Restate That Again?

Interests associated with the construction insurance industry are expressing concerns about the potential impact of the Restatement of the Law of Liability Insurance (RLLI), which was voted on and approved at the 2018 Annual Meeting of the American Law Institute (ALI).

Restatements are generally summaries of existing common law. However, the newest Restatement appears to go further, with some critics saying it amounts to an advocacy piece. Nevertheless, the ALI approved the Restatement over the objections of insurer and policyholder advocacy groups that had been raising concerns since the genesis of the project back in 2010, including whether the guidance is a proper interpretation of the common law. This will undoubtedly be tested as it relates to emerging construction claims. 

ALI is an independent organization that releases Restatements of the Law, Model Codes, and Principles of Law. Its self-imposed responsibility is “to promote the clarification and simplification of the law,” as stated in its Certificate of Incorporation. ALI’s Restatements are often taught in law schools and referenced in court cases due to their reputation for neutrality, and their helpfulness in summarizing and clarifying established common law.

But the RLLI deviates from the neutrality found in previous Restatements. This article will explore the history of the RLLI, some of its more controversial provisions, and the response that it has received.

History of the RLLI

The RLLI is the first Restatement in the area of insurance. In 2010, the RLLI began as a Principles of Law (Principles). Principles are primarily addressed to legislatures, administrative agencies, or private actors, and advocate for a specific interpretation of the law, or new laws altogether. Principles are opinion pieces released by the ALI to express what it feels the law should be.

But in 2014, halfway through drafting, the ALI announced that the Principles of Law, Insurance would be converted into the Restatement of the Law, Liability Insurance. ALI presumably failed to revise the already-completed work to reflect the change from an advocacy piece to a neutral restatement of the law. As a result, many provisions included in the final draft of the RLLI rely on minority law, dissent opinions, and even law review articles.

Following criticism, the RLLI’s release was pushed back a full year, from May 2017 to May 2018. Although marketed as a decision to allow for thoughtful consideration of the negative feedback, and although the final provisions contained some edits from their original form, the application and substance of the RLLI provisions do not differ in any significant way from the originals.

A Shift in Purpose?

During the RLLI’s incubation period, ALI appointed Richard Revesz as its new director, and the ALI Style Manual was revised to reflect the ALI’s position on adopting minority law. Following these changes, the ALI received criticism regarding the seemingly new objectives of the organization and how they would be reflected in Restatements. Revesz responded to this criticism, stating that the ALI has never had the mission of simply summarizing “undisputed legal rules.” Revesz claimed it is not accurate to say that the Restatements reflect ALI’s view on how the law “ought to be,” because even if a rule is overwhelmingly the minority, it still is the law somewhere, so in those jurisdictions it is an accurate reflection of established law. Revesz explained that, although the ALI has a history of generally restating majority rules in Restatements, it should not be “wed” to the majority rules when doing so would ignore “better rules or trends,” making the ALI a “roadblock to change.”

This new articulation of what Revesz claims has always been the position of the ALI reflects the ALI’s new reputation for law-reform activism. Although Revesz may claim that the ALI’s position has not changed, it is obvious that its application of its mission has shifted to align with a new goal.

Following are some of the more controversial provisions from the RLLI, which have been the subject of much controversy and debate.

Defense

The most controversial provision in the RLLI is Section 12, which holds insurers potentially liable for harm caused by appointed defense counsel, such as being held liable for negligent selection of counsel if appointed counsel commits malpractice. Earlier drafts of the provision created a “vicarious liability rule,” holding insurers vicariously liable for the professional obligation breaches of the appointed defense counsel.

In the final version of Section 12, the RLLI abandons the vicarious liability rule and instead considers two situations in which an insurer may be held directly liable for the conduct of appointed counsel. These obligations are imposed on insurers regardless of a reservation of rights letter that specifically addresses defense obligations.

First, the RLLI imposes tortuous liability (negligence) on an insurer if it fails to “reasonably” determine appointed counsel’s competency. The Comments explain that the duty to defend is breached when the insurer “fails to take reasonable care in selecting the attorney who will provide the insured with a defense. What constitutes ‘negligence’ is a fact-specific question that turns on the insurer’s efforts to ensure that the lawyer has adequate skill and experience in relation to the claim in question.” The Comments also state that if appointed counsel lacks “adequate” malpractice insurance, the insurer could be held liable.

The second situation in Section 12 would hold an insurer liable “for harm caused by the negligence of defense counsel if the insurer has acted to override the defense counsel’s independent professional judgment and directed defense counsel to act, or fail to act, in a manner that breached the professional standard of care and caused harm to the insured.”

The Comments show that the Reporters—the authors of the Restatements—justify this rule by analogizing the insurer-retained counsel relationship to an employer-employee relationship subject to agency laws such as vicarious liability and apparent authority. Although the RLLI restates established agency law, applying agency law to insurer-retained counsel relationship lacks any legal precedent. The Notes readily admit that “no cases were found holding a liability insurer liable for the torts of counsel on a theory of apparent authority.”

In Section 13, the RLLI articulates conditions under which the insurer must defend the insured. This section rejects the majority rule that the duty only extends to those allegations listed within either the complaint or the policy (four corners or eight corners rule), stating instead that “an insurer must resolve any factual uncertainty in favor of the duty to defend.” This rule allows the insured to introduce new information once the duty to defend has been established that the insurer may then have a duty to also defend.

The RLLI adopts another minority rule in Section 21, which creates a rule limiting an insurer’s recovery of defense costs. The rule holds that an insurer cannot recover defense costs even after the court determines that the insurer has no duty to defend. The rule goes on to state that a reservation of rights letter is insufficient to create a right to recovery.

The ALI claims that the rule derives from “emerging state court majority rule,” however the Comments state that “about half of the state courts that have considered this issue, and majority of federal courts making Erie predictions, have held to the contrary based on a theory of unjust enrichment.”

Settlement

Section 24 interprets an insurer’s “duty to settle” as a broad duty to make “reasonable settlement decisions” when there is potential for judgment in excess of the policy limit. The obligation to make “reasonable settlement decisions” is imposed when the “insurer has authority to settle a legal action brought against the insured, or the insurer’s prior consent is required for any settlement by the insured to be payable by the insurer.”

Because Section 24 may not be an accurate reflection of the black letter law, it has the potential to create a post hoc jury trial over every unsuccessful negotiation to determine what a “reasonable insurer” would have “reasonably done” under the circumstances.” A primary concern among insurance professionals is how Section 24 will be applied in light of a confidentiality rule in Section 11. An insured may use Section 11 to justify non-disclosure of information that the insurer would use to determine potential damages.

Section 25 attempts to address the issues in Section 24 created by Section 11 by adding that a reservation of rights does not relieve the insurer of its duty to make “reasonable settlement decisions,” and further authorizes an insured to settle a claim without the insurer’s consent “without violating the duty to cooperate.” The Comments concede this approach is “perhaps not yet the majority rule.”

Section 27 effectuates liabilities onto an insurer for breach of duty that extends to any foreseeable harm, such as excess judgment against the insured. An example of this would be if an unreasonable failure to settle resulted in a punitive damages award. Section 27 requires the insurer to indemnify the insured for judgments that are categorically uninsurable, such as punitive damages. This rule appears to be based solely off of two dissenting opinions and a legal-malpractice case from 1990.

Remedies

Section 49 of the RLLI provides that “an insurer is subject to liability to the insured for insurance bad faith when it fails to perform…without a reasonable basis for its conduct and with knowledge of its obligation to perform or in reckless disregard of whether it had an obligation to perform.” This rule invites a range of interpretations, and states that “an insurance company is not acting in bad faith when it employs a rigorous claims-handling process, but only when its actions evince a conscious or reckless disregard of a policyholder’s rights and deliberate choice to promote the insurance company’s interests at the policyholder’s expense.” These principles are based off of contract law in the “Restatement Second, Contracts,” and again applies law established in another area to insurers in a way that it has not been done before.

Public Reactions

Many legislative and judicial fronts have responded by taking measures to avoid any potential or actual reliance on the RLLI. These responses are necessary considering the differences in each state’s insurance law.

Even before the RLLI was released, Kentucky’s House of Representatives passed a resolution in March 2018 to “urge the [ALI] to materially change the proposed [RLLI], and if meaningful change is not made prior to the final approval of the Restatement, that the Restatement not be afforded recognition by courts as authoritative reference.” After the release of the RLLI, which did not meaningfully change, Kentucky’s House adopted a resolution to oppose the RLLI.

Ohio was the first state to entirely reject the RLLI. Ohio’s legislature amended the Ohio Revised Code of Insurance, R.C. 3901.82, to read: “The [RLLI] that was approved at the 2018 annual meeting of the [ALI] does not constitute the public policy of this state and is not an appropriate subject of notice.” North Dakota followed, adopting a similar bill rejecting the RLLI.

Tennessee’s response to the RLLI legislatively limits an insurer’s duty to defend to reflect the “four corners” rule (the duty only extends to the allegations included in the complaint). The state also amended its insurance statute to formally adopt the “plain meaning rule” of interpretation when dealing with policy language.

The ALI received a joint letter from the governors of South Carolina, Maine, Texas, Iowa, Nebraska, and Utah stating their concerns that the RLLI did not represent the insurance law in each state.

The insurance commissioners of Michigan, Idaho, and Illinois also wrote to the ALI expressing their concern that the RLLI does not accurately codify the law and could adversely impact the insurance system.

In reference to the RLLI, the Superior Court of Delaware held “the restatements are mere persuasive authority until adopted by a court; they never, by mere issuance, override controlling case law.” Catlin Specialty Ins. Co. v. CBL & Assocs. Props., 2018 Del. Super. LEXIS 342 at 8 (Super. Ct. Aug. 9, 2018).

Following the backlash by state governors, legislatures, insurance professionals, and attorneys, it is unclear who will apply the RLLI or how it will be referenced in accordance with established law. It is important for those working in the construction and insurance industries to be aware that the RLLI is unique, and, unlike other Restatements, it is a biased expression of viewpoints and cannot fairly be described as a neutral clarification of established law. This awareness is essential for the advocacy of state insurance law, and for parties adhering to the language in the policy.