In AIU Insurance Co. v. TIG Insurance Co., No. 07-7052, 2013 US Dist. LEXIS 41716 (S.D.N.Y. Mar. 25, 2013), the US District Court for the Southern District of New York held that a reinsurer could deny coverage to its cedant because the cedant had, as a matter of law, failed to give prompt notice of the claims against it and Illinois law—which takes the minority view that a reinsurer need not show prejudice under such circumstances—governed.
The cedant, AIU, had purchased certificates of facultative reinsurance (“CFRs”) from reinsurer TIG, providing that “[p]rompt notice shall be given to the Reinsurer [TIG] by the Company [AIU] of any occurrence or accident which appears likely to involve this reinsurance.” The CFRs did not contain a choice-of-law provision. In a letter dated October 28, 2003, attorneys representing a manufacturing company that AIU insured demanded $20 million for asbestos-related personal injury claims. AIU settled with the manufacturing company in June 2006, but did not notify TIG of the claims or settlement until January 2007, when AIU stated that it would begin billing TIG for the claims. When TIG refused to pay the reinsurance claims on the ground of late notice, AIU sued for breach of contract and declaratory judgment regarding TIG’s liability. At the summary judgment stage, the key issue was whether the court should apply New York’s majority rule that a reinsurer must show prejudice in addition to late notice in order to avoid coverage, or whether Illinois’ minority rule that late notice is sufficient should apply.
Beginning with New York’s “grouping of contacts” or “center of gravity” approach to choice-of-law questions, the court noted the general rule that “[t]he relevant contacts a court should consider principally include ‘the place of contracting, negotiation[,] and performance; the location of the subject matter of the contract; and the domicile of the contracting parties.’” It clarified that “in the specific context of reinsurance disputes,” however, “‘the state where the reinsurance certificate issued and the location where performance is expected, i.e. the place to which the ceding insurer must make its demand for payment, typically control for purposes of choice of law.’”
The place of contracting (i.e., the place “where the last act necessary to make [the agreement] binding takes place”) was Illinois, because the CFRs stated that their issuance was conditioned on a countersignature by the reinsurer, which took place in Illinois. The place of performance was likewise Illinois, because, even though the CFRs themselves were silent or at least vague and ambiguous on this point, there was extrinsic evidence of actual performance: the cedant’s sending of prior claims to the reinsurer’s intermediary in Illinois. The negotiations took place in both states, thus rendering this factor inconsequential, while the location of the contract’s subject matter was essentially irrelevant given that “generally a reinsurer has little actual role to play in any dispute involving the underlying insurance policies.” While the fifth factor could point away from Illinois law, as the reinsurer’s officers directed the company from outside Illinois, the court concluded that this factor did not outweigh the others. Illinois law therefore applied.
Turning to the substance of Illinois law, the court noted that no Illinois appellate authority existed on this issue. The Seventh Circuit had predicted Illinois law seventy years earlier, however, not to require prejudice in addition to late notice in the reinsurance context. Reluctantly finding itself bound by a 1981 Second Circuit decision holding that federal courts applying the law of a state outside their territorial jurisdiction must generally defer to a federal court of appeals’ prediction of the law of a state within its territorial jurisdiction, the court concluded that the Seventh Circuit’s prediction had not been displaced by subsequent developments in Illinois law. While recognizing that the “emerging majority of jurisdictions require the reinsurer to prove not only that it received late notice of the ceding insurer’s claim, but also that the reinsurer suffered prejudice as a result of the notice being late,” the court explained that whether Illinois would be in the minority is irrelevant. The Illinois Supreme Court had recently overruled intermediate appellate decisions in the direct insurance context that required proof of prejudice. Thus, there was nothing to show that Illinois law would be different in the reinsurance context today.
Finally, the court concluded that, as a matter of law, the cedant’s delay of three years was “well outside the bounds of reasonable notice.” It reasoned that the cedant was a sophisticated company, was aware of the fact that triggered the CFRs’ notice provision (i.e., the demand letter), and was aware that coverage under the CFRs was available because it had paid other claims under the CFRs. Thus, even assuming the reinsurer did not suffer prejudice from the delay, the reinsurer could refuse coverage and summary judgment for the reinsurer was appropriate.
This decision reaffirms the importance of choice-of-law clauses in reinsurance agreements that provide for resolution in courts of law. While the parties may not be able to predict a jurisdiction’s substantive law pertaining to every issue that may arise over the course of a lengthy reinsurance relationship—indeed, the court noted that at the time of contracting the parties could not have reasonably anticipated that New York would require prejudice, given the state of the case law at that time—such clauses may reduce the uncertainty.