Most states apply the rule of contra proferentem, resolving ambiguous policy language against the insurer and in favor of coverage. Insurers, after all, have control over their policy language and it is

their responsibility to ensure the language is clear. Some states require the use of extrinsic evidence before resolving ambiguous language in favor of the policyholder, and many consider the reasonable expectations of the parties in interpreting policy language.

Arizona courts have applied a variant of contra proferentem. They first view the language from the standpoint of the average layman untrained in insurance. If the language can be interpreted in more than one way, courts will attempt to determine its meaning by examining (1) the language of the provision, (2) the purpose of the transaction, and (3) public policy considerations. If after that analysis the provision language is still ambiguous, the courts will construe the language in favor of coverage.

Recently, however, the Superior Court of Arizona in Maricopa County lost its way in deciding to grant an insurer’s motion to dismiss.

In Certain Underwriters at Lloyd’s London v. Republic Services Inc., policyholder Republic claimed that its excess insurer, Lloyd’s, was obligated to reimburse it for the millions of dollars it had paid out over and above its underlying primary policy’s $25 million policy limit in remediation and defense costs related to air and groundwater pollution charges tied to a municipal solid waste landfill it owned in Missouri.

Republic’s primary insurer, Chubb, denied coverage on other grounds that Republic was in the process of disputing, and so had not paid under the primary policy. Lloyd’s argued that its coverage obligations had not been triggered because Republic—and not Chubb—had paid out the amounts.

The dispute between Lloyd’s and Republic arose from a provision in the Lloyd’s excess policy, which stated:

If by reason of the payment of any claims or losses or costs and expenses incurred in defense or settlement of such claims or losses by the insurers of the Underlying Policies, the amounts of the Underlying Policy Limits are:

A. Partially reduced, then this Policy shall continue to apply in excess of the reduced amounts of the amounts of the Underlying Policy Limits; or

B. Totally exhausted, then this Policy shall continue in force as primary insurance with respect to any subsequent claim…

Lloyd’s claimed that this provision was a condition precedent to coverage. Lloyd’s argued that the phrase, “by the insurers of the Underlying Policies,” modified the word “payment,” so that Lloyd’s obligation to pay a claim only arose when the underlying insurer paid out its portion of the claim. Lloyd’s also compared this provision to another policy provision that stated if the underlying insurer went bankrupt, the policyholder could pay out the underlying limits itself to reach the Lloyd’s excess coverage. According to Lloyd’s, similar language could have been used if the parties had meant for Republic to be able to pay the limits on its own where the primary insurer was still solvent, like Chubb was here.

In contrast, Republic claimed that this was a “drop down” provision that dealt with instances where the Lloyd’s policy would drop down to provide primary coverage when the underlying policy limits were partially reduced or when a subsequent claim arose after the underlying policy limits were exhausted. Neither was the case here, as Chubb, the underlying insurer, was refusing to pay altogether. Further, Republic argued that the phrase, “by the insurers of the Underlying Policies,” modified only the word “incurred,” which by definition meant “to become liable for.” Republic argued that Chubb had become liable for coverage, but was wrongfully denying it, thereby triggering the Lloyd’s policy limits.

The one thing the parties’ arguments made clear was that the policy provision in issue was not clear. In their briefing, both parties suggested that the court could find the language ambiguous. Republic argued that the provision should be interpreted in favor of the policyholder, while Lloyd’s claimed that the court should permit the parties to present extrinsic evidence.

The court did decide the provision was ambiguous, agreeing with both parties that the language was “not 100% clear.” There was, therefore, no plain meaning readily available. But the court didn’t decide to look to extrinsic evidence under the Arizona Supreme Court’s contra proferentem rule. The court conceded that the policy language was “not totally inconsistent with the Insureds’ interpretation”—yet this did not lead to a decision in favor of the policyholder.

Instead, the court veered off track, asserting that it had the task of deciding the “most reasonable interpretation.” Angling off the roadmap set by Arizona precedent, the court didn’t consider public policy implications or the purpose of the transaction between Republic and Lloyd’s. While turning briefly to the policy language, the court noted that both the disputed provision and the bankruptcy provision spoke in terms of payment of claims or losses by the insurer, to “suggest” that payment was the key element. However, the court appeared less than convinced that this was clearly the case.

In the end, the court simply concluded that the insurer’s interpretation made “more sense,” bypassing the controlling doctrines of insurance policy interpretation. Driven off the map, the policyholder was left without coverage, even while the disputed provision remained ambiguous.