U.S. Fid. & Guar. Co. v. Am. Re-Ins. Co., No. 1 (N.Y. Ct of App. Feb. 7, 2013)
In a closely watched asbestos settlement allocation case, the New York Court of Appeals has modified the order of an intermediate appellate court to deny summary judgment to the cedent based on two issues of fact raised to challenge the reasonableness of the cedent’s settlement allocation. The court affirmed the judgment rejecting the other defenses to payment raised by the reinsurers.
This case involved asbestos claims arising out of policies issued in the 1950s and 1960s to a distributor of asbestos products. The underlying policies were not “occurrence” based policies, but were the old form of “per accident” policies with no aggregate limits. The case is further complicated by corporate acquisitions in the 1960s, which led to questions about whether the cedent’s policies covered the successor company. Those and other issues were litigated in California, including whether the successor corporation succeeded to the insurance issued by the cedent to the original insured.
Meanwhile, claims came pouring in, resulting in default judgments after the cedent and other insurers refused to defend and the insured agreed not to oppose the entry of default judgments. In the coverage litigation, the insured had alleged that the cedent’s refusal to defend breached the implied covenant of good faith and fair dealing (i.e. “bad faith”). The coverage suit settled while trial was in progress and resulted in the insured’s filing for bankruptcy and the creation of an asbestos trust.
After the settlement, the cedent billed its excess-of-loss reinsurers who refused to pay. The motion court granted summary judgment to the cedent directing them to pay the reinsurance recoverables and the appellate division affirmed with one judge dissenting. This appeal ensued.
In modifying the appellate division’s order, the Court of Appeals provided a detailed analysis of the rules governing reinsurance allocation in the context of a follow-the-settlements clause under New York law. It is important to note that the reinsurance contracts here had a following clause binding the reinsurer to pay claims allowed by the cedent. The court’s analysis was premised on that follow-the-settlements clause.
The court articulated the well-established rule that a follow-the-settlements clause (like the one here) ordinarily bars challenge by a reinsurer to the ceding company’s decision to settle a case. That rule, said the court, makes sense because there is little risk of unfairness as the parties are typically aligned to pay as low a settlement amount as possible. In this case, the few exceptions to that rule did not apply because the reinsurers did not challenge the cedent’s decision to settle or the amount of the settlement. Here, the dispute was about the settlement allocation to the reinsurers.
In discussing the reinsurance allocation, the court accepted that the follow-the-settlements rule raises problems because the interest of the cedent and the reinsurer may often conflict. The court concluded that this was the case here where an allocation of the settlement to losses less than $100,000 would result in no reinsurance recovery, but allocation to losses of $200,000 would result in the reinsurers paying half the cost. Because of this, the reinsurers argued that the cedent’s allocation decision should not bind reinsurers under a follow-the-settlements clause.
While finding logic to the reinsurers’ argument, the Court of Appeals nevertheless agreed with the majority of courts and held that a follow-the-settlements clause requires a level of deference to a cedent’s allocation decision. The rationale for this deference was described by the court as providing for a more orderly and predictable resolution of claims. But the court made it clear that deference did not mean that cedent’s allocation decisions were immune from scrutiny.
The allocation decision still must be in good faith and reasonable. The court stated that “[i]n our view, objective reasonableness should ordinarily determine the validity of an allocation. Reasonableness does not imply disregard of the cedent’s own interests. Cedents are not the fiduciaries of reinsurers, and are not required to put the interests of reinsurers ahead of their own.” The court held that a cedent’s allocation “must be one that the parties to the settlement of the underlying insurance claims might reasonably have arrived at in arm’s length negotiations if the reinsurance did not exist.”
The court concluded that the cedent’s motive “should generally be unimportant. When several reasonable allocations are possible, the law, as several courts have recognized, permits a cedent to choose the one most favorable to itself.” But, said the court, “the choice must be a reasonable one, and we also conclude that reasonableness cannot be established merely by showing that the cedent’s allocation for reinsurance purposes is the same as the allocation that the cedent and the insurance claimants actually adopted in settling the underlying insurance claims.” The court rejected the cedent’s argument that if the allocation is the same as the underlying settlement it establishes the validity of the allocation. Instead, the court held that under a follow-the-settlements clause (like the one here), a cedent’s reinsurance allocation of a settlement will be binding on a reinsurer if, “but only if, it is a reasonable allocation, and consistency with the allocation used in settling the underlying claim does not by itself establish reasonableness.”
In reversing the summary judgment decision, the Court of Appeals concluded that the reasonableness of the assumptions in the allocation that (1) all of the settlement amount was attributable to claims within the limits of the cedent’s policies and none was attributable to the claims against the cedent for bad faith in refusing to defend the insured; and (2) all claims for lung cancer had a $200,000 value, while certain other claims had values of $50,000 or less, presented issues of fact that required a trial. The court pointed to evidence in the record to show that a fact finder could conclude that an allocation giving no value to the bad faith claims was unreasonable and that assigning high values to lung cancer claims instead of allocating some of that value to bad faith or other claims was unreasonable. The court pointed to an underlying settlement demand that included a significant amount for bad faith presented just shortly before settlement and the parties’ arguments to the bankruptcy court to approve the plan partly on the basis that the bad faith claims had significant value. The court concluded that it was impossible to find as a matter of law that parties bargaining at arm’s length, in a situation where reinsurance was absent, could reasonably have given no value to bad faith claims.
The Court of Appeals did find that there was no evidence from which a fact finder could infer that allocating all the losses to a single insurance policy was unreasonable. The court discussed California law and the continuous trigger and related rules to support its holding. It also rejected the reinsurers’ argument that the Other Insurance clause precluded allocation to one policy year. Finally, the court rejected the argument concerning an alleged amendment to the retention per loss for the reinsurance contracts.
This case provides the latest and certainly one of the more detailed roadmaps for addressing reinsurance allocation determinations under a follow-the-settlements clause. And that is a key point. Even with a reinsurance contract containing a follow-the-settlements clause, an allocation is subject to scrutiny for reasonableness. This case is fact intensive. An important fact for the court was the existence of bad faith claims as articulated in the related California coverage case and Bankruptcy Court approval of the plan. It is rare to have underlying court decisions that provide significant support for the unreasonableness of an allocation decision.
Reasonableness is the catchword, but reasonableness based on the objective standard of what the underlying parties’ to a settlement would consider reasonable if there were no reinsurance. Allocating all of the settlement to claims covered by the cedent’s policies and nothing to the bad faith claims may or may not be reasonable – only a trial and a decision by a fact finder will decide that issue.
What we can say is that the courts will still defer—and reinsurers will be bound— to the cedent’s claim decisions, including settlement allocation decisions, as long as those decisions are reasonable.
The ultimate take away here is that the specific facts matter, that a reinsurer will still be bound to a cedent’s good faith and reasonable claim determination, and that a follow-the-settlements clause like the one here will bind the reinsurer to an objectively reasonable allocation decision without regard to the cedent’s motive, as long as it could have been derived from an arm’s length negotiation by the underlying parties as if no reinsurance existed.