Excess Insurance v. Factory Mutual Insurance

822 N.E.2d 768, 3 N.Y.3d 577, 789 N.Y.S.2d 461, 2004 N.Y. LEXIS 3728

• Court: New York Court of Appeals
• Decided: December 2, 2004
• Status: Published

Opinions

OPINION OF THE COURT

G.B. Smith, J.

The issue presented by this appeal is whether respondents’ obligation to pay sums for certain loss adjustment expenses arising from a “follow the settlements” clause is subject to the indemnification limit stated in a reinsurance policy. Like the Appellate Division, we conclude that it is, and therefore affirm the order of the Appellate Division.

In December 1990, appellant Factory Mutual Insurance Company (formerly known as Allendale Mutual Insurance Company) entered into an agreement with Bull Data Systems Inc. to provide property insurance with an indemnification limit of $48 million. Specifically, the policy covered against the risk of loss or damage to Bull Data’s personal computer inventory stored in a warehouse located in Seclin, France. In turn, Factory Mutual obtained facultative reinsurance¹ from various London reinsurers which have severally subscribed to the reinsurance agreement at issue in this litigation. The reinsurance policy states, in pertinent part:

“REASSURED: ALLENDALE INSURANCE COMPANY “ASSURED: BULL DATA CORPORATION and/or as original. “PERIOD: Twelve months at 1st June, 1991 and/or as original. Both days inclusive. “LOCATIONS: Bull Data Corporation, Seclin, France as original. “INTEREST: Goods and/or Merchandise incidental to the Assured’s business consisting principally of personal computers and/or as original. “LIMIT: US$ 7,000,000 any one occurrence p/o US$ 13,500,000 any one occurrence excess of US$ 25,000,000 any one occurrence. “CONDITIONS: As original and subject to same valuation, clauses and conditions as contained in the original policy or policies but only to cover risks of All Risks of Physical Loss or Damage but excluding Inventory Shortage. Including Strikes, Riots, Civil Commotions and Malicious Damage risks if and as original. Premium payable as in original. 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 defence of any claim hereunder. Service of Suit Clause (U.S.A.). Insolvency Clause.”

In June of 1991, a fire that generated a spate of litigation, in the United States and abroad, destroyed the warehouse. Bull Data presented a claim to Factory Mutual and, suspecting that the fire was the result of arson, Factory Mutual refused to satisfy it.

Bull Data brought suit in the courts of France to recover under its insurance 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 respondent reinsurers. The reinsurers refused payment and filed an action in the courts of England seeking a declaration that the reinsurance contract was invalid. The English courts dismissed the case for lack of jurisdiction. During that period, 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, allegedly the proportionate share of 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.

District Judge Shira A. Scheindlin granted partial summary judgment to the reinsurers and dismissed Factory Mutual’s claim for loss adjustment expenses (Allendale Mut. Ins. Co. v Excess Ins. Co. Ltd., 970 F Supp 265 [SD NY 1997], amended upon rearg 992 F Supp 271 [SD NY 1997]). 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 (Allendale Mut. Ins. Co. v Excess Ins. Co. Ltd., 62 F Supp 2d 1116 [SD NY 1999]).

The reinsurers thereafter commenced this declaratory judgment action in 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.² Factory Mutual interposed a counterclaim, seeking the $7 million indemnification limit under the reinsurance policy as well as $5 million in loss adjustment expenses incurred by Factory Mutual in the litigation of the original claim with Bull Data. Both Factory Mutual and the reinsurers moved for partial summary judgment on Factory Mutual’s counterclaims seeking loss adjustment expenses in excess of the amount stated in the indemnification limit. Supreme Court denied the reinsurers’ motion, granted Factory Mutual’s cross motion and declared 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 by granting the reinsurers’ motion and denying Factory Mutual’s cross motion. The 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 policy. The Appellate Division granted Factory Mutual leave to appeal to this Court. We now affirm the order of the Appellate Division.

In resolving the issue before us, we are mindful that in interpreting reinsurance agreements, as with all contracts, the intention of the parties should control. To discern the parties’ intentions, the court should construe the agreements so as to give full.meaning and effect to the material provisions (see Breed v Insurance Co. of N. Am., 46 NY2d 351, 355 [1978]; see also Greenfield v Philles Records, Inc., 98 NY2d 562, 569 [2002]; Slatt v Slatt, 64 NY2d 966, 967 [1985]).

Here, there is no dispute that the reinsurance agreements set the policy limit at $7 million per occurrence. The so-called “follow the settlements” clause is thereafter set forth in the section of the policy entitled “CONDITIONS.”³ As provided in the agreement, the clause requires the reinsurers to pay their portion of expenses incurred in the investigation and defense of any claim under the agreement. The reinsurers, however, contend that their liability to pay is subject to the $7 million cap negotiated under the policy. By contrast, Factory Mutual argues that the reinsurers’ liability to pay the defense expenses is separate and apart from the indemnification cap on the policy.

We agree with the reinsurers and hold that they cannot be required to pay loss adjustment expenses in excess of the stated limit in the reinsurance policy. Once the reinsurers have paid the maximum amount stated in the policy, they have no further obligation to pay Factory Mutual any costs related to loss adjustment expenses. In so holding, we follow the decisions of the United States Court of Appeals for the Second Circuit as expressed in Bellefonte Reins. Co. v Aetna Cas. & Sur. Co. (903 F2d 910 [2d Cir 1990]) and Unigard Sec. Ins. Co., Inc. v North Riv. Ins. Co. (4 F3d 1049 [1993]). In both cases, the ceding insurers claimed that a similar “follow the fortunes” clause required the reinsurers to reimburse litigation costs beyond the stated limit in the policy. The court in both cases concluded that such a reading of the policy would render meaningless the liability cap negotiated in the policy. According to the Bellefonte court, to “allowt ] the ‘follow the fortunes’ clause to override the limitation on liability—would strip the limitation clause and other conditions of all meaning; the reinsurer would be obliged merely to reimburse the insurer for any and all funds paid. . . . The ‘follow the fortunes’ clauses in the certificates are structured so that they coexist with, rather than supplant, the liability cap. To construe the certificates otherwise would effectively eliminate the limitation on the reinsurers’ liability to the stated amounts” (903 F2d at 913).

Likewise here, the parties negotiated an indemnity limit of $7 million per occurrence. Thus, any obligation on the part of the reinsurers to reimburse Factory Mutual, whether it be for settling the original insurance claim with Bull Data or for the loss adjustment expenses incurred in the protracted litigation that ensued, must be capped by the negotiated limit under the policy. Otherwise, the reinsurers would be subject to limitless liability. Indeed, this case well illustrates such an injustice as Factory Mutual now seeks to saddle the reinsurers with a portion of a litigation bill that exceeds the negotiated policy limit by more than 70%.⁴ To permit such a result would render the liability cap a nullity.

Factory Mutual asserts that this case is distinguishable from Bellefonte and Unigard in that those cases involved liability insurance while this case involves property insurance. According to Factory Mutual, a liability insurance product normally encompasses the obligation to pay the legal defense costs on behalf of the insured as well as the cost of the loss itself. Thus, the risk to be spread in reinsurance would already include loss adjustment expenses. However, a property insurance product would cover only the value of the property item to be insured. Under those circumstances, Factory Mutual contends, an insurer would have no contractual obligation to incur investigation or litigation costs and the risk of those costs is not already included in the reinsurance product. We find this argument unpersuasive and conclude that this distinction does not provide a sufficient basis to extend the reinsurers’ liability beyond the limit stated in the reinsurance policy.

The limit clause in the policy is intended to cap the reinsurers’ total risk exposure. Although Judge Scheindlin’s decision in Allendale was vacated and is not binding, we find her reasoning persuasive, “Whether [the reinsurers] reimburse [Factory Mutual] for claims for property losses or defense costs makes no difference to them. Reinsurers of property insurance policies have the same interest in controlling their maximum exposure as do reinsurers of liability insurance policies. Thus, Bellefonte and Unigard’s holdings that the limit clauses define the reinsurers’ bargained-for maximum exposure to liability inclusive of all costs and expenses are applicable even where the underlying insurance policy does not oblige the insurer to cover the insured’s defense costs” (992 F Supp at 277).

Of course, both parties were well aware of the type of product that was being reinsured. It would be far from unreasonable to expect that at the time of procuring reinsurance, Factory Mutual could anticipate the possibility of incurring loss adjustment expenses in settling a claim from Bull Data. Certainly, nothing prevented Factory Mutual from insuring that risk either by expressly stating that the defense costs were excluded from the indemnification limit or otherwise negotiating an additional limit for loss adjustment expenses that would have been separate and apart from the reinsurers’ liability on the insured property. Failing this, the reinsurers were entitled to rely on the policy limit as setting their maximum risk exposure.

Accordingly, the order of the Appellate Division should be affirmed, with costs, and the certified question answered in the affirmative.

1 . “Facultative reinsurance is policy-specific, meaning that all or a portion of a reinsured’s risk under a specific contract of direct coverage will be indemnified by the reinsurer in the event of loss” (Travelers Cas. & Sur. Co. v Certain Underwriters at Lloyd’s of London, 96 NY2d 583, 587 [2001]).

2 . Factory Mutual moved Supreme Court to dismiss the action on the grounds of forum non conveniens and also commenced an action in the Superior Court of Providence, Rhode Island. Supreme Court granted Factory Mutual’s motion. While the reinsurers appealed the order, they sought a preliminary injunction in Supreme Court to enjoin the Rhode Island proceeding, which that court denied. While the Rhode Island court was considering Factory Mutual’s motion for partial summary judgment on its claims for loss adjustment expenses in excess of the indemnification limit, the Appellate Division reversed the order of Supreme Court, reinstated the reinsurers’ lawsuit and enjoined the Rhode Island litigation.

3 . In the reinsurance industry a “follow the settlements” clause “refers to the duty to follow the actions of the cedent in adjusting and settling claims” (Barry R. Ostrager and Thomas R. Newman, 2 Handbook on Insurance Coverage Disputes § 16.01 [b], at 1020 [12th ed 2004]). Thus, the reinsurers will be bound by the settlement or compromise agreed to by the cedent unless they can show impropriety in arriving at the settlement (id.).

4 . Such an outcome would be particularly unfair given that the “follow the settlements” clause gave the reinsurers no control over the management of the unsuccessful litigation that Factory Mutual launched against Bull Data and no voice in limiting the $35 million litigation expense.