The Insurance Company of the State of Pennsylvania v. Argonaut Insurance Company

Filing 45

OPINION AND ORDER re: 19 MOTION for Partial Summary Judgment. filed by The Insurance Company of the State of Pennsylvania, 24 MOTION for Summary Judgment. filed by Argonaut Insurance Company. (Signed by Judge Denise L. Cote on 8/6/2013) (djc)

UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
---------------------------------------X
:
THE INSURANCE COMPANY OF THE STATE OF :
PENNSYLVANIA,
:
Plaintiff,
:
:
-v:
:
ARGONAUT INSURANCE COMPANY,
:
:
Defendant.
:
:
---------------------------------------X
Plaintiff:

12 Civ. 6494 (DLC)
OPINION AND ORDER

Andrew S. Amer
Rae C. Adams
Simpson Thacher & Bartlett LLP
425 Lexington Avenue
New York, New York 10017
Defendant:
Sean Thomas Keely
Benjamin J.O. Lewis
Pooja Boisture
Hogan Lovells U.S. LLP
875 Third Avenue
New York, New York 10022
DENISE COTE, District Judge:
In this non-jury action, the plaintiff Insurance Company of
the State of Pennsylvania (“ICSOP”) sues to enforce the terms of
a reinsurance contract against defendant Argonaut Insurance
Company (“Argonaut”).

In the reinsurance contract, Argonaut

agreed to reinsure ICSOP for a portion of an excess insurance
policy ICSOP had issued to Kaiser Cement Corporation (“Kaiser”).
Following discovery limited to Argonaut’s affirmative defense of

1

late notice, the parties cross-moved for summary judgment on this
defense.
For the following reasons, Argonaut’s motion is granted in
part.

This Opinion identifies California law as the law which

will govern this defense.

There is no material issue of fact

which precludes a finding that ICSOP breached its contractual
obligation to provide timely notice to Argonaut.

The obligation

to provide notice arose no later than 2002, but ICSOP did not
provide notice until 2009.

A trial will be held to determine

whether Argonaut can demonstrate that it suffered actual and
substantial prejudice from the breach, and whether ICSOP’s gross
negligence or bad faith excuses Argonaut from demonstrating
prejudice.

BACKGROUND
The following facts are undisputed unless otherwise noted.
Many years prior to the instant litigation, nonparty Kaiser
manufactured products containing asbestos.

From 1953 through

1987, Kaiser purchased primary, umbrella, and excess insurance
policy coverage from a number of insurance companies.
Primary Insurance Policy
Kaiser acquired comprehensive general liability insurance
from Truck Insurance Exchange (“Truck” or “Primary Insurer”)
through a primary insurance policy that commenced on January 1,

2

1974 (the “Truck Policy”).
through January 1, 1977.

The Truck Policy provided coverage
It limited Kaiser’s recovery to

$500,000 per “occurrence” but contained no aggregate limit on the
sums Truck could be required to pay for multiple occurrences
during the policy period.
Excess Insurance Policy
Kaiser also acquired excess umbrella insurance from ICSOP
(“1974 ICSOP Policy”), a Pennsylvania insurance company with its
principal place of business in New York City, for the same policy
period as the Truck Policy.

The 1974 ICSOP Policy provided so-

called “umbrella” coverage above the $500,000 Truck primary limit
up to a limit of $5,000,000 per occurrence.

Like the Truck

Policy, however, the 1974 ICSOP Policy contained no aggregate
limit.

The 1974 ICSOP Policy was not the only insurance policy

issued to Kaiser by an AIG member company.

In total, AIG member

companies issued over a dozen insurance policies to Kaiser.

For

the most part, the other policies contained annual aggregate
limits.
Reinsurance Policy
The 1974 ICSOP Policy was issued to Kaiser by ICSOP’s
underwriting manager -- another AIG company -- C.V. Starr & Co.
(“C.V. Starr”) out of its California office.

Thereafter, C.V.

Starr, on behalf of ICSOP, requested facultative reinsurance from
Argonaut, an Illinois insurance company with its principal place

3

of business in San Antonio, Texas, for the 1974 ICSOP Policy. 1
In response to C.V. Starr’s request, Argonaut issued a
facultative certificate (the “Facultative Certificate”) in which
Argonaut agreed to reinsure 20% of the 1974 ICSOP Policy’s
$5,000,000 limit -- or, in other words -- $1,000,000 per
occurrence.

The policy was issued from Argonaut’s then-home

office in Menlo Park, California.

It was subsequently delivered

through the California office of AIG’s reinsurance broker Guy
Carpenter to C.V. Starr’s California Office.

In exchange for

agreeing to reinsure 20% of the 1974 ICSOP Policy, Argonaut
received a proportionate share of the premium paid on that
policy.
Under the Facultative Certificate, Argonaut’s liability
“follow[s] that of [ICSOP]” and “upon receipt of a definite
statement of loss” from ICSOP, Argonaut is instructed to
“promptly pay its proportion of such loss.”

Like many

reinsurance contracts, the Facultative Certificate requires ICSOP
to give prompt notice to Argonaut that its reinsurance

1

Facultative reinsurance is one of two principle types of
reinsurance. Reinsurance enables one insurer -- called the
ceding insurer or reinsured -- to cede “all or part of the risk
it underwrites” to another insurance company. Unigard Sec. Ins.
v. North River Ins. Co., 4 F.3d 1049, 1053 (2d Cir. 1993)
(“Unigard II”). It is colloquially referred to as insurance for
insurance companies. Facultative reinsurance allows the
reinsured to cede risk on a specific insurance policy that is
identified in the reinsurance agreement. The other principal
type of reinsurance is treaty reinsurance, through which the
reinsured cedes risk on identified classes of the reinsured’s
policies.
4

obligations may be triggered:
[ICSOP] shall notify [Argonaut] promptly of any
occurrence which in the Company’s estimate of the value
of injuries or damages sought, without regard to
liability, might result in judgment in an amount
sufficient to involve this certificate of reinsurance.
[ICSOP] shall also notify [Argonaut] promptly of any
occurrence in respect of which [ICSOP] has created a
loss reserve equal to or greater than fifty (50)
percent of [ICSOP’s] retention specified in Item 3 of
the Declarations; or, if this reinsurance applies on a
contributing excess basis, when notice of claim is
received by the Company.
The Facultative Certificate applies on a “contributing
excess” basis, which means that Argonaut’s liability “applies
proportionately to all loss within” the policy’s limit. 2

The

Certificate also granted Argonaut the “right to associate” in the
defense and control of any claim, suit or proceeding involving
the Facultative Certificate:
While the Reinsurer does not undertake to investigate
or defend claims or suits, it shall nevertheless have
the right and shall be given the opportunity, with the
full cooperation of the Company, to associate counsel
at its own expense and to join with the Company and its
representatives in the defense and control of any
claim, suit or proceeding involving this certificate of
reinsurance.
1980-1996: Kaiser Asbestos Litigation
As the deleterious effects of asbestos came to light in the
1980s, Kaiser began to face thousands of lawsuits alleging bodily
injury and property damage caused by its asbestos-laden products.
Truck, as one of four of Kaiser’s primary insurers, initially

2

In contrast, excess of loss reinsurance covers losses exceeding
a specified amount.
5

handled many of the asbestos claims asserted against Kaiser.

In

1988, Kaiser, Truck, and other insurance carriers attended a
meeting to discuss the possibility of a cost-sharing arrangement.
Alicia Arencibia (“Arencibia”), an AIG employee, attended the
meeting on behalf of National Union Fire, one of Kaiser’s primary
insurers.

Following the meeting, Arencibia wrote an internal

memorandum, dated August 8, 1988, which stated that “[f]or those
AIG Companies with excess coverage (see attached list) my
recommendations are that files be created and reservation of
rights be sent out immediately.”

The 1974 ICSOP Policy was among

the policies contained in the list attached to the memorandum.
The following year, in an internal memorandum dated March
28, 1989, Bart Tesoriero, a claims office employee of C.V. Starr,
stated that he had reviewed “the various files for Kaiser Cement
& Gypsum,” and noted that “no reinsurance notifications [had]
been sent by this office.”

He further stated that “[m]y

preliminary evaluations would be that in those periods where we
are excess of $500,000 in underlying coverage we may face a very
real possibility of some impairment.”

Tesoriero attached a list

of “open asbestos claims as of March 29, 1989.”

The list

included a claim number for the 1974 ICSOP Policy.

Several years

later, in 1991, the Toxic Tort Department of AIG sent a “Key
Account Summary” of Kaiser claims to AIG management, which stated
that “AIG related companies have been put on notice for excess

6

coverage.”

Despite these documents from the period between 1988

to 1991 which indicate an awareness by C.V. Starr and components
of AIG that excess coverage would be affected by asbestos claims
against Kaiser, no steps were taken to give notice to Argonaut.
In 1996, AIG created a master claim file for claims against
the 1974 ICSOP Policy.

The master case file was assigned case

number 170-016800 and the physical file with this case number
contained a copy of the 1974 ICSOP Policy and a confirmation from
C.V. Starr reflecting details of the reinsurance coverage
provided under Argonaut’s Facultative Certificate. 3

ICSOP

explains that the opening of a claim file is triggered by the
receipt of “notice” under a policy.

In the present context, this

means that, as of 1996, AIG had received notice under the 1974
ICSOP Policy. 4

AIG did not provide notice to Argonaut at this

3

From the 1980’s to the present, ICSOP has used automated
systems for providing notice to reinsurers. Because the 1974
ICSOP Policy was issued before ICSOP adopted an automated system,
the reinsurance agreement was originally recorded on a layoff
sheet -- which ordinarily lists all of the applicable reinsurance
for the underlying policy. At some point, ICSOP explains, the
layoff sheet would have been coded into the automated system.
Evidently, the Facultative Certificate was not coded into the
automated system. ICSOP further explains that, had the
Facultative Certificate been coded into the automated system,
notice would have been generated as soon as a claim file was
opened.
4

Receipt of notice under a policy, ICSOP further explains, is
distinct from receipt of “notice of a claim” tendered under the
policy. The 1974 ICSOP Policy required Kaiser to give notice of
an occurrence to ICSOP as follows: “Whenever the Insurance
Manager or a representative of the Insurance Department of the
Insured has information from which it may be reasonably concluded
that an occurrence covered hereunder involves injuries or
7

time that it had received notice under a policy.
2001-2009: California Coverage Action
In 2001, Truck notified ICSOP and other excess carriers that
its primary limits were exhausted.

At this time, ICSOP did not

notify Argonaut of the potential impairment of the Facultative
Certificate.

Truck proceeded to initiate a declaratory judgment

action against Kaiser in California state court in order to
establish that it owed no further obligation to provide coverage
for Kaiser’s asbestos claims under its primary policies
(“California Coverage Action”).

In February 2002, Truck’s

counsel informed AIG that its excess policies would “definitely
be brought into” the Coverage Action between Truck and Kaiser.
Two months later, on April 8, 2002, Kaiser filed a crosscomplaint against ICSOP and other excess insurers.

ICSOP and

other AIG member companies were represented in the Coverage
Action by the firm of Lynberg & Watkins.

In August 2002, an AIG

claims handler designated a new “master” claim file for claims
against the 1974 ICSOP Policy.

Following these events, ICSOP

still did not send notice to Argonaut under the Facultative
Certificate.
In 2004, Truck filed a motion for summary judgment that
sought, among other things, a declaration that the asbestos
claims asserted against Kaiser constituted a “single occurrence.”

damages, which, in the event that the Insured shall be liable, is
likely to involve this policy, notice shall be sent to C.V. Starr
8

Because the 1974 Truck Policy had occurrence limits, but no
aggregate limits, a finding that the asbestos claims constituted
a single occurrence would dramatically reduce the amount Truck
would have to pay on Kaiser’s claims before its limits were
exhausted.

The London Market Insurers, other providers of excess

coverage, opposed Truck’s motion and argued that each asbestos
bodily injury claim constituted a separate occurrence.

For its

part, Kaiser made submissions to the court that agreed with
Truck’s position that the asbestos claims constituted a single
occurrence, but argued, in the alternative, that the number of
occurrences should be limited to two or three occurrences.
Counsel for the AIG member companies, including ICSOP,
decided to take no position on Truck’s motion.

The rationale

behind the decision was explained as follows:
The AIG Member Companies took no position on Truck’s
Motion, as there are inherent conflicts between the
umbrella and excess coverage issued by these Companies
to Kaiser. Specifically, while most of the excess
policies issued by the AIG Member Companies would
benefit from a multiple occurrence finding, i.e., by
prolonged exhaustion of the primary coverage, the first
layer umbrella policies issued by Insurance Company of
the State of Pennsylvania (“ICSOP”), which have no
aggregate limits, would face increased exposure from a
multiple occurrence finding.
(emphasis in original).

AIG’s counsel recognized that “[s]hort

of a number of occurrences ruling that obligates Truck to fund a
significant portion of the [asbestos bodily injury claims], a one
occurrence ruling appears to be the most beneficial to ICSOP in
& Company . . . as soon as practicable.”
9

terms of limits and prolonged exposure for the [asbestos bodily
injury claims].”
In 2005, the California trial court issued an Opinion
denying Truck’s motion for summary judgment.

In the Opinion, the

court adopted the “underlying cause test” as the method for
determining the number of occurrences represented by the asbestos
claims asserted against Kaiser.

While the court concluded that

disputed issues of fact precluded a determination of exact number
of occurrences, it also ruled as a matter of law that the
asbestos claims did not constitute a single occurrence.
In 2006, the trial court decided to reconsider its 2005
ruling and called for supplemental briefing.

This time AIG’s

counsel submitted a brief urging the trial court to deny Truck’s
motion for summary judgment on the basis that disputed issues of
material fact precluded summary adjudication.

AIG’s submission

did not take a position on the number of occurrences presented by
the Kaiser asbestos claims.

On January 10, 2006, the trial court

reversed its 2005 ruling and concluded that Truck and Kaiser
intended to treat all asbestos bodily injury claims as a single
occurrence under the Truck policies.

Its conclusion was based,

in part, on a determination that Kaiser’s design, manufacture,
and distribution of asbestos products constituted the single
underlying cause of the asbestos bodily injury claims.

In August

2006, AIG increased its indemnity reserve on the master file for

10

the 1974 ICSOP Policy from $5 up to $249,995.
The London Market Insurers appealed the trial court’s
decision and in January 2007 the appellate court reversed the
trial court’s decision.

See London Market Insurers v. Superior

Court, 146 Cal.App.4th 648 (Cal. Ct. App. 2007); see also Kaiser
Cement and Gypsum Corp. v. Insur. Co. of the State of Penn., 155
Cal.Rptr.3d 283 (Cal. Ct. App. 2013).

The appellate court found

that “the plain language of the policies was not susceptible of
the conclusion that Kaiser’s design, manufacture, and
distribution of asbestos products was an ‘occurrence.’”
Market Insurers, 146 Cal.App.4th at 672.

London

Instead, it concluded

that “the relevant ‘occurrence’ was injurious exposure to
asbestos products.”

Id.

On remand, in January 2008, the

California trial court held that “the claim of each asbestos
bodily injury claimant shall be deemed to have been caused by a
separate and distinct occurrence within the meaning of Truck
policies.”
Pursuant to California precedent which allowed an insured to
select a single year of coverage within an exposure period to
respond to claims resulting from a continuous injury, Kaiser
selected the 1974 policy year.

Truck’s 1974 Policy, as

mentioned, had no aggregate limit.

Kaiser then sought a

declaration from the trial court that “if any asbestos bodily
injury claim alleged against Kaiser triggers the primary policy

11

of comprehensive general liability issued by Plaintiff [Truck]
for the year 1974, and Kaiser selects that policy year to
respond, then the first-level umbrella policy issued by CrossDefendant [ICSOP] incepting January 1, 1974 -- and, if necessary,
any excess policies directly above it -- become liable for that
claim once Truck has paid and exhausted its $500,000 peroccurrence limit for that year, and Kaiser has paid its $5,000
deductible for that year.”
Cal.Rptr.3d at 289.

Kaiser Cement and Gypsum Corp., 155

ICSOP opposed Kaiser’s motion, arguing that

principles of “horizontal exhaustion” require an insured to
exhaust the limits of all applicable primary policies covering
the entire exposure period -- rather than simply exhausting the
limits of a primary policy for a single targeted year -- before
an excess insurer can be required to indemnify the insured.

Id.

In June 2008, the trial court held that once Truck exhausted
its $500,000 per occurrence limit under the 1974 Truck Policy,
coverage under the 1974 ICSOP Policy would attach, and that
horizontal exhaustion or “stacking” of primary policy limits was
not appropriate.

Following this ruling, Kaiser, ICSOP and the

London Market Insurers decided to participate in mediation.

In

March 2009, the indemnity reserve on the master claim file for
the 1974 ICSOP Policy was increased from $249,995 to $5,000,000.
Once again, through the entire course of these proceedings, ICSOP
did not notify Argonaut pursuant to the Facultative Certificate.

12

Mediation sessions took place on April 21 and 22, 2009.

The

mediation resulted in an interim settlement agreement
(“Settlement Agreement”) that was subject to ICSOP’s appeal of
the trial court’s horizontal exhaustion ruling.

Pursuant to the

Settlement Agreement, ICSOP agreed to pay millions of dollars in
satisfaction of Kaiser’s demand for amounts owed on asbestos
claims already settled by Kaiser through March 31, 2009.

The

Settlement Agreement called for ICSOP to make installment
payments of half of that amount between August 2009 and January
2010.

The Agreement further contemplated that the funding of the

remaining money would be contingent on the outcome of the appeal
of the trial court’s decision.

Although the trial court’s

decision essentially relieved the London Market Insurers of any
direct indemnification responsibility, the London Market Insurers
agreed to fund 40% of the settlement amount for past claims and
50% of any amounts paid on pending and future claims. 5

The

Settlement Agreement was executed in July 2009.
2001-2009: Argonaut Executes Commutation Agreements with
Retrocessionaires
Argonaut had itself ceded some of the risk it had
underwritten in the Facultative Certificate and other policies,

5

Although the record is less than clear on this point, the
parties appear to agree that ICSOP would have been entitled to
seek contribution from the London Market Insurers had they not
agreed to shoulder a portion of the settlement funding. It also
appears that ICSOP may still be entitled to seek contribution
from other insurers that did not participate in the settlement.
13

to its own reinsurers -- known as retrocessionaires -- through a
Special Participating Excess Reinsurance Agreement (“Treaty X”).
Treaty X applied on a quota share basis, thereby requiring the
retrocessionaires to accept their percentage of losses on any
policy ceded to the treaty.

Between 2001 and 2009, Argonaut

entered into roughly a dozen commutation agreements with
retrocessionaires who participated in Treaty X.

A commutation

agreement is a type of settlement agreement through which the
retrocessionaires’ reinsurance obligations are terminated in
return for the retrocessionaires agreeing to pay a stipulated
amount to the first level reinsurer -- in this case, Argonaut.
Through these commutation agreements, Argonaut released roughly
23% of its reinsurance coverage.
In order to determine the price to charge for commutations,
Argonaut explains, it begins by considering paid balances due
from the retrocessionaires along with ceded case reserves. 6

It

also tries to estimate a figure called IBNR, which stands for
“incurred but not reported.”

This figure, according to Argonaut,

is “really grounded on looking at claims that are open and going
year by year.”

Argonaut argues that with earlier notice from

ICSOP it could have (1) avoided the commutation agreements; or
(2) charged higher prices for its commutation agreements.
Notably, the evidence submitted by Argonaut strongly suggests

6

A case reserve is an insurer’s estimate of the amount it will
ultimately need to pay on a particular claim or group of claims.
14

that the latter possibility was more likely than the former. 7
Notice to Argonaut
Over the course of 2009, ICSOP provided Argonaut with its
first notice of loss under the Facultative Certificate.

In April

2009, AIG’s broker, Guy Carpenter, sent Argonaut an “Initial Loss
Advice.”

The Facultative Certificate was not referenced in the

loss advice.

Instead, the loss advice referred to a loss

reinsurance treaty between Argonaut and ICSOP that, like the
Facultative Certificate, covered the 1974 ICSOP Policy.

On April

3, after Argonaut received the loss advice, Nadine Stuhr, an
Argonaut employee, wrote to the reinsurance department at AIG to
request additional information about the loss.
On April 27, an AIG representative responded by email,
attaching a copy of the 1974 ICSOP Policy and a Status Report
dated April 22, 2009.

The Status Report included a section

entitled “Declaratory Judgment,” which stated simply: “There is
an active Declaratory Judgment action in which all coverage
issues are being litigated.”

Following receipt of the loss

advice, Argonaut searched its own records and determined that it

7

When asked if there were any commutation agreements Argonaut
would have avoided had notice been given sooner, Christopher
Hollender -- Argonaut’s Vice President -- responded “There’s a
few -- I don’t know that there’s any that we necessarily would
have avoided, but I think we would have increased our demand for
that release on the Treaty X program.” In addition, when asked
whether it was Argonaut’s position that there is a commutation
agreement it would not have entered into if it had been given
earlier notice, Hollender responded “It’s hard to say. I think
15

had also issued the Facultative Certificate, and that the
Facultative Certificate also covered the 1974 ICSOP Policy.
Accordingly, in May, Argonaut sent notice to its
retrocessionaires, alerting them to the possibility that claims
would be made.
Then, on June 3, 2009, Argonaut received a copy of a
“reinsurance Notice of Loss.”

Unlike the loss advice, the notice

of loss did reference the Facultative Certificate.

But, the

notice of loss did not reference the California Coverage Action,
nor did it mention ICSOP’s settlement negotiations with Kaiser
and the London Market Insurers.

In December 2009, Argonaut sent

a letter to ICSOP advising that Argonaut reserved its right to
deny payment on the basis of late notice.

This action followed.

The instant action was originally filed in the Supreme Court
of the State of New York, and was removed to this Court by
Argonaut on August 24, 2012.

Following discovery limited to the

existence of prejudice from any delay in ICSOP’s provision of
notice to Argonaut, the parties filed motions for summary
judgment.

The parties’ motions were fully submitted on June 14,

2013.

DISUCSSION
A motion for summary judgment may be granted only if the

the pricing would have been different.
would have been different all along.”
16

I don’t know that it

submissions of the parties, taken together, “show[] that there is
no genuine dispute as to any material fact and the movant is
entitled to judgment as a matter of law.”

Fed.R.Civ.P. 56(a).

In deciding whether a party is entitled to summary judgment the
Court “must view the evidence in the light most favorable to the
non-moving party and draw all reasonable inferences in its
favor.”
2000).

Sologub v. City of New York, 202 F.3d 175, 178 (2d Cir.
When, as here, the parties present cross-motions for

summary judgment, “the court must evaluate each party's motion on
its own merits, taking care in each instance to draw all
reasonable inferences against the party whose motion is under
consideration.”

Heublein Inc. v. United States, 996 F.2d 1455,

1461 (2d Cir. 1993).

The substantive law governing the case will

identify those issues that are material, and “only disputes over
facts that might affect the outcome of the suit under the
governing law will properly preclude the entry of summary
judgment.”
(1987).

Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 249

Thus, in order to decide whether to grant summary

judgment, this Court must determine (1) whether a genuine factual
dispute exists based on the admissible evidence in the record,
and (2) whether the facts in dispute are material based on the
substantive law at issue.
I. Choice of Law
In a case grounded in diversity jurisdiction, a federal

17

court “must apply the choice of law analysis of the forum state.”
GlobalNet Financial.Com, Inc. v. Frank Crystal & Co., Inc., 449
F.3d 377, 382 (2d Cir. 2006).

Under New York law, when the law

of more than one state is potentially applicable to the parties’
dispute, the threshold question is whether the applicable rules
of the competing jurisdictions actually conflict.

Licci ex rel.

Licci v. Lebanese Canadian Bank, 672 F.3d 155, 157 (2d Cir.
2001).

An actual conflict exists where “the applicable law from

each jurisdiction provides different substantive rules.” Int’l
Bus. Machines Corp. v. Liberty Mut. Ins. Co., 363 F.3d 137, 142
(2d Cir. 2004).

“If no actual conflict exists, and if New York

is among the relevant jurisdictions, the court may simply apply
New York law.”

Licci, 672 F.3d at 157.

If an actual conflict exists, the court must proceed to
apply New York’s choice of law rules to determine which
jurisdiction’s law should govern the parties’ dispute.

In cases

like the present one, where the parties’ dispute arises out of a
contract, New York courts rely on the “center of gravity” or
“grouping of contacts” choice of law theory.
N.Y. 155, 160 (1954).

Auten v. Auten, 308

“Under this approach, the spectrum of

significant contacts -- rather than a single possibly fortuitous
event -- may be considered.”
N.Y.2d 219, 226 (1993).

Matter of All State Ins. Co., 81

In selecting the jurisdiction with the

most significant relation to the transaction and the parties,

18

courts consider “the place of contracting, the places of
negotiation and performance, the location of the subject matter,
and the domicile or place of business of the contracting
parties.”

Kaszak v. Liberty Mut. Ins Co., 744 N.Y.S.2d 286, 287

(2d Dep’t 2002).
Both New York and California have ties to the instant
litigation, making the law of each jurisdiction potentially
relevant.

If it were necessary to apply New York’s choice of law

analysis, the parties appear to agree that California has the
strongest connection.

The parties’ agreement is well-founded.

The Facultative Certificate was issued and delivered in
California.

Kaiser, the underlying insured, was also located in

California.

Moreover, at the time of contracting, Argonaut’s

home office was located in California, making it likely that the
parties intended, at that time, that ICSOP’s requests for payment
would be submitted in California.

The other potentially

interested jurisdictions -- Pennsylvania, Texas, and New York -have admittedly thinner connections to the parties and the
Facultative Certificate.

Accordingly, to the extent California

and New York law conflict, the Court will apply California law in
addressing the parties’ dispute.

The parties dispute, however,

whether the substantive rules of New York and California actually
conflict on any issues relevant to the present litigation.
While Argonaut argues that there are no relevant conflicts

19

between New York and California law, ICSOP posits roughly three
conflicts between the two states’ treatment of notice issues in
the reinsurance context.

Specifically, ICSOP contends that (1)

under California law the reinsurer must always demonstrate
prejudice from late notice, even if the reinsured acted in bad
faith by failing to give timely notice; (2) California’s standard
for prejudice is more demanding; and (3) California law
recognizes constructive notice.
Despite this dispute, the parties recognize that the law of
reinsurance is essentially identical in California and New York
and both draw freely from precedent in the two jurisdictions.
Similarly, California courts frequently rely on decisions from
circuits other than the Ninth Circuit, and from other states’
courts of appeal.

In light of the general uniformity in

reinsurance law across jurisdictions, the only area in which the
substantive law of the New York and California may be in conflict
is the issue of constructive notice.

While it is not entirely

clear that New York would recognize constructive notice to the
reinsurer, California does.

Therefore, because California has

the greater interest in the parties’ dispute, California law will
be applied.

Where California law is unknown, unsettled, or

ambiguous, however, this Court is free to seek guidance from New
York case law, and the case law of other jurisdictions in
attempting to predict what New York courts would predict

20

California courts would hold if faced with the issues encountered
here.

See Rogers v. Grimaldi, 875 F.2d 994, 1002 (2d Cir. 1989).

It should be noted, however, that the application of New York law
to the discussion that follows would not alter the outcome.
II. Late Notice
Argonaut argues that ICSOP should have provided it with
notice in 1989 or no later than April 2000.

Under California

law, insurance agreements are subject to “the ordinary rules of
contractual interpretation.”

Employers Reinsurance Co. v.

Superior Court, 161 Cal.App.4th 906, 919 (Cal. Ct. App.
2008)(citation omitted).

“Thus, the mutual intention of the

contracting parties at the time the contract was formed governs.”
London Market Insurers v. Superior Court, 146 Cal.App.4th 684,
656 (Cal. Ct. App. 2007).

The intention of the parties is

inferred solely from the written provisions of the contract, if
possible.

Great Western Drywall, Inc. v. Interstate Fire & Cas.

Co., 161 Cal.App.4th 1033, 1040 (2008).

In construing contract

language, words are interpreted in “their ordinary and popular
sense, unless the words are used in a technical sense or a
special meaning is given to them by usage.”

Employers

Reinsurance Co., 161 Cal.App.4th at 919 (citation omitted); see
also Berger v. New York State Dep’t of Social Services, 181
N.Y.S.2d 238, 240 (3d Dep’t 1992).
For ease of reference, the notice provision of the

21

Facultative Certificate is repeated here:
[ICSOP] shall notify [Argonaut] promptly of any
occurrence which in [ICSOP’s] estimate of the value of
injuries or damages sought, without regard to
liability, might result in judgment in an amount
sufficient to involve this certificate of reinsurance.
The Company shall also notify [Argonaut] promptly of
any occurrence in respect of which the Company has
created a loss reserve equal to or greater than fifty
(50) percent of [ICSOP’s] retention specified in Item 3
of the Declarations; or, if this reinsurance applies on
a contributing excess basis, when notice of claim is
received by [ICSOP].
(Emphasis supplied.)
Notably, the Ninth Circuit confronted and interpreted an
identical notice provision in Associated, 922 F.2d at 519.
Perhaps for this reason, the parties have offered little to no
analysis of the Facultative Certificate’s notice provision.

In

Associated, the Ninth Circuit observed that “insurance companies
have been held to a higher standard of compliance with notice
provisions.”

Id. at 521.

It also observed that the term

“occurrence,” frequently found in insurance policies, has been
interpreted by the Supreme Court of California to mean “an
accident which results, during the policy period, in bodily
injury neither expected nor intended from the standpoint of the
insured.”
(1986)).

Id. (quoting Preston v. Goldman, 42 Cal.3d 108, 119
It further recalled its own definition of occurrence as

“an event upon which the liability of the [reinsured] was
predicated.”

Id. (citation omitted).

Importantly, the Ninth

Circuit went on to hold that a “cross-claim brought by [the
22

insured] against [its excess insurer] was an ‘occurrence’” under
the reinsurance contract, and “presented a ‘reasonable
possibility’ of resulting in a claim under the reinsurance
policy,” thus triggering the obligation of the excess insurer to
notify its reinsurer.

Id. at 521-22.

With respect to the clause

requiring the excess insurer to notify the reinsurer “when notice
of a claim is received,” the Ninth Circuit “broadly defined the
term ‘claim’ as an ‘assertion, demand or challenge of something
as a right; the assertion of a liability to the party making it
to do some service or pay a sum of money.’”
omitted).

Id. at 522 (citation

It therefore concluded that the excess insurer, which

was incidentally ICSOP, had an obligation to provide notice to
its reinsurer that was additionally triggered because the
insured’s cross-claim asserted against ICSOP constituted a
“claim” within the meaning of the reinsurance agreement.

Id.

Applied to the present case, ICSOP’s obligation to notify
Argonaut arose, at the latest, in 2002 when Kaiser asserted a
cross-claim against ICSOP in the California Coverage Action. 8

8

ICSOP was aware of a significant risk that its excess coverage
-- and thus Argonaut’s reinsurance coverage -- would be impaired
long before 2002. As the parties’ briefs do not adequately
address the meaning of “occurrence” within the Facultative
Certificate, however, the Court declines to determine whether
ICSOP’s obligation to notify Argonaut may have arisen in 1989 or
2000, as Argonaut suggests. Nonetheless, it is worth noting
that, in Unigard II, the Second Circuit held that the relevant
“occurrences” within the meaning of the reinsurance agreement’s
notice provision were the “exposures to asbestos” and that the
ceding insurer’s signing of a cost-sharing agreement was an event
23

Because ICSOP did not provide Argonaut with notice until June
2009, ICSOP breached its notice obligation under the Facultative
Certificate.
A. Constructive Notice
ICSOP concedes that its provision of notice under the
Facultative Certificate in 2009 was untimely.

It claims,

however, that the question of whether ICSOP breached the
Facultative Certificate’s notice requirement cannot be determined
at this time because a genuine dispute exists regarding whether
Argonaut had constructive notice of the Facultative Certificate’s
potential involvement.
As ICSOP points out, California courts have recognized that
constructive notice to a co-insurer satisfies the obligation to
give notice under an insurance policy.

OneBeacon Am. Ins. Co. v.

Fireman’s Fund Ins. Co., 175 Cal.App.4th 183, 200 (Cal. Ct. App.
2009)(primary policy co-insurers).

Where there is “adequate

notice of the potential for contribution and the opportunity for
investigation and participation in the defense in the underlying
litigation,” constructive notice will suffice.

Id. at 201; see

also Span, Inc. v. Assoc. Int’l Ins. Co., 227 Cal.App.3d 463, 483
(Cal. Ct. App. 1991)(the knowledge of the excess insurer of the
underlying action and of the insolvency of the primary carrier
placed it on inquiry notice).

increasing the likelihood to a reasonable possibility that the
reinsurance would be involved. Unigard II, 4 F.3d at 1065.
24

In New York, it is well established that an insured may not
rely on the doctrine of constructive notice.

The general rule is

that “[n]either notice provided by another insured nor the
insurer’s actual knowledge of the claim satisfies the contractual
obligation of an insured to give timely notice.”

Roofing

Consultants v. Scottsdale Ins. Co., 709 N.Y.S.2d 782, 783 (4th
Dep’t 2000); see also State v. Ackley, 664 N.Y.S.2d 876, 878 (3d
Dep’t 1997); Heydt Contracting Corp. v. Am. Home Assurance, 536
N.Y.S.2d 770, 773 (1st Dep’t 1989).

It is less clear that the

doctrine is unavailable in New York in the context of reinsurance
policies.

Because the doctrine is clearly available in

California, the Court applies California law on the issue of
constructive notice.
ICSOP has not presented evidence, however, from which a
reasonable trier of fact could conclude that Argonaut had notice
of any facts in 2002 that would have put Argonaut on inquiry
notice of the Facultative Certificate’s impairment.

ICSOP’s sole

support for its constructive notice contention is its speculation
that Argonaut may have received notice in 2002 pursuant to a
different reinsurance agreement between ICSOP and Argonaut -- the
Miscellaneous Special Business Treaty (“MSB Treaty”) -- which
also reinsured the 1974 ICSOP Policy as one of the policies that
fell within a class of policies covered by the MSB Treaty.
contends that, if received, this notice would have alerted

25

It

Argonaut to the possibility that the Facultative Certificate
would also be impacted.
In support of this argument, ICSOP points to two notices
generated by ICSOP’s computer system with respect the MSB Treaty
in 2000 and 2002.

According to ICSOP these notices were sent to

Guy Carpenter, AIG’s reinsurance broker, in 2000 and 2002.

ICSOP

evidently concedes, however, that the 2000 notice never reached
Argonaut. 9

In addition, inspection of Guy Carpenter and

Argonaut’s files uncovered neither notice.
In the absence of evidence that Argonaut received the 2002
notice concerning the MSB Treaty, it is unnecessary to decide
whether receipt of such notice would have imposed a duty of
inquiry on Argonaut.

Thus, no reasonable trier of fact could

find that Argonaut was aware of facts that should have alerted it
to the potential involvement of the Facultative Certificate.
III. Prejudice
Both New York and California require a reinsurer to
demonstrate that it was prejudiced by the reinsured’s late notice
in order to invoke a late notice defense. 10

Under California

9

A memorandum from Guy Carpenter dated June 16, 2003 explains
that notices and bills sent by ICSOP to Guy Carpenter under the
MSB Treaty between April 1999 and September 2001 were being
withheld from reinsurers by Guy Carpenter because they contained
an error in the treaty participation share. Before the error was
corrected, Guy Carpenter’s offices at Two World Trade Center were
destroyed in the 9/11 terrorist attack.
10

ICSOP, citing to a handful of California cases, protests that
the burden of proving prejudice is more onerous in California.
26

law, “an insurer may assert defenses based upon a breach by the
insured of a condition of the policy” -- such as a notice clause
-- “but the breach cannot be a valid defense unless the insurer
was substantially prejudiced thereby.”
Co., 60 Cal.2d 303, 305-06 (1963). 11

Campbell v. Allstate Ins.

The Ninth Circuit has

predicted that the California Supreme Court “would apply the
notice-prejudice rule to contracts of reinsurance.”
922 F.2d at 525.

Associated,

Similarly, in New York, the reinsured’s breach

of a reinsurance agreement’s notice provision “will excuse
performance only if it is material or demonstrably prejudicial.”
Unigard Sec. Ins. Co. v. North River Ins. Co., 79 N.Y.2d 576, 584
(1992) (“Unigard I”). 12

ICSOP’s cases do not articulate a more demanding standard of
prejudice, however, they merely reflect the fact that the
“ultimate conclusion” on the existence of prejudice “in each case
must depend on its own facts.” Abrams v. Am. Fidelity & Cas.
Co., 32 Cal.2d 233, 239 (1948).
11

A California Court of Appeals addressed the late notice
defense by a reinsurer in Central Nat. Ins. Co. of Omaha v.
Prudential Reinsurance Co., 196 Cal.App.3d 342 (Cal. Ct. App.
1987). In Central Nat. Ins., the Court of Appeals placed the
burden of proving compliance with the reinsurance contract’s
notice provision on the reinsured and further provided that “[i]f
the reinsured is unsuccessful in meeting its burden, a rebuttable
presumption of prejudice arises.” Id. at 787. The Opinion in
Central Nat. Ins., however, was depublished by the California
Supreme Court, and was consequently rendered nonprecedential.
See Cal. Rules of Ct. 8.1105, 8.1115.
12

In the context of primary insurance, New York courts
traditionally treated notice as a condition precedent to the
primary insurance contract. Accordingly, a primary insurer who
demonstrated that the insured’s notice was unreasonably late did
not ordinarily need to also demonstrate prejudice as a result of
the untimely notice. In 2008, the New York legislature departed
27

In both New York and California, the burden of proving such
prejudice is placed on the reinsurer.

See Shell Oil Co. v.

Winterthur Swiss Ins. Co., 12 Cal.App.4th 715, 760 (Cal. Ct. App.
1993); Unigard I, 79 N.Y.2d at 584.

Moreover, in both States,

the fact that a reinsurer has lost its right to associate in the
control and defense of the underlying claim as a result of the
reinsured’s late notice is insufficient on its own to constitute
prejudice.

Associated, 922 F.2d at 524; Unigard II, 4 F.3d 1068.

Where the reinsurer has lost the right to associate itself with
the underlying litigation due to late notice, the loss of that
right will only establish prejudice if the reinsurer shows that
“the results of the litigation would have been different” with
its participation.

Unigard II, 4 F.3d at 1068-69.

Argonaut has submitted sufficient evidence to raise a
genuine issue of disputed fact with respect to whether it was
prejudiced in at least two ways by ICSOP’s breach of the
Facultative Certificate’s notice provision.

But, the existence

of prejudice cannot be determined as a matter of law based on the

from the no-prejudice rule and codified a prejudice requirement
into New York’s Insurance Law. See N.Y. Insur. Law § 3420(a)(5).
Section 3420’s prejudice requirement, however, is only applicable
to insurance policies issued or delivered in New York State after
January 17, 2009. See An Act to Amend the Civil Practice Law and
Rules and the Insurance Law, in Relation to Liability Insurance
Policies § 8, 2008 N.Y. Sess. Laws 388 (McKinney 2008). New York
courts continue to apply the no-prejudice rule to primary
insurance policies issued before that date. See, e.g., 310 East
74 LLC v. Fireman’s Fund Ins. Co., 964 N.Y.S.2d 512, 513-14 (1st
Dep’t 2013); Tower Ins. Co. of New York v. Classon Heights, LLC,
920 N.Y.S.2d 58, 62 (1st Dep’t 2011).
28

record presented with this motion.

Although Argonaut is unlikely

to show that its participation in the litigation would have
altered the ultimate legal rulings in the California Coverage
Action, Argonaut may establish that its participation in the
litigation would have resulted in not merely an earlier
settlement but a more advantageous one as well.

See Sequoia Ins.

Co. v. Royal Ins. Co. of Am., 971 F.2d 1385, 1393 (9th Cir. 1992)
(the excess insurer would have encouraged settlement).
Argonaut has submitted evidence suggesting that the 1974
ICSOP Policy exhibited a number of characteristics that would
have raised a “Red Flag” for Argonaut had it received earlier
notice.

In particular, Argonaut notes that its $1,000,000 per

occurrence indemnification obligation under the Facultative
Certificate was significantly higher than its average obligation
under its treaty reinsurance agreements, which constituted the
bulk of its business.

According to Argonaut, the fact that the

Facultative Certificate was written without an aggregate limit
would have also raised a red flag.

In addition, Argonaut had

previous informative experience with settling asbestos claims.
Argonaut had issued direct insurance policies containing no
aggregate limits to a precedcessor of a company called Western
MacArthur.

In the 1990’s and early 2000’s, Argonaut engaged in

coverage litigation with MacArthur in connection with those
policies and ultimately settled the claims in 2004.

29

See, e.g.,

Argonaut Ins. Co. v. MacArthur Co., No. C 012-03878 (WHA), 2002
WL 145400, at *1 (N.D. Cal. Jan. 18, 2002).

Argonaut contends

that with earlier notice it could have brought its experience to
bear in the handling of the Kaiser asbestos claims.

There is,

moreover, no indication in the record that ICSOP sought to engage
in settlement negotiations with Kaiser at any time prior to 2009.
By the time it agreed to participate in mediation, the tide of
litigation had turned strongly against it, naturally diminishing
its bargaining position.
It is also noteworthy that the ordinarily appropriate
assumption in reinsurance cases that the interests of the
reinsurer and the reinsured will be aligned is not justified in
this case.

See, e.g., Unigard II, 4 F.3d at 1054 (reinsurers are

“protected . . . by a large area of common interest with ceding
insurers.”); Associated, 922 F.2d at 523 (“[B]ecause primary
insurers will usually provide an experienced defense, the
likelihood of prejudice from late notice is more remote.”);
Transport Ins. Co., 202 Cal.App.4th at 989 (describing parties to
reinsurance agreement as “essentially aligned -- not adverse.”).
There is undisputed evidence that ICSOP’s counsel chose not to
advocate the position most beneficial to the 1974 ICSOP Policy in
order to remain neutral on an issue with respect to which its
multiple clients had conflicting interests.

A reasonable trier

of fact could infer that ICSOP’s counsel adopted a similar “best

30

interests of the group” mentality in its approach to considering
the possibility of settlement.

Argonaut may demonstrate

prejudice as a result of being denied an opportunity to encourage
an earlier and more advantageous settlement.

Such prejudice may

be shown even though Argonaut had no right to dictate ICSOP’s
settlement decisions.

The parties’ agreement that Argonaut would

have an opportunity to associate in the defense of any claim
implicating the Facultative Certificate would be rendered hollow
if it is presumed that a reinsurer will never have a meaningful
influence on its reinsured’s litigation and settlement decisions.
Under the circumstances, a reasonable trier of fact could
conclude that Argonaut was substantially prejudiced by ICSOP’s
provision of late notice.
In addition, Argonaut has raised a genuine issue of fact
with respect to whether, if it had received timely notice from
ICSOP, it would have charged higher prices from its
retrocessionaires for commutation agreements. 13

Between 2001 and

2009, Argonaut entered into roughly a dozen commutation
agreements through which it commuted approximately 23% of its
reinsurance coverage.

Argonaut’s Vice President testified that

he believed that if Argonaut had been notified of the California

13

The Court declines to adopt a per se rule that prejudice never
exists where a reinsured’s late notice caused a reinsurer to
enter into disadvantageous commutation agreements with
retrocessionaires. While ICSOP argues that Associated prevents
reliance on “collateral” prejudice, that decision did no more
31

Coverage Action, Argonaut would have charged a higher price for
the commutations.

While ICSOP disputes this point, highlighting

the fact that the IBNR -- a component of the formula used to set
an appropriate price for commutation agreements -- accounts for
the risk of unreported claims, that dispute merely creates an
issue of fact to be decided at trial.

After all, an IBNR is

necessarily an estimate, and it is not clear from the record that
the commutation formula would be unaffected by Argonaut’s receipt
of notice that it’s reinsured had actually become involved in the
California Coverage Action.
IV. Bad Faith
Argonaut may be relieved of its burden to show prejudice,
however, in the event that it can demonstrate that ICSOP acted in
bad faith in not providing Argonaut with timely notice.

This

exception to the requirement to show prejudice arises from the
nature of the relationships among companies in the reinsurance
industry.
In Unigard II, the Second Circuit offered an extended
discussion of the purpose of reinsurance and the propriety of a
bad-faith exception to the notice-prejudice rule.

The Court

began by discussing the purpose of prompt notice in the
reinsurance context:
To enable them to set premiums and adequate reserves,
and to determine whether to “associate” in the defense
than find a failure to show prejudice in the circumstances of
that case. Associated, 922 F.2d at 525.
32

of a claim, reinsurers are dependent on their ceding
insurers for prompt and full disclosure of information
concerning pertinent risks. The reinsurance
relationship is often characterized as one of ‘utmost
good faith.’ This utmost good faith may be viewed as a
legal rule but also as a tradition honored by ceding
insurers and reinsurers in their ongoing commercial
relationships. Historically, the reinsurance market
has relied on a practice of the exercise of utmost good
faith to decrease monitoring costs and ex ante
contracting costs. Reinsurance works only if the sums
of reinsurance premiums are less than the original
insurance premium. Otherwise, the ceding insurers will
not reinsure. For the reinsurance premiums to be less,
reinsurers cannot duplicate the costly but necessary
efforts of the primary insurer in evaluating risks and
handling claims. Reinsurers may thus not have
actuarial expertise, or actively participate in
defending ordinary claims. They are protected,
however, by a large area of common interest with ceding
insurers and by the tradition of utmost good faith,
particularly in the sharing of information.
Unigard II, 4 F.3d at 1054.

While recognizing that the modern

relationship of reinsurers and their reinsureds may no longer be
characterized by utmost good faith, the Second Circuit
nevertheless concluded that “because information concerning the
underlying risk lies virtually in the exclusive possession of the
ceding insurer, a very high level of good faith -- whether or not
designated ‘utmost’ -- is required to ensure prompt and full
disclosure of material information without causing reinsurers to
engage in duplicative monitoring.”

Id.

Thus, the Court

concluded that a ceding insurer’s failure to provide prompt
notice will entitle a reinsurer to relief without showing
prejudice if (1) the ceding insurer deliberately deceives a
reinsurer, or (2) the ceding insurer fails to implement routine
33

practices and controls to ensure notification to reinsurers.
at 1070.

Id.

Specifically,

the proper minimum standard for bad faith should be
gross negligence or recklessness. If a ceding insurer
deliberately deceives a reinsurer, that deception is of
course bad faith. However, if a ceding insurer has
implemented routine practices and controls to ensure
notification to reinsurers but inadvertence causes a
lapse, the insurer has not acted in bad faith. But if
a ceding insurer does not implement such practices and
controls, then it has willfully disregarded the risk to
reinsurers and is guilty of gross negligence. A
reinsurer, dependent on its ceding insurer for
information, should be able to expect at least this
level of protection, and if a ceding insurer fails to
provide it, the reinsurer’s late loss notice defense
should succeed.
Id. at 1069; see also Christiania Gen. Ins. Corp of New York v.
Great Am. Ins. Co., 972 F.2d 268 (2d Cir. 1992).
While California courts have not yet addressed this
exception to the requirement that a reinsurer show prejudice from
late notice, 14 it is possible here to predict how the “state’s
highest court would rule on an issue.”

Fieger v. Pitney Bowes

Credit Corp., 251 F.3d 386, 399 (2d Cir. 2001).
There are at least two reasons to predict that the

14

It worth noting that the California Supreme Court has spoken
on the issue of late notice in the reinsurance context in at
least one instance, although the unusual facts of the case limit
the lessons to be gleaned. In Pacific Mut. Life Ins. Co. of
Calif. v. Pacific Surety Co., 182 Cal. 555 (1920), the California
court addressed a failure to give a reinsurer notice of an
additional policy covered by its reinsurance. The court
construed the notice provisions in the reinsurance contract and
held that the reinsurer was not relieved of its obligations under
the reinsurance agreement. It was observed, however, that “[o]f
course, any claim of fraud or negligence would place a different
aspect upon the case.” Id. at 560.
34

California Supreme Court would adopt a bad faith exception to the
notice-prejudice rule.

First, the Second Circuit’s decision in

Unigard II relied, in part, on the fact that reinsurance
agreements have historically been characterized by a duty of
utmost good faith.

Pursuant to this duty, the reinsured is

expected to covey all information material to the underlying risk
to the reinsurer.

As Argonaut points out, this principle is

reflected in California’s Insurance Code, which instructs a
reinsured to “communicate all the representations of the original
insured, and also all the knowledge and information he possesses
whether previously or subsequently acquired, which are material
to the risk.”

Cal. Ins. Code § 622; see also Unigard II, 4 F.3d

at 1069.
Second, California courts recognize that reinsureds, who are
themselves insurance companies, are sophisticated parties
familiar with the practice of giving and receiving notice.

See,

e.g., Transport Ins. Co. v. TIG Ins. Co., 202 Cal.App.4th 984,
989 (Cal. Ct. App. 2012); Associated, 922 F.2d at 521; see also
Am. Bankers Ins. Co. of Florida v. Northwestern Nat. Ins. Co.,
198 F.3d 1332, 1335 (11th Cir. 1999).

Accordingly, a requirement

that the reinsured implement adequate practices and controls with
respect to the provision of notice is minimally burdensome and
consistent with the expectation of parties entering into a
reinsurance agreement.

35

ICSOP argues that the California Supreme Court would be
unlikely to adopt the Second Circuit’s approach in Unigard II.
ICSOP points to the fact that California and New York
historically applied different standards to an insurer’s late
notice defense in the direct insurance context.

While California

law requires insurers relying on a late notice defense in the
direct insurance context to demonstrate prejudice, New York
courts have traditionally followed the no-prejudice rule in the
direct insurance context.
This difference in the direct insurance context is not
compelling evidence regarding the existence of a bad faith
exception in the reinsurance context.

In this regard, it is

worth highlighting the decision of the New Hampshire Supreme
Court in Certain Underwriters at Lloyd’s London v. Home Ins. Co.,
146 N.H. 740 (2001).

New Hampshire, like California, requires

insurers in the direct insurance context to demonstrate prejudice
in order to invoke the defense of late notice.

Dover Mills

P’ship v. Comm. Union Ins. Co., 144 N.H. 336, 339 (1999).
Despite the difference in approaches taken by New York and New
Hampshire courts in the direct insurance context, the New
Hampshire Supreme Court decided to “adopt the Second Circuit’s
rule that a reinsurer may be relieved from indemnifying its
reinsured if it proves that the reinsured’s late notice was due
to gross negligence or recklessness, i.e., bad faith.”

36

Certain

Underwriters at Lloyd’s London, 146 N.H. at 743-44.

In doing so

it observed that “[t]he trend in modern case law is to recognize
that a very high level of good faith is required in the
relationship between reinsurers and reinsureds.”

Id. at 742.

The court further explained that “[b]ecause the reinsurer relies
on the reinsured for information in order to properly assess the
risks, the good faith standard particularly applies to reinsureds
timely notifying reinsurers of potential claims.”

Id.

There are other reasons as well to discount any difference
regarding the notice-prejudice rule in New York and California in
the direct insurance as predictive of differences that may exist
in the reinsurance context, and in particular in the recognition
of a bad faith exception to the prejudice requirement in the
reinsurance context.

First, the co-existence of a default

notice-prejudice rule and a bad faith exception is not unusual.
The notice-prejudice rule furthers a public policy that disfavors
technical forfeitures, and a bad faith exception, consistent with
this policy, acknowledges that when the reinsured has been
grossly negligent in providing notice to the reinsurer, its
forfeiture of coverage is not the result of a mere technicality.
Second, because the purpose of reinsurance differs in
important respects from the purpose of direct insurance, the
reasoning of decisions issued in the direct insurance context is
not uniformly persuasive on questions arising in the reinsurance

37

context.

For each of these reasons, it is appropriate to predict

that a New York court would decide that California courts would
adopt a bad faith exception to the duty of a reinsurer to
demonstrate prejudice.
ICSOP next urges the Court to follow the course of the
Seventh Circuit in Zenith Ins. Co. v. Employers Ins. Of Wausau,
141 F.3d 300, (7th Cir. 1998), which found no analog to New
York’s bad faith exception under Wisconsin law, and concluded
that the district court erred in predicting that the Wisconsin
Supreme Court would be likely to adopt the exception.
308.

Id. at

ICSOP’s reliance on the Zenith decision is not persuasive.
The Zenith court relied on its conclusion that Wisconsin

courts had only acknowledged “a general duty of good faith and
fair dealing between the parties to a contract,” and had not
adopted the “‘utmost’” good faith standard for reinsurance
contracts.

Zenith, 141 F.3d at 308.

As already noted,

California has expressly codified a reinsured’s obligation to
provide its reinsurer with all information relevant to the risk
underwritten -- a codification which reflects the principal of
utmost good faith historically recognized in reinsurance
contracts, and which was borrowed from New York’s Field Code.
See Staring, Grayon, The Law of Reinsurance Contracts in
California in Relation to Anglo-American Common Law (1988).
California courts also recognize that parties to reinsurance

38

contracts are sophisticated parties.

It is therefore easy to

infer that those courts would impose on those sophisticated
parties a higher duty of good faith than that which inures to
every contractual relationship.
In sum, although California courts have not decided whether
to recognize a bad faith exception to the notice-prejudice rule
in the reinsurance context, this Court predicts that it would
recognize such an exception.

The initial phase of litigation in

this action, however, was restricted solely to the issue of
whether Argonaut was prejudiced by ICSOP’s late notice, and no
discovery into ICSOP’s bad faith has been conducted.

Argonaut

has accordingly submitted a declaration pursuant to Federal Rule
of Civil Procedure 56(d) in which it requests an opportunity to
conduct discovery on the issue of ICSOP’s bad faith.

Following

the issuance of this Opinion, the parties will be permitted to
take discovery on this issue before proceeding to trial.
CONCLUSION
The plaintiff’s June 12, 2013 motion for summary judgment is
granted in part.

The defendant’s June 12, 2013 motion for

summary judgment is denied
Dated:

New York, New York
August 6, 2013

39