On May 20, 2013, the American Law Institute adopted some of the initial sections of its Principles of Liability Insurance. I’ll be honest. When I first heard about the ALI’s Principles Project – essentially a rule book for liability coverage issues -- I did not pay much attention. It sounded like the stuff of law professors, academic mumbo jumbo, and nothing I needed to know about. When I need to know what the law is, I’ll look to the courts, not people that smoke pipes and wear tweed sport jackets with patches on the sleeves -- thank you very much. Well I was wrong.
The ALI’s Principles Project brings together a host of stakeholders in liability insurance – law professors, lawyers on both sides of the aisle, brokers, insurance company representatives and judges -- to produce a text that sets forth the law on several liability insurance coverage issues. The finished work is the result of a lengthy and painstaking process of drafts and debates by those involved. Of course, with so many different interests represented, the final product may not reflect everyone’s beliefs. Compromise is certainly a part of the process.
The American Law Institute is best known for drafting Restatements of the Law, such as the Restatement of Torts, Restatement of Contracts and Restatement of Conflict of Laws, the last which has played a huge part in the resolution of choice of law for purposes of coverage disputes. So what is a “Principles Project?” And how does it differ from a Restatement? These are the obvious first questions.
First, it helps to start with the question what is an ALI Restatement? In simple terms, a Restatement sets forth what the law is concerning a certain issue. A Principles Project sets forth what is the best law or what the law should be. To the extent that a Principle sets forth what is already the existing law, there is no practical difference between a Restatement and Principles Project. However, a Principles Project also purports to set forth more direct statements of what courts actually do and make adjustments to the law that are superior.
Here’s why the ALI’s Principles Project should matter to you, even if your involvement with liability insurance is not on the academic side. Mike Marick, of Meckler, Bulger, Tilson, Marick & Pearson, Chair of the DRI Insurance Law Committee, speaking in his From the Chair column in the January 29, 2013 issue of DRI’s Covered Events, explained that in instances where there is no law on an issue in a state, the litigants and courts could look to ALI’s work as persuasive authority. Mike’s point is particularly apt when you consider that so many coverage issues have two schools of thought. A host of courts nationally have resolved an issue one way and another group have resolved the issue in an alternative manner. Courts that are called upon to resolve an issue for the first time in their state will often examine the case law that makes up these two schools of though and decide which camp to join. When weighing this decision it would not be surprising for the court to look at the Principles, the diverse parties involved in their development and consider the authoritative nature of the ALI. Having done so, the court may choose the rule set out in the Principles as the “tie-breaker.” In addition, a court may look to the Principles as support for altering an existing rule or addressing a certain aspect of a general rule that has never come before it. The Principles are prepared and adopted in a slow and bureaucratic process. As far as I can tell, being an outsider, it works like this. There is a Reporter and Associate Reporter – Professor Tom Baker of the University of Pennsylvania Law School and Professor Kyle Logue of the University of Michigan Law School, respectively. These law professors are essentially the quarterbacks. A project with this many involved needs people in charge to keep it on track and do the heavy lifting. The Reporters prepare the first draft of the Principles (so, of course, they have a big influence on the process). Then there are “Advisors.” These are about 40 law professors, lawyers (both sides), judges and insurance company executives. They discuss and debate the draft under consideration and are critical participants influencing the final outcome. Then there is a “Members Consultative Group,” which is comprised of over 100 ALI members (also law professors, lawyers, judges and insurance company executives) that weigh in on the discussion. Like any group that large, I suspect that some ALI members are much more active than others. Next is the ALI Council, which is a 55 person group of law professors, lawyers and judges that are essentially the ALI leaders. The Council must approve the final draft. Lastly there is the entire ALI membership which also must approve the finished draft at a meeting. When that happens, white smoke billows from the chimney where the ALI membership meeting is being held. When the text is approved it includes the Principles themselves, as well as comments, which basically explain the rules and provide examples, and reporter’s notes, which is the technical legal support underlying the Principles. With all of this background, necessary I believe to fully appreciate the project, just what are some of these so-called Principles of Liability Insurance? First, Chapter 1 of the Principles covers basic liability insurance contract issues, such as definitions, policy interpretation, ambiguity, misrepresentation, waiver, estoppel, etc. The entirety of Chapter 1 was approved by the ALI membership at the May meeting. These provisions are very significant as they are the foundation of liability insurance coverage. However, they are not the subject of disputes that coverage professionals confront on a daily basis. For this reason I’ll pass over any discussion of Chapter 1 [but, take my word, it is very important] and get to Chapter 2, which addresses issues that are the subject of disputes that frequently confront coverage professionals. These are the coverage issues that get fought on the front lines on a frequent basis. Chapter 2 is where the meat and potatoes of the Principles kick in. Forthcoming Chapters 3 and 4 will address substantive coverage issues, such as trigger, allocation and bad faith. Chapter 2 of the Principles addresses management of potentially covered claims -- essentially rules governing the duty to defend. Sections 12 to 15 of Chapter 2 were approved by the ALI membership in May. Sections 16 to 23 have been approved by the ALI Council but not yet submitted to the full membership. Chapter 2, Section 15, addresses the conditions under which an insurer must defend. Essentially the answer is that the duty to defend shall be based on the allegations in the complaint and extrinsic evidence (“Any additional allegation or legal theory, identified in the course of the investigation or defense of the claim or inferable from the complaint or comparable document, that a reasonable insurer would regard as an actual or potential basis for all or part of the claim.”) In general, a duty to defend standard that is tied to the allegations in the complaint and the allowance of extrinsic evidence benefits policyholders. Section 15 also includes a duty to defend provision that will benefit insurers. It permits an insurer to use extrinsic evidence, to disclaim a duty to defend [which is usually a major no-no], when the issue is a fundamental one -- whether a person or entity is even an insured under a policy. It also allows the use of extrinsic evidence, to disclaim a duty to defend, when the question is whether the events required for the claim to trigger the policy took place during the policy period. This will benefit insurers that must now defend, based on a complaint that does not contain dates of damage (so the potential for the policy to be triggered cannot be ruled out), yet there is evidence available of the timing of such damage that demonstrates that the insurer’s policy is not triggered.Section 18 [not yet approved] states that when a defense is provided under a reservation of rights and “there are common facts at issue in the claim and the coverage defense such that the claim could be defended in a manner that would advantage the insurer at the expense of the insured, the insurer must provide an independent defense of the claim.” This is essentially the adoption of California’s “Cumis rule.” In general, many states apply a rule that looks something like Cumis (just not in statute form). Further, under Section 19 [not yet approved], “[t]he insurer is obligated to pay the reasonable fees of the defense counsel and related service providers on an ongoing basis in a timely manner.” This too is generally the rule in many states. However, the comment to the rule states that an insurer’s panel rate is not the reasonable fee to be paid to the insured’s independent counsel. It is relevant but not dispositive. The comment also states that “[i]n the event of a dispute during the course of the defense about the reasonableness of fees, the insurer must pay the disputed fees and may bring an action against the independent defense counsel seeking return of the disputed fees after the duty to defend has ended and any coverage defenses have been adjudicated or settled, so as not to invade the attorney—client privilege or work-product immunity. If the fees are later found to be unreasonable, the insurer’s sole recourse is from defense counsel, not the insured.” While this provides a much-needed rule, on the much-disputed rate issue, it goes very far and proposes a standard (and one that I’ve never seen) that is not workable. It is easy to see the problems that will arise when an insurer would have paid panel counsel a rate in the $200 per hour range and the insured hires counsel at $600 (or more) and claims it is reasonable. This a recipe for litigation between insurers and independent counsel over the reasonableness of the fees. Section 21 [not yet approved] states that an insurer that breaches the duty to defend loses the right to defend or associate in the defense of the claim, the right to assert any control over the settlement of the claim AND the right to contest coverage for the claim. Waiver of coverage defenses is a very strong consequence for a breach of the duty to defend. It is the rule adopted by the New York Court of Appeals this year in K2 (rehearing granted).Damages for breach of the duty to defend include the amount of any judgment entered into against the insured or the reasonable portion of a settlement entered into by or on behalf of the insured after breach, subject to the policy limits, and the reasonable defense costs incurred by or on behalf of the insured. Here, by limiting the insurer’s liability for any judgment or settlement to policy limits, the Principles are answering a question that needs guidance and doing so in a manner that favors insurers (compare to Columbia Casualty Company v. Hiar Holdings, LLC, discussed further on).This description of the ALI’s Principles of Liability Insurance is just the tip of the iceberg. The ALI Principles are here to stay. Dismiss them as academic mumbo jumbo at your peril. I believe that there is little doubt that the Principles will be raised by litigants and cited by courts in coverage decisions. Anyone doing liability coverage work would be well-served to follow the progress of the Principles and become familiar with what’s been proposed and adopted.
Coverage Opinions is a bi-weekly (or more frequently) electronic newsletter reporting or providing commentary on just-issued decisions from courts nationally addressing insurance coverage disputes. Coverage Opinions focuses on decisions that concern numerous issues under commercial general liability and professional liability insurance policies. For more information visit www.coverageopinions.info.
The views expressed herein are solely those of the author and not necessarily those of his firm or its clients. The information contained herein shall not be considered legal advice. You are advised to consult with an attorney concerning how any of the issues addressed herein may apply to your own situation. Coverage Opinions is gluten free but may contain peanut products.
Randy J. Maniloff is an attorney in the Philadelphia office of White and Williams, LLP. He concentrates his practice in the representation of insurers in coverage disputes over primary and excess obligations under a host of policies. Randy is co-author of “General Liability Insurance Coverage - Key Issues In Every State” (Oxford University Press, 2nd Edition, 2012). For the past twelve years Randy has published a year-end article that addresses the ten most significant insurance coverage decisions of the year completed.
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