Court of Appeals Limits Reinsurer's Obligation for Adjustment Loss Expenses Under "Follow the Settlement" Clause to Policy Indemnification Limit
January, 2005
The New York Court of Appeals held in Excess Insurance Company Ltd., et al. v. Factory Mutual Insurance Company, 3 N.Y.3d 577, 822 N.E.2d 768, 789 N.Y.S.2d 461 (2004), that a reinsurer's obligation to pay loss adjustment expenses arising from a “follow the settlements” clause may not exceed the indemnification limits contained in the reinsurance policy.
In 1990, Factory Mutual Insurance Company entered into an agreement with Bull Data Systems Inc., providing property insurance against the risk of loss or damage to Bull Data's personal computer inventory stored in a warehouse located in Seclin, France. The Policy contained an indemnification limit of $48 million. Subsequently, Factory Mutual obtained facultative (policy-specific) reinsurance from various London reinsurers, including Excess Insurance Company Ltd.. The reinsurance agreement contained limits of $7,000,000.00 for any one occurrence and a specific clause with the condition that “Reinsurers agree to follow the settlements of the Reassured in all respects and to bear their proportion of any expenses incurred, whether legal or otherwise, in the investigation and defense of any claim hereunder.”
In June of 1991, a fire destroyed the Seclin warehouse. Factory Mutual denied Bull Data's claim under its Policy, suspecting that the fire was the result of arson. Bull Data brought suit in France to recover under its Policy. Factory Mutual also commenced an unsuccessful litigation against Bull Data in the United States District Court for the Northern District of Illinois, claiming that the loss was due to arson, and the limit of liability under the insurance Policy was $48 million. After incurring approximately $35 million in litigation expenses, both lawsuits were terminated and Factory Mutual settled the claims with Bull Data for nearly $100 million.
Factory Mutual thereafter sought payment from its London based reinsurers. After refusing to pay Factory Mutual, the reinsurers filed a declaratory judgment action in England seeking a ruling that the reinsurance contract was invalid. After the case was dismissed for lack of jurisdiction, Factory Mutual commenced a declaratory judgment action in the United States District Court for the District of Rhode Island seeking $7 million from the reinsurers and an additional $5 million in loss adjustment expenses under the reinsurance agreement (the proportionate share of legal expenses that the reinsurers owed Factory Mutual for having defended the Bull Data claim). Factory Mutual later discontinued the action upon stipulation and commenced a similar action in the United States District Court for the Southern District of New York.
In Allendale Mutual Ins. Co. v Excess Ins. Co. Ltd., 970 F.Supp. 265 (S.D.N.Y. 1997), modified following motion for reargument, 992 F.Supp. 271 (S.D.N.Y. 1997), Judge Shira A. Scheindlin granted partial summary judgment to the reinsurers and dismissed Factory Mutual's claim for loss adjustment expenses. During the pendency of Factory Mutual's appeal to the United States Court of Appeals for the Second Circuit, that court decided an unrelated case which affected the subject matter jurisdiction of the pending case, resulting in dismissal of the appeal and vacatur of the judgment of the District Court. See Allendale Mutual Ins. Co. v Excess Ins. Co. Ltd., 62 F. Supp.2d 1116 (S.D.N.Y. 1999).
Thereafter, the reinsurers commenced this declaratory judgment action in the New York Supreme Court, New York County, seeking to annul the reinsurance agreement based on material nondisclosures and misrepresentations or, in the alternative, a judgment awarding damages. Factory Mutual interposed a counterclaim seeking the $7 million indemnification limit under the reinsurance agreement as well as $5 million in loss adjustment expenses incurred by Factory Mutual in the litigation of the original claim with Bull Data. The reinsurers then moved for summary judgment and Factory Mutual cross-moved for partial summary judgment. The trial court denied the reinsurers' motion and granted Factory Mutual's cross-motion, declaring that the reinsurers' obligation to pay their proportionate share of the loss adjustment expenses was not subject to the stated indemnity limit of $7 million. The Appellate Division reversed, thereby granting the reinsurers' motion and denying Factory Mutual's cross-motion. The Appellate Court thus declared that any portion of the loss adjustment expenses that the reinsurers were obligated to bear was subject to the $7 million limit stated in the reinsurance agreement. The Appellate Division granted Factory Mutual leave to appeal to the Court of Appeals.
In its decision, the Court of Appeals looked to the intent of the parties in entering the reinsurance agreement. Excess v. Factory Mutual, 3 N.Y.3d 577, 582, 789 N.Y.S.2d 461, 463. Reviewing the evidence, the Court stated that the reinsurance agreement set the policy limit at $7 million per occurrence. Id. However, the parties had differing views on whether the policy limits included the loss adjustment expenses as set forth in the “follow the settlements” clause of the Policy. Factory Mutual argued that the clause required the reinsurers to pay their portion of expenses incurred in the investigation and defense of any claim under the agreement and that these expenses are separate and distinguished from the indemnification cap on the reinsurance agreement. In contrast, the reinsurers argued that their liability is only subject to the $7 million cap negotiated under the reinsurance agreement.
In holding for the reinsurers, the Court applied two Second Circuit decisions, Bellefonte Reinsurance Co. v Aetna Cas. and Surety Co., 903 F.2d 910 (2d Cir. 1990) and Unigard Security Ins. Co., Inc. v North River Ins. Co., 4 F.3d 1049 (2d Cir. 1993). Both cases presented similar fact patterns to the instant case; the Second Circuit and Court of Appeals held that requiring reinsurers to reimburse litigation costs beyond the stated indemnification limit in the policy would render the liability cap a nullity. It was noted from the Bellefonte court that the “follow the settlement” clause is structured so that it coexists with, rather than supplants, the liability cap.
Learning Point:
In concluding that loss adjustment expenses are limited to the indemnification amount contained in reinsurance policies, the Court of Appeals ensured that reinsurers are no longer subject to potentially limitless liability. Such a result will have an enormous impact upon the assessment of litigation costs, strategies and maximum risk exposure for both primary and reinsurance carriers not only for potential suits, such as here, for the recovery of litigation expenses between carriers, but an overall impact on the industry concerning the costs of policy premiums and litigation expenses in areas of coverage. Further, because the Court of Appeals refused to extend the limits of the policy as negotiated between the parties, insurers and reinsurers alike may no longer rely on the “catch-all” quality that “follow the settlement” clauses once commanded. In this light, it is imperative that reinsurance agreements contain express language regarding contingencies for protracted litigation outside of the indemnification limits within the policy agreement. •
Back to New York CM Report of Recent Decisions (2005v1) 2005 Volume 1 Table of Contents
