceeding its self-insured retention. The district court concluded that Santa Fe did not have such knowledge for the policy years at issue,” with the relevant “loss” being “liability,” not the underlying harm); SCA Servs., Inc. v. Transp. Ins. Co., 646 N.E.2d 394, 398 (Mass. 1995) (“However, SCA’s knowledge goes beyond simply knowing that there was environmental contamination and that its landfill was the probable source of this contamination. SCA knew that the residents of Wilsonville were damaged by the operation of the site. Therefore, the nuisance for which SCA sought personal injury coverage was not only a known but an adjudicated fact at the time SCA purchased the insurance and thus was uninsurable.”); CPC Int’l, Inc. v. Hartford Accident & Indem. Co., 720 A.2d 408 (N.J. Super. Ct. App. Div. 1998); Ins. Co. of N. Am. v. Kayser-Roth Corp., 770 A.2d 403, 415 (R.I. 2001) (citations omitted) (loss is still insurable “when there is uncertainty about the imposition of liability and no legal obligation to pay yet established”). Cf. Montrose Chem. Corp. of Cal. v. Admiral Ins. Co., 913 P.2d 878 (Cal. 1995) (en banc) (requiring that the insured be certain about both liability and damages in order for the insurer to avoid coverage under California’s known-loss statute, which limits the insurability of a liability and does not simply impose an obligation to disclose a liability).

The Supreme Court of Hawai’i held that the known-loss doctrine does not bar liability insurance coverage even when the adjudication of third-party claims against the insured had already begun prior to the policy period unless “the insured’s liability as alleged in the lawsuit or claim is a certainty” when the policy period began. Sentinel Ins. Co. v. First Ins. Co. of Hawai’i, 875 P.2d 894, 920 (Haw. 1994), as amended on reconsideration (June 24, 1994). The known-loss doctrine did not bar coverage, it continued, “if the insured’s liability is in any degree contingent.” Id. (emphasis added) (citations omitted). Likewise, the Fourth Circuit held that the known-loss doctrine did not bar coverage for an insured who was already being sued when the policy period began, because, at that time, it had “sufficiently viable defenses” against the third-party claims being adjudicated “so as to prevent the conclusion that [the insured] had knowledge that entry of a judgment against it was substantially certain to occur.” Stonehenge Eng’g Corp. v. Emp’rs Ins. of Wausau, 201 F.3d 296, 303 (4th Cir. 2000) (applying South Carolina law).

It is sometimes argued that, under the known-liability standard, the known-loss doctrine applies whenever the insured is made aware of a serious legal dispute, as when it receives a demand letter or notice of a lawsuit prior to the inception of the policy period, irrespective of the substantial probability that the insurer will have to make payouts for defense costs or indemnification. There is little support for this interpretation of the known-loss doctrine in the case law, however. Many of the cases typically cited to support this proposition are not in fact known-loss-doctrine cases; rather, they are cases involving the interpretation of the “occurrence” or “accident” language found in many liability insurance policies. See, e.g., Chem. Leaman Tank Lines, Inc. v. Aetna Cas. & Sur. Co., 788 F. Supp. 846, 853 (D.N.J. 1992) (applying New Jersey law) (explaining that an “insured is not entitled to coverage when it is aware of an occurrence prior to the policy period”), aff’d in part, rev’d in part, 89 F.3d 976 (3d Cir. 1996); U.S. v. Conservation Chem. Co., 653 F. Supp. 152 (W.D. Mo. 1986) (applying Missouri law) (same); W. Cas. & Sur. Co. v. Hays, 781 P.2d 38 (Ariz. Ct. App. 1989) (finding no coverage because insured’s prior knowledge of dispute resulted in claim falling outside policy’s definition of “occurrence”); and City of Okanogan v. Cities Ins. Ass’n of Wash., 865 P.2d 576 (Wash. Ct. App. 1994) (same). Moreover, in the cases that do appear to apply the known-loss doctrine to deny coverage in cases involving an insured’s having received notice of a lawsuit prior to the policy’s inception, it is not clear either that the relevant liability insurance policies contained substantial self-insured retentions or, if they did, that the courts took that fact into account in rendering their decisions. See, e.g., Outboard Marine Corp. v. Liberty Mut. Ins. Co., 607 N.E.2d 1204 (Ill. 1992) (no coverage for environmental liabilities arising out of its discharge of PCBs after the insured was put on notice of the claim prior to beginning of policy period); Westchester Fire Ins. Co. v. G. Heileman Brewing Co., 747 N.E.2d 955 (Ill. App. Ct. 2001) (no right to indemnification when lawsuit had been filed against the insured prior to beginning of policy period).

For examples of the known-harm standard, under which coverage is said to be barred for claims arising out of harm to third parties that was known to the insured prior to the policy period, see Aetna Cas. & Sur. Co. v. Dow Chem. Co., 10 F. Supp. 2d 771, 790 (E.D. Mich. 1998) (applying Michigan law) (ruling that “the crucial issue” in determining whether the known-loss doctrine bars coverage “is whether [the insured] was aware, at a minimum, of an immediate threat of the contamination for which it was ultimately held responsible and for which it now seeks coverage; not [the insured’s] awareness of its legal liability for that contamination.”); Two Pesos, Inc. v. Gulf Ins. Co., 901 S.W.2d 495, 502 (Tex. App. 1995) (holding that coverage of an insured’s liability arising out of its infringement of a third party’s trade dress was precluded because, inter alia, the insured knew about the infringement before obtaining the policy); Am. Family Mut. Ins. Co. v. Am. Girl, Inc., 673 N.W.2d 65, 85–86 (Wis. 2004) (“Here, the fact that [property damage] was occurring on the 94DC was known as early as March of 1995, and the extent of the damage was substantially known by the time of the meeting in January or February, 1997. The policies of these remaining insurers post-date this period. Accordingly, the known loss doctrine precludes coverage under these policies.”).

Illustration 1 is based on State v. Hydrite Chem. Co., 695 N.W.2d 816 (Wis. Ct. App. 2005). For further support of the requirement that the insured be substantially certain that the liability will reach the level of coverage at issue, see Gould, Inc. v. Arkwright Mut. Ins. Co., 907 F. Supp. 103 (M.D. Pa. 1995) (applying Pennsylvania law); UTI Corp. v. Fireman’s Fund Ins. Co., 896 F. Supp. 362 (D.N.J. 1995) (applying Pennsylvania law).

d. A subjective standard.Among courts that have considered the question, the majority rule is that the known-liability standard is subjective. See Stonehenge Eng’g Corp. v. Emp’rs Ins. of Wausau, 201 F.3d 296 (4th Cir. 2000) (applying South Carolina law); Aetna Cas. & Sur. Co. v. Dow Chem. Co., 10 F. Supp. 2d 771, 789 (E.D. Mich. 1998) (applying Michigan law) (adopting the subjective standard because the known-loss doctrine’s function is to prevent fraud and noting that the subjective standard has the advantage of “protect[ing] against the misuse of hindsight to avoid indemnification coverage.”); Gould, Inc. v. Arkwright Mut. Ins. Co., 907 F. Supp. 103 (M.D. Pa. 1995) (applying Pennsylvania law); Gen. Housewares Corp. v. Nat’l Sur. Corp., 741 N.E.2d 408 (Ind. Ct. App. 2000); Ins. Co. of N. Am. v. Kayser-Roth Corp., 770 A.2d 403 (R.I. 2001); Pub. Util. Dist. No. 1 of Klickitat Cty. v. Int’l Ins. Co., 881 P.2d 1020 (Wash. 1994). But see Sentinel Ins. Co. v. First Ins. Co. of Hawai’i, 875 P.2d 894, 919 (Haw. 1994), as amended on reconsideration (June 24, 1994) (holding that the known-loss doctrine bars coverage for liability that the insured “was or should have been aware of before coverage began”).

f. Relationship to misrepresentation and concealment doctrine.Because the known-loss doctrine includes neither a materiality nor a reliance requirement, there are plausible circumstances under which it could bar coverage that would not be barred under the misrepresentation or concealment doctrines. See Kenneth S. Abraham, Peril and Fortuity in Property and Liability Insurance, 36 TORT & INS. L.J. 777, 795–796 (2001). This is because “[t]he relevance of information about known losses undoubtedly varies, depending on the potential size of the known loss, … and the frequency and severity of other losses that the insured can be expected to suffer during the policy period, among other factors.” Id. For examples of the very few cases that apply the known-loss doctrine as the sole basis for denying coverage under a liability insurance policy, see the Reporters’ Note to Comment a. For an illustration of the known-loss doctrine’s overlap with the doctrines against fraud and concealment, see, e.g., Rohm & Haas Co. v. Cont’l Cas. Co., 781 A.2d 1172, 1181 (Pa. 2001) (Nigro, J., concurring) (because “the evidence clearly supported the jury’s verdict with respect to [the insurer]’s defense of fraud,” there is “no need for the majority to address the merits of [the insurer]’s additional defenses of known loss and late notice”).

g. Not a doctrine of legal insurability.See Gen. Housewares Corp. v. Nat’l Sur. Corp., 741 N.E.2d 408, 414–415 (Ind. Ct. App. 2000) (reversing summary judgment in insurer’s favor because there was a genuine issue of material fact as to whether the insurer as well as the insured knew about the insured’s liabilities before the policy was issued, which would have rendered the known-loss doctrine inapplicable); Atchison, Topeka & Santa Fe Ry. Co. v. Stonewall Ins. Co., 71 P.3d 1097, 1137 (Kan. 2003) (citations and quotations omitted) (upholding a trial court’s ruling that an insurer’s knowledge precluded its avoiding coverage based on the known-loss doctrine, because, “[g]iven the underlying basis of the doctrine, and the right of the parties to agree to cover existing losses, it has been recognized that the known loss doctrine does not apply if the insurer also knew of the circumstances on which it bases the defense.”). See also Outboard Marine Corp. v. Liberty Mut. Ins. Co., 607 N.E.2d 1204, 1210 (Ill. 1992) (emphasis added) (“[T]he insurer has no duty to defend or indemnify the insured with respect to the known loss ab initio, unless the parties intended the known loss to be covered.”).

Restatement of the Law - Liability Insurance © 2012-2019 American Law Institute. Reproduced with permission. Other editorial enhancements © Thomson Reuters.

824 F.Supp. 624

United States District Court,

N.D. Texas,

Dallas Division.

Harry B. BARTLEY, Jr., et al., Plaintiffs,

and

Ronald Brown, et al., Intervenors,

v.

NATIONAL UNION FIRE INSURANCE COMPANY OF PITTSBURGH, PA, Defendant.

Civ. A. No. 3–91–CV–1857–H.

|

MEMORANDUM OPINION AND ORDER

SANDERS, Chief Judge.

Before the Court are [[[various motions of ]]] National Union Fire Insurance Company of Pittsburgh, PA’s (“National Union”) [[[and others to dismiss.]]] 

I. Background

This is a suit between former officers and directors of First RepublicBank and the insurance company that contracted to provide them with liability insurance. Plaintiffs are former directors and officers of First RepublicBank–Dallas. They have been sued by the Federal Deposit Insurance Corporation (“FDIC”) for negligence and breaches of their common law and statutory duties as officers and directors. Plaintiffs brought this action seeking a declaratory judgment regarding the coverage obligations of National Union under an officers and directors liability insurance policy and a binder that superseded the policy. Plaintiffs also seek monetary damages, including all past and future costs of defense incurred in their defense against the FDIC’s claims. Intervenors are former directors and officers of First RepublicBank–Houston who present similar claims for the cost of defending a *628 similar suit brought by the FDIC in Houston. Plaintiffs and Intervenors alike claim that National Union provided, but failed to honor, an insurance policy which covered the FDIC’s claims against them.

… 

II. The Claims

Plaintiffs’ Second Amended Complaint, filed January 24, 1992, alleges that Plaintiffs are insureds under National Union Policy No. 943–64–66 (“Policy” or “Year 1 Policy”) and a Binder for Policy No. 943–67–64 (“Binder”) that provided insurance coverage to the directors and officers of the First RepublicBank Corporation “Until the [88–89] policy [is] Received.” See Exhibit A to Plaintiffs’ Second Amended Complaint. The Policy became effective on June 6, 1987 and expired on June 6, 1988. The Binder became effective on June 6, 1988.

Plaintiffs state that on June 23, 1989, while the Binder was still in effect, they received notice that the FDIC would bring claims against them. Plaintiffs allege that they then forwarded this notice to National Union during the coverage period of the National Union policies and that they otherwise complied with the conditions required of them for coverage. Plaintiffs state that National Union then denied that claims brought by regulators, such as the FDIC, were covered by the policies and informed Plaintiffs that coverage would not be provided. See Exhibit C to Plaintiffs’ Second Amended Complaint.

Plaintiffs thus allege that National Union breached its duties to Plaintiffs. Specifically, Plaintiffs have brought: (1) a breach of contract claim against National Union for its failure to provide coverage for the claims brought by the FDIC and its failure to pay the costs of defending the FDIC suit; (2) a declaratory judgment action, seeking a declaration that, under the National Union policies, Plaintiffs have a right to coverage for the FDIC’s claims and the costs of defending against those claims; (3) a claim asserting that National Union breached its duty of good faith and fair dealing and was grossly negligent; and (4) a claim alleging that National Union [[[the predecessor to Chapter 541 of the Texas Insurance Code]]]. Plaintiffs also seek attorney’s fees for costs incurred in this action.

In response, National Union contends that the Plaintiffs’ complaints fail to state a claim upon which relief can be granted because National Union’s policies, the Year 1 Policy and the Binder, both contain an Endorsement that specifically excludes coverage for suits brought by regulatory agencies such as the FDIC. Specifically, National Union points to Endorsement 3 to the Year 1 Policy, a provision that National Union argues is equally applicable to the period covered by the Binder, which states that:

In consideration of the premium charged, it is hereby understood and agreed that the insurer shall NOT be liable to make any payment for loss in connection with any claim based upon or attributable to any action or proceeding brought by or on behalf of the [FDIC], including any type of legal action which [the FDIC has] the legal right to bring as receiver, conservator, liquidator or otherwise; whether such action or proceeding is brought in the name of [the FDIC] or by or on behalf of [the FDIC] in the name of any other entity or solely in the name of any Third Party.

See Exhibit A to Plaintiffs’ Second Amended Original Petition. National Union reasons that because their policies explicitly exclude coverage for claims brought by the FDIC, Plaintiffs’ contract and declaratory judgment claims fail to state a claim upon which relief can be granted. Moreover, National Union asserts, since no coverage exists, Plaintiffs’ claims that National Union breached its duty of good faith and fair dealing, violated [[[Chapter 541]]] and was grossly negligent also fail to state a claim upon which relief can be granted.

III. Analysis

[[[ Boilerplate on standards for dismissal omitted ]]]

A. Does the Binder include the regulatory exclusion?

The first substantive issue to address is whether the Binder is subject to the regulatory exclusion contained in Endorsement 3 to the Year 1 Policy. Plaintiffs contend that the Binder does not incorporate the terms of the Endorsement upon which National Union relies for this motion to dismiss; National Union responds that the phrase “policy as expiring” contained in the Binder clearly refers to the entire Year 1 Policy, not just the forms which make up the policy without its endorsements.

Because this aspect of the parties’ dispute concerns the interpretation of the terms of the Binder, the Court briefly reviews the applicable Texas law concerning the interpretation of contracts.[[[ Write this portion of the opinion ]]]

To interpret the meaning of the Binder, it is first necessary to summarize the Binder’s language. On the first page, “Coverage” is described to be “Directors & Officers Liability Policy/National Union Forms 8749 & 8750 (6/85).” Second, boilerplate language on the Binder states that the Binder is “subject to the provisions of the standard policies” and that it “shall be cancelled by: (1) issuance of the formal policy or endorsements....” Third, under “Remarks”, the Binder states “See Attached pages 2–3.” Thus, the Binder incorporates two extra pages, styled “Terms & Conditions.” The “Terms & Conditions” detail special provisions beyond those embodied on the first page. These pages describe “Coverage” to be the “Policy as expiring subject to endorsements stated on this binder.” See Plaintiffs’ Second Amended Complaint Ex. A. The Binder is attached to this Order as Appendix A.

Plaintiffs contend that the “Terms & Conditions” coverage statement cannot be read to incorporate the Endorsements included in the Year 1 Policy. Instead, Plaintiffs argue that only the terms found in National Union forms 8749 and 8750 make up the Binders’ terms. Plaintiffs observe that these forms were the standard forms used to make up the body of the first (’87–’88) policy and note that these forms by themselves do not include any of the Endorsements to the Year 1 Policy. The first argument Plaintiffs make in support of this contention is that some of the Terms & Conditions of the Binder repeat in substance provisions of the Year 1 Policy that appear in Endorsements 19, 20, and 21. This fact, Plaintiffs argue, demonstrates that the Endorsements from the Year 1 Policy were not automatically incorporated into the Binder by reference.

However, an examination of the Binder’s Endorsements and Endorsements 19, 20, and 21 of the Year 1 Policy reveals that the Binder does not “repeat in substance” the provisions of the Year 1 Policy Endorsements. National Union states that the Endorsements on the Binder are complementary to the Endorsements contained in the Policy and support the conclusion that the Binder did incorporate the Endorsements of the Year 1 Policy. For example, National Union notes that coverage of the former officers and directors of InterFirst is extended in Endorsement 21 of the Year 1 Policy, not in form 8749 or 8750, which offer coverage only to the company named in the Declarations—First RepublicBank Corporation. Without the extension of coverage provided to former officers and directors of InterFirst in Endorsement 21, there is no logical reason for the Binder to exclude coverage for certain wrongful acts of the former officers and directors of InterFirst, as one endorsement in the Binder does. This fact points to the conclusion that the only reasonable construction of the phrase “policy as expiring” is that it refers to the entire Year 1 Policy, not merely to forms 8749 and 8750, to the exclusion of the Endorsements.

Plaintiffs’ second argument in support of their contention that the Binder is not subject to the regulatory exclusion is that to read the Binder’s “Policy as expiring” language to include the Year 1 Policy Endorsement by reference requires that the word “policy” be assigned a different meaning on *632 the second page of the Binder than it is given on the first page, hence violating the cardinal rule that terms in a contract be given the same meaning throughout the instrument.

Plaintiffs state that the term “policy” found on the first page of the Binder should be read to refer to the old, ‘87–’88 Policy, but not to its Endorsements. In support of this position, Plaintiffs note that “Coverage” on the first page of the Binder is defined to be “Directors & Officers Liability Policy/National Union Forms 8749 & 8750 (6/85).” Moreover, Plaintiffs note that the Binder then indicates that it “is subject to the provisions of the standard policies.” Plaintiffs also note that the Binder states that it “shall be cancelled by (1) issuance of the formal policy or endorsements....” In other words, Plaintiffs contend that the Binder initially uses the word “policy” to refer to the “standard policy”, but not to the Endorsements to the Year 1 policy. Hence, Plaintiffs conclude that the Binder recognizes a difference between the standard policy and the appended endorsements. Thus, Plaintiffs reason that the regulatory exclusion does not apply to the Binder.

National Union’s response to this argument emphasizes the tenet of contract interpretation which admonishes against reading the words of a contract in isolation. When read as a whole, National Union argues, the only reasonable construction of the word “policy” as it appears in the Binder is that it refers to the entire insurance contract for the Year 1 Policy, not just Forms 8749 and 8750.

National Union states that the illogic of Plaintiff’s construction of the phrase “policy as expiring” is revealed by an examination of the insurance contract that would result from Plaintiffs’ construction of the Binder. According to Plaintiffs, the insurance contract in effect when Plaintiffs notified National Union of the FDIC’s claims against them consisted only of the Binder and Forms 8749 and 8750. Under this construction, however, coverage would only be provided to the directors and officers of First RepublicBank Corporation, not to the directors and officers of any of its subsidiaries. Coverage for the officers and directors of the subsidiaries is only extended by examining the definition of the named insured on the Declarations page of the Year 1 Policy, a document which Plaintiffs contend is not a part of the Binder. National Union observes that Plaintiffs have been sued by the FDIC for their acts as directors and officers of First RepublicBank–Dallas and First RepublicBank–Houston, both of which are subsidiaries of the First RepublicBank Corporation. As directors and officers of subsidiaries of the First RepublicBank Corporation, Plaintiffs would not be insured for the FDIC’s claims under their own construction of the Binder.

Thus, National Union argues, the only reasonable construction of the Binder is that it incorporates the entirety of the Year 1 Policy, including the regulatory exclusion. Any other construction of the Binder discards the generally accepted meaning of the word “policy”, fails to read the document as a whole, and provides no benefit to Plaintiffs who, as directors and officers of subsidiaries of First RepublicBank Corporation, would not be insured under their own construction of the Binder.

[[[ How would you resolve this issue ]]] 

B. Is the Regulatory Exclusion Ambiguous?

Plaintiffs’ second contention is that the regulatory exclusion itself is ambiguous. Plaintiffs assert that the phrase “based upon or attributable to any action or proceeding brought by or on behalf of the [FDIC]” could reasonably be construed to apply only to “secondary suits”—i.e., claims asserted by 633 the FDIC against third parties and not to claims asserted by the FDIC directly against the officers and directors of an institution.

As discussed above, the interpretation of an insurance contract is a question of [[[fill this in ]]] 

In support of their reading of the regulatory exclusion, Plaintiffs cite American Casualty Co. v. FSLIC, 704 F.Supp. 898, 902 (E.D.Ark.1989). … The American Casualty case dealt with a regulatory exclusion to a directors’ and officers’ liability contract. [Analysis] of this clause turned on the meaning of “based upon or attributable to ... any action or proceeding resulting from violation of any laws [or] regulations.” Id. at 902. The court rejected the insurer’s argument that the exclusion removed coverage for officers’ and directors’ conduct which violated any law or regulation and thereby gave rise to a claim. The court stated that the more reasonable construction of the phrase excluded coverage for actions or proceedings which directly resulted from violations of laws or regulations, not to actions or proceedings based on conduct which violated a law or regulation. Id. at 903.

Plaintiffs [further cite] FSLIC v. Mmahat No. 86–5160, 1988 WL 19304, 1988 U.S.Dist. LEXIS 1825 (E.D.La. March 3, 1988). In that case, the court interpreted language identical to that found in National Union’s regulatory exclusion and found it to be ambiguous. National Union attacks this precedent on the grounds that it is based upon a similar holding in American Casualty Co. v. FDIC, 677 F.Supp. 600 (N.D.Iowa 1987), a holding which was reversed upon reconsideration. See American Casualty Co. v. FDIC, No. C–86–4018, 1990 WL 66505 at *11 (N.D. Iowa Feb. 26, 1990). The ruling which held the regulatory exclusion to be unambiguous was affirmed by the Eighth Circuit. See American Casualty Co. v. FDIC, 944 F.2d 455, 460–61 (8th Cir.1991).

Other courts have held that similarly worded regulatory exclusions are not ambiguous. For example, in St. Paul Fire & Marine Ins. Co. v. FDIC, 765 F.Supp. 538 (D.Minn.1991), the court held that an identical regulatory exclusion which excluded coverage “based upon or attributable to any claim, action or proceeding brought by or on behalf of the [FDIC]” was unambiguous. The court wrote that the insurer’s “intent to preclude [coverage for] all suits brought by the FDIC could not be stated in more explicit language.” Id. at 549. This decision was affirmed on appeal. See St. Paul Fire and Marine Ins. Co. v. FDIC, 968 F.2d 695 (8th Cir.1992). Similarly, the court in *634 Gary v. American Cas. Co., 753 F.Supp. 1547, 1550–51 (W.D.Okla.1990), found identical language to be unambiguous, and described the “secondary suit” argument that Plaintiffs forward here “strained and unreasonable.” Id. at 1550. The Tenth Circuit reached the same conclusion in FDIC v. American Cas. Co., 975 F.2d 677 (10th Cir.1992).

[[[ Resolve this issue ]]] 

C. Is the Regulatory Exclusion Against Public Policy?

Plaintiffs also claim that the regulatory exclusion is contrary to public policy. Plaintiffs [argue] that the Financial Institutions Reform, Recovery and Enforcement Act of 1989, 12 U.S.C. §§ 1811–1833e, (“FIRREA”) provides a dominant public policy which would justify voiding the regulatory exclusion on public policy grounds. [[[National Union notes that ]]] FIRREA’s legislative history revealed that Congress intended to remain neutral regarding regulatory exclusions. [[[ Finish this section ]]] 

D. Is the National Union Contract Unconscionable?

 Plaintiffs have argued in their brief that National Union’s policies are unconscionable. Plaintiffs allege that the facts of this case will show that application of the regulatory endorsement would effect an unconscionable result, especially in light of the special relationship of trust Texas law has imposed in the insurance context. … Preliminarily, the Court notes that other courts have held that “the issue of unconscionability must be pleaded to be considered by [[[ fill this in ]]].

[[[ Resolve this issue under the RLLI and the law of a jurisdiction you or your professor select ]]] 

E. The Reasonable Expectations Doctrine

Plaintiffs have argued that the National Union Policy and the Binder are contrary to their “reasonable expectation” that they secured coverage for claims asserted by the FDIC. Plaintiffs explain that the doctrine of reasonable expectations honors the objectively reasonable expectations of insureds “even though painstaking study of the policy provisions would have negated those *636 expectations.”  [[[Resolve this issue under the law of your jurisdiction; you may wish to take into account your resolution of the ambiguity issue.]]]

F. Implied Warranty of Fitness

 Finally, Plaintiffs claim that the surrounding factual circumstances may also indicate that any regulatory exclusion clause would be unenforceable because it conflicts with an implied warranty of fitness.[[[ Resolve this issue ]]] 

G. Good Faith [and Statutory] Claims

[[[ Resolve this issue]]] 

IV. Conclusion

[[[ Finish this opinion ]]] 

2005 WL 3487723

Only the Westlaw citation is currently available.

United States District Court,

W.D. Texas, San Antonio Division.

PAK-MOR MANUFACTURING CO., Plaintiff

v.

ROYAL SURPLUS LINES INSURANCE CO. et al., Defendants

No. SA-05-CA-135-RF.

|

Nov. 3, 2005.

ORDER REVERSING BANKRUPTCY COURT’S DENIAL OF ROYAL’S MOTION FOR SUMMARY JUDGMENT

FURGESON, J.

This appeal from the Bankruptcy Court involves the question of whether the obligations of Royal Surplus Lines Insurance Co. (“Royal”) under its insurance contract with Pak-Mor Manufacturing Co. (“Pak-Mor”) are triggered even though Pak-Mor failed to satisfy the self-insured retention provision of that contract. This Court answers in the negative.

INTRODUCTION

On September 1, 2001, Royal commenced insurance coverage of Pak-Mor under a commercial general liability insurance policy. A year later-around November 12, 2002-Lorenza Lockhart, a garbage collector in Tyler, Texas, slipped off the back step of his garbage truck, fell to the ground, and suffered horrific injury when the wheels of the truck rolled over his legs and crushed them.¹ Lockhart blamed Pak-Mor for his injuries, taking the view that Pak-Mor had improperly designed the step from which he had slipped, and that this had caused him to fall.² Accordingly, on May 22, 2003, Lockhart filed suit against Pak-Mor.³

Very shortly after Lockhart filed suit-on June 2, 2003-Pak-Mor filed for bankruptcy. This immediately sparked a tussle between Royal and Pak-Mor as to Royal’s obligations under their insurance policy. Royal’s view was that Pak-Mor’s bankruptcy and consequent inability to satisfy the self-insured retention provision of the policy relieved Royal of any liability to Pak-Mor under the policy. Pak-Mor took the opposite view, that Royal’s obligations under the policy persisted whether or not Pak-Mor satisfied the policy’s self-insured retention provision.

Eventually, on August 28, 2003, Pak-Mor initiated this declaratory judgment action in the Bankruptcy Court. … After considering both parties’ arguments, the Bankruptcy Court denied Royal’s motion and in fact awarded partial summary judgment in favor of Pak-Mor. Royal appealed.

The question presented on appeal is whether the Bankruptcy Court erred when it denied summary judgment on Royal’s claim that, under the policy, Royal’s obligations do not arise until Pak-Mor satisfies the self-insured retention. [The] Court reverses the Bankruptcy Court and grants summary judgment for Royal.⁶

REASONING

1. The Plain Meaning of the Policy’s Text Compels the Conclusion that Royal Has No Obligation Until Pak-Mor Pays the Retained Limit.

The unambiguous text of the insurance policy compels the conclusion that Pak-Mor must pay the self-insured part of the policy before Royal has any obligation to pay any excess. Section 3.11 of the policy’s Self-Insured Retention Endorsement says:

Notwithstanding any provisions of the policy or any endorsements to the contrary, it is a condition precedent to the company’s liability under this policy that the insured, and no other person, insurer or organization for or on behalf of the insured, makes actual payment of the ‘Retained Limit’. Any of our obligations under the policy shall not attach or arise unless or until the insured alone, and no other person, insurer or organization for or on behalf of the insured, pays the amount of the ‘Retained Limit’....¹⁰

This language is clear as daylight. … The policy is thus totally unambiguous. There is only one reasonable way to interpret the policy, and this interpretation says that Royal does not have to pay anything until Pak-Mor first pays the retained limit.¹²

It follows that the Court must so find as well. In a case like this, where the question is one of contract interpretation, state law controls.¹³ And under Texas law, a court seeking to determine the meaning of a contract must follow the plain meaning of the text when it can be ascertained-that is, when the text can reasonably be interpreted in only one way.¹⁴ Since the plain meaning of the policy’s text is evident here, the Court must follow what it says: Royal is not obligated to pay anything until Pak-Mor first pays the retained limit.

2. Equity Considerations Also Support This Conclusion.

Equitable arguments generally do not carry predominant weight with this Court in cases where, as here, the law clearly declares the legal primacy of a contract’s plain meaning and the decision therefore invariably turns on a close reading of the specific text at issue. Nevertheless, this Court takes them seriously here, because this case comes out of the Western District’s Bankruptcy Court, and the Fifth Circuit has held that “the bankruptcy court is a court of equity and it must undertake an analysis of equitable considerations.”¹⁵

The reasoning must start with the candid acknowledgment that there is an equitable problem here that cries out for a solution. As Pak-Mor notes, relieving insurers of liability in the bankruptcy context leaves “third party plaintiffs ... no means of recovery in the event that they are successful despite the fact that the insured [defendants] took the precaution of obtaining insurance to cover such losses such as those the claimants have suffered.”¹⁶ And this is a tragic position for plaintiffs to be in. Having endured suffering and having finally won a favorable judgment from the courts, it is unfair for them to get nothing because culpable defendants throw up their arms in insolvency and insurers quietly exit through the back door. This is an injustice, and something ought to be done about it.

The solution, however, does not lie in judicially compelling an insurer to pay plaintiffs the amount they are due, contrary to contractual obligations. After all, the injustice does not lie at the insurer’s doorstep. Indeed, an insurer should not be put on the hook in this kind of situation because it writes liability insurance generally. Insurers, like anyone else, make a living by promising to do particular things in exchange for the payment of premiums. They are bound to keep the promises they make, but they cannot be held to promises they never made and never received payment for. Here, if the insured had wanted this insurer to assume liabilities in the bankruptcy context, then the insured could have paid the insurer to do it. But where the insured has asked the insurer to assume liability in a situation such as this, and where no payment was made to do so, this Court cannot simply order the insurer now to do it for free. That would only replace one injustice with another one.

3. Pak-Mor’s Intention Argument Fails.

Because the written instrument here is unambiguous (as already discussed), Pak-Mor’s intention argument cannot persuade the Court.

4. Pak-Mor’s Bankruptcy Clause Argument Fails.

Similarly, a plausible argument can be made that the policy’s bankruptcy clause negates the retained limit requirement in the bankruptcy context and thereby establishes Royal’s liability here. The bankruptcy clause states, “Bankruptcy, insolvency or any other inability of the insured or of the insured’s estate or any other insured to pay the ‘Retained Limit’ will not increase or otherwise change our obligations under this Coverage Part and our obligations shall continue to apply only in excess of the ‘Retained Limit’.”²¹

At first blush, of course, this clause appears to confirm the retained limit requirement’s applicability in the bankruptcy context. After all, that requirement appears to apply upon reading the rest of the policy, and the clause explicitly states that it “will not increase or otherwise change [Royal’s] obligations” when the context is shifted to bankruptcy.

But, as this argument goes, this “plain meaning” reading of the clause does not get it right. Instead, Pak-Mor asserts, one must conduct a historical reading of the clause to properly understand it. In the past, retained limit requirements yielded unhappy results in the bankruptcy context. It was precisely when the insured went bankrupt that his creditors most needed the insurance funds, since the insured was not in a position to pay them. Yet it was precisely at that moment that the insurer was relieved of liability, since the insured could not pay the retained limit.²² Several legislatures did not like that creditors thus got nothing, while the insurers paid nothing, so they mandated that insurers insert “bankruptcy clauses” into their policies.²³ These clauses were to negate the retained limit requirements in the bankruptcy context and thereby keep insurers on the hook when the insureds went bankrupt.²⁴ Many insurers (both in states with such statutes and in other states) inserted bankruptcy clauses into their policies pursuant to these laws.²⁵ And Royal’s should be understood as one such, according to Pak-Mor. It looks unmistakably like traditional bankruptcy clauses, and it was included in policies issued after the state statutes were in place.²⁶ Because such clauses were never intended to relieve insurers of liability in the bankruptcy context, but indeed precisely the opposite, is it not now totally disingenuous for Royal to turn the clause on its head through artfully drafted language?

This argument has a certain appeal. Indeed, what does not make immediate sense is why Royal would insert the bankruptcy clause into its policy if that clause actually does nothing.²⁷ Parties seeking to accomplish nothing usually do nothing, and parties who insert clauses into contracts are usually instead trying to accomplish something. Nevertheless, this Court cannot accept the historical reading argument. For one thing, it only properly offers a historical account of bankruptcy clauses in general. Pak-Mor has offered no evidence to indicate that Royal specifically intended its bankruptcy clause to negate the retained limit requirement in the bankruptcy context. Furthermore (and more importantly), Texas law says: “It is the settled law in this state that contracts of insurance in their construction are governed by the same rules as other contracts, and that terms used in them are to be given their plain, ordinary and generally accepted meaning unless the instrument itself shows them to have been used in a technical or different sense.”²⁸ And here, there is nothing in the written policy to indicate that the bankruptcy clause was intended to mean anything other than what its plain meaning says. This Court has to assume that what parties agree to in plain English is their actual agreement. When the policy’s words have a clear meaning and the writing nowhere indicates the parties’ intentions to convey something else, this Court must honor the plain meaning of the words. The argument therefore fails.

5. Pak-Mor’s Precedential Argument Fails.

Finally, Pak-Mor seeks to bring the weight of precedent in support of its position. The first case it cites is Columbia Casualty Co. v. Federal Press Co.²⁹ In that case, the policy stated,

No action shall lie against the Company with respect to any one occurrence unless, as a condition precedent thereto, the Insured shall have fully complied with all the terms of this policy, nor until the amount of the Insured’s obligation to pay an amount of ultimate net loss in excess of the retained limit shall have been finally determined either by judgment against the Insured after actual trial or by written agreement of the Insured, the claimant and the Company.... Bankruptcy or insolvency of the Insured shall not relieve the Company of any of its obligations hereunder.³⁰

In other words, the policy was similar to the policy here. And the court concluded “that Federal Press’ possible inability to satisfy its retained limit of $300,000 due to its bankruptcy or insolvency does not relieve Columbia of its obligation to indemnify Federal Press.”³¹

Pak-Mor also cites Home Ins. Co. of Illinois v. Hooper.³² That case also contained a retained limit requirement like the one here. The court stated, “[T]he unambiguous language of the self-insured provision contained in the instant policy would release Home from the obligation of payment under the policy due to Lester’s bankruptcy. Lester’s pending bankruptcy petition will almost certainly make it impossible for Lester to pay the initial $250,000 of any judgment.”³³ The court held that the insurance company would be liable even in the event that the insured was unable to satisfy the self-insured retention.³⁴

As a final example, Pak-Mor cites Albany Ins. Co. v. Bengal Marine, Inc.³⁵ [[[a Fifth Circuit case from 1988 applying Louisiana law]]]. Once again, the court there faced a policy similar to the one here, and once again, the court held that the insurer would be liable even if the insured failed to pay the retained limit.³⁶

None of these cases affects the outcome here. As an initial matter, two of them were decided by courts with no controlling authority over this Court. Columbia Casualty was decided by the United States Bankruptcy Court of the Northern District of Indiana, and Home Ins. was decided by the Appellate Court of Illinois. But beyond this (and more importantly), the reasoning in those cases does not apply to this case. In all those cases, the courts’ decisions were virtually compelled by applicable statutes in those states that required insurers to assume liability in the bankruptcy context just as they would outside the bankruptcy context, regardless of what the policies themselves said.³⁷ Texas law provides no such restriction, however. Under Texas law, insurers are free to issue policies that relieve them of liability in the bankruptcy context. This Court is thus not constrained by statutory law in interpreting particular policies that claim to so relieve insurers. Since the policy here plainly says that the retained limit requirement applies in the bankruptcy context, that is what this Court holds as well.³⁸

Indeed, this Court believes that the best approach in these matters is a case-by-case approach. One interesting case this Court reviewed in its research was Fidelity and Guaranty Ins. Co. v. Employers Ins. of Wausau.³⁹ That case, in setting forth its reasoning, reviewed several cases confronting the issue here: “whether or not the SIR must be exhausted in order for the [insurer’s] duty to arise.”⁴⁰ The review revealed that, in case after case, every court ultimately reached its decision by closely examining the precise text of the policy before it.⁴¹ Indeed, that is what the Fidelity and Guaranty court itself did.⁴² Thus, this Court emphasizes the necessity in deciding these cases of applying the specific law of contract interpretation in the jurisdiction to the specific text of the policy at issue. Even though persuasive precedents often concern insurance policies that look very similar and legal questions that look nearly identical to those in a particular case, even minor differences in law and fact require this practice. Pak-Mor’s precedential argument fails.

6. Pak-Mor Can Pay the Retained Limit in Any Form.

Thus, Royal has no obligation under the policy to pay anything until Pak-Mor satisfies the self-insured retention. This leaves two remaining points of dispute: (1) In what form can Pak-Mor pay its $100,000 retained limit?;⁴³ and (2) If Pak-Mor satisfies its self-insured retention, then what does Royal have to pay?⁴⁴

To answer the first question, Pak-Mor can pay the retained limit in any form. Again, the plain meaning of the policy compels this conclusion. The policy consistently describes Pak-Mor’s duty as being to “pay” the retained limit.⁴⁵ Yet the plain meaning of “pay” does not indicate a required method of payment. To the contrary, the standard dictionary definition leaves it open: “to discharge indebtedness for.”⁴⁶ Common usage does as well; people often speak of paying by check or money order, paying in cash, and paying by credit card. Even Black’s Law Dictionary fails to confuse the matter: “performance of an obligation by the delivery of money or some other valuable thing accepted in partial or full discharge of the obligation.”⁴⁷ Indeed, there is case law to support this conclusion: “An obligation to pay is satisfied when something of value is given and accepted in full discharge of that obligation.”⁴⁸ Thus, this Court finds that Pak-Mor may satisfy the self-insured retention by making its payment in whatever form it wants.⁴⁹

….

Therefore, under the circumstances, while Royal’s summary judgment must be granted at this point in the proceedings, facts can change to change the result. If Pak-Mor issues a promissory note to its judgment creditor in the sum of $100,000, which note is not dischargeable in bankruptcy and which note is shown to be a credible obligation of Pak-Mor and its estate and its principals, then the Bankruptcy Court would be within its power to find Pak-Mor’s self-insured retention requirement to be satisfied, triggering Royal’s obligation under its policy.

7. Royal Need Only Pay the Amount Beyond the $100,000 Retained Limit.

[[[omitted]]]

CONCLUSION

In conclusion, this Court finds that, as the facts presently stand, Royal has no obligations under the policy until Pak-Mor satisfies the self-insured retention. Pak-Mor can pay the retained limit in any form it desires, so long as the Bankruptcy Court confirms that the payment is performed in a credible and reliable manner. And upon satisfaction of the self-insured retention, Royal is obligated only to pay amounts beyond the $100,000 self-insured retention, up to the limits of the policy.

The Bankruptcy Court’s order is REVERSED, and summary judgment for Royal is GRANTED. This matter is REMANDED to the Bankruptcy Court for further action, consistent with this Order.

[[[Footnotes deleted except the ones you should read]]]

Not Reported in F.Supp.2d, 2005 WL 3487723