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Navigating Insurance Coverage Ambiguities: Extrinsic Evidence in Insurance Policy Disputes

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Navigating Insurance Coverage Ambiguities: Extrinsic Evidence in Insurance Policy Disputes

Insurance touches every facet of our businesses and private lives. When insurance coverage litigation ensues, the dispute often stems from what particular provisions mean, whether policy terms are ambiguous, and whether information outside the four corners of the policy can be introduced to reconcile the meaning/intent of policy language. In this insurance law seminar, we will cover key issues regarding when extrinsic evidence may be used to establish that a particular policy provision is ambiguous and under what circumstances courts allow extrinsic evidence to resolve an ambiguity. This presentation will benefit insurance litigators, as well as general counsel, in-house counsel, risk managers, claims professionals and any other individuals who are involved in insurance policy interpretation and coverage disputes.

Transcript

- Hello, my name is Verne Pedro. I'm a partner and insurance coverage attorney at Fullerton Beck. Today we're gonna talk about insurance coverage interpretation. But I'm gonna take a deeper dive into a smaller topic within this large substantive area and talk about insurance policy ambiguities and when courts are going to use extrinsic evidence to analyze and resolve an insurance coverage dispute. Now, just by way of background, insurance coverage disputes primarily involve whether one party's interpretation of an insurance policy provision is correct or not. And there's a general rule that's stated in contract law as well as in insurance coverage interpretation, that ambiguities are construed against the drafter of the contract. Now, while this is a basic principle, like I said, of both contract law and insurance law, this rule is not applied automatically. To the contrary, the determination that an ambiguity must be construed against the drafter of an insurance policy comes at the end of the court's analysis after it's applied other interpretive tools to see if that ambiguity can be resolved. Now we're gonna define ambiguity in a minute, but against the backdrop of what I just summarized, we're gonna talk about four issues today. One, we're gonna focus on some of the interpretive rules applied by the courts to analyze policies generally. And then that's going to lead to when courts may determine that a policy or policy provision is indeed ambiguous. These interpretive rules are gonna lay the foundation for the next couple of issues. Again, what is ambiguity? How do courts determine there is an ambiguity in the first place? Next subject is gonna be whether and when courts are going to permit extrinsic evidence to resolve a duty to defend issue, since the duty to defend is really a threshold consideration, at least in a general liability policy, will there be some requirement to establish whether the underlying claims trigger coverage under the policy or not, whether there's additional factual or documentary evidence that may need to be considered to make that determination, whether and when the courts are gonna do that, what will they actually rely upon or allow a party to the dispute to present to the court to make that determination on the duty to defend. And then taking that a step further, how are ambiguities resolved by the courts? And when does extrinsic coverage come into play in their analysis? As I touched upon a moment ago, often the most important argument in an insurance coverage dispute is whether or not a term or provision is ambiguous. Again, bear with me, we're gonna define ambiguity momentarily. But by way of background, historically the onus of ambiguous or uncertain terms in an insurance contract was on the insurer because insurers generally were considered to have the better bargaining position and because as drafters the insurer was in a better position to avoid whatever the ambiguity was in the document. Once insurance policies became mass marketed products, the existence of an ambiguity in an insurance contract resulted in a presumption of coverage in favor of the policy holder. This is now the minority view. In most jurisdictions today, courts have adopted an approach that considers the basic standards of policy interpretation, which we're gonna get to in a minute, meaning they're going to examine the language of the particular policy language provision. They're gonna look at public policy. They're gonna look at the purpose of the insuring transaction as a whole. And then if necessary, they may include an analysis of some extrinsic evidence relating to the negotiations, maybe the knowledge and shared understanding of disputed ambiguous terms, maybe through some industry, maybe there's an industry standard or a particular phraseology that is known in a particular area of law or industry. They'll consider all of these sources of information to see if the party's intent to the ensuring agreement can be ascertained. If it can be, based on this multifaceted analysis, then the intent of the policy and the provision will be enforced. But when extrinsic evidence is required and consideration of that evidence does not resolve the ambiguity, then the rule is called contra proferentem, that rule meaning construed against the drafter will be applied as an interpretive tool of last resort. In other words, ambiguity is construed against the drafter only if the policy language is still ambiguous after primary standards of interpretation and consideration of extrinsic evidence are applied by the court. So what is ambiguity? Some courts look at it and say that ambiguity exists when the policy language has two or more reasonable yet conflicting meanings. Another way of looking at it is that the policy language is so confusing that the average insured can't figure out the boundaries of coverage. And whether the phrasing is confusing may depend on among other things, the type of coverage provided, the sophistication of the insured, the prior relationship between the insured and the insurance company, resolution of prior claims and particular facts and circumstances giving rise to the claim. Now, if you notice those couple of items that I listed, they're already reflecting a view towards sources of information that are outside of the policy. So sometimes just as a threshold matter, other things outside of the corners of the contract have to be considered to give some context and meaning to the issue at hand when either of those considerations are in play, either that the policy language has two or more reasonable meanings, or it's so confusing that it just can't possibly be reconciled, then the court will probably look to extrinsic evidence at that point to see if either of those facets of the analysis can be determined, and if not, then again, as an exercise of last resort, the court will rule against the drafter. By way of example here, I had a client who had a commercial property policy that had a debris removal provision in it. After suffering a fire the insurer tried to read the policy form itself very narrowly in terms of how it was going to apply the policy limit to the debris removal, which was written as a percentage of the overall loss as opposed to a stated policy limit. However, there was conflicting language in the declarations page. I was able to argue convincingly in favor of my client that the language in the declarations page, which is really tailored to the policy holder as opposed to the form language should actually control. And here you had, again, two conflicting policy provisions applying to the same exact aspect of the risk, one of which could be interpreted one way, one of which could have been interpreted another. We were able to argue for the broader application of the policy and the broader application of coverage so that it applied as a percentage of the overall loss, which was tens of millions of dollars as opposed to the narrow reading that the insurer tried to apply. We started with a working definition of ambiguity, again, two potentially reasonable interpretations of the policy provision or the policy language is so confusing that the reasonable insured can't make out the boundaries of court. But what is not ambiguity? Ambiguous language is not elephant talk. What does that mean? Some of you may know the King Crimson song, "Elephant Talk" where the lyrics are made up of synonyms for argument and disagreement, starting from the letter A through the letter E. The point here is that policy language is not ambiguous just because the insurer and the insured disagree about the meaning. An insured cannot create an ambiguity merely by asserting a conflicting interpretation of the policy, nor is policy language necessarily ambiguous, just because a relevant term is not defined. For instance, the standard homeowners or business property policy, they don't generally define the term collapse. The meaning of the term has been subject of substantial litigation, commentary and debate and courts are split on whether to define the term narrowly to include only the complete falling down of a structure or more broadly so that a complete destruction of falling down is not required. Related to this is what constitutes hidden decay for purposes of a covered collapse. Again, just because these terms are not defined doesn't mean they're per se ambiguous. So at this point, we've talked about some interpretive rules that the courts are gonna look at. We've defined ambiguity and we've talked about what ambiguity is not. So how do we get to the first steps of the analysis? The policy holder has the burden of showing the claim is covered in the first instance, and where there's a dispute over the interpretation of the policy, the policy holder is gonna have to show that the claim itself is gonna fall within the basic terms and coverage grant of the policy. Thereafter the insurer has the burden of proving that a claim is either not covered or excluded under the policy. And once the insurer establishes that an exclusion is potentially applicable, the burden is gonna shift back to the policy holder to establish that there may be some exception to that particular exclusion. Taking this a step further, relevant rules of contract interpretation are going to apply to the policy as we talked about before, an insurance contract is a creature of contract law, may have some specialized terms because in some instances may be a mass produced mass marketed product, but it's still essentially a contract and it's going to be interpreted according to rules of contract law. And each state has their own particular rules on contract interpretation. So the jurisdiction, interpretation of the policy may depend on the jurisdiction, excuse me, that you're in. Some of the fundamental rules of contract interpretation are based on the premise that the interpretation must give effect to the party's mutual intent. As we talked about before, the courts are gonna see if they can figure out what's the purpose for the transaction, what's the intent of the parties, what are they trying to accomplish by entering into this contract. One of the rules the courts use to get there is called the plain meaning rule, meaning that clear and unambiguous terms in the insurance policy are gonna be enforced as they're written. The policy is going to be read in its entirety. Coverage provisions are gonna be construed as liberally as any reasonable interpretation will allow. Exclusions are going to be construed narrowly. Courts are not gonna rewrite insurance policies or provisions that are clear and unambiguous. As we talked about before, ambiguities are ordinarily construed against the insurer, but that is not an automatic exercise. And in the absence of ambiguity in the language of an insurance policy, a court is not in the normal course going to engage in a strained construction to support the imposition of liability or right for the insured a better policy of insurance than the one that was purchased. Again, when a policy's clear it'll be enforced as written, when it's unclear, the ambiguities are ordinarily resolved in favor of the insured with a caveat that we're gonna continue to talk about. So as I just noted, state law will apply to policy interpretation. The reason for that is because insurance policies are contracts and state law applies to actions on contracts and contractual interpretation. There's going to be, just as a reminder, subtle differences from one state to the next that can have important consequences depending on how your particular state looks at various issues of contract interpretation. The law of the applicable jurisdiction will control the interpretation of the policy, but keep in mind, there may be uncertainty regarding which particular state law or states law, depending on the actual issue involved, which particular states law is gonna control the interpretation of the policy, conflict of law, choice of laws beyond the scope of this particular presentation. But I mention it so you keep that in mind because you may have a risk or a particular policy or issues that span various states and jurisdictions. We touched on this briefly, but why are there special rules of interpretation for insurance policies? And that's typically because insurance policies are mass marketed, they're referred to as contracts of adhesion and specific terms and conditions were not necessarily negotiated between the insured and policy holder unequal footing. There may be some exceptions to that with some of the larger policyholders that have risk management departments and specialized brokers that are negotiating on their behalf. But for the most part, when we're talking about an insurance policy, we're looking at a document that was created by the insurance company and purchased by a policy holder more or less as it was produced. These are standard form policies, they've been created by the insurance industry. They have been developed over many years. So they have taken on this designation as being a contract of adhesion. So the courts have taken that into consideration and applied special rules of policy interpretation as a result of that, given the disparity in bargaining power between the insurance industry and the purchasers of the insurance product. As a footnote to that, courts are aware that the policy holders are relying on the insurer's representations regarding the coverage that's being offered under the particular policy. We touched on this before, courts are going to apply the plain meaning rule. Plain meaning rule states that words in insurance policy are gonna be interpreted according to their plain and ordinary meaning, courts aren't going to strain to find some hidden meaning in the policy language. The exception to that is if the particular language used in the policy, if those words have taken on a technical meaning. For instance, something that's specific to a particular industry, like I mentioned before, that's understood by the insurer and the policy holder and courts will sometimes refer to dictionary definitions to determine what the plain and ordinary meaning of a particular policy usage. Plain meaning rule also indicates that the courts are gonna look for the intent of the parties when interpreting the insurance policy. And of course the language is going to dictate what the party's intent might have been. Some courts are gonna have held that absent fraud or unconscionable conduct, the insured is charged with the knowledge of the terms and conditions of the policy even when the insured has not read the policy prior to the loss. In New York, for instance, courts will consider that the policy holder has constructive presumptive knowledge of the terms and conditions of the policy. And if they haven't read it, unfortunately that presumption can sway against them depending on the particular issue. Now, before we completely get into the extrinsic evidence issue, I just wanna mention that sources of meaning outside the four corners of the policy are admissible to aid in interpretation. So for instance, I mentioned the courts may look to a dictionary to determine what the plain meaning of the particular policy term is. And just as a basic threshold consideration that facts about the underlying claim are sources of information outside of the policy that you can't get into the policy without knowing what the pleading says, what the actual dispute is about, what the risks are that are involved. So those underlying facts, they're all sources of information outside of the policy, but the policy could not be applied at all without them. So it's not as static an interpretive exercise as it may seem in terms of what does the policy say, what does it apply to, and whether there's coverage or not. I mentioned the Latin phrase before, contra proferentem, and that's the interpretive rule where the ambiguity will be construed against the drafter. But as we talked about, there's many steps that the court can and in the normal course will take before they get to that determination that the policy has to be, or should be interpreted against the drafter. They're gonna apply other general rules of interpretation, like we mentioned, the plain meaning rule. They may look to a dictionary to see if there's some way to extract a reasonable interpretation of the policy terms before they have to say that, well, it's just so confusing or that the reasonable policy holder can't determine the bounds of coverage from the particular policy language. Again, before they get to construing the policy against the drafter, several steps are gonna take place. If it is ambiguous however, the policy holder's typically gonna win. Again, that's construed against the drafter. If it's unambiguous, the insurer will win. Keep in mind, rather than applying contra proferentem, some courts hold that once an ambiguity is found the meaning of an ambiguous term is an issue of fact that must be resolved by the trial of fact and may go to the jury. And in other jurisdictions, if extrinsic evidence does not resolve the ambiguity, then contra proferentem will apply. And we're going to get into extrinsic evidence in a minute, since we've really only talked so far, about a court looking at maybe a dictionary definition as an external source of information, or from a claims handling perspective, or from an initial policy interpretation exercise, what are the underlying facts, what am I looking at, what's triggering coverage, those are external sources, but there's gonna be other things we're gonna talk about in a minute to determine the interpretation of the policy, and then whether extrinsic evidence will resolve potentially or actually ambiguous policy provision. I just wanna make sure I'm clear. I know we're covering a couple of different overlapping concepts here, so I just wanna make it clear that when extrinsic evidence is required and consideration of that evidence does not resolve the ambiguity, then the contra proferentem rule would be applied as an interpretive rule of last resort. And then the corollary to that is that ambiguity is construed against the drafter only if the policy language is still ambiguous after primary standards of interpretation and consideration of extrinsic evidence. To this point, we've talked about some interpretive rules, talked about ambiguity, what ambiguity is not. Honing in a little bit more on contra proferentem it's quite possible as we can, I think, establish that for policy provision can remain ambiguous even after consideration of extrinsic evidence relevant to the meaning of the provision. In such cases, the provision will be construed against the drafter as the contra proferentem rule dictates. There's a limit to this though, at least with respect to standard form provisions, is that an interpretation that affords a policy holder coverage that they could not reasonably expect will not be adopted. And this might be understood as an interpretive limit on contra proferentem, meaning that in a sense an interpretation that would afford policy holders more coverage than they would reasonably expect is not a reasonable interpretation of the policy. And then just as another footnote, there's other interpretive rules that we're really not gonna get into now 'cause I wanna really save some time for the extrinsic evidence discussion. But for instance, there are specific rules about words that might be listed, very similar categories of items or categories of types of things identified by specific words in a policy, the court may look at those particular listed items to determine whether the issue falls within the categories or types of items identified in the particular policy provision. As an example, where the court looked at dictionary definitions, as well as listed categories of items, the Authentic Title Services Incorporated versus Greenwich Insurance Company case out of the District of New Jersey in 2020, it's actually a cyber insurance case. The ENO insurer in that case denied coverage for the claim based on an exclusion for any claim arising out of the commingling, improper use, theft, stealing, conversion, embezzlement, or misappropriation of funds. The court looked at the definition of these terms with respect to the exclusion and the actual underlying facts of the case and felt that the claim itself fell squarely within this particular exclusion, but it took the time and the exercise to provide a dictionary definition for all of these particular categories of conduct and wrongdoing to determine whether the issue in that case was actually a misappropriation of funds. One tool that courts used to resolve ambiguity is their reasonable expectations doctrine. And that contemplates interpreting insurance policies with the reasonable expectation of the insured in mind. The New Jersey Supreme Court explained reasonable expectations this way, "When members of the public purchase policies of insurance, they are entitled to the broad measure of protection necessary to fulfill their reasonable expectations. They should not be subjected to technical encumbrances or to hidden pitfalls and their policy should be construed liberally in their favor to the end that coverage is afforded to the full extent that any fair interpretations will allow." And this quoted from the Zacarias v. Allstate Insurance Company case of New Jersey Supreme Court, 168, N.J. 590 from 2001. So when insurance policy language is ambiguous, the reasonable expectations of the insured will be applied even if a detailed analysis of the policy provisions would result in a finding of no coverage. And the reasonable expectations doctrine is based in part on the insured not having equal bargaining power and generally being required to accept the insurance policy as written. Of course, expectations must be objectively reasonable and not contrary to the plain language of the insurance policy. So you see how these rules really overlap. We've started with looking at what the policy says. Do the words make sense? Is there a meeting that can be derived from the insurance policy without having to do anything else in terms of external sources? What's the intent of the agreement? The reasonable expectations doctrine really drills down on what the intent of the policy is, and trying to find a way to resolve the ambiguity or the confusion in the policy language by just looking to the insuring intent and of course, favoring the insured's interpretation and intent and expectation of coverage, assuming it's reasonable even if there is an ambiguity in the policy. And getting to the flavor of extrinsic information that courts will consider, they may look to prior and contemporaneous negotiations to determine the meaning of an ambiguous policy and that would apply to both standardize and manuscript or tailored policy forms to determine what the reasonable expectation of the insured might be. So going back to the example I gave of my client with the equipment policy, one of the arguments I made in that situation was that the reasonable expectation was that they would be covered for 100% of their debris removal cost and not some fractional or proportional amount of money after a particular loss. And in that case, there was a, again, a multimillion dollar fire that damaged the brick and mortar structure as well as their equipment. So now they have a pile of burned damage equipment that they can't remove from the premises, didn't want to have to foot the bill 100% for all of that debris removal, which is why they had separate debris removal coverage in the policy in the first place. Insurer tried to narrow the scope and the amount of money that was available to them under the policy for debris removal costs and the policy form language and the proportional formula that was stated in the debris removal provision in the standard form language differed from what was on the declarations page. And as we mentioned before, the dec page is really the one document that is created specifically for that policyholder. And in that case, there were some manuscript specifications included in the declarations page. We argued that, well, not only was it ambiguous to have these two provisions that conflicted, but also the reasonable expectations of the insured would indicate that they expected 100% coverage for their debris removal expenses after a covered property loss. Some courts have held, keep in mind, that the expectations are different for a sophisticated insured with an in-house risk management department or assistance from an insurance broker or attorneys when they obtain a manuscript or specifically tailored insurance policy versus the normal consumer purchasing, say a homeowner's policy or an auto policy, the expectations are gonna be different between those categories of insured's. And then going back to the point that I just made, that courts may look to the policy declarations to analyze the insured's reasonable expectations. And I just gave you an example where I was able to do that in the real world, not only to show ambiguity, but to show my client's expectations of coverage. And just to emphasize the reason why the declaration page is important is that the courts have said that this is really the one document in the entire policy or one series of documents in the policy that is tailored to the particular insured. And it's not merely standard boilerplate insurance language. So they can look to that and say that, well, doesn't, this really define the scope of coverage as well as the insured's expectations of coverage? As a recap, we've talked about what ambiguity is and what it's not. We've talked about some interpretive rules that the court is going to look at when it one, is confronted with a policy dispute before it even gets to the determination that something is or is not ambiguous. How are the courts going to interpret the policy, what rules apply, what law applies, who has the burden, and then we've narrowed from there to some of the interpretive rules that the courts are gonna focus on when there may be a question as to the meaning of the policy provision. Whether they need a dictionary to assess plain meaning, whether they need to assess the reasonable expectations of the insured because there is some conflict between the various positions taken by the parties as to what a particular policy means or what coverage is in play. Now, I want to shift gears a little bit and talk about the duty to defend. And it's all gonna come together with the rules of interpretation, extrinsic evidence, and duty to defend. But one of the most fundamental concepts in insurance coverage is the duty to defend. Now, although it's a seemingly straightforward question, the issue of whether the duty to defend is triggered has a lot of challenges and consequences and may implicate everything we've talked about up to this point. What are the reasonable expectations of the insured? What does one particular state say about a particular policy interpretive rule versus another? What are the underlying facts and circumstances that may trigger coverage in one jurisdiction versus another? And as an example, another cyber insurance matter, if you're looking at coverage B under a CGL policy, which covers personal and advertising injury, one of those enumerated offenses is for invasion of privacy. Some courts look at a cyber breach and theft or exfiltration of personal data as an invasion of privacy, but the particular policy provision for invasion of privacy also requires a publication. Some courts look at the term publication narrowly, so that it means that the named insured had to publish the personal information that's at issue in the breach. Some courts look at it a little broader, much more broadly, and say that even third parties who may have hacked and stolen personal information, personally identifying information and published it, whether that's on the dark web or through some other method that that is enough to trigger the publication requirement for coverage B for the invasion of privacy coverage grant. And that's important because that's gonna impact whether the duty to defend is triggered in one jurisdiction that reads it narrowly versus the duty to defend that may be triggered in a jurisdiction that's gonna look at it much more broadly. So it's a challenging question and it's an important threshold issue as to whether a policy is implicated and whether it has to respond to a particular claim. And the duty to defend is typically determined by the allegations of the complaint against the insured, regardless of the truthfulness or accuracy of those allegations. Taking it a step further, in some jurisdictions courts are going to allow the parties to rely upon extrinsic evidence to determine whether a duty to defend is owed. Now, generally policy holders may seek to introduce extrinsic evidence to establish a duty to defend where the facts of the complaint are insufficient to trigger that obligation. Conversely insurers may try to introduce extrinsic evidence in order to negate the duty to defend. Jurisdictions vary as to whether extrinsic evidence is permitted. Some courts only allow a policy holder but not the insurer to rely upon extrinsic evidence with respect to duty to defend while other courts will allow either party to use such information and then other jurisdictions don't permit any extrinsic evidence at all, when it comes to a duty to defend analysis. Just to make sure I've been clear on what extrinsic evidence is, I know I've mentioned that it's information outside the context of the complaint, and I just wanna make sure I emphasize that here in case it was lost in some of the other issues that we discussed, extrinsic evidence is evidence outside of the insurance policy used to determine the objective intent of the parties. Normally extrinsic evidence is used only where the court finds an ambiguity in the language of the policy as we've talked about. When that extrinsic evidence is allowed, the proffered evidence must predate the dispute or the controversy. There are three basic categories of extrinsic evidence. One is evidence that relates solely to the merits of the plaintiff's allegations against the insured, two, evidence that relates solely to the insurer's duty to indemnify the insured, that is, which goes solely to the question of coverage under the policy of issue, and three, evidence that relates both to the merits of the plaintiff's claims and to coverage. Evidence which might be described as overlapping evidence. Extrinsic evidence rule varies by state. As we've talked about, contract interpretation rules are gonna be different state by state. And in some states, an insurer can look beyond the policy and the complaint while in other states, an insurer is limited to the corners of the policy and the corners of the complaint, and that's it. And then still in other states like New York, the rule's not so clear, an insurer may consider extrinsic evidence, but only in limited circumstances. So what types of extrinsic evidence are allowed and when? Generally relevant extrinsic evidence consists of acts, words or conduct of the parties as expressed between them or others. We mentioned declarations pages and dictionary definitions regarding reasonable expectations, but what other types of extrinsic evidence have the courts considered? Well, courts have considered the purpose of the policy as evident by the parties prior or contemporaneous negotiations. They've looked at drafting history of standardized policy forms and changes in those forms over the years. They've looked at insurance industry statements submitted to state insurance regulators. They've looked at how a particular loss or claim has been handled previously, implicating the similar policy language. Look at custom and practice of the parties, drafting history, again, adoption of standard form language. They've looked at past claims and they've looked at the party's conduct or acts after issuance or renewal of an insurance policy. An example of party's conduct after issuance of the policy is the Zito versus Fireman's Fund case. In that case, Mr. Zito owned a small food processing business and was insured under an auto policy issued by Fireman's Fund. The policy covered two vehicles owned by Zito, one for his business, and one for personal use. And the policy specifically excluded coverage for non-owned vehicles. When the policy was delivered, Zito told his insurance agent that he sometimes rented a large truck to pick up supplies for his business, agent told him that he did not have non-owned auto coverage in the policy, but Zito told the agent not to worry about it because he always bought insurance from the rental company when he rented the truck. He declined the agents offered to add non-owned vehicle coverage to the policy. While driving a rented Ford truck, Zito was killed in a multi-car accident in which other persons were also injured. After his estate was sued by these injured persons, Fireman's Fund denied liability based on the non-owned vehicle exclusion. Plaintiff argued that the exclusion was ambiguous and applied only to the use of a non-owned vehicle driven by a third person while engaged in the business of the insured. In finding in favor of Fireman's Fund, the trial court and appellate courts both found that evidence of Zito's post-issuance conduct demonstrated there was no coverage. Zito confirmed his belief that the Fireman's policy did not afford liability coverage for the rented truck, not just by words, but by mentioning that he purchased special insurance to cover that contingency every time he rented the truck. So both by what he said in conversations with the agent and by his conduct, he acknowledged that the Fireman's Fund policy was not intended to afford liability coverage when he rented a truck and used it in his business. So in some, the construction or interpretation given to a contract is evidence by the acts and conduct of the parties with knowledge of the terms is entitled to great weight and is noticed above, courts consider the acts of the parties themselves before disputes arrived to be the best evidence of the meaning of doubtful contract terms. So a quick survey of courts allowing or disallowing extrinsic evidence, and the duties to defend. In Connecticut, for instance, extrinsic evidence is only allowed to establish coverage. In Illinois, extrinsic evidence is only allowed in special circumstances. And there, for instance, one court considered extrinsic evidence beyond the one underlying complaint if the court does not determine the issue critical to the underlying action. And of course there's gonna be a defense obligation if the insurer has knowledge of true but facts that are not in the complaint, which were taken together with the complaint's allegations and the claim is within or potentially within coverage. In Pennsylvania, extrinsic evidence is generally not allowed. California courts have held that extrinsic evidence is allowed to establish or negate coverage. Under fairly recent case law in New York, an insurer may consider extrinsic evidence that is irrelevant to the principle merits of the underlying action. Insurer cannot rely on extrinsic evidence in a collateral proceeding to defeat or terminate its duty to defend when the facts it seeks to establish are related to the merits of the underlying case. Under Texas law, extrinsic evidence is generally not allowed. However, some recent case law indicates that the court will not preclude extrinsic evidence of some collusive fraud. As a follow up note on Texas, I do want to highlight a couple of cases just to bring your attention. If you're interested in this area with the extrinsic evidence and duty to defend, two new cases have come out, fairly new cases came out in 2020 out of Texas, where the analysis is fairly in depth and gives a really good synthesis of how the courts are gonna look at these issues and reconcile when extrinsic evidence should be allowed on the defense obligation. Those cases are Richard versus State Farm. And the other is Loya Insurance Company v. Avalos. They should be in the materials. If you get an opportunity to take a look at those, they'll give a really good overview of where the shift is taking place in terms of considering when the courts are going to consider extrinsic evidence on this duty to defend. As I mentioned, if there's some evidence of fraud, they're gonna allow that they basically say that an insurer should not be obligated to defend a case just to extricate itself if there's some information available that shows that the policy holder was trying to procure coverage through some fraudulent means. In the Richard's case, the court disallowed extrinsic evidence, basically stating that the extrinsic evidence that the carrier wanted to introduce in that case was really overlapping with the underlying merit to the case like we talked about in New York. New York courts are not going to allow any extrinsic evidence that's going to implicate the underlying merits. Court in Richard's had that same approach in terms of disallowing the extrinsic evidence in that case. I'm gonna talk about a few more cases where the courts reconciled ambiguous language with extrinsic evidence, or at least considered extrinsic evidence as part of the analysis to resolve the dispute over an ambiguous policy provision. And the first case gonna talk about is World Trade Centers Properties LLC versus Hartford Fire Insurance Company. That's out of the Second Circuit, 2003, and this case goes back a little bit, but it involved the 9/11 World Trade Center attacks. The issue in this case is whether the two hijacked planes intentionally crashing into the Twin Towers 16 minutes apart was one or two occurrences. And the term occurrences was defined as all losses or damages that are attributable directly or indirectly to one cause or to one series of similar causes. All such losses will be added together and the total amount of such losses will be treated as one occurrence, irrespective of the period of time or area over which such losses occur. The argument was over the definition of occurrence. And the court there held that the language is unambiguous and the way they described it, or the way the holding basically says no find or effect could reasonably find the intentional crashes into the World Trade Center of two hijacked airplanes, 16 minutes apart as a result of a single coordinated plan of attack was at the least a series of similar causes. Second Circuit there agreed with the District Court that under this definition, the events of September 11th were a single occurrence. In SR international versus World Trade Center Properties, another Second Circuit case, this particular case addressed an event based occurrence form, which defined occurrence as loss, disaster, or casualty or a series of losses, disasters, or casualties arising out of one event. In that particular policy, the term event was not defined. The insured argued that event meant all related phenomena while the policy holders contended that... The insurer argued that event meant all related phenomena while the policy holders contended that event meant a physical phenomenon. The court held the definition of occurrence was ambiguous because event is susceptible to more than one reasonable interpretation. In New Seacrest versus Lexington, 2014 case out of the Eastern District of New York. It was a Hurricane Sandy case, this involved whether damage caused by storm surge, which was a defined term, is damaged by flood and therefore subject to a flood sum limit. The policies holders argued that flood and storm surge were separate perils because the policy listed flood and storm surge separately in the name storm sub limit. Flood was defined as whether natural or manmade, flood waters, surface water, waves, tide, or tidal water overflow or rupture of a dam, levee, dyke or other surface containment structure. Storm surge, the rising overflowing or breaking of boundaries of natural or manmade bodies of water or the spray from any of the foregoing, all weather driven by wind or not. A tsunami shall not be considered flood. There the court held that the policy unambiguously included storm surge within the definition of flood and therefore the flood sub limit applied. As we talked about before, the listing of various types of categories of risk or items can sometimes impact the interpretation of the policy and here that's the practical effect of what this definition did in this case. In Bamundo versus Sentinel Insurance Company, case out of the Southern District of New York, 2015, another Super Storm Sandy case, but this involved business interruption loss resulting from the evacuation. And the issue was whether a civil authority provision applied where the predicate evacuation order was due to flooding. The analysis turned on whether the term, covered cause of loss, quote unquote, used in the civil authority provision incorporated the flood exclusion. The civil authority provision read, "This insurance is extended to apply to the actual loss of business income you sustain when access to your scheduled premises is specifically prohibited by order of a civil authority as the direct result of a covered cause of loss to property in the immediate area of your scheduled premises." There the court held that the language of the applicable civil authority provision was unambiguous and that plaintiff's business income claim was not covered under the policy. And in the court's language, they reached this conclusion for the simple reason that covered cause of loss is defined in the policy to exclude loss due to flooding. In Wakefern versus Liberty Mutual, New Jersey Appellate Division case outta 2009, problems with the interconnected North American Electrical Power Grid in August, 2003 caused a four day electrical blackout over Northeastern US and Eastern Canada. A group of supermarkets sought coverage under their commercial property policies for food spoilage and loss revenue. And the issue there was whether the losses resulted from, quote unquote, physical damage to certain specified electrical plant and equipment. Physical damage was not defined. In that case the court held that the undefined term, physical damage, was ambiguous. In the context of this case, the electrical grid was physically damaged because due to a physical incident or incidents, the grid and its component generators and transmission lines were physically incapable of performing their essential function of providing electricity. In Lantheus v. Zurich, another case outta the Southern District of New York in 2015, the insured Lantheus Medical sought coverage under a commercial property policy for contingent business income loss that was related to a 15 month shutdown of a nuclear reactor that supplied a radioactive isotope that the policy holder used for their diagnostic medical imaging products. The issue was whether the shutdown at the nuclear power plant was caused by corrosion, which was not a covered cause of loss. Because the policy did not define the term corrosion, the court used a dictionary to determine the ordinary meaning of the word. Both parties had submitted scientific expert testimony regarding whether corrosion caused the shutdown of the nuclear reactor. The court noted that both parties agreed that the common meaning of the term corrosion and not the definition that a scientist or one of the parties experts might use actually controls the court's interpretation of the policy language. The court held that the insurer had met its burden of establishing the corrosion exclusion was unambiguous, and that the subject claim fell squarely within that exclusion. In Computer Corner versus Fireman's Fund, which is case out of the New Mexico Court of Appeals in 2002, the issue was whether the CGL policy there afforded coverage for liability rising from the loss of data stored on a computer hard drive. The insurer denied coverage based on an impaired property exclusion, which state says follows, "This insurance does not apply to property damage to impaired property or property that has not been physically injured, arising out of one, a defect, deficiency, inadequacy, or dangerous condition in your product or your work, or two, a delay or failure by you or anyone acting on your behalf to perform a contract or agreement in accord with its terms. This exclusion does not apply to the loss of use of other property arising out of a sudden and accidental physical injury to your product or your work." Another case I'd like to discuss is 7001 East 71st LLC versus Continental. This is a 2018 case out of the Second Circuit. In that case the policy holder owned a shopping center that sustained damage during Super Storm Sandy due in part to rainwater intrusion. On motions for summary judgment, the District Court held the damage unambiguously fell within the windstorm exclusion of the subject policy. 7001 appealed, arguing that the District Court got it wrong. So the Second Circuit took a look at the policy and the case turned on the interpretation of the windstorm exclusion. The exclusion stated generally, "We will not pay for loss or damage caused directly or indirectly by any of the following; such loss or damage is excluded regardless of any other cause or event that contributes concurrently or in any sequence to the loss." Exclusionary section went on to list numerous excluded conditions, including a breakdown caused by windstorm or hail. The policy specifically defined a breakdown as a sudden and accidental direct physical loss to covered equipment, which manifests itself by physical damage, necessitating its repair or replacement, unless such loss is otherwise excluded within the coverage form. Placed in context, the court read the exclusion as follows, "We will not pay for loss or damage caused directly or indirectly by a breakdown as previously defined that is caused by a windstorm." The court noted the exclusion did not simply read, "We will not pay for loss or damage caused directly or indirectly by windstorm," which might have actually barred coverage for the claim. Looking at the facts, the claim alleged that a windstorm caused the roof of the policy holder shopping center to tear, which in turn allowed rainwater intrusion and rainwater damage to covered equipment. Accordingly, the court observed the damage was caused directly or indirectly by rainstorm as a factual matter. In its analysis, the court emphasized that the insurer drafted the exclusion. As we talked about before, exclusionary language is going to be when it's ambiguous construed against the drafter. But the insurer also has the burden of proving that the claim falls squarely within the exclusionary language. So the court made a point of emphasizing that. Parsing the language, the court went to comment that a reader might understand the exclusion as simply an inartful way of saying that the insurer will not pay for loss or damage caused directly or indirectly by a windstorm. On the other hand, the court found that it could be read as, if a breakdown that is caused by a windstorm occurs, the insurer will not pay for loss or damage that such breakdown directly or indirectly causes. The court then read the exclusion by inserting the contractual definition of breakdown in place of the word breakdown. So that the language read like this, "We will not pay for loss or damage caused directly or indirectly by a sudden and accidental direct physical loss to covered equipment that is caused by windstorm." The court held this language can be reasonably read to mean that the broad exclusion applies only when a windstorm directly cause damage to covered equipment and not when a windstorm indirectly damages covered equipment. Because there were two reasonable readings of the exclusion, the court held it was ambiguous. The court further commented that once it is determined that an insurance provision is ambiguous, the court may accept any available extrinsic evidence to ascertain the meaning intended by the parties during the formation of the contract. In this particular case, the parties did not have any extrinsic evidence to introduce. Accordingly the court held that the policy provision was ambiguous, vacated the district court decision and remanded the case for further proceedings after it has been put to its intended use. The court held the exclusion was ambiguous and its commentary is noteworthy. The court said, "This exclusion is unintelligible from the standpoint of a hypothetical reasonable insured operating a computer repair service. We find it difficult to believe that anyone genuinely interested in communicating information to another person, whether in a cookbook, a home appliance manual or a contract, would employ the type of convoluted, intractable language used in this policy." So you can see that the court's holding in this case really incorporates a laundry list of the concepts that we've talked about today, the plain meaning rule, the interpretive rules of reasonable expectation and how all of these distill down to a single overarching approach by the courts to try to make sense of what's on paper and whether the policy fits to do what it's supposed to do. Whether the policy accomplishes what it's intended to do and what the party's expectations are reasonably satisfied by the outcome of the policy. So a couple of key takeaways here. One, overriding applies to any type of insurance policy analysis, that the policy must be read carefully and examined as a whole and in context to determine what the boundaries of coverage are, but also determine whether it truly is ambiguous or not ambiguous. Going back to where we started our discussion is that before applying the contra proferentem, before construing the policy against the insurer, the courts are gonna generally try to resolve the ambiguity by considering certain evidence of the party's intent. And that may be again, through interpretive rule, through dictionary or through actual consideration of other types of extrinsic evidence like we talked about, whether that's drafting history or cause of dealing between the parties or something along those lines. But only then will ambiguity be construed against the drafter. Again, just to really highlight this, it's not a automatic perfunctory application of the rule, it's really a interpretive rule of last resort. And then getting to the duty to defend, we saw that although it's an important consideration in the defense context, it's still evolving. New York has some new case law that we talked about as well as Texas. And I refer you to those Texas opinions again, for just a fantastic analysis on how these issues are framed, how they get in front of the court and how they are truly evolving to determine whether an insurer's duty to defend will be excused or whether extrinsic evidence can be used to frame and define that duty. And again, really, it's gonna be considered in terms of there may be circumstances of fraud or collusion where the evidence will be allowed, even in those jurisdictions where they hesitate to introduce any proffered extrinsic evidence. Thank you very much for your time. I hope that you found this presentation interesting and helpful. And if you have any questions or would like to discuss any issues further, feel free to reach out and contact me at the contact information provided. Thank you very much.

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Verne Pedro
Managing Partner
Fullerton Beck LLP

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