Contract Interpretation

VIRGINIA SUPREME COURT CONSIDERS TERMS OF ASSUMPTION REINSURANCE TRANSACTION IN DETERMINING OBLIGATIONS OF INSOLVENT INSURER

December 21, 2017 by Michael Wolgin

A group of Kentucky hospitals sought reimbursement for legal fees incurred in two lawsuits related to the insolvency of their insurer, Reciprocal of America (“ROA”). In the 1970s and 1980s, the hospitals created two trusts to provide the hospitals with workers’ compensation and employers’ liability coverage. In 1997, the trusts were merged into ROA, and ROA agreed to assume the trusts’ business liabilities and to indemnify the trusts and their member insureds, including the hospitals, “in defending [themselves] against any claim Damages arising from or connection with the Damages.”

In 2003, ROA was placed into receivership and was later found insolvent and ordered liquidated. This led to two judicial proceedings in which the hospitals were involved—one that they joined as claimants seeking to have ROA continue to pay worker’s compensation claims that ROA had assumed from the trusts, and one seeking a declaration that the Kentucky Insurance Guaranty Association (KIGA) was obligated to cover the hospitals’ claims that ROA had assumed but could not pay. After both matters were resolved, the hospitals filed claims with ROA’s Special Deputy Receiver for reimbursement of the legal fees and costs incurred in those matters under ROA’s indemnification obligations. The claim was denied, and the case ended up before the Virginia Supreme Court.

The court affirmed the denial of the hospitals’ claim. The court explained that the plain meaning of the phrase “defending against any claim” and the specific contractual definition of “Damages,” together support the characterization of the agreements as an assumption reinsurance transaction in which ROA stepped into the shoes of the trusts. ROA’s indemnity could rise no higher than the pre-merger obligations of the two trusts — for those were the only liabilities that ROA assumed, and thus the only “Damages” for which it was responsible to indemnify the trusts. This contractual definition of “Damages” necessarily excludes any obligation for ROA to indemnify the trusts and their member insureds for the legal fees and costs incurred in the underlying judicial proceedings. The court rejected the hospitals’ argument that ROA’s duty to pay for the expense of defending against claims covered the expense of asserting claims. While it may have been good legal strategy for the hospitals to proactively assert such claims, this did not turn the assertion of claims into the defense of claims covered by ROA’s indemnification agreement. Appalachian Regional Healthcare v. Cunningham, Case No. 161767 (Va. Nov. 22. 2017).

This post written by Jason Brost.

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COURT RULES AGAIN ON MOTION TO DISMISS IN MATTER INVOLVING UNFILED RATES CHARGED UNDER REINSURANCE AGREEMENT

November 15, 2017 by John Pitblado

On July 21, 2016, we reported on a putative class action filed in a California U.S. district court by Shasta Linen Company against Applied Underwriters, Inc. and its affiliated entities, alleging that the “EquityComp” workers’ compensation insurance program marketed and sold by Applied Underwriters violated California insurance law and regulations. Shasta asserted that the defendants unlawfully used a Reinsurance Participation Agreement (“RPA”) to control workers’ compensation rates (and thus, charge higher rates) without first having the RPA filed and approved by the department of insurance as required by law. The court dismissed Shasta Linen’s claims to the extent that they sought to invalidate the RPA’s rates on the theory that the RPA was an unfiled plan pursuant to section 11735 of the California Insurance Code. The court reasoned that the use of a rate that has not been filed is not an unlawful rate unless and until the commissioner conducts a hearing and disapproves the rate.

On December 1, 2016, we reported that subsequent to the court’s ruling, the California Commissioner issued an order in an administrative proceeding, finding that the RPA was void because it had not been filed and approved by the department. Shasta Linen then sought reconsideration of the court’s prior dismissal, arguing that the Commissioner’s Order was a “change in controlling authority meriting reconsideration” by the court. On October 17, 2016, the court held that the Commissioner’s order misinterpreted the law, and was not “controlling.” The court denied reconsideration, but it did so “without prejudice as to attempts by plaintiff to invalidate the [RPA] on grounds other than the theory that defendants violated” section 11735.

Since our last blog on the case, Pet Food Express filed a separate class action against Applied Underwriters and its affiliates in California state court, which was removed to federal court. As they had in the Shasta case, the defendants moved to dismiss Pet Food’s complaint to the extent it sought to invalidate the RPA on the ground that it is an unfiled plan in violation of section 11735. The court denied the motion as Pet Food’s complaint did not rely on section 11735. Both plaintiffs in the two action then filed nearly identical amended complaints, asserting claims under RICO, the California Unfair Competition Law (“UCL”), California Business and Professional Code and for unjust enrichment. Defendants moved to dismiss. The court consolidated the actions for pre-trial purposes.

With respect to the motions to dismiss, the court granted them as to the RICO claims because plaintiffs had not sufficiently alleged a plausible basis to infer a specific intent to defraud with respect to the RPA. Consistent with its earlier rulings, it also again granted defendants’ motions to dismiss as to plaintiffs’ attempts to invalidate the RPA on the theory that defendants violated Insurance Code section 11735. The court denied as to plaintiffs’ UCL claim and unjust enrichment claim, and on the ground that plaintiffs lacked standing to seek injunctive relief and to seek restitution.

Shasta Linen Supply, Inc. v. Applied Underwriters, Inc., Case No. 2:16-cv-00158 and Pet Food Express Ltd. V. Applied Underwriters, Inc., Case No. 2:16-cv-012111 (E.D. Cal. Oct. 17, 2017).

This post written by Jeanne Kohler.

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DISTRICT OF SOUTH CAROLINA DENIES MOTION TO DISMISS ACTION INVOLVING FRONTING RELATIONSHIP

October 25, 2017 by John Pitblado

Applying Delaware law, a South Carolina District Court found Plaintiff had properly pled its causes of action for breach of contract, breach of fiduciary duty, negligence/gross negligence and negligent misrepresentation involving allegations that Defendant approved multiple transactions depleting the trust account which protected Plaintiff’s obligations under its fronting agreement.

The Court found Plaintiff adequately pled that Defendant breached its duty under the fronting agreement when it depleted the trust’s legitimate assets and left Plaintiff with a duty to pay claims. While the Court acknowledged that the fronting agreement did not explicitly impose a duty on Defendant to validate and confirm the assets admitted to the trust, nevertheless, at the very least, “the duty to provide an ‘accounting’ required Defendant to submit a ‘rendition of [the] account’ and the assets it contained.”

The Court also found Plaintiff adequately pled that Defendant breached its fiduciary duty owed to Plaintiff, as Defendant was the trustee and Plaintiff the trust’s sole beneficiary. Although Delaware law prohibits fiduciary duty claims that are wholly duplicative of contract claims, the Court found Plaintiff’s allegations of fiduciary duty were based on additional facts which were broader in scope than the parties’ contractual obligations.

The Court further found Plaintiff sufficiently alleged an independent duty of good faith and duty of care, which supports Plaintiff’s claim for negligence/gross negligence.

Finally, while the Court acknowledged Defendant’s argument that under the trust agreement Defendant had “no duty or responsibility with respect to the qualification, character, or valuation of the Assets deposited into the trust account,” in the contract between the parties, Defendant (as trustee) “agreed to maintain assets of the trust. . . to be negotiable at any time.” Being the agreed upon terms, the Court held that “Defendant cannot alter these terms by placing boilerplate disclaimer language as to the value of the funds on the statement to absolve itself of contractual duties. When Plaintiff attempted to withdraw the assets of the trust account, Defendant could not negotiate these assets.”

Accident Insurance Company, Inc. v. U.S. Bank National Association and U.S. Bank Trust N.A., 15-cv-02621-JMC (USDC D.S.C. Sept. 28, 2017)

This post written by Nora A. Valenza-Frost.

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ILLINOIS DISTRICT COURT DISMISSES CASE FILED BY INSURANCE DEPARTMENT, AS REHABILITATOR, AGAINST REINSURER

October 11, 2017 by John Pitblado

The District Court for the Northern District of Illinois dismissed a complaint filed by Plaintiff-Rehabilitator, the Illinois Director of Insurance, against Defendant-Reinsurer, Twin Rivers, alleging breach of contract, breach of the implied covenant of good faith and fair dealing, unjust enrichment and a violation of the Real Estate Settlement Procedures Act (RESPA).

The underlying reinsurance agreement stemmed from a previous “rehabilitation” proceeding under which the Illinois Department of Insurance was appointed as the rehabilitator for a now-defunct insurer, Triad, and as such was authorized to “bring any action, claim, suit or proceeding against any person with respect to that person’s dealings with Triad.” The present dispute concerns a reinsurance arrangement by which Twin Rivers agreed to reinsure certain private mortgage insurance (PMI) policies issued by Triad on mortgages originated by banks affiliated with Twin Rivers. In exchange for the reinsurance, Triad would pay a certain percentage of each referred borrower’s PMI premiums to Twin Rivers. These so-called “ceded” premiums were deposited into a trust account and invested and used to fund any payments due to Twin Rivers under the reinsurance agreement. Twin Rivers would periodically receive dividends out of the trust account for the benefit of itself and its affiliated banks. A balance of approximately $1,741,655 remained in the trust account as of the filing of the original complaint in this action.

With regard to the breach of contract claim, the Illinois Director of Insurance alleged that Twin Rivers breached its agreement by failing to provide certain disclosures to borrowers whose PMI policies it would be reinsuring consistent with U.S. Department of Housing and Urban Development (HUD) regulations requiring the disclosure of the benefits that Twin Rivers was receiving through the captive reinsurance arrangement. In its motion to dismiss, Twin Rivers argued that no provision in the agreement obligated it to provide HUD disclosures to borrowers and, in any event, the Illinois Department of Insurance was not harmed by the absence of disclosures. The Director argued that language in the agreement requiring that Twin Rivers not violate any “agreement with, or condition imposed by, or consent required by… any governmental… body” imposed a continuing commitment on the part of Twin Rivers to provide the HUD disclosures. Ultimately, the Court found the language “fairly susceptible to Defendant’s interpretation, but not [to] Plaintiff’s.” In so finding, the Court found more plausible the meaning attributed by Twin Rivers, that the language was merely a representation that, at the time of contracting, it was not specifically and individually subject to any legal constraints that would preclude it from agreeing to and fulfilling its obligations under the agreement.

The Court also dismissed the good faith and fair dealing claim, citing the Director’s failure to allege that Twin Rivers exercised its discretion in bad faith, unreasonably, or in a manner inconsistent with the reasonable expectations of the parties. The RESPA claims were also dismissed on account of statute of limitations, and the unjust enrichment claim was dismissed in light of the express contract governing the relationship between the parties.

State of Illinois ex rel. Hammer v. Twin Rivers Ins. Co., No. 16 C 7371 (USDC N.D. Ill. Jul. 5, 2017).

This post written by Gail Jankowski.

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APPLIED UNDERWRITERS, INC., LOSES ARGUMENT TO ENFORCE MANDATORY FORUM SELECTION CLAUSE IN REINSURANCE CONTRACT

October 10, 2017 by John Pitblado

On September 12, the District Court for Connecticut denied a motion to transfer predicated on a mandatory forum selection clause in a reinsurance contract. The contract was one of several entered into by Applied Underwriters, Inc., and its affiliates (collectively “Applied”) with Aiello Home Services (“Aiello”) for a “novel [workers’ compensation] insurance product known as ‘EquityComp,’ which required participation by the insured in a reinsurance facility. Applied’s relations with Aiello broke down when Applied sent Aiello a statement “assessing an additional premium charge of $195,786.52, and reporting total estimated costs nearly $200,000 higher than the previous month’s total cost estimate.” Aiello filed suit alleging violations of the Connecticut Unfair Trade Practices Act and other statutory violations. Applied removed the case to federal court and sought to transfer to the District of Nebraska based on the forum selection clause.

The court denied the motion to transfer. The court found that the bulk of Aiello’s claims arose from statutory violations, not the contract, and therefore were not within the scope of the forum selection clause. The fact that Applied’s defenses relied primarily on the contract was insufficient to bring the statutory claims within the scope of the clause.

The court also analyzed whether the clause would be enforceable under the law of the chosen forum state (Nebraska). As part of that analysis, the court had to determine if Aiello had sufficient minimum contacts to establish personal jurisdiction in Nebraska. “[T]here is a clear distinction between conventional commercial contracts and those that arise in the business of insurance.” While an insurance company that markets policies to residents of a given state establishes sufficient minimum contacts within that state, the insureds do not simultaneously establish sufficient contacts with the insurer’s home state. As a result, the court refused to enforce the clause.

Charter Oak Oil Co., Inc. v. Applied Underwriters, Inc., No. 3:17-cv-00689 (SRU) (USDC D. Conn. Sept. 12, 2017).

This post written by Benjamin E. Stearns.

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