Commercial Union Ins. Co. v. Seven Provinces Ins. Co., Ltd.

Issue Discussed: Follow the Fortunes / Settlements

Submitted by Cecilia Froelich Moss, Karen C. Baswell

Date Promulgated: June 15, 1998

Commercial Union Ins. Co. v. Seven Provinces Ins. Co., Ltd., 9 F. Supp. 2d 49 (D. Mass. 1998); aff’d 217 F.3d 33 (1st Cir. 2000), cert. den., 531 U.S. 1146 (2001)

Court:                         United States District Court for the District of Massachusetts; United States Court of Appeals for the First Circuit

Issues Decided:          Whether the “follow-the-settlements” doctrine applies to a cedent’s post-settlement allocation decisions?

                                    (Note, this case also addresses issues related to a cedent’s ability to carry treaty reinsurance on amounts it retains under a net retention clause in a facultative certificate, and bad faith insurance claims under Massachusetts state law.)

Factual Background

Commercial Union’s predecessor insured Teledyne (a manufacturing company) under various insurance policies.  Seven Provinces provided facultative reinsurance on a portion of the 1963-1964 insurance policy.  The facultative certificate provided coverage for 50% of losses between $50,000 and $500,000, and contained a follow-the-settlements clause.

Following a dispute over environmental contamination at a number of Teledyne sites, Commercial Union and Teledyne settled for $2.2 million.  Commercial Union then allocated the settlement for reinsurance purposes between various sites based on the their percentage of Teledyne’s estimated total clean-up costs, and then between policy years based on the years the sites were in operation.  Only one site was in operation during the 1963-1964 policy year, the semiconductor site, and it represented 38.32% of Teledyne’s total clean-up costs.  Commercial Union thus allocated $843,040 (38.32% of $2.2 million) of the settlement to that site, and billed Seven Provinces for its share of the loss.  Seven Provinces refused to pay, raising several issues, including challenges to Commercial Union’s coverage determinations and allocation of the settlement.  Litigation followed.

Key Holding

In the district court proceeding, Seven Provinces claimed that Commercial Union’s allocation: (i) was not in good faith; (ii) included ex gratia payments; and (iii) did not include an additional “differences in conditions” policy issued to Teledyne.  Seven Provinces also argued that the allocation was “commercially unreasonable” and that other allocations would have been “more reasonable.”  Finally, Seven Provinces argued that the follow the settlements doctrine did not apply because Seven Provinces was challenging Commercial Union’s allocation and not its settlement.

The court rejected these arguments, holding that under the follow-the-settlements doctrine, the reinsurer is required “to cover settlements made by the reinsured, as long as they are not fraudulent, collusive, or made in bad faith.”  The court also held that follow-the-settlements applies to both allocations and settlements and that Seven Provinces’s attempt to differentiate the two failed because this was “a distinction without a difference,” noting that “the determination of which among several policies covers which particular loss among many is not much different from the more general decision that the losses are covered by the policies.”

The court emphasized that “the attempt to distinguish settlement from allocation would undermine the entire ‘follow-the-settlements’ doctrine,” explaining that “[i]f a reinsured could be forced into litigation over its good faith judgment as to which policies covered which losses, it would be impossible for it to come to any settlement of such complex claims.”  The court also noted that, in situations where loss is allocated among several insurance policies, each with various reinsurers, “a ceding insurer could, in good faith, select any one of [multiple allocation] options, only to have its various reinsurers each propose an alternative formula.  If the ‘follow the settlements’ principle did not apply to the allocation of those settlements, litigation would surely proliferate.”

Based on the facts as presented at trial, the court found that Commercial Union’s allocation was reasonable, and that Seven Provinces had failed to provide any evidence of bad faith, ex gratia payments, fraud, or unreasonableness.

Thus, the district court held that the follow-the-settlements doctrine “requires the reinsurer to follow the reinsured’s good faith and reasonable allocation of settlement dollars between different policies and sites,” and ruled for Commercial Union.

The First Circuit affirmed, adding that in the absence of any evidence of bad faith or unreasonableness, “the fact that alternative allocations were ‘possible,’ was legally irrelevant.”

Key Takeaway

The follow-the-settlements doctrine requires a reinsurer to follow its cedent’s post-settlement allocation, so long as the allocation is reasonable and made in good faith.  Whether other allocations are also possible is irrelevant to that determination.