Mike Aylward: Chapter One of Tentative Draft No. 1 of the Principles of the Law of Liability Insurance says some very interesting things about how insurance contracts should be interpreted and, in particular, what role ambiguity should play in creating coverage.
Section 3 states that insurance terms are to be interpreted in accordance with their “plain meaning” and presumes that a reasonable policyholder would share that plain meaning unless the insured presents “highly persuasive evidence demonstrating that a reasonable person in this policyholder’s position would give the term a different meaning under the circumstances.”
That doesn’t sound like much of a change from mainstream law until you get to Comment (a) to Section 3, which states that “extrinsic evidence is admissible to show the meaning of a policy term that is unambiguous on its face, but the language of the term must be susceptible to the alternative interpretation and that evidence must be sufficiently persuasive to the court to overcome the presumption in favor of the plain meaning of the term.” In short, even clear language can be ambiguous based on highly persuasive extrinsic evidence as to its meaning.
Section 4 is even more interesting. Instead of the “tie goes to the insured” rule followed in most states, whereby an insured gets coverage as long as it can demonstrate an alternative reasonable meaning, Section 4 states that contra proferentem is an interpretive rule of last resort and that a judge should only use ambiguity as a means of finding coverage after “using all other permissible sources of meaning, including extrinsic evidence.” Consistent with this view, Comment (k) says that the same rules should apply to “sophisticated” and unsophisticated insureds. The reporters observe that, “[B]ecause contra proferentem is a doctrine of last resort. . .the doctrine should be applied irrespective of the sophistication of the parties.”
We asked our contributors whether these statements reflect the existing law in their jurisdictions and how they may impact the practice of insurance litigation in the future?
Kevin Merriman: Kevin: New York law generally is in accord with the ALI’s position on the use of contra proferentem as a tool of “last resort”; typically, the rule is applied only after other principles of contract construction have been exhausted. However, New York courts will apply contra proferentem if ambiguities still exist after consideration of extrinsic evidence, if any. Contrary to the ALI’s position that extrinsic evidence should be used even when a plain reading of the policy terms eliminates any ambiguity, New York courts have applied the parol evidence rule, and will only look to extrinsic evidence if an unambiguous meaning cannot be discerned from the explicit language of the policy. See Union Carbide Corp. v. Affiliated FM Ins. Co., 16 N.Y.3d 419, 425 (2011) (“This is an approach strongly favored in our precedents, which hold that, where the meaning of a writing is clear from its text, extrinsic evidence will not be considered…. Nevertheless, there inevitably will be cases in which the parties have not expressed themselves clearly in writing, and in which resort to extrinsic evidence will be necessary”).
Shaun Baldwin: Is the ALI really suggesting that a court could pick what it views as the more realistic meaning of a particular word proffered by the insurer over a remotely possible interpretation suggested by the insured? That would be refreshing! If the rule of contra proferentem was truly a rule of last resort, this would be a change from existing IL law.
There is some precedent in Illinois for looking outside the four corners of the insurance contract to find ambiguity, however. In Hoglund v. State Farm Mut. Automobile Ins. Co., 148 Ill. 2d 272 (1992), the Illinois Supreme Court allowed the consideration of extrinsic evidence to “interpret” the plain meaning of the set off provision in an uninsured motorist provision.
Diane Polscer: Allowing extrinsic evidence to infer ambiguity in language that is otherwise clear on its face is definitely contrary to existing principles of Oregon and Washington law. In fact, Oregon law never allows reference to extrinsic evidence for purposes of interpreting an insurance policy. See, e.g., Laird v. Allstate Ins. Co., 221 P.3d 780 (Or. 2009) (“extrinsic evidence of the parties’ intent is not part of the interpretation of an insurance policy under Oregon law”). Instead, if a policy term is not defined and lacks a plain meaning, Oregon courts will apply a contextual analysis in an effort to resolve the ambiguity. If the contextual analysis fails to resolve the ambiguity (i.e., two reasonable interpretations remain after considering plain language and context), then the term is construed against the drafter. Extrinsic evidence never enters this analysis because the disputed term is automatically construed in the insured’s favor if the meaning of that term cannot be determined from the policy itself. While this interpretive methodology clearly favors the insured, it also tends to lower the costs of litigation by avoiding the discovery and litigation expenses associated with arguments premised on extrinsic evidence.
Washington law follows a middle approach between Oregon law and the ALI Principles. Specifically, extrinsic evidence cannot be introduced if the disputed term is deemed unambiguous, but it can be considered if an ambiguity is found, and “[a]ny ambiguity remaining after examination of the applicable extrinsic evidence is resolved against the insurer and in favor of the insured.”
My particular concern is that by allowing reference to extrinsic evidence even when policy language is plain on its face, this section of the Principles threatens to dramatically increase the costs of insurance litigation in both Oregon and Washington. While the ALI Principles state that only “highly persuasive extrinsic evidence” is sufficient to overcome a presumption of plain meaning, this limitation would not help control the high costs associated with allowing reference to extrinsic evidence. This is because broad discovery would have to be allowed in order to give a party the opportunity to develop its “highly persuasive extrinsic evidence.” Even where policy language is clear on its face, the ALI Principles would allow an insured broad discovery rights on the topic of
Prohibiting reference to extrinsic evidence keeps costs down for both sides, and the insured is not prejudiced by this approach because it automatically prevails in the event of a “tie,” i.e., where two reasonable interpretations remain following a plain meaning and contextual analysis. The Oregon approach also increases certainty by preventing attempts to undermine policy language that is unambiguous on its face. This means parties can rely on the policy language without concern that some outside evidence will be used to introduce an ambiguity and change the policy’s meaning.
Sara Thorpe: The ALI starts from the correct premise that interpretation of an insurance contract is a question of law. Indeed, the Section 3 makes a good point that is the "policyholder's" expectation and not just any "insured" that is the relevant inquiry, since it is the policyholder that entered into the contract. However, the description of the types and use of extrinsic evidence appears overly broad. It’s worth noting that California cases do frequently feature evidence extrinsic to the contract, even though it is only meant to explain an ambiguity, not to create one. Extrinsic evidence should not be permitted to establish an ambiguity, but rather should only be permitted to explain and resolve an ambiguity that is evident from reading the words of the policy.
Michael Aylward: This really would be a change from the rule in most New England states. Our courts have nearly universally held that extrinsic evidence is not material to establish the plain meaning of the documents at issue. Nor can extrinsic evidence be relied on to contradict the unambiguous written terms of the parties’ contract
Chris Martin: The criticism of extrinsic evidence as a means of establishing an ambiguity articulated so well by my colleagues need not be repeated but it is worth noting the two decades of completely contrary precedent from the Texas Supreme Court and the Fifth Circuit Court of Appeals. What has been so clear in Texas, and in the many states mentioned by my friends, will now become ripe for a decade or more of unnecessary and costly coverage litigation over the purported ambiguity of insurance policies fueled by new allegations of “extrinsic evidence” regardless of the sophistication of the parties, the clarity of the policy language, and the prior duration of the coverages.
One of the greatest failures of the ALI regarding the changing face of insurance policies concerns the failure to recognize the sophisticated nature of many commercial policyholders. Today, many Fortune 500 companies have large and sophisticated risk management departments who specialize in creating and negotiating layers aggressive insurance coverage programs with many of them retaining claims handling responsibilities through SIRs and fronting arrangements with carriers. Many of these same commercial insureds use some of the world’s largest insurance brokers to negotiate and place complex manuscript coverages with carriers from all over the world. Ten and twenty years ago such practices were rare to non-existent. Today, they are commonplace and account for many billions of dollars of insurance coverage just in the U.S. In any other field of American contract law, the sophistication of the parties would be a relevant factor at multiple levels in dealing with legal questions over the meaning and enforcement of a contract. ALI’s silence on the issue is deafening.