Historically, the duty of utmost good faith has been held to require a ceding insurer to place its reinsurer in the same position as itself and to give to the reinsurer the same means and opportunity of judging the value of the risks. Unigard Sec. Ins. Co., v. North River Ins. Co., 4 F.3d 1049, 1069 (2d Cir. 1993). Under this doctrine, the cedent: will carefully underwrite its business; will provide to the reinsurer all facts and information material to the risk; does not conceal facts which ought in good conscience to be communicated to the reinsurer; and takes the interests of its reinsurer into consideration when settling claims. The reinsurer, on the other hand, does not second guess the cedent’s claim practices and pays claims upon demand. In other words, the reinsurer follows the fortunes of its cedent as if it were a party to the original insurance contract. See, e.g., Sun Mut. Ins. Co. v. Ocean Ins. Co., 107 U.S. 485 (1883); N. River Ins. Co. v. Ace Am. Reins. Co., 361 F.3d 134, 139-40 (2d Cir. 2004).
A typical follow-the-fortunes clause might say:
“All claims involving this reinsurance when settled by the Company shall be binding on the Reinsurer, which shall be abound to pay its portion of such settlements….”
American Bankers Ins. Co. of Fla. v. Northwestern Nat. Ins. Co., 198 F.3d 1332, 1334 (11th Cir. 1999).
In the absence of such an express provision, courts and arbitrators are often asked to imply a following provision. The Eleventh Circuit recently examined a case in which a cedent claimed that its reinsurer had a duty to follow its fortunes and reimburse it for a settlement and defense costs although the reinsurance contract did not contain an explicit follow-the-fortunes clause. Public Risk Mgmt. of Fla. v. Munich Reinsurance Am., Inc., 38 F.4th 1298 (11th Cir. 2022).
Public Risk Management of Florida (“PRM”) is a self-insured public entity risk management program. PRM exclusively insures certain local government entities in Florida, including the City of St. Pete Beach (“St. Pete”). PRM provided Public Officials Errors and Omissions Coverage (“E&O coverage”) to St. Pete under a Coverage Document covering the period from April 1, 2008, to April 1, 2009 (the “Coverage Document”). Munich Reinsurance America, Inc. (“Munich Re”) reinsured the E&O coverage provided by PRM’s Coverage Document from April 1, 2008, to April 1, 2009. Prior to this policy period, Certain Underwriters at Lloyds (“Underwriters”) provided reinsurance to PRM. Public Risk Management, 38 F.4th at 1301.
In 2006, Chester and Katherine Chmielewski, a couple residing in St. Pete, sued the city in state court to quiet title to their beach property after the city allowed the public to access their land and publicly took the position that the couple could not exclude the public from their property. The state court entered a Stipulated Final Judgment in the Chmielewskis’ favor and quieted title to the beach property. However, St. Pete continued to allow public access to their property and kept taking the position that the Chmielewskis had no right to keep the public off their beach parcel. So, in November 2009, the couple again sued St. Pete in state court, alleging inverse condemnation. PRM denied coverage to St. Pete for this suit because the Coverage Document excluded coverage for inverse condemnation claims. Id. at 1302.
In 2013, the Chmielewskis amended their complaint to assert a Section 1983 claim alleging violation of their Fourth Amendment rights and an inverse condemnation claim under the Florida Constitution. St. Pete removed the case to federal court. PRM covered the Section 1983 claim but would not cover the inverse condemnation claim. In December 2013, PRM gave Munich Re notice of the Section 1983 suit against St. Pete. Id.
In January 2014, Munich Re denied coverage for the Section 1983 claim because it arose from alleged wrongful acts that occurred prior to the Reinsurance Agreement’s coverage period of April 1, 2008, to April 1, 2009. Munich Re encouraged PRM to notify Underwriters of the claim, and PRM did advise Underwriters that it believed the wrongful acts underlying the claim occurred in their reinsurance policy period. Underwriters eventually denied coverage for the Section 1983 claim shortly before the October 2015 trial of the inverse condemnation/Section 1983 case. The Chmielewskis won a jury award of $725,000 for the Section 1983 claim and $1.5 million for inverse condemnation. Id.
PRM did not communicate with Munich Re from the time of its denial until after the verdict. Based on the evidence at trial, PRM contacted Munich Re, contending that the date of loss was November 28, 2008 – within the Reinsurance Agreement coverage period – and asked Munich Re to reconsider its position. Munich Re again denied coverage on the basis that the testimony relevant to the Section 1983 claim showed the damages for interference with property rights had gone on since at least 2005. PRM settled the Section 1983 claim for $750,000, and Munich Re refused to reimburse it. Id. at 1302-03.
PRM sued Munich Re in federal court in Florida for breach of contract, seeking $750,000 for the settlement and $200,000 in defense costs. It further sought a judgment declaring that Munich Re owed defense and indemnity under the Coverage Document and Reinsurance Agreement. The trial court granted summary judgment in favor of Munich Re. PRM appealed to the Eleventh Circuit. Id.
The Eleventh Circuit first considered whether the text of the Reinsurance Agreement and Coverage Document provided coverage for St. Pete. The Court held that the plain language of the Reinsurance Agreement required Munich Re to reimburse PRM for amounts PRM had paid to its insured, St. Pete, and to prove that the Reinsurance Agreement provided coverage for such payment. However, because the Reinsurance Agreement covered only “sums paid by PRM for which it is liable, under the Coverage Document reinsured hereunder,” the Court found that Munich Re was not obligated to reimburse PRM for the amounts PRM had paid but was not required to pay as defense or indemnity on St. Pete’s behalf. Id. at 1304-05. The Court thus found that the case turned on whether the Coverage Document (reinsured by Munich Re) required PRM to defend against the Section 1983 claim and indemnify St. Pete for the settlement of that claim. The Coverage Document was an “occurrence” policy, defining a series of wrongful acts as one occurrence, and fixing the date of that one occurrence as the date of the first wrongful act in the series. Because the evidence showed that the first wrongful act occurred as early as 2003, or in any case by 2005, i.e., prior to the time frame of the Coverage Document, the Court found no duty to defend or indemnify under the Coverage Document, and thus no duty by Munich Re to reimburse PRM. Id. at 1305-09.
The primary issue considered by the Eleventh Circuit, however, was whether Munich Re was required under the follow-the-fortunes doctrine to reimburse PRM for its decision to defend and indemnify St. Pete. Id. at 1310. The court noted that the doctrine provides that “reinsurers are generally bound by the reinsured’s decision to pay the claim and must refrain from second guessing a good faith decision to do so.” Id. (quoting Am. Bankers Ins. Co. of Fla. v. Nw. Nat’l Ins. Co., 198 F.3d 1332, 1335 (11th Cir. 1999)). The court explained that the doctrine is supported by several policy reasons: (1) reinsurers do not examine risks, receive notice of loss from the original insured, or investigate claims, so reinsurers generally rely on the exercise of the reinsured’s exercise of utmost good faith; and (2) to avoid placing insurers in “the untenable position of advancing defense costs in coverage contests that would be used against them by reinsurers seeking to deny coverage.” Id. (quoting N. River Ins. Co. v. CIGNA Reinsurance Co., 52 F.3d 1194, 1206 (3d Cir. 1995)).
PRM argued that the Reinsurance Agreement contained a follow-the-fortunes clause and that, even if it did not, the Court should infer such a clause. The Court determined that the Reinsurance Agreement was inconsistent with the follow-the-fortunes doctrine, because it expressly required PRM to submit to Munich Re proof not only that it had paid its insured but also proof that the Reinsurance Agreement provides coverage for such payment:
Payment by the Reinsurer of its portion of loss and expense, paid by or on behalf of PRM, will be made by the Reinsurer to PRM promptly after proof of payment by PRM and coverage hereunder is received by the Reinsurer.
Id. Further, the court noted that Munich Re had agreed only to indemnify PRM for occurrences during the Coverage Document:
The Reinsurer agrees to indemnify PRM, on an excess of loss basis, for Ultimate Net Loss paid by PRM as a result of Occurrences . . . during the term of this Agreement under PRM’s Coverage Document underwritten by PRM and covered by this Agreement.
Id. at 1311. Finally, the court noted that the Reinsurance Agreement defines “Ultimate Net Loss” as “the sum or sums paid by PRM for which it is liable, under the Coverage Document reinsured hereunder, i.e., the 2008/2009 Coverage Document.” Id. at 1311.
The court thus determined that these clauses were the opposite of a follow-the-fortunes clause, because, rather than providing that Munich Re would be bound by PRM’s good faith coverage decisions, they required that PRM provide proof to Munich Re that it had paid amounts to its insured and that the Reinsurance Agreement provided coverage for such payments. Id. at 1311.
Furthermore, the Court rejected PRM’s invitation to infer a follow-the-fortunes clause absent a specific finding that such a clause existed. Confident that the Supreme Court of Florida would not infer application of the follow-the-fortunes doctrine under Florida law based on these facts, the Eleventh Circuit declined to rewrite the Reinsurance Agreement to add meaning or reach conclusions contrary to the intent of the parties. Id.
The Court’s decision is similar to a 2019 opinion of the federal District Court for the Northern District of New York in Utica Mutual Insurance Company v. Munich Reinsurance America, Inc., 381 F. Supp. 3d 189 (N.D.N.Y. 2019) (Utica II). There, the District Court held that neither “follow the fortunes” nor “follow the settlements” was implicit in facultative certificates issued by Munich Re and that the ceding company had failed to sustain its burden to prove that it was “legally obligated” under its policies to pay the expenses it sought to recover from Munich for payment of asbestos claims. See generally id. The Second Circuit made an analogous finding in 2018, when it held that a follow-the-settlements obligation should not be implied into reinsurance certificates as a matter of law. See Utica Mut. Ins. Co. v. Clearwater Ins. Co., 906 F.3d 12, 17, 25 (2d Cir. 2018) (“We see no reason to read such a term into the contract by implication. Instead, we follow the New York Court of Appeals’ instruction: where a contract is ‘reasonably susceptible of only one meaning, a court is not free to alter the contract to reflect its own personal notions of fairness and equity.”).
The Eleventh Circuit in PRM expressly refused to address whether it might be appropriate to infer the follow-the-fortunes doctrine under other circumstances such as where the reinsurance agreement contained neither a follow-the-fortunes clause or language plainly inconsistent with the follow-the-fortunes doctrine. 38 F.4th at 1311. The Court noted that this is an issue over which courts are divided. See 2 Allan D. Windt, Insurance Claims & Disputes: Representation of Insurance Companies & Insureds § 7:10 (6th ed. Mar. 2022 Update) (stating that “courts in the majority of states” have held that a reinsurer does not have to follow the fortunes of the insurer if their contract does not contain an express follow-the-fortunes clause); Steven C. Schwartz, Reinsurance Law: An Analytic Approach § 9.02 (2021) (noting that “[c]ourts are split as to whether a follow-the-fortunes clause is required, or whether the doctrine is implicit in every reinsurance contract”).
As the few precedents on the subject make clear, cedents face an uphill battle convincing a court to imply following provisions into a reinsurance contract. Courts are understandably reluctant to imply a term into a contract between sophisticated parties. See Vermont Teddy Bear Co. v. 538 Madison Realty Co., 1 N.Y.3d 470, 475 (2004) (court was “extremely reluctant to interpret an agreement as impliedly stating something which the parties have neglected to specifically include.”). In the absence of an express follow-the-fortunes clause, courts typically hold that a question of fact exists. In such cases, they look to extrinsic evidence such as industry custom and practice, presented through fact and expert witnesses.
The insured bears a heavy burden of proof in this regard. See, e.g., Utica Mut. Ins. Co. v. Munich Reins. Am. Inc., 2018 WL 1737632, at *21-22 (N.D.N.Y. Mar. 20, 2018) (Utica I). In Utica I, the court ruled on summary judgment that Utica had failed to prove that follow the fortunes was so “fixed and invariable in the facultative reinsurance industry as to warrant importing them into [the reinsurance contract]”). As a result, Utica was required to prove that the loss was caused by a risk specifically covered by the reinsurance contract. Utica II, 381 F. Supp. 3d at 208 (quoting Clearwater Ins. Co., 906 F.3d at 25). See also Hutner v. Greene, 734 F.2d 896, 900 (2d Cir. 1984) (“Under New York law … custom and usage evidence must establish that the omitted term is ‘fixed and invariable’ in the industry in question.”). Notably, a case in which the court implies a following provision into a reinsurance agreement as a matter of fact will rarely serve as precedent in other cases, as factual determinations vary from case to case. See Tug Helen B. Moran, Inc. v. Moran Towing & Transp. Co., 607 F.2d 1029, 1031 (2d Cir. 1979).
Contract wording is crucial in cases seeking the implication of a following provision. While the use of the word “follow” is not determinative of whether the clause is a following clause that binds the reinsurer, the Eleventh Circuit’s decision in PRM highlights the importance of including language in the reinsurance contract indicating that the reinsurer is bound by the reinsured’s claim determination. In such cases, the clause is likely to be viewed as a following clause. Without such express language, courts will likely reach a contrary view.
Sharon D. Stuart is a founding partner of Christian & Small LLP in Birmingham, Alabama and serves as President and Claims Counsel of Attorneys Insurance Mutual of the South, Inc. Sharon is a member of DRI’s Law Institute and is chair of the Reinsurance SLG of the Insurance Law Committee. She is a member of the IADC, the FDCC, and is a past President of the Alabama Defense Lawyers Association.
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