Ambiguities in Insurer and Broker-Drafted Policy Forms: Revisiting "Reasonable Expectations" and the Contra Proferentem Rule in Commercial Insurance Disputes

Under the doctrine of Contra Proferentem, ambiguities in contract language are to be construed against the drafter.⁽¹⁾  More than 10 years ago, Steven H. Cohen and Katherine L. Quaintance reviewed the developing case law that was limiting the application of the Contra Proferentem doctrine in cases involving commercial policyholders.⁽²⁾  In their article, the authors cited market and legal/ doctrinal developments that underpinned this trend:

• The increased knowledge, sophistication and bargaining power of large policyholders. Many policyholders have in-house corporate Insurance departments and risk managers who are fully capable of understanding the terms and parameters of the coverage they purchase.
• The development and use of large and knowledgeable national insurance brokerage houses to help policyholders analyze and understand both their insurance needs and the policies purchased to meet those needs. Insurance brokers frequently advise policyholders of the meaning and intent behind policy provisions that, in the abstract, might be ambiguous. In addition, insurance consultants, risk managers and attorneys are hired by policyholders to assist in the design of insurance packages to meet the insured's particular needs and to aid in the negotiation for the purchase of such insurance.
• The development of the doctrine of reasonable expectations, under which courts attempt to enforce the "reasonable expectation of the insured."  While the reasonable expectations doctrine initially was advanced as a corollary to the contra insurer doctrine of resolving ambiguities against the carrier, courts today note that enforcement of reasonable expectations requires that the actual expectations of the contracting parties be determined. If the policyholder neither reasonably nor actually expected coverage on a particular issue, no coverage will be provided.⁽³⁾

Cohen and Quaintance then went on to show that many modern courts, motivated by these three factors, had abandoned the automatic application of the Contra Proferentem doctrine when confronted by ambiguities in commercial policy disputes.⁽⁴⁾  Instead, courts had adopted an analytical approach, which, among other techniques, consulted extrinsic evidence relating to the parties' negotiations, knowledge, and shared understanding of disputed "ambiguous" terms.⁽⁵⁾  If the parties' intent could be derived from this analysis, that intent would be enforced. The Contra Proferentem doctrine would be reserved for those situations in which neither the standard processes of analyzing contract language nor the consideration of extrinsic evidence could determine the parties' intent.⁽⁶⁾

This article revisits the trend identified by Cohen and Quaintance to determine not only whether it has continued, but also whether the courts, when confronted with ambiguities that survive the analysis of extrinsic evidence, are interpreting those unresolved uncertainties against the drafter of the language in question, even if the drafter is the insured or its agent/broker.

History and Parallels to General Contract Law

Prior to the mass marketing of insurance to consumers, the application of the contra proferentem doctrine was not particularly associated with insurance contracts.⁽⁷⁾  The rationale and historical setting for this circumstance is simple and straightforward:  The earliest insurance policies, typically written through Lloyd's and involving marine risk in the mid- 1700s, were negotiated as business arrangements between parties of roughly equal standing.⁽⁸⁾  If disputes arose that resulted in litigation, the language involved was strictly enforced, with courts assuming that both parties understood "traditional" or "idiosyncratic" terms and rarely applying interpretational rules in favor of either party.⁽⁹⁾  In short, insurance contracts at this stage were treated like other business contracts. This does not mean that the doctrine of contra proferentem had no place. In fact, because of the greater enforcement of the parol evidence rule in earlier times, courts would apply the contra proferentem rule instead of looking for outside evidence of intent when confronted with a true ambiguity.⁽¹⁰⁾  This practice, however, was not typical of judicial treatment of insurance contracts.

This state of affairs changed when insurance policies in the personal lines (particularly homeowners and automobile policies) were mass marketed. In this context, the policies ceased to be negotiated business arrangements and instead became "contracts of adhesion" that were offered on a virtually marketwide basis as take-it-or-leave-it propositions.⁽¹¹⁾  Insureds typically had no bargaining power and no effective means of changing the terms of the policy forms offered. The reaction of the courts was to place the onus of uncertain or ambiguous terms on the drafters, particularly since such entities (invariably insurers) controlled the marketplace and rarely engaged in policy discussions or bargaining with their customers.⁽¹²⁾

Hence, mass-marketed insurance policies were treated by the courts in a manner similar to the treatment of other mass-marketed contracts, such as consumer sales instruments, loan agreements, and the like. To address the general imbalance of power between the merchant-drafters of these documents and the consumer-purchasers, the courts relied on and further developed the doctrines of contra proferentem, unconscionability, and other related protective concepts (e.g., duress, undue influence, misrepresentation/nondisclosure) as well as specified requirements for the form and readability of consumer contracts.⁽¹³⁾  Nowhere were these techniques more vigorously applied than in the insurance field.⁽¹⁴⁾

While the history of applying the contra proferentem doctrine to insurance cases, as well as the history of the development of the bad faith concept, has largely involved mass consumer coverages (disability, homeowners, automobile, etc.), commercial insureds have been far from shy in invoking the doctrines to their own advantage in disputes with their insurers.⁽¹⁵⁾  Of course, in the case of proverbial "Mom and Pop" enterprises, the original rationales of gross imbalance of economic power and contracts of adhesion still legitimately underlay application of the doctrines. However, this was not the case with respect to large-scale commercial entities, particularly those represented by major brokerage houses, which possess their own market power and, in many cases, actively negotiate with carriers over the terms of insurance agreements, including supplying terms or entire forms themselves.

For a time, the courts seemed willing to allow these businesses a place under the protective tent of contra proferentem and other consumer-oriented protective doctrines.⁽¹⁶⁾  When Cohen and Quaintance published their article in 1989, however, this phase was changing, marked by the displacement of contra proferentem in commercial insurance disputes with the technique of consulting extrinsic evidence to determine the intent of the parties with respect to ambiguous terms. Only when this process failed, would contra proferentem be used.

Rule Not Automatically Applied

A review of the case law indicates that courts have continued and expanded the trend of considering evidence outside the parties' expectations and intent in resolving ambiguities in commercial cases.⁽¹⁷⁾  Although this trend is widespread, developments in California are representative. Indeed, a series of four California Supreme Court cases spanning the 1990s established the following interpretational system:

1. While insurance contracts have special features, they are still contracts to which the ordinary rules of contractual interpretation apply.
2. The mutual intention of the parties at the time the contract was formed is paramount in governing interpretation of the policy, and, if possible, the court will infer this intent solely from the written provisions of the policy.
3. If the language of the insurance policy is clear and explicit, judged according to the ordinary and popular use of such language (unless the parties clearly are using such language in a technical or special sense), it governs interpretation of the policy.
4. If a specific term is unclear after applying the rules set forth above, the court must then attempt to resolve the ambiguity by considering the terms in the context of the insurance policy as a whole, considering its intended function and the circumstances of the case.
5. ;In conjunction with the other procedures for interpretation set forth above, the court (or a jury under instruction of the court) will consider the insured's "objective reasonable expectations" at the time of policy formation. In the case of insureds who do not suffer from lack of legal sophistication or a relative lack of bargaining power, and where it is clear that the policy actually was negotiated or jointly drafted, the courts will not "lean" toward the insured with respect to these expectations.
6. In the event that the ambiguity in question still cannot be resolved, the court will apply the doctrine of contra proferentem by construing the language against the party who caused the uncertainty-- typically the insurer as policy drafter.⁽¹⁸⁾

In considering this system of interpretation, it is notable that California courts have had a long-standing position of liberally considering parol evidence in resolving disputes over the interpretation of contract language. For example, in Pacific Gas and Electric Company v. G. W Thomas Drayage and Rigging Company,⁽¹⁹⁾ a 1968 California Supreme Court decision written by Chief Justice Traynor, the court ruled that extrinsic evidence was admissible to explain the meaning of a contract, whether or not ambiguous on its face, if the offered evidence was relevant to prove a meaning to which the contract was reasonably susceptible.⁽²⁰⁾  Within these rules, California courts will consider "reasonably susceptible" extrinsic evidence to determine whether an ambiguity exists, even if the explicit language appears to be unambiguous. The very broad rule of Pacific Gas may have been narrowed by decisions of the California Supreme Court interpreting insurance policies in the 1990s. See interpretional rules 2 and 3 above.

It also should be noted, as a technical matter, that the rules of insurance policy interpretation set forth above also apply to mass-marketed, consumer-oriented policies, such as disability, homeowner, and automobile policies. In these cases, however, since there is rarely any negotiation, discussion, or other extraneous evidence of intent, and since the insurer almost always exclusively drafts the policies, any ambiguities in policy language ordinarily will be resolved against the insurer pursuant to the contra proferentem rule. Thus, the fifth rule of policy interpretation cited above rarely will be invoked in these cases.

While this system of interpretation was being formulated in California during the late 1980s and 1990s, a number of supplementary rules also were being adopted to refine its application. For example, the only relevant extrinsic evidence of the parties' intent is the objective intent, manifested by acts, words, or other conduct at or near the time of contract formation; evidence of unexpressed subjective intent is not relevant to determine a contract's meaning.⁽²¹⁾

Similar rules for interpreting insurance policies and dealing with the contra proferentem doctrine have evolved in other states.⁽²²⁾  On the other hand, in the few states that still do not allow extrinsic evidence to be introduced for purposes of interpreting written policy language. interpretation must remain within the four squares of the contract language, with ambiguities resolved by the contra proferentem rule.⁽²³⁾

Interpretation of Ambiguities in Broker-Drafted Forms

Today, most corporations place their insurance through insurance brokers.⁽²⁴⁾  When confronted by an irresolvable ambiguity in policy language drafted by an insured's broker. how will courts apply the contra proferentem rule? As will be seen, most recent court decisions have disfavored automatic application of the contra proferentem rule with respect to broker-drafted language in the same manner that they have with insurer-drafted language. That is, if ambiguities cannot be resolved by reference to the other components of the policy, courts will refer to parol evidence to determine the governing intent or "reasonable expectations of the parties." If an ambiguity in a broker-drafted form cannot be resolved by these methods, most recent court decisions involve the principle, often through dicta, that the ambiguity will be resolved against the drafterin these cases the insured through its agent-broker.⁽²⁵⁾  However, no published decision actually has applied this "tie-breaking rule" against the insured, and, in fact, courts typically go to great lengths to find evidentiary or interpretational means to avoid this result.

This principle may be debatable with respect to consumer insurance, where some commentators contend that the "typical independent agent is more interested in supporting the insurers whose products he sells."⁽²⁶⁾  On the other hand, it is generally accepted that this concern typically is not present in the commercial context:

In commercial insurance where policyholders pay big premium dollars, expect broker performance, and have enough information and experience to fire brokers who fail to perform, the presumption of broker as agent for the policyholder usually is realistic.⁽²⁷⁾

Another issue concerns the size, sophistication, and resources of brokers as a consideration in reversing the normal application of the contra proferentem rule in disputes over broker-drafted policy terms. In the last few years, there have been dramatic changes in the commercial insurance brokerage market, particularly with respect to the top two brokers, Aon Group and Marsh & McLennan. Indeed, in 1997, Aon Group acquired Alexander & Alexander while Marsh & McLennan acquired Johnson & Higgins.⁽²⁸⁾  In the following year, Marsh acquired the Sedgwick Group.⁽²⁹⁾  As a result, Marsh and Aon together now account for over 70 percent of the of the top ten brokers' business,⁽³⁰⁾ as shown in Figure 1.

Marsh and Aon, and other top ten insurance brokers listed in Figure 1, have the resources and leverage not only to develop their own forms for different areas of coverage but also to apply substantial pressure on insurance carriers to accept them in the commercial sector.⁽³¹⁾  This leverage is particularly potent given the trend toward broker-organized multilayered coverage packages in which various carriers take a portion of each layer. The empowerment of these commercial insurance brokers is matched by the size and market power of their large-scale corporate customer insureds, making them, together. more than a match for property and casualty insurance carriers.

Given these market realities, there should be little reason not to apply the rule of contra proferentem against corporate insureds when their brokers provide policy language that is determined to be both ambiguous and irresolvable after application of interpretational rules (e.g., comparison with other policy terms, historical usage, or logic) or by reference to extrinsic evidence of expectation, understanding, or intent.  However, no court appears to have ever actually applied the doctrine of contra proferentem to resolve an ambiguity against an insured in a commercial context, although courts from various parts of the United States have indicated their theoretical willingness to do so, as a last resort, in conformance with the general contract interpretational rule that ambiguities be resolved against the "drafter."

FIGURE 1. Top 10 Brokers in 1998

Rank Company                                      *Revenue

1.       Marsh & McLennan Cos. (Marsh)  $ 3,350.5

2.       Aon Group, Inc. (Aon)                    $ 2,286.4

3.       Willis Corroon Group P.L.C.           $ 630.6

4.       Arthur J. Gallagher & Co.                $ 472.0

5.       USI Insurance Services Corp.          $ 327.0

6.       Acordia Inc.                                    $ 306.9

7.       hub, Rogal & Hamilton                    $ 172.2

8.       Norwest Insurance Inc.                   $ 161.1

9.       Brown & Brown Inc.                      $ 150.4

10.     Jardine Lloyd Thompson Group      $ 146.2

*In millions of dollars
Source: Striking a Match, Best's Review-Property-Casualty
Insurance Edition, Oct. 1, 1999.

One such example is Puerto Rico Electric Power Authority v. Phillips,⁽³²⁾ which involved the number of deductibles to apply under the policy language.  In that case, 238 separate acts of sabotage or vandalism had occurred during a four-month strike at the insured's premises. The policy provided coverage subject to a $1 million deductible.⁽³³⁾  The court found the relevant terms of the policy to be ambiguous but determined that it could go beyond these terms to consider extrinsic or parol evidence to determine the parties' intent.⁽³⁴⁾  The court also noted that because it had been demonstrated that the insured drafted the policy and presented it to the insurer for approval, the insured "was better situated than [the insurer] to correct its own contractual uncertainties or needs," particularly in a situation in which there is no evidence that the parties were in unequal bargaining positions.⁽³⁵⁾  Under these circumstances, and applying Puerto Rican law, the federal district court would not interpret policy terms in a manner favoring the insured.⁽³⁶⁾  Hence, the Phillips case at least implies that the contra proferentem rule would be applied against a sophisticated insured if it was the policy drafter. The rule was not applied, however, because the extrinsic evidence of intent resolved the interpretation dispute. Indeed, the court applied 238 separate deductibles as advocated by the insurer.⁽³⁷⁾

A similar analysis is evident in Fireman's Fund Insurance Co. v. Fibre boa rd Corp.⁽³⁸⁾  There, the insured sought coverage for asbestos claims under its liability policy. The California Court of Appeal held that the exclusions were clear and unambiguous.⁽³⁹⁾  Then, in dicta, the court addressed the insured's argument that the exclusions should be strictly construed against the insurer. The court not only stated that this rule was inapplicable under the circumstances because the insured drafted the language at issue, but it implied that a reversal of the contra proferentem rule would be in order:

Here, as in Garcia⁽⁴⁰⁾ the typical relationship (unequal bargaining strength, use of standardized language by more powerful insurer-draftsman) simply did not exist. Rather, two large corporate entities, each represented by specialized insurance brokers or risk managers, negotiated the terms of the insurance contract. Neither Truck nor other respondents drafted or controlled the policy language: thus, the reasons for the general rule of construction--  "to protect the insured's reasonable expectation of coverage in a situation in which the insurer-draftsman controls the language of the policy"were non-existent. In fact, the record clearly shows that Fibreboard itself proposed or drafted language for the asbestos exclusion.

None of the authorities relied upon by Fibreboard reflects a comparable factual situation where the insured itself drafted or proposed the policy language. Moreover, to the extent that any ambiguity exists, ordinarily it would be interpreted against Fibreboard, the party who caused the uncertainty to exist.⁽⁴¹⁾

Metpath, Inc. v. Birmingham Fire Insurance Company of Pennsylvania⁽⁴²⁾ is another instructive case.  In Metpath, the policy covered extra expenses for operating the insured's medical laboratory company as a result of an anticipated air-traffic controllers' strike.⁽⁴³⁾  The policy was supposed to cover only a strike that was scheduled to begin on June 27, 1981, and subsequent postponements of that strike. The policy contained a seven-day waiting period. The strike occurred, but two days later, President Reagan fired all the air-traffic controllers, thereby ending the strike.⁽⁴⁴⁾  The insurer denied coverage because the loss did not extend beyond the seven-day waiting period.⁽⁴⁵⁾  Once in suit, the insurer argued that any ambiguity in the policy should be construed against the insured, which drafted the policy. The New York appellate court held that the policy language regarding the seven-day waiting period was unambiguous.⁽⁴⁶⁾ However, the court also stated that even if the policy language was considered ambiguous, any ambiguity would have to be resolved against the insured and in favor of the insurer because the insured's broker drafted the policy, including the provisions regarding the seven-day waiting period:

[E]ven if the policy language is considered ambiguous or open to doubt, any ambiguity or doubt must be resolved against Metpath and in favor of Birmingham since the drafter of the insurance policy was Metpath's agent, J&H, and those provisions requested by Metpath's representatives are the very provisions which limit the coverage to the period of the strike.⁽⁴⁷⁾

The Third Circuit Court of Appeals, applying Pennsylvania law, reached a similar conclusion in Eastern Associated Coal Corp. v. Aetna Casualty & Surety Co.⁽⁴⁸⁾  There, the insured, a coal mine owner, sought recovery under its business interruption coverage for additional expenses associated with the closure of one of its mines after an underground fire.⁽⁴⁹⁾  The insured was under contract to provide coal to a customer at a certain price. After the fire, the insured had to go to the market to buy the coal to meet its contract requirements.⁽⁵⁰⁾  At that time, however, the market price of coal had risen sharply ($2 million for the volume in question) above the contract price agreed to with the customer.⁽⁵¹⁾  The insured's insurance broker selected the policy forms, prepared the policies, and sent them to the insurance companies for execution.⁽⁵²⁾  The court stated that under these circumstances, "the Pennsylvania cases indicate that conflicts over the interpretation of an insurance contract should be resolved against the party preparing the contract."⁽⁵³⁾  Because the insured's broker was the drafter, the court stated that "[a]t a minimum, the above cited cases require that we not construe the language against the defendants [insurers]."⁽⁵⁴⁾  However, the court found no ambiguity and held that the additional expenses produced by the interruption were not covered by the business interruption provision.⁽⁵⁵⁾

Similarly, the California Supreme Court, in the line of cases cited above, which developed the interpretational concept of "objective reasonable expectations," indicated that ambiguous broker-drafted language would be interpreted against the insured. In AIU Insurance Company v. Superior Court,⁽⁵⁶⁾ for examples the court reviewed the contra proferentem rule, as well as the court's practice of "generally interpret[ing] the coverage clauses of insurance policies broadly. protecting the objectively reasonable expectations of the insured," and noted that ambiguities would be construed against the drafter:

These rules stem from the fact that the insurer typically drafts policy language, leaving the insured little or no meaningful opportunity or ability to bargain for modifications. Because the insurer writes the policy, it is held "responsible" for ambiguous policy language, which is therefore construed in favor of coverage.⁽⁵⁷⁾

Furthermore. the court cited California statutory law to the effect that "ambiguous language is construed against the party who caused the uncertainty to exist."⁽⁵⁸⁾  The clear implication is that if the drafter is the insured or its broker, unresolved ambiguities will be resolved against it.

Finally, commentators also have recognized the appropriateness of reversing the contra proferentem rule when the insured or its broker is the drafter:

Almost everyone would agree that where a policyholder or its bonafide agent drafts a contract term, the rule of contra proferentem should not operate in its favor. On the contrary, in these instances, the ambiguity principle should operate in favor of the insurer and against the insured. Although this might shock consumer advocates, it is a sensible approach.  Contra proferentem becomes an untenable, unprincipled doctrine if it comes to mean the insurer always loses regardless of the situation.⁽⁵⁹⁾

Conclusion

It now appears that many courts have accepted that they will apply a variety of interpretational devices in the face of insurance policy ambiguities short of automatic invocation of contra proferentem. The initiating step involves considering so-called ambiguous terms not in the abstract, but rather in the context of the written policy itself as well as the fact of the case involved. Hence, courts will employ standard contractual construction principles, such as reading the contract as a whole and considering all terms, to understand particular words or phrases properly in a full policy context. Furthermore, they will look at the historical meaning given to certain terms in the insurance context, as well as employing "interpretive logic," in an effort to ascertain the parties' intent through the written terms themselves. All this will be done in the context of the facts of the case rather than in an "abstract void." When this approach fails, courts will turn to extrinsic evidence relating to the communications, negotiations, knowledge, and common understanding of the parties in order to determine their mutual intent (or at least the "objective reasonable expectations of the insured" if the insurer is the drafter of the policy). If a resolution can be achieved through such extrinsic evidence, the inquiry will end there. If, after all these means have been exhausted, the intent of the parties cannot be determined because more than one reasonable meaning still can be attributed to the terms in question, then the rule of contra proferentem will be applied against the drafter of the language. If the drafter is the insured or its broker, the "tie-breaking" rule will be applied against the insured. Otherwise, the traditional application against the insurer will remain in effect.

As shown above, the law as it developed in the 1980s and 1990s fundamentally adopted this scheme of interpretation for commercial policies negotiated between insurers and insureds with equal or greater economic power.⁽⁶⁰⁾  While use of the rule of contra proferentem against sophisticated commercial insureds in the case of broker-drafted policies has not yet directly occurred, dicta in several cases, as well as commentary and logic, supports this result.