by ~ John T. Harding (Email) (Web Site)
In a case that illustrates how the worlds of direct claims and reinsurance can overlap and collide, a federal court in New York recently concluded that a reinsurer was entitled to present its case at trial on whether it was prejudiced by the ceding company's admittedly late note, and would also be permitted to take discovery on whether it should be excused from having to prove prejudice because the ceding company¡¯s late notice was in "bad faith." Insurance Company of the State of Pennsylvania v. Argonaut Ins. Co., 2013 WL 4005109 (S.D.N.Y. Aug. 6, 2013).
The reinsurance dispute arose out of the long-standing war going on in California regarding coverage for the asbestos liabilities of Kaiser Cement and Gypsum Company--a war that resulted earlier this year in a decision on allocation and stacking that seemed to cut back on the expansive pronouncement by the California Supreme Court just last year in the State of California case. Kaiser Cement and Gypsum Corp. v. ICSOP, 155 Cal. Rptr. 3d 283 (Cal. App. 2d Dist. 2013)(holding that the primary policies issued by Truck Insurance Exchange could not be stacked and that only a single limit of liability applied to each "occurrence").
Although the asbestos dust had far from settled on this underlying dispute, ICSOP filed an action against its reinsurer, Argonaut, in New York seeking to enforce its rights to reinsurance for amounts that it might be required to pay pursuant to any final resolution of the <>Kaiser Cement litigation relating to the policy it had issued to Kaiser in 1974. Argonaut contested the claim on the grounds of late notice as the facultative certificate issued by Argonaut specified that:
ICSOP shall notify Argonaut promptly of any occurrence which in the Company's estimate of the value of injuries or damages sought, without regard to liability, might result in judgment in an amount sufficient to involve this certificate of reinsurance. ICSOP shall also notify Argonaut promptly of any occurrence in respect of which ICSOP has created a loss reserve equal to or greater than fifty (50) percent of ICSOP's retention specified in Item 3 of the Declarations; or, if this reinsurance applies on a contributing excess basis, when notice of claim is received by the Company.
Slip op. at *2. The ICSOP policy provided limits of $5 million above the $500,000 per occurrence limits of the underlying Truck policy and, like the Truck policy, did not contain a products aggregate.
During the course of the litigation, discovery revealed that ICSOP had been aware of the underlying cases brought against Kaiser for a long period and yet had failed to give notice to Argonaut that its reinsurance might be triggered. For example:
• In 1988, a representative of AIG attended a meeting of insurers to discuss a possible cost sharing arrangement as AIG had also issued primary insurance to Kaiser.
• In 1989, the broker noted in a memorandum that there was a "very real possibility of some impairment" of the ICSOP policy.
• In 1991, the Toxic Tort Department of AIG prepared a Key Account Summary that listed the Kaiser exposure.
• In 1996, ICSOP opened a master claim file indicating that it had received formal notice of the Kaiser claims.
• In 2002, ICSOP was brought into the California coverage litigation commenced by Truck Insurance Exchange.
• In 2004, Truck brought a motion for summary judgment on the number of "occurrences" issue, seeking to confine its exposure to a single "occurrence." ICSOP took no position on the motion since there was an inherent conflict between the ICSOP policies (which did not have an aggregate) and AIG's upper layer policies (which would benefit from a multiple occurrence ruling).
• In 2005, the California trial court ruled that there were disputed issues of fact relating to the number of "occurrences" issue.
• In 2006, the trial court reversed its decision and ruled that Kaiser's asbestos liabilities were a single "occurrence."
• After appeal and remand, the trial court concluded that each bodily injury asbestos claimant would be considered a separate occurrence.
• The court further ruled that Kaiser could select a triggered year of coverage--it chose the 1974 year in which ICSOP had issued its policy.
• These rulings were followed by extensive negotiations among the impacted insurers, including ICSOP, including an interim settlement agreement.
Throughout all of these events, ICSOP never provided notice to Argonaut under the facultative certificate. At the same time, Argonaut was involved in negotiating commutation agreements with certain of its retrocessionaires. Under these agreements, Argonaut released approximately 23% of its reinsurance coverage. Argonaut contended that if it had been aware of the potential liabilities flowing from the ICSOP policy, it could have charged a higher price for these agreements. ICSOP finally reported the claim under the facultative certificate in 2009, more than twenty years after the underlying claims had commenced.
Concluding that to the extent there was any conflict the law of California (rather than New York) would govern the reinsurance dispute, the District Court ruled that ICSOP clearly breached the notice requirement of the facultative certificate. The court concluded that, at the latest, ICSOP had an obligation to notify Argonaut of a claim that potentially triggered the facultative certificate in 2002 when Kaiser brought ICSOP into the California coverage dispute.
This conclusion was only the start of the battle, however. ICSOP next contended that even if it had failed to give notice under the facultative certificate, Argonaut had "constructive notice" of the potential impairment of its reinsurance such that the failure by ICSOP to give timely notice was not material. The court determined that California law (which permits constructive notice) would apply but that ICSOP had failed to present any evidence from which it could be concluded that Argonaut should have been on inquiry notice concerning the claims. ICSOP's only support for its position was the contention that Argonaut may have been on notice under another treaty which also reinsured the ICSOP policy. The alleged notices upon which ICSOP based this theory could never be found in Argonaut's files or the broker's files and so there was no triable issue of fact on what effect (if any) the unproven notice from an alternative source should have had on Argonaut.
Judge Cote next turned to the question of whether Argonaut was prejudiced by the late notice--an issue on which the parties had engaged in extensive discovery. The judge first concluded that both California and New York would require a showing of prejudice by the reinsurer in order to avoid the contract on the grounds of late notice and that the reinsurer has the burden of proving prejudiced from the untimely notice. In particular, the court determined that Argonaut would have the burden of showing prejudice and that the question of prejudice could not be established as a matter of law. While concluding that if Argonaut had availed itself of its contractual right to associate in the defense it is unlikely that Argonaut's participation would have changed the outcome of the litigation, the court did agree that Argonaut had presented substantial evidence that it participation might have resulted in an earlier and more favorable settlement of the dispute. In this regard, the court noted that the usual assumption that the interests of the reinsurer and the reinsured were "aligned" would not be applicable since it was clear that ICSOP's handling of the Kaiser claims was influenced by the fact that the ICSOP policy was part of a larger group of AIG policies implicated by the claims that had conflicting provisions and interests on the key coverage issues. The court has determined that Argonaut had raised significant issues with respect to the lack of timely notice on the various commutation agreements that it had entered into--in other words, whether Argonaut could have obtained additional amounts for releasing its retrocessionaires if the Kaiser claims had been factored into he mix. On all of these issues, the court concluded that Argonaut should be allowed to present its case at trial.
Judge Cote also recognized, however, that in the context of reinsurance relationships, Argonaut could potentially be relieved of its obligation to prove "prejudice" if it could demonstrate that ICSOP had acted in "bad faith" in failing to provide timely notice of the claims under the facultative certificate. Based upon the Second Circuit's ruling in the Unigard case, the District Court held that "a ceding insurer's failure to provide prompt notice will entitle a reinsurer to relief without showing prejudice if (1) the ceding insurer deliberate deceives a reinsurer or (2) the ceding insurer fails to implement routine practices and controls to ensure notification to reinsurers." Slip op. at *13. The court went on to predict that California would adopt the same rule based upon provisions in the California Insurance Code, as well as California cases that recognize that ceding insurers are sophisticated entities that are familiar with the practices relating to notice. See e.g., Transport Ins. Co. v. TIG Ins. Co., 202 Cal.App. 4th 984, 989 (Cal. Ct. App. 2012). However, since discovery in the case had been limited to the facts surrounding notice and prejudice to Argonaut, the court determined that Argonaut should be entitled to take discovery on the issue of ICSOP's alleged "bad faith" before the case would be set for trial.
The decision in ICSOP v. Argonaut illustrates the uphill battle that a reinsurer faces when challenging a claim by the ceding company on the grounds that notice was untimely. Notwithstanding the sophistication of the ceding company and the extremely long period during which notice was delayed, the court was unwilling to find that prejudice had been established as a matter of law. Particularly notable is the fact that nowhere in the discussion is there any suggestion that ICSOP offered any meaningful reason or excuse for its failure to provide notice under the facultative certificate--whether through administrative oversight or because ICSOP did not believe that the notice requirement had been triggered. While the court left open the door of proving "bad faith" as a potential way around the prejudice issue, attempting to prevail on such a claim is unlikely to be an easy task for Argonaut to prove. If the case does not get resolved, this will certainly be a trial worth watching.
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