Pop quiz: the law of which jurisdiction should govern a coverage dispute arising under D&O insurance policies issued by U.S-domiciled insurers to an NYSE company incorporated in Delaware with its headquarters in Oregon? If you find the answer "British Columbia" as surprising as I do, read on. The court decision discussed below could have important implications for the typical U.S. D&O policy, with its extension of "worldwide coverage," particularly as both commerce and litigation become increasingly global.

Background

Now-bankrupt forest products company Pope and Talbot, Inc. was incorporated in Delaware and had its corporate headquarters in Portland, Oregon. Until its bankruptcy, its shares traded on the NYSE. Pope and Talbot conducted business through several operating subsidiaries, the largest of which was P&T Ltd., a Canadian federally chartered company with its principal operations in British Columbia. The bulk of Pope and Talbot’s operations ran through P&T Ltd. and the bulk of Pope and Talbot’s employees were employed by P&T Ltd.

P&T Ltd. is now in receivership. PricewaterhouseCoopers is the receiver for P&T Ltd. PWC, in its role as receiver, has instituted an action in British Columbia seeking a judicial declaration of coverage under the parent company’s D&O insurance policies for claims against P&T Ltd.’s directors and officers brought by former P&T Ltd employees under the Canadian Business Corporations Act for unpaid wages.

Pope and Talbot’s D&O insurance program was structured in several layers, involving three U.S. domiciled insurers. The negotiation and placement of the policies took place in the United States.

In a prior ruling, British Columbia Supreme Court Justice Paul Walker determined that the British Columbia court had jurisdiction over PWC’s declaratory judgment action. The insurers then sought a declaration that Oregon law would govern the dispute.

The November 12 Opinion

In his November 12, 2009 decision (here), Justice Walker determined that British Columbia law is the proper law to be applied to the interpretation of the policy.

He began with the determination that the parties intended different laws to apply to different parts of the policy (a choice of law principle known as dépeçage). In reaching this conclusion, Justice Walker referenced several different parts of the policies at issue, including in particular the primary policy’s definition of "Loss," which contained a provision specifying that the policy’s coverage for punitive and exemplary damages would be determined under the law most favorable to the insured. Justice Walker also referenced the policy’s Oregon state amendatory endorsements, which specified that Oregon law would govern any disputes regarding alleged misrepresentations in the insurance application.

Justice Walker determined that given these clause-specific choice of law provisions, and given the absence from the policies of any general choice of law provisions, the "proper law" governing the disputes arising under other policy provisions "is left to be determined by the court hearing the dispute to find based on the application of its own laws, taking into account the directing language in the policies."

Reviewing these circumstances in this light, and discounting the policies’ various connection to jurisdictions in the United States, and applying British Columbia choice of law principles, Justice Walker concluded that "the policies have the closest and most substantial connection with BC," and therefore BC law governs the coverage dispute presented by the receiver.

In substantiating this decision, Justice Walker stated that given the importance of the Canadian subsidiary, "most of the claims could be expected to arise from Canadian operations," and he stressed that the P&T Ltd. employees’ wage claims are "unique to Canadian operations" and have "no equivalent in Oregon," as a result of which Justice Walker concluded that "the proper law of the policies to determine the carriers’ coverage obligations for these claims is BC law."

He added that the parties "would reasonably have expected BC law to apply to determine the insurers’ coverage obligations."

Discussion

Suffice it to say that I have concerns with Judge Walker’s analysis. He managed to blow right past the fact that all of the acts involved with the formation of the insurance contracts took place in the U.S. and that insurance contracts were formed between a U.S.-domiciled company and U.S.-domiciled insurers, and that the key risks insured against and for which the policy was purchased were U.S.-based.

Justice Walker simply jumps to the conclusion that given the size of the P&T Ltd’s operations, the insurance contracts were primarily designed to protect against Canadian exposures. However, the company that purchased the policy was the parent company, a U.S.-domiciled company whose shares traded on a U.S. securities exchange. Is there any possible doubt that the most important reason the company bought the policy – and the reason the policies cost so much in U.S. currency – is because the company and its directors and officers wanted protection against corporate litigation in U.S. courts under U.S. law?

Of course the policies do provide "worldwide coverage" and, yes, of course substantive local law governs the local claims wherever the claims might arise. But Justice Walker seems to have telescoped the primacy of local law regarding the underlying dispute into a determination that local law should govern questions of policy interpretation, which analytically are two completely different issues.

All of that said, there are a couple of points in Justice Walker’s analysis that do give me pause. In particular, the considerations on which he relied in concluding that principles of dépeçage control the choice of law issue are by no means far-fetched. His consideration of the "law of the most favorable venue" wording in the provisions relating to coverage for punitive and exemplary damages is interesting and raises issues I had not previously considered. He may have a point that this language could be interpreted to suggest that the parties intended the laws of different jurisdictions to apply to different parts of the policy.

Where his analysis goes off track, in my view, is having found that different jurisdictions’ laws may apply to different policy provisions, he concluded both that BC choice of law principles should determine which law should apply, and he applied these BC choice of law principles in a blunderbuss way to conclude that BC law governed interpretation of the policy (see, e.g., his assertion that the likeliest claims to arise under the policies were Canadian claims.)

But the most significant aspect of Justice Walker’s decision is the unmistakable message that if a policy provides "worldwide coverage," the policy not only applies to claims wherever they may arise, but courts in those far flung jurisdictions may push ahead and apply their own local laws to questions of coverage relating to the local claim.

In the increasingly global economy, many businesses have significant operating subsidiaries in many countries. And as the rest of the world become increasingly litigious, too, the possibility of claims arising in these multifarious jurisdictions is increasingly likely. But while the U.S. D&O insurance industry has long noted the increasing possibility of claims arising outside of the U.S., I suspect it may come as a big surprise to many U.S. D&O insurers that local will law will not only govern the local claim itself, but the local court could also determine that local law governs questions of policy coverage for the local claim.

I have no idea what the insurance coverage laws are in vast smorgasbord of countries outside the U.S. Who knows what a court in, say, Vietnam or Slovakia or Gabon might conclude about a U.S-issued D&O insurance policy’s coverage for a local claim? I doubt that many domestic U.S. D&O insurers do either, and I suspect they have little interest in finding out.

On that score, it should be noted that Justice Walker repeatedly recognized the right of the parties to choose the law that would govern the interpretation of the policies, and it was only the absence of any such a provision that allowed him to conclude that BC law should govern.

All of which suggests to me that we may have reached the point where, at least from the carriers’ perspective, it may be time to for U.S.-based D&O insurers to consider the inclusion of a general choice of law clause in their policy. The inclusion of a choice of law clause would have the advantage of predictability and certainty, and it would spare the parties from a post-claim surprise discovery that, for example, the parties reasonably expected that BC law would govern the interpretation of these policies. (I am sure it was news to these carriers to learn that they had "expected" the interpretation of these polices to be governed by the law of British Columbia.)

Given the increasingly global nature both of commerce and of litigation, the inclusion of a choice of law clause arguably could be the reasonable next step in the evolution of the U.S. D&O insurance policy. Many international contracts in many contexts (including the insurance and reinsurance context) as a matter of course specify which jurisdiction’s law should govern the interpretation of the contract. Indeed, the typical D&O policy, with its "worldwide coverage" provision, really is itself an international contract, and to that extent it may be anomalous that U.S. D&O policies often do not have choice of law provisions.

Of course, were general choice of law clauses to be included in D&O insurance policies, the clauses would have to be carefully coordinated with other policy provisions, including in particular the most favorable venue wording relating to coverage for punitive and exemplary damages.

I recognize that both my analysis of Justice Walker’s opinion and my suggestions about the inclusion of choice of law language in U.S. D&O insurance policies could be controversial. I can well imagine D&O professionals who advocate for policyholders arguing that the local law ought to govern policy coverage issues. I can also imagine some insurance professionals objecting that whatever benefit a choice of law clause might produce in the international context, it might produce some unexpected and even unwanted results in the domestic context.

I am very interested in readers’ views, particularly those who may have a perspective different than mine regarding Justice Walker’s opinion and also with respect to my suggestions about choice of law provisions.

Very special thanks to loyal D&O Diary reader Raymond Sieh, whom I just met for the first time at last week’s PLUS International Conference, for providing me with a copy of the opinion.