Following last May’s tumultuous decision by the American Law Institute to defer a final vote on its proposed Restatement of Law, Liability Insurance, the Restatement reporters have been busy drafting new text to meet the concerns that were expressed by defense lawyers, state regulators and other groups in the weeks leading up to last May’s meeting.  On August 4, the Reporters released Preliminary Draft No. 4, which was debated yesterday at a meeting in Philadelphia between the project’s Reporters and a hundred lawyers, judges and law professors from the Advisers Group and Members Consultative Group for this project.

Here is a summary of the key changes in this latest draft:

–Principles of Policy Interpretation (Section 3)

The Reporters have made a concerted effort in this new Preliminary Draft to rationalize their novel “presumption of plain meaning” approach to contract interpretation and to minimize the extent to which it diverges from the traditional “plain meaning” view.   They explain that their proposed approach is a compromise between “strict plain meaning” and the “contextual” approach favored by the Restatement of Contracts that construes terms in accordance with the circumstances and context of the contract that because a determination of ambiguity is to be made without regard to extrinsic evidence, this section did not recognize the concept of “ambiguity in context.”  Notably, the Reporters assert that extrinsic evidence may not be used to “manufacture” an alternative meaning.  Rather, a plausible basis must exist for arguing that an alternative meaning exists before courts should allow discovery of extrinsic evidence to determine the relative reasonableness of the proposed latent meaning.

–Liability of Insurer for Conduct of Defense (Section 12)

As revised, Section 12 imposes vicariously liability if counsel is an employee of the insurer (ie. staff counsel) and direct liability if the insurer “has undertaken a duty to select defense counsel and the insurer breaches that duty, including by retaining counsel with inadequate professional liability insurance” or where “the insurer has undertaken a duty to supervise defense counsel and the insurer breaches that duty.”  Confusion persists, however, with respect to what constitutes “supervision.”   The Reporters explained at the September 7 meeting that they are focusing on cases where the insurer somehow controls the conduct of defense counsel and that a mere engagement letter of the issuance of Billing Guidelines would not give rise to liability.   There was also widespread criticism at the September 7 meeting of the vague statement that insurers may be liable if defense counsel does not have adequate malpractice coverage.  While insurers nowadays typically require panel counsel to produce a dec page or other proof of E&O coverage, how much coverage is enough?

–Conditions Under Which Insurers Must Defend (Section 13)

Section 12 requires insurers to defend any cases where facts are alleged that, if proven, would be covered or if there are “facts not alleged in the complaint…that a reasonable insurer would regard as a basis for adding an allegation to the action.”    Insurer advocates at the September 7 meeting argued for an elimination of the “reasonable insurer” language in favor of limiting an insurer’s duty to consider extrinsic facts to those actually known by the insurer.  The Reporters responded that they are worried about insurers that stay “willfully ignorant” by conducting little or no investigation.   Controversy also remains with respect to what it means for an “allegation” to be added to an action.  Are the Reporters referring to new facts concerning existing causes of action or an amendment to the pleadings that adds new theories of liability altogether. The Reporters have clarified Section 13 to make clear that, while “factual uncertainty” gives rise to a duty to defend, “legal uncertainty” that may exist when a jurisdiction does not have settled coverage law does not.  This drew criticism from policyholder advocates at the September 7 meeting, who argued that it would encourage delay and obfuscation by insurers.

–Duty to Make Reasonable Settlement Decisions (Section 24)

The Reporters have added language to Comment d. to Section 24 to state that their conception of a “reasonable insurer” includes not only an average ordinary insurer but also “a more aspirational concept that protects against circumstances at which average conduct is objectively unreasonable.”  They have clarified, however, that the duty to make reasonable settlement decisions only extends to excess judgments that are otherwise covered by the policy, language that was lacking in earlier drafts.

The Reporters continue to equivocate with respect to whether insurers must make an offer of settlement in the absence of a demand from the plaintiff.  Comment f. states that they are adopting a “reasonableness” standard, not a “hard and fast rule” and that whether an insurer owes the duty to make an offer depends on the particular circumstances as where the facts known to the insurer make clear that the policy limits are significantly less than the reasonable settlement value of the underlying case given the severity of the claimant’s damages and the likelihood of liability being found.  They acknowledge, however, that there may be strategic value in not making an offer early on.

Allocation in Long-Tail Losses (Section 42)

Despite policyholder efforts to return Section 42 to an “all sums” approach, the reporters have retained a “pro rata by years” allocation methodology for long tail losses.   Recently, the insureds shifted their emphasis from arguing for “all sums” to arguing instead that equity required that insureds not be required to assume responsibility for “pro rata” shares allocable to years when insurance was “unavailable,” as was largely the case for asbestos losses and, to a lesser extent, pollution claims after 1986.  The Reporters did include a discussion of “unavailability” in a new Comment h. but do not expressly endorse it.

–Known Losses (Section 47)

The Reporters have amended both the black letter rule and Comments for Section 47 to make clear that conventional CGL insurers do not have a duty to defend claims that are already in suit before their policies are issued.  This is in contrast to the text that was in last Spring’s Proposed Final Draft, which found that the liability of insurers whose obligations were subject to large self-insured retentions might still be uncertain in such circumstances.  In this latest draft, the Reporters declare that “the touchstone from whether the doctrine applies is substantially certain is whether, absent the application of the doctrine, the insurer will be required to pay some amount of money on behalf of an insured under the policy that is about to be issued.”

–Fee Shifting (Sections 48-49)

Sections 48 and 49 set forth the remedies available to policyholders and, in particular, the circumstances in which policyholders can recover their fees for litigating coverage disputes.  Section 48 states that insurers that substantial prevail in coverage suits commenced by insurers seeking to terminate a defense obligation may recover their fees, whereas Section 49 allows fees if the insurer has declined to defend and the insured obtains a ruling finding a duty to defend.  At the September 7 meeting, insurer advocates protested that Section 48, while consistent with the Mighty Midgets rule in New York, unfairly penalized insurers for bringing DJs to clarify their obligations, especially in states like Illinois where the failure to bring a DJ may estop the insurer from contesting its indemnity obligations.

It is likely that the Reporters will make a few adjustments to this latest drafting, especially as regards Section 12 but that major changes are unlikely before the draft Restatement is submitted to the ALI Council in January.   While there may be efforts to lobby the Council between now and January, there is danger in such efforts as the ALI is sensitive to efforts by outside interests to influence its deliberations.

Assuming that the ALI Council approves the revised draft, a second Proposed Final Draft will be presented to the ALI membership next Spring for a final vote in May 2018.  This time around, nearly eight years after this project began in 2010, final approval seems likely.