A standard feature of virtually every commercial contract is a choice-of-law clause. The general perception is that these types of clauses help facilitate settlement and reduce litigation costs. There is, however, one type of contract the usually omits choice-of law-clauses – insurance policies. Throughout the insurance industry and across most lines of coverage, insurance policies lack choice of law clauses. The reasons why insurance policies omit provisions that are standard for virtually every other type of commercial contract is the subject of an interesting new paper from University of North Carolina Law Professor John F. Coyle, entitled “The Mystery of the Missing Choice-of-Law Clause.” Coyle’s paper raises a number of interesting questions, some of which may be relevant as some insurers consider the question of whether they many need to add choice of law clauses to their policies. A copy of Professor Coyle’s December 2, 2021 paper can be found here.
Professor Coyle begins his paper with a statistical overview mean to substantiate a couple of basic points – first, that choice of law clauses are ubiquitous in commercial contracts generally, and, second, that, by contrast to other commercial contracts, insurance policies usually omit the clauses. Given the widely recognized advantages associated with choice of law clauses, Coyle can only describe the absence of choice of law clauses in insurance policies as “weird.”
In order to try to understand the reasons for the absence of choice of law clauses in insurance policies, Professor Coyle interviewed a wide range of insurance professionals, practitioners, and regulators. Through this process, he identified several factors that may be contributing to the omission of the clauses. In reviewing his findings, Professor Coyle divided his analysis between insurance sectors where policy forms are standardized, and sectors where the policies are more highly negotiated, and often issued as “manuscript” policies.
With respect to the standard policies, Coyle first identifies a number of regulatory and legislative restrictions that constrain insurers from designating governing law that insurers believe is more favorable. For starters, thirteen states have passed laws that specifically invalidate choice of law clauses in insurance contracts that select the law of another state. Eight states have passed laws stating that insurance contracts generally shall be governed by the laws of the enacting state without specifically referencing choice of law clauses. So clearly one of the reasons many insurance policies do not have choice of law clauses is that state legislators and regulators discourage them.
A second reason why insurance policies may not have choice of law policies has to do with developed legal principles of contract interpretation. Coyle quotes the Second Restatement of Conflict of Laws to the effect that choice of law clauses are disfavored in insurance contracts where the chosen law provides less protection to the insured. Courts in some jurisdictions have declined to enforce choice of law clauses where the courts believe to enforce them would violate a “fundamental policy” of the jurisdiction. These cases, Coyle observes, suggest that choice of law clauses in insurance policies may be subjected to greater scrutiny than similar clauses in other types of contracts.
A third reason why many standardized insurance policy forms omit choice of law clauses has to do with the fact that many policies are based on Insurance Services Organization policy forms. The ISO policy library contains over 10,000 policy forms, and “virtually none of these forms contain choice-of-law clauses.”
In considering why the ISO forms omit choice-of-law clauses, Coyle considers a fourth possibility explaining why insurance contracts omit the clauses, and that is that it may be a strategic choice. The silence gives the insurer two potential advantages in the event of a coverage dispute. The absence of a choice-of-law clause increases litigation costs, which are easier for the insurer to bear, and the lack of a choice-of-law clause gives the insurer the flexibility to shop for law by strategically filing a lawsuit in a jurisdiction in which the insurer believes the law is more favorable. Coyle also refers to statements made to him in the course of his research by policyholder-side advocates who also prefer the flexibility that the absence of choice-of-law clauses gives them to try to argue that a more favorable law applies.
Coyle also considers a fifth possibility, which is that lack of a choice-of-law clause in insurance policies may simply be due to inertia and inattention. In considering this possibility, Coyle reviews what he calls “stickiness” in contract wording; certain words and phrases become standardized over time, and tend to get reused in subsequent contracts. Coyle speculates that just as there is a “stickiness” to contract wordings, there may be a stickiness to contract omissions as well.
After having reviewed the possible reasons for the absence of choice-of-law clauses in standardized insurance policies, Coyle then reviews the reasons for the absence of choice-of-law clauses in manuscript forms.
The first problem is that there “does not seem to be any jurisdiction in the United States whose law is viewed as neutral when it comes to insurance law.” Insurers might prefer New York law to apply, and policyholders might prefer the law of Delaware, but “if there can be no agreement on a neutral jurisdiction, and if neither party has the leverage to force its preferred choice on the other, then the logical thing to do is to omit the clause altogether.”
Another reason why insurers may not have tried to insert choice-of-law clauses into manuscript insurance policies may have to do with what Coyle called “first mover disadvantage.” That is, in a competitive insurance environment, if an insurance buyer has multiple alternatives but only one alternative with a choice-of-law clause, the buyer may select away from the alternative with the choice-of-law clause.
After reviewing the various reasons why most insurance policies do not have choice-of-law clauses, Coyle then reviews the few specialized areas of the insurance arena where choice-of-law clauses are in fact standard. For example, choice of law clauses are standard in Reps and Warranties insurance policies. From his interviews with insurance practitioners, Coyle found that not only are these policies highly manuscripted, but the negotiations on the buyers’ behalf often are conducted by M&A lawyers, rather than insurance lawyers, and the M&A lawyers live in a world where choice-of-law provisions are not only standard but viewed as mandatory. Coyle also notes that the absence of case law interpreting this relatively new type of policy militates in favor of trying to introduce some elements of certainty that would kick in if there were to be a dispute.
In reviewing the reasons that possibly explain the absence of choice-of-law clauses in insurance policies, Coyle suggests that insurers seeking advantages in possible insurance coverage disputes may want to consider adopting a variable approach to choice-of-law clauses – for example, adopting choice of law clauses designating the law of the policyholder’s domicile in policies issued in states where the law is perceived to be advantageous to the insurer.
Discussion
My own experience litigating insurance coverage disputes convinces me that choice-of-law disputes can be time-consuming, expensive, and vexing. Moreover, it is not at all uncommon for choice-of-law disputes to result in a determination that the policy is governed by law that is both unexpected and undesirable. From time to time, the choice-of-law decision can be outcome determinative. Given all these factors, it really is kind of a mystery, as Coyle notes, why insurance policies don’t have choice-of-law provisions.
Coyle’s analysis of the reasons for the omission of choice-of-law clauses is interesting and useful. For example, I was unaware (except in a general, uninformed way) of the various regulations and statutes constraining insurers with respect to the use of choice-of-law clauses.
I will say that Coyle’s paper is timely. As it happens, there is a general conversation going on in the D&O insurance industry about whether or not it is time for D&O insurance policies to incorporate choice-of-law (and choice-of-forum) provisions.
The trigger for this conversation, at least on the insurers’ part, is a perception that policyholder are turning to Delaware’s court and Delaware’s laws to address coverage disputes, and that Delaware’s courts are proving all too willing to take on cases that insurers believe should be in the courts of other jurisdictions, and also overwhelmingly likely to rule in the policyholder’s favor and against the insurer. Frankly, it should come as no surprise to anyone that insurers have just about had it with getting dragged into Delaware and getting handed yet another policyholder-friendly ruling.
Insurers wanting to try to stay out of Delaware’s courts might want to try to insert a choice-of-law clause designating the law of a jurisdiction they consider more favorable –say, the law of New York. There are at least two problems with this approach that I can see. The first that a choice-of-law clause alone may not be sufficient to avoid the Delaware problem. The policyholder could still file a declaratory judgment action in Delaware and seek to have the Delaware court refuse to enforce the choice of law provision. The avoiding-Delaware goal will only work if the policy includes both choice-of-law and choice-of-forum provisions, designating both the law and courts of a jurisdiction other than Delaware.
There is another problem for insurers that want to try to designate the law of a jurisdiction they consider more favorable. And that is that there are the various state laws to which Coyle refers in his paper in which the state legislatures have prohibited insurers from designating the law of another state as the governing law.
However, these laws would permit insurers to designate the law of the policyholder’s home state as the governing law. So insurers thinking about how to avoid having to wind up in Delaware courts litigating coverage under Delaware law might want consider inserting choice-of-law and choice-of-forum provisions designating the policyholder’s state as the forum and law governing the policy. This could easily be achieved by a provision stating that the policy is to be governed by the law of the states designated in Item 1 of the Declarations page and any disputes regarding coverage are to be determined by the courts of the state identified in the Declarations page (or in a federal court located in the state identified in Item 1). This type of approach wouldn’t necessarily get a dispute decided under insurer-friendly laws, but it would at least avoid litigating the dispute in Delaware’s courts and under Delaware’s laws.
Any insurer considering this type of approach would face one further problem. And that is what Coyle called the “first mover disadvantage.” In a marketplace where there is still a lot of competition, any insurer that “went first” so to speak with trying to insert choice-of-law or choice-of-forum provisions would be strongly selected against – and for good reason. Policyholders want to be able to preserve the possibility of litigating any coverage disputes in Delaware, and any insurer that tried to modify the policy to take that option away would be selected against in a competitive marketplace.
All of that said, choice-of-law issues are surprisingly important. While it isn’t clear at all how insurers might best try to address these issues, I suspect this seemingly obscure topic winds up as a major source of focus and attention in coming months and years. If nothing else, Delaware’s courts are pretty much forcing this issue onto the agenda.
Special thanks to a loyal reader for sending me a link to Professor Coyle’s paper.