Questions involving “choice of law” for insurance coverage issues frequently are overlooked when a new claim or lawsuit is filed. Failing to include choice of law analysis in your toolbox can result in the payment of claims that would not be covered, overpayment, or, more significantly, defending your claims handling procedures from accusations of bad faith or unfair claims handling practices based on the law of the state that had nothing to do with the underlying claim. For our purposes here, let’s focus on choice of law for coverage determinations versus choice of law for an underlying tort against an insured.
An insurance policy is a contract between the insurance company and its insured, so it should be subject to contract law when deciding whether an insurance policy covers a claim. That there can be several sources of information that must be considered complicates choice of law questions. There is no uniformity among the states regarding common law choice of law analysis, and certain policies may also include choice of law language that dictates which jurisdiction’s substantive law is to be applied to any policy dispute or interpretation.
Lex loci contractus, lex loci delicti, and lex fori are the three rules traditionally relied on to resolve choice of law issues. Under lex loci contractus, the substantive law of the state where the contract was made governs the validity, nature construction, and interpretation of a contract—except instances where the contract is made in one state and is to be performed in another state (lex loci solutionis)—the substantive law of the state where the contract is to be performed applies. Under the rule of lex loci delicti, tort cases are governed by the substantive law of the state where the tort was committed. Finally, the rule of lex fori holds that procedural or remedial questions are governed by the law of the forum—the state in which the action is brought. Nevertheless, most jurisdictions will not apply the substantive law of the jurisdiction where the contract was executed if it is contrary to the forum state’s public policy. Most jurisdictions have statutory choice of law rules. Additionally, the Restatement (Second) of Conflicts of Law § 188, Law Governing in Absence of Effective Choice by the Parties, provides that “[I]n the absence of an effective choice of law by the parties (see § 187), the contact to be taken into account in applying the principles of § 6 to determine the law applicable to an issue include” a list of contacts that “are to be evaluated according to their relative important with respect to the particular issue.”
Lex loci contractus was the traditional approach for resolving choice of law issues in contract cases, but is now considered a minority approach. Most jurisdictions now use the “significant relationship” test that applies the law of the state with the most significant relationship to the dispute. This approach is set forth in the Restatement (Second) of the Conflict of Laws § 193, which provides that the governing law is “the local law of the state which the parties understood was to be the principal location of the insured risk during the term of the policy, unless with respect to some issue, some other state has a more significant relationship under the principles stated in § 6 to the transaction and the parties.”
Applying these principles is straightforward in most insurance claims. Most claims occur in the same jurisdiction where the insured resides or has its principal place of business. In that situation, the substantive law to be applied to a coverage dispute would likely be the same regardless of whether the choice of law issue is resolved through the doctrine of lex loci contractus or the significant relationship test. A more challenging analysis, however, arises when the insured is involved in some act or omission that occurs in a jurisdiction other than the one where the insured resides or has its principal place of business. By themselves, these facts are not problematic unless the jurisdiction where the event occurred has different standards that apply to insurance coverage.
For example, in Crossman Cmtys. of N.C. v. Harleysville Mut. Ins. Co., the Supreme Court of South Carolina held that construction defect claims are subject to a continuous trigger of coverage that increases the number of insurance policies that potentially will provide coverage for a loss. In contrast, in Gaston County Dyeing Machine Co. v. Northfield Ins. Co., the North Carolina Supreme Court rejected a “continuous trigger” and instead applied an injury-in-fact analysis for insurance coverage. North Carolina also applies the doctrine of lex loci contractus to issues of insurance contract interpretations, while South Carolina applies a statutorily created exception to the lex loci contractus standard that applies to insurance policies. An insurance company that has issued a commercial general liability policy to a contractor located in North Carolina may be surprised to discover that years of coverage are triggered for an event in South Carolina, while a similar event occurring in North Carolina might only trigger one year of coverage. Whether or not the insurer can avail itself of North Carolina or South Carolina law when interpreting the insurance policy may be determined by where the insurance coverage litigation is initiated.
Choice of law issues are not limited solely to questions of policy interpretation, but may also involve questions of unfair claims settlement actions or extracontractual claims for bad faith. For example, in Martin v. Gray, the Supreme Court of Oklahoma was asked to determine whether Kansas law or Oklahoma law applied to a claim for bad faith arising from an insurer’s failure to pay uninsured motorist coverage. In overruling the trial court’s holding that a bad faith claim arose out of an insurance contract, the Supreme Court of Oklahoma found that a claimed violation of an insurer’s implied-in-law duty of good faith presented an independent tort that required application of the law of the state with the most significant relationship to the alleged violation. The court then noted that the actions by the insurer related to the bad faith claim appear to have occurred primarily in Oklahoma and Pennsylvania.
Under the examples that have been discussed, it is important for claims professionals to give consideration to choice of law issues in making coverage decisions. Making a determination early in the consideration of a case can be a critical component of any accurate, and hopefully early, resolution of a claim. Similarly, questions involving tort claims (possibly including bad faith claims) would need to be considered under the law of the state with the most significant relationships to the alleged violations.
Choice of law issues can have a significant impact on certain claims, and it is important to carefully consider these issues early in the claims process in order to understand the actual exposure facing the insured and the insurer for any particular loss.