A recent decision from the Third Circuit has some rather interesting things to say about the reasonable expectations standard of policy interpretation. In G-I Holdings, Inc. v. Reliance Insurance Co., 586 F.3d 247 (3rd Cir. 2009), the Court rejected a rather novel invocation of the reasonable expectations doctrine as a means to circumvent the interrelated wrongful acts provision in a D&O policy (unfortunately we cannot provide page citations in this post because there is no pagination in the Westlaw publication of the decision).

The decision arises in a rather unusual context. In February 2000, G-I Holdings purchased from Reliance a D&O policy covering claims made against G-I’s directors and officers between July 1, 1999 and July 1, 2002. The coverage limit was $15 million. The policy included an interrelated wrongful acts provision, which stated that the filing date of all suits arising from the same wrongful act would be the date on which the first suit was filed. G-I paid a premium of $185,000.

Shortly after the policy was issued, Reliance encountered financial difficulties. In the summer and fall of 2000, Hartford Fire Insurance Company (“Hartford”), pursuant to an Asset Purchase Agreement and Claims Servicing Agreements, became a reinsurer of Reliance and claims administrator of certain Reliance policies.

In July 2000, after Reliance’s rating fell below the minimum financial guidelines for insurers set by G-I’s insurance broker, Marsh & McLennan Companies, G-I’s risk manager (Robert Flugger) instructed Marsh to arrange for G-I to acquire a director’s and officer’s insurance policy from Hartford. In response, Reliance and Hartford then split the policy period of the Reliance policy. Reliance changed the coverage determination date of its policy to July 15, 2000 from July 1, 2002, and Hartford issued G-I an identical policy with a period of July 15, 2000 to July 1, 2002. By an endorsement to its policy, Hartford limited the sum of coverage under its policy and the amended Reliance policy to $15 million. Hartford received from Reliance $153,935.18 of the premium originally paid by G-I.

In consequence, G-I had two policies: the amended Reliance policy which covered claims made between July 1, 1999 and July 15, 2000; and the Hartford policy, which covered claims made between July 15, 2000 and July 1, 2002.

The underlying claim stemmed from G-I’s liability exposure for asbestos claims. In 1997, facing more than $200 million in existing asbestos liability and the prospect of hundreds of thousands of future claims, G-I distributed to Samuel J. Heyman, its CEO and controlling shareholder, the stock of a profitable subsidiary. Asbestos claimants with their representatives filed fraudulent conveyance actions against Heyman and G-I. These suits were filed on January 3, 2000 by an injured employee (“the Nettles action”); on September 19, 2000 by the Center for Claims Resolution (“the CCR action”); and September 17, 2001 by the Official Committee of Asbestos Claimants (“the Claimants Committee”) in G-I’s Chapter 11 bankruptcy case filed in 2001.

The Nettles action filing date thus fell within the amended Reliance policy period, and the CCR and Claimants Committee filing dates fell within the Hartford policy period. Because Reliance went into liquidation, G-I nonetheless sought coverage from Hartford for the three fraudulent conveyance suits against Heyman.

G-I rested its claim for coverage on three arguments: (1) Reliance and Hartford agreed to provide insurance coverage for a single policy period, so the Hartford policy period includes the amended Reliance policy period; (2) the interrelated wrongful acts provisions in the policy should not apply, so that the two later-filed fraudulent conveyance actions fell within the Hartford policy; and (3) the purchasing, servicing, and reinsurance agreements between Hartford and Reliance made Hartford directly liable under the amended Reliance policy. The Third Circuit rejected each of these arguments, affirming the district court’s grant of summary judgment to Hartford.

The Court observed that under New Jersey law, which supplied the rule of decision, “it is open to G-I to argue that (1) it was reasonable to expect that the Hartford policy would include the period initially covered by the Reliance policy and (2) this is one of those situations in which its reasonable expectations should trump the plain meaning of the policy.” Under New Jersey law, the reasonable expectations approach to policy interpretation applies to even where the insured is a sophisticated actor. 586 F.3d 247 n. 10.

In the context of G-I’s claim, the Court framed its reasonable-expectations analysis in this manner:

In performing the reasonable-expectations analysis, we must first ask whether, without making a request or receiving some affirmative signal, an insured can reasonably expect that the policy period of a new policy it takes out in response to the financial difficulties of a prior insurer would include the period of the old policy. If such an inclusion would follow as a matter of course that would strengthen G-I’s position considerably. However, G-I has provided no evidence to show that the process of acquiring a new policy from one insurer in response to the financial difficulties of a prior insurer is so standardized or driven by such determinant purposes that an insured (here G-I) can reasonably expect a specific relationship between the policy periods of the prior and new policies. As a result, to put at issue whether it was reasonable for G-I to have expected the Hartford policy to cover the entire Reliance policy period, G-I had to establish either that (1) it requested a policy covering the entire policy period and Hartford did not clearly refuse to provide it or, more generally, that (2) Hartford by its actions or representations otherwise created a reasonable expectation in G-I that Hartford would provide such a policy.

Applying this analysis, the Court held that G-I had failed establish its claim to coverage.

First, the Court remarked that G-I had failed to provide evidence to support the proposition that G-I had requested that Hartford provide coverage for a policy period that included the amended Reliance period. In the Court’s view, “the handling of premiums and the combined liability cap could not have created a reasonable expectation that Hartford would cover the amended Reliance policy period.” Rather, the fact that Reliance and Hartford split the premium “should have suggested to a reasonable corporate insured employing a risk manager that Reliance and Hartford were splitting the risk insured by the original policy.” Id. That is, “G-I should have concluded that Hartford was not agreeing to cover the entire Reliance policy period.” Id.

The Court rather pointedly observed that “if Hartford had assumed all risk under the initial Reliance policy, then a reasonable insured should have expected Hartford to acquire the entire premium G-I had initially paid to Reliance and to have assumed coverage up to the full $15 million limit.” The Court acknowledged, however, that Hartford’s share of the premium was disproportionate, but did not find this circumstance to be material:

“We are mindful that Hartford took over 80% of the initial premium, and this exceeded the portion of the initial policy period that Hartford assumed (roughly 6-7%). If, as a matter of industry practice, premium and policy period should be proportional (a possibility not addressed in the record), then this suggests that Hartford’s share of the original premium was out of proportion to its period of coverage.” Id. n. 15.

But the Court nonetheless concluded that there was “no evidence that Hartford received a grossly excessive share of the initial premium in any event.” 586 F.3d 247 n. 15.

The Court further observed that, under New Jersey law, it “may take G-I’s sophistication into account in deciding what was objectively reasonable for it to expect from its insurers.” On this standard, the Court concluded that it was not material that Hartford provided claims administration under the Reliance policy. That is, “a reasonable insured with enough sophistication to employ a risk manager would know the difference between claims servicing and the assumption of liabilities.” Id.

The Court also rejected G-I’s argument that the interrelated wrongful act provision did not bar its claim for coverage. G-I contends that the provision should not apply because the purposes for which an insurer includes such a provision in an insurance policy had no application in this instance. G-I reasoned that the purposes of such a provision are (1) to ensure that the risks arising out of the same wrongful act are subject to one policy and therefore one policy limit, and (2) to prevent changes in policy language from one policy period to another from creating disparate coverage determination for the same wrongful act. Because the Hartford and the amended Reliance policy had a combined cap of $15 million, G-I argued that it could not recover more than $15 million in all claims combined for both policies.

The Court rejected this argument. “Even were we inclined to make application of the policy’s interrelation wrongful actions provision contingent on the purposes behind that provision—as opposed to applying the contract as written—we would still apply the provision.” In the Court’s view, one of the purposes of the provision had application in the case:

Such a provision not only allows insurers to cabin related wrongful acts to a single policy period (thus subject to one limit), it also, as one of the treatises that G-I itself points out, allows an insured (such as G-I) to obtain coverage under a new policy, despite facing additional liability exposure from its past acts, by preserving the argument that any future claims arising out of the interconnected wrongful acts of a previously submitted claim will be covered by the former policy.

The Court observed that G-I could well have paid a higher premium and shifted to Hartford all of the risk under the Reliance policy, but G-I had not done so. “Because it did not pay that higher price and Reliance became insolvent, G-I must seek coverage for risk it kept with Reliance in that company’s liquidation proceeding.”