by ~ Adam R. Doherty (Email) (Web Site)
In a case that the reinsurance industry knows well, Unigard Sec. Ins. Co. v. N. River Ins. Co., 4 F.3d 1049 (2d Cir. 1993), the Second Circuit held that a reinsurer need not show prejudice to establish a lack of notice defense, if it demonstrates that the cedent acted in bad faith by failing to provide timely notice. The court reasoned that, because the ceding insurer is in virtually exclusive possession of information concerning the underlying risk, it is required to exercise a high level of good faith to ensure that material information is fully and promptly communicated to its reinsurers. Id. at 1069. The court held that the minimum standard for bad faith is �gross negligence or recklessness, and explained that a ceding insurer that establishes routine practices and controls to ensure notification to reinsurers does not act in bad faith if inadvertence causes a lapse in notification.
In late April, the U.S. District Court for the Southern District of New York rejected a cedent�s attempt to limit the scope of the bad faith defense under Unigard, as well as the discoverability of information concerning the defense. In Granite State Ins. Co. v. Clearwater Ins. Co., 2012 WL 1520851 (S.D.N.Y. April 30, 2012), the reinsurer (Clearwater) moved to compel the production of its cedent�s asbestos loss reserve documents related to one of the reinsurer�s affirmative defenses, which claimed that:
Plaintiff failed to implement reasonable and adequate practices and procedures to ensure the proper reporting to Clearwater of notice and related claim information, including, but not limited to, information specifically requested by Clearwater about claims.
After a magistrate judge allowed Clearwater�s motion and ordered the plaintiff-cedent "to produce copies of any final reviews, analyses, or studies conducted by any consultants or other third parties on the principal subject of the adequacy of Granite State's reserves for asbestos exposures, claims, and/or losses," Granite State moved to set the order aside on two grounds. First, Granite State argued that the magistrate�s order was contrary to law because it was based on a misinterpretation of the Second Circuit's decision in Unigard. Without conceding that Unigard is the law in New York, Granite State argued that it satisfied the Unigard standard because Unigard requires a cedent to establish routine practices and controls to ensure notification to its reinsurers, but is silent about the adequacy of those practices and procedures. In other words, according to Granite State, as long as a cedent establishes a procedure for notifying its reinsurers of claims, it cannot be held to be in bad faith under Unigard, whether or not the procedure is reasonable or adequate. Because Granite State had some notification system in place, Granite State took the position that inquiries into the adequacy or reasonableness of its reserving practices were nothing more than a fishing expedition.
Second, Granite State argued that the magistrate's order was "clearly erroneous" because it was undisputed that Clearwater had received notice, as required under the relevant reinsurance certificates. Moreover, the notification procedure utilized by Granite State in that particular case, manual notification -- unlike its alternative notification method, which automatically gave notice when reserves reached a certain level -- was not tied to the reserving of claims. On that basis, Granite State asserted that its reserving practices, and its alternative method of automatic notification based on the setting of loss reserves, were irrelevant and not discoverable.
The court relied on Unigard and the broad scope of discovery under Fed. R. Civ. P. 26 to reject both arguments. The court first determined that the proper question under Unigard was not simply whether a policy or procedure for notification exists, but whether a cedent exercises good faith in implementing the policy or procedure to ensure prompt and full disclosure to its reinsurer. The court similarly rejected Granite State's second argument, finding that, even if Granite State ultimately defeated the late notice defense, its argument that loss reserve information was irrelevant to its claims because it provided timely notice to Clearwater addressed the merits of the defense, not the relevance of the discovery sought.
The court found that documents related to Granite State�s loss reserves and the procedures for establishing them -- including any responsive documents related to the reserving practices of Granite State's parent company, AIG -- were directly relevant to whether Clearwater received notice at all, and to whether Granite State ultimately exercised good faith in establishing policies and procedures for notifying its reinsurers of claims. Accordingly, the court denied Granite State's motion, but ordered the parties to stipulate to a mutually-agreeable protective order because of the sensitive and proprietary nature of the reserve information to be produced by Granite State.
This decision highlights difficulties faced by cedents that rely on the mere existence of notification procedures to defeat a bad-faith defense based on late notice. If the reinsurer has good grounds to argue that a claim is not covered due to a lack of timely notice, the cedent may be required to not only produce reserve information, but information broadly related to its reserving practices as well.
Adam R. Doherty may be reached at email@example.com.
© 2012 Prince Lobel Tye LLP. All rights reserved.
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