Today, let’s begin our section by section tour through the American Law Institute’s new Insurance Restatement.
Chapter 1, Section 1 of the Restatement includes definitions of common terms found in the law of liability insurance, including such commonplace concepts as a condition, the insuring clause, a mandatory (versus non-mandatory) rule, a policy limit and a standard-form term. Although most of the definitions in the Restatement are non-controversial, a couple of points bear mentioning. In Section 1(2), the Restatement states that “Unless otherwise stated in the insurance policy, none of the insurer’s duties with respect to defense or indemnification are contingent upon the insured’s payment of the deductible.” In fact, according to the Rutter Guide, “Most E[rrors] & O[missions] policies” provide that the insured’s obligations with respect to the deductible “must be satisfied before the insurer is obligated to make any payments under the policy.” Hon. H. Walter Croskey (Ret.), Hon. Rex Heeseman (Ret.), Jeffrey I. Ehrlich and Peter H. Klee, California Practice Guide: Insurance Litigation, Chapter 7K-D, Section 7-2489. In the second sentence of the definition for a “Self-insured retention,” the Restatement says that “Unless otherwise stated in the insurance policy, an insurer has no duty to defend or indemnify the insured until the insured has paid any applicable self-insured retention.” Restatement, Section 1(12). In California, there is law for the opposite proposition – that the duty to defend is only excused until the self-insured retention is paid where the policy expressly (and clearly) says so. American Safety Indem. Co. v. Admiral Ins. Co. (2013) 220 Cal. App. 4th 1, 4.
Section 2 of the Restatement defines “insurance policy interpretation,” and provides that a court’s construction of policy language involves the resolution of a question of law. Restatement, Ch. 2, Sec. 2(2). This is the general rule under California law as well, although a number of courts have added the slight qualifier “Absent a factual dispute as to the meaning of policy language . . . “ E.g., Jordan v. Allstate Ins. Co. (2004) 116 Cal. App. 4th 1206, 1212. The importance of this rule, of course, is that the interpretation of an insurance term or clause will receive de novo review by each appellate court. In Section 2(3), the Restatement provides that the ordinary rules of contract construction are equally applicable to construing insurance policies “Except as this Restatement or applicable law otherwise provides.” California law has repeatedly recognized that although “insurance contracts have special features,” ordinary contract construction rules apply. E.g., State of Calif. v. Continental Ins. Co. (2012) 55 Cal. 4th 186, 194.
Section 3 of the Restatement is the earliest clause in the treatise which caused considerable controversy among the members of ALI and outside observers. As written in the Proposed Final Draft No. 2 (Sept. 7, 2018), subsection 1 provides that where a term has a plain meaning “when applied to the facts of the claim at issue,” that plain meaning applies. According to subsection 2, “plain meaning” is “the single meaning to which the language of the term is reasonably susceptible when applied to facts of the claim at issue in the context of the entire insurance policy.”
Although there’s no shortage of case law, as we’ll discuss in a moment, the basic rules of policy construction are largely a matter of statute in California. Section 1636 of the Civil Code provides that contracts must be interpreted “to give effect to the mutual intention of the parties as it existed at the time of contracting.” Section 1638 states that “The language of a contract is to govern its interpretation, if the language is clear and explicit, and does not involve an absurdity.” Section 1641 provides that the entire contract must be construed as a whole, “so as to give effect to every part, if reasonably practicable, each clause helping to interpret the other.” Finally, Section 1644 says “The words of a contract are to be understood in their ordinary and popular sense, rather than according to their strict legal meaning” absent proof that the parties intended to use the language in a technical sense, or a special meaning is given to them by usage.
Likewise, California courts hold that the mutual intent of the parties is to be inferred, if possible, solely from the written provisions of the contract. E.g., AIU Ins. Co. v. Superior Ct. (1990) 51 Cal. 3d 807, 822. If the plain meaning of a policy term is clear and express, “it governs.” Palmer v. Truck Ins. Exch. (1999) 21 Cal. 4th 1109, 1115; Bank of the West v. Superior Ct. (1992) 2 Cal. 4th 1254, 1115. The plain meaning rule applies equally to negotiation and standard-form insurance policies. Powerine Oil Co. v. Superior Ct. (2005) 37 Cal. 4th 377, 391. It can’t be overridden by claims about the insured’s “reasonable expectations,” since if the language of the policy is clear and explicit, an insured can have a “reasonable expectation” of what the policy gives him or her, no more. Sarchett v. Blue Shield of Cal. (1987) 43 Cal. 3rd 1, 15.
As recently as the Proposed Final Draft of the Restatement, which was published about a year and a half before the Proposed Final Draft No. 2, Restatement Section 3 had a substantial loophole in its statement of the plain meaning rule: “An insurance-policy term is interpreted according to its plain meaning, if any, unless extrinsic evidence shows that a reasonable person in the policyholder’s position would give the term a different meaning. That different meaning must be more reasonable than the plain meaning in light of the extrinsic evidence, and it must be a meaning to which the language of the term is reasonably susceptible.” Although some remnants of this extrinsic evidence loophole appear to remain in Final Draft No. 2’s endorsement in Comment c of admitting evidence of “custom, practice, and usage,” in considering plain meaning – a step which would be contrary to California law, as summarized above, at least some of the uncertainty and unnecessary litigation which would have been triggered by the First Final Draft’s open-ended endorsement of extrinsic evidence appears to have been dispelled in the latest version of Section 3.
Join us back here in two weeks as we analyze the Restatement’s approach to ambiguity.