The ALI Restatement – What Lies Ahead?
White and Williams Holds Seminar with ALI Reporter Tom Baker to Discuss the Practical Impact of the Recently Adopted Restatement of the Law of Liability Insurance
The American Law Institute voted on May 22, 2018 to approve the final draft of its “Restatement of the Law of Liability Insurance.” This was the culmination of an eight-year project that evolved through 29 drafts resulting in a nearly 500-page final product. At least nine courts cited to the Restatement while it was still in draft form. On June 28, 2018, White and Williams LLP had the privilege of hosting a seminar about the Restatement, chaired by the Reporter for the Restatement, University of Pennsylvania Law Professor Tom Baker, and Randy Maniloff of White and Williams, author of “General Liability Insurance Coverage, Key Issues In Every State.” The seminar was geared toward assisting members of the liability insurance community in navigating the key provisions of the Restatement, including how they compare and contrast with existing case law and the role the Restatement may play in courts’ decision-making processes going forward.
This was the first program of its kind that Professor Baker attended since the Restatement was approved. The prior ALI programs regarding the Restatement of the Law of Liability Insurance involved an element of debating and lobbying for positions, as various aspects of the Restatement had generated extensive controversy during the drafting process. Now that the final Restatement has been approved, the debate turns to what impact the Restatement may have in practice. At the outset, Mr. Maniloff opined that the Restatement would be impactful in situations where limited case law exists nationally on a given issue. He also suggested that courts may look to the Restatement on issues where (1) case law exists nationally, but the relevant state law is silent, or (2) where some relevant case law exists in a jurisdiction, but no clear rule has yet emerged. On the other hand, where clear precedent exists in a state, Mr. Maniloff commented that a court would be unlikely to look to the Restatement for guidance.
The Restatement contains 50 sections that address the key issues in liability insurance claims. Much has been and will continue to be written about many of these provisions. The following is a summary of the topics that were highlighted at the seminar, including those that generated the most interest and spirited discussion among the claims professionals and counsel in attendance.
Duty to Defend
- Extrinsic Evidence and the Duty to Defend
Restatement Section 13 incorporates the familiar rule that that “[a]n insurer that has issued an insurance policy that includes a duty to defend must defend any legal action brought against an insured that is based in whole or in part on any allegations that, if proved, would be covered by the policy, without regard to the merits of those allegations.” Section 13 further includes what Professor Baker described as a “non-exhaustive” list of situations where there is clearly no duty to defend, including, for example, where the defendant is not an insured, the property is not covered under the policy, the claim was reported late under a claims made policy, the action is subject to a prior and pending litigation or related claim exclusion, or the policy has been properly cancelled. While the list is relatively uncontroversial, Section 13 further states that the duty to defend determination can be based on the allegations of the complaint or on extrinsic evidence known to the insurer. Although insurers may take issue with a blanket rule permitting the use of extrinsic evidence to establish the duty to defend, Mr. Maniloff noted that, because almost all states have controlling precedent on this very issue, it is the type of issue where the Restatement is unlikely to have a significant impact.
- Defense Counsel’s Sharing of Information with the Insurer
Among a number of controversial provisions of the Restatement concerning the duty to defend, commentators have taken particular issue with Section 11, which states that “an insurer does not have the right to receive any information of the insured that is protected by attorney-client privilege, work-product immunity, or a defense lawyer’s duty of confidentiality under the rules of professional conduct, if that information could be used to benefit the insurer at the expense of the insured.” Mr. Maniloff commented that this would “present real challenges for defense counsel” who ordinarily are not informed at a detailed level about the insurer’s potential defenses to coverage and usually seek to avoid having any involvement there. The rule arguably places a greater burden on defense counsel to evaluate whether information is potentially detrimental to the insured’s interests and could lead counsel to err on the side of not providing information to insurers to avoid any suggestion that they were not honoring their professional obligations.
- Supplementing the Reservation of Rights
Section 15 of the Restatement, which addresses reservation of rights, was described by Mr. Maniloff as a potential “sleeping giant.” First, under Section 15(2), an insurer is obligated to continuously update its reservation of rights as it obtains new information that provides a ground for contesting coverage or risk waiving the right to rely on the new defense. While Professor Baker pointed out that an insurer would have to update its reservation only to the extent a new ground for contesting coverage had been discovered (as opposed to a new fact that further supported a previously asserted reservation), the participants expressed concerns about the increased burden that could be placed on claims handlers as a result of this provision. Mr. Maniloff noted that an insurer arguably would be forced to review every filing, transcript, or other piece of information it receives (no matter how voluminous) in order to determine whether it contained any new grounds for contesting coverage. Moreover, the claims handler’s efforts to comply with such a requirement could even be hindered if defense counsel provides less information to the insurer out of concern that it is violating Section 11.
- Liability of Insurers for Defense Counsel’s Malpractice
Restatement Section 12, entitled “Liability of Insurer for Conduct of Defense” provides that insurers may be held liable under certain circumstances for the malpractice of defense counsel assigned to the underlying claim. This section may have more of an impact due to the limited case law that exists nationwide on the issue. Under this Section, if the retained defense counsel does not have the “adequate skill and experience in relation to the claim in question,” a direct liability claim may be brought against the insurer for any resulting harm. Comment “c” to Section 12 states that liability may be imposed when an insurer appoints defense counsel who lacks “adequate professional liability insurance.” Section 12 also provides that liability may be imposed on an insurer when it “overrides” the professional judgment of defense counsel and directs counsel to act or not act in a way that constitutes a breach of professional standards. The commentary to Section 12 offers as an example a situation in which an insurer directs defense counsel, against his or her advice, not to demand an independent medical examination of a plaintiff and the insured subsequently suffers a judgment in excess of the policy limits. Assuming the decision not to obtain a medical examination was malpractice under the circumstances, and the excess judgment can be attributed to that decision, the insurer may be held liable for the excess judgment.
An insurer’s potential liability under Section 12 is not based on a theory of vicarious liability, but rather on the theory that, under certain circumstances, an insurer may be held directly liable for its failure to exercise reasonable care in its selection or direction of counsel assigned to defend the insured. This section has faced particular criticism, with critics arguing that it does not give due consideration to defense counsel’s right and obligation to exercise independent professional judgment, and because a cause of action for negligent retention of defense counsel has not been expressly recognized previously.
- No Reimbursement of Defense Costs
Section 21 incorporates a per se rule that that an insurer cannot recoup its defense costs under any circumstances, unless that is specifically provided for in the insurance policy or otherwise agreed to by the insured. There is only limited case law on this issue nationwide. This rule could have a significant impact in those states that have not addressed the issue.
Settlement of the Claim
Several sections of the Restatement outlining the obligations of an insurer with respect to settlement of an underlying claim have been met with disapproval within the insurance community, in part because they adopt new or minority views to a certain extent. For example, Section 24 adopts a new view and broadly mandates that insurers have a duty to make “reasonable settlement decisions” when there is a potential for a judgment in excess of the policy limit. This potentially includes making the policy limits available to the insured for settlement even in the absence of a settlement demand from the claimant that is at or within the limits.
Under Section 25, where the insurer has reserved its rights, the insured may settle a claim without the insurer’s consent, provided the settlement is reasonable and the insured makes a reasonable effort to keep the insurer informed and to obtain the insurer’s consent. This has been a minority view. Finally, under Restatement Section 27, damages for breach of the duty to make a reasonable settlement decision includes any foreseeable harm, including the full amount of damages assessed against the insured, without regard to the policy limits, as well as consequential damages. Comment (e) to Section 27 of the Restatement supports holding an insurance company responsible for punitive damages awarded against the insured as a result of the insurance company’s unreasonable failure to settle, even when coverage for punitive damages is excluded by the policy and barred by the public policy of the state involved. This is also a minority view in the law.
Under Restatement Section 49, an insurer is subject to liability for insurance bad faith when it fails to perform under the policy (a) without a reasonable basis for its conduct; and (b) with knowledge of its obligation to perform or in reckless disregard of whether it had an obligation to perform. Professor Baker described the position adopted by the Restatement as applying both an objective and subjective standard that is more demanding than a purely objective standard applied by some states. Although much of the debate during the Restatement’s drafting process centered on the concept of insurer “bad faith,” Professor Baker and Mr. Maniloff agreed that the end result would likely have limited impact on the insurance industry because most states most states have clearly established a “bad faith” standard through existing case law. Likewise, another topic that was subject to heated debate during the drafting process concerns remedies available once the bad faith of an insurer has been established.
Pursuant to Restatement Section 50, the remedies for bad faith include (1) “compensatory damages … and any other loss to the insured proximately caused by the insurer’s bad-faith conduct;” (2) “other remedies as justice requires;” and (3) “punitive damages when the insurer’s conduct meets the applicable state-law standard.” Comment (c) to Section 50 further states that an insurer may be “estopped by its bad faith conduct from asserting a coverage defense that it would have been able to assert had it fulfilled its contractual obligations.”
Allocation in “Long-Tail” or Continuous Injury Claims
The Restatement has, however, adopted a more pro-insurer approach to the issue of allocation of indemnity costs in claims involving continuous injury. In Section 41, the Restatement establishes that where indivisible harm occurs over multiple policy periods, a default rule of pro-rata allocation under occurrence based liability policies should apply for indemnity costs. Further, the insured would be responsible for periods during which it is uninsured or underinsured. The Restatement’s authors maintain that this approach is the “most consistent, simplest, and fairest solution” as opposed to the all-sums approach to allocation, which “allows an insurer to be held responsible for a large amount of losses that did not occur during the policy period that the insurer agreed to cover.” Restatement § 41, pp. 351, 353.
It is important to note that the Restatement does allow for the application of an allocation scheme other than pro-rata if the terms of the policy itself support deterring from the default rule “except to the extent that the term cannot be harmonized with an allocation term in another policy that provides coverage for the claim.” Restatement § 41(2). Moreover, while the Restatement’s adoption of pro-rata allocation benefits insurance companies, Mr. Maniloff pointed out that the fact that so many states have already adopted an allocation scheme, “the Restatement is unlikely to have a major impact” in this area.
Finally, § 41(3) provides that defense costs in long-tail claims would not be allocated on a pro-rata basis, but instead each insurer with a duty to defend would be obligated to provide a complete defense to the insured, with a right to obtain contribution from other insurers that also have a duty to defend for their pro-rata shares of the defense costs. See also Restatement § 20.
Only time will tell how impactful the Restatement will be and whether courts and state governments will ultimately utilize or disregard it as to particular issues. In the meantime, the liability insurance community will certainly be closely attuned to these developments.
 Notably, shortly after the seminar, both the House and Senate of the state of Ohio passed a proposed bill providing that the Restatement “does not constitute the public policy of this state.” Most states, however, are more likely to address the Restatement on an issue-by-issue basis.