Episode 26. Extrinsic Evidence in Policy Interpretation

Insurance policies aren’t always beacons of clarity. Industry jargon and technical terms can make them murky and ambiguous. This week, Robert Sallander discusses how to use extrinsic evidence- like industry custom and practice- to interpret insurance policies.

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Transcript

In episode 24 of Coverage Counsel is in, I discuss general principles concerning the

interpretation of insurance policies. As a quick recap, keep in mind that you have

to start with the language of the policy itself, and that policy language needs to

be ambiguous. The ambiguity has to be a legitimate dispute.

In other words, legitimate alternative interpretations of the same language.

If it's not ambiguous, the court's just going to apply the languages written.

If there's no ambiguity, there is no need for interpretation. Now,

you can show ambiguity in several different ways.

And generally that's going to be a question of law. Sometimes you can make it a

question of fact and your strategy on whether to make it a question of law or a

question of fact is based on a variety of considerations that we're not going to

discuss here. Today I'm going to talk though about using external evidence or

extrinsic evidence to aid in the interpretation of the insurance policy.

So what is extrinsic evidence?

When two equally plausible interpretations of an insurance policy exist,

you're not going to be able to rely on the language of the policy itself. So you

have to go outside. You have to go to the communications that exist between and

among the insurer, the broker, the agent, and the insured.

You may also need to look at industry materials. And then, of course, while it's

not really evidence, you have, as an aid to interpretation, the determination of

other courts.

Now here's something important to keep in mind. Where extrinsic evidence is not in

conflict, interpretation of the agreement remains a question of law,

but where extrinsic evidence conflicts, the decision of which evidence to believe

converts the interpretation of the contract into a question of fact.

Some common forms of extrinsic evidence include industry custom and practice,

underwriting information that was provided in the course of placement of the policy,

communications about the intent of the parties, and the purposes of the contract

generally.

So let's talk about industry custom and practice as a form of extrinsic evidence.

One of the presumptions that is a baseline in contract interpretation is that the

words of the contract have been used in their ordinary and popular sense rather than

according to either a strict legal meaning or a technical meaning.

In the insurance industry, however, there are often terms that have technical

meanings.

Many of those are defined in the policy itself, but there are many more terms that

are just really jargon, especially used by agents and brokers.

It's shorthand for what they think they mean. And those shorthand terms are often

problematic because they are in and of themselves ambiguous. So one of the things

you're gonna wanna figure out is whether the term it issue is being used in its

ordinary in popular sounds or whether it was intended to be used according to its

technical meaning and if it was to be used according to its technical meaning

evidence may be admissible to prove what that meaning is.

For example, words may have a local or otherwise peculiar meaning.

they may have a technical meaning among brokers or agents or the insurance

professionals. Lots of times though the insured is not going to be privy to those

technical meanings and is not really going to understand what they mean.

Similarly the insured in its industry may have terms of a peculiar or technical

meaning.

And the question would become, how is the insurer to understand that the insured is

using those words in a technical sense?

Either way, the agreement has to be construed according to the understanding of the

parties. Evidence of custom and practice or technical meaning is usually offered

through expert testimony. If the individuals to the parties to the contract,

so the insured and the insurer, are offering their own internal meetings,

well those are not industry custom and practice. Those may be custom and practice

within the insurance company, or they may be technical terms used by the insured

within its own industry, you're going to need somebody who talks about custom and

practice in an industry in general rather than the proprietary meanings or peculiar

meanings that one party or the other has provided in its discussions.

Technical or proprietary meanings used by one party that are not industry custom in

practice will not usually be admitted to provide that a word or phrase was used in

a special or technical sense. The special meaning must be common to the industry so

that both parties are deemed to have had a common knowledge or understanding.

Keep in mind also that the circumstances under which a contract was made,

including the situation of the subject of the contract and of the parties to it,

may also be shown by extrinsic evidence to place the judge or the jury in the

position of those whose language is to be interpreted.

The rule of construction is based on the concept that actions speak louder than

words and that words are an imperfect medium to convey thought and intention.

Therefore you want to put the fact finder or the judge in the position of the

parties who were communicating about what a particular term meant,

this most often comes up when the insurer is trying to explain what risks they were

trying to ensure, what their insurance program was about, how they wanted to obtain

insurance and what risks they wanted to retain, and how the insurer,

the broker, or the agent was to communicate that information to the other side.

Again, this interpretation is all about figuring out what the party is intended to

do and what they meant by the words they used.

Another way to bring in extrinsic evidence to help interpret an insurance policy is

to look at terms that might be implied by usage. Usage or custom may not only

explain the meaning of language, but may also be used to imply terms where no

contrary intent appears from the express terms of the contract.

In this context a usage is a habitual or customary practice and a usage of trade

is one having such regularity of observance in a place, vocation,

or trade as to justify an expectation that it will be observed with respect to a

particular agreement. In this context an insurer will have

evidence or at least can talk about their habitual or customary usage and regularity

of usage of certain terms, but that's only half the equation. The insured has to be

involved in that habitual or customary practice. Now some sophisticated insureds may

be shown to have that knowledge, but not all insurers will. Similarly insurers that

are in specialty areas take construction, engineering,

any of the professions may have customary terms that they use and the question is

whether within that profession or vocation the insurer should have or did have reason

to know the peculiar usage. Here's a way that an insurer may have difficulty.

If the insurer has underwriters that focus on a specific industry and participate in

evaluating the risks of that entry, the chances are much higher that those

underwriters were aware of the specific terms, or at least should have been aware of

specific terms of art that the insured was using and expressing what they wanted to

ensure.

Under the restatement, usage can be invoked only to interpret contractual terms,

not to create them.

This next argument that exists is one that I see only very rarely.

That's the implied covenant of good faith and fair dealing. We've all heard of this

implied covenant on the tort of bad faith in connection with claims handling. It has

a place, however, in the underwriting context. The duty of good faith and fair

dealing is implied into every contract and it provides that each party owes the

other a high level of good faith in their dealings. This includes dealings in the

underwriting process. Good faith is a basic requirement of central importance to the

structure of insurance and insurers and insurers alike need to make sure that they're

communicating clearly and that they are making sure that in the case of the insurer

the insured knows what risks the insurer is taking on and in the case of the

insured they must make sure that they know what risks They want they are

communicating what risks they want the insurer to take on now, of course in the

general liability context the

the scope of coverage is so broad that it's difficult to Define with precision the

risks so the argument comes up whether the uniqueness of each case was something

that was contemplated and frankly, it's usually not not by either side and So that's

why good faith is something that's usually dealt with on the back end after the

interpretations have been made rather than on the front end when trying to Do the

interpretation in the first place? Mentioning the implied covenant of good faith and

fair dealing is a nice segue Into another common form of extrinsic evidence,

which is evidence of a course of performance where either party has had repeated

opportunities to perform a contract or To object to the performance of the other,

any course of performance accepted or acquiesced in without objection is given great

weight in the interpretation of the agreement. The party's conduct may demonstrate an

understanding of the agreement, and courts are often inclined to enforce that

understanding. This is not always a fair measure of the meaning of the policy,

however, because sometimes claims are so small that getting into a dispute doesn't

matter. And that's why we see the ubiquitous reservation of rights,

whether by the insured or by the insurer, and frankly mostly by the insurer,

they reserve rights to make arguments. In a different episode,

we'll deal with the efficacy of a general reservation of rights, but here,

know that reserving rights is some indication that you don't want to be bound by

the conduct in a particular case and don't want that to be applied to interpret the

policy's applicability to a different situation. For example,

occasionally an insurer will agree to coverage that it later determines it did not

afford. Now this is not a course of performance. A party is entitled to change its

mind under particular circumstances. So the fact that the insurer agreed to coverage,

usually subject to reservation rights and later determined that it did not afford

coverage is not a basis for offering that particular circumstance as evidence of

course of performance.

I've also been faced with situations where an insurer has taken an incorrect position

multiple times and the insured has acquiesced in it and in those situations it

becomes very difficult for the insured to assert a different position or a different

interpretation. That's like changing horses in the middle of the stream.

So Both sides need to be careful and need to make sure that they understand what

they're doing and what that action or conduct will do to possibly affect the

interpretation of the policy later.

The law also implies terms into an insurance policy.

A good example is the duty to investigate. So it's often alleged that after tender,

the insurance company failed to adequately investigate a matter. If the investigation

would have showed that the insurer owed a duty to defend, well then that breach of

the duty to investigate may be significant. The other side of that coin is the

insured cannot lie in wait for the insurer. So if the insured has information that

bears on coverage, the insured is duty bound to provide that information and cannot

later assert that because the insurer did not ask for it or did not adequately

investigate the case before denying a tender of defense, for example,

that the insurer has somehow acted improperly. The insured in that case,

with knowledge of the facts, is bound to bring them to the insurer's attention.

As you can see from the last two episodes of Coverage Counsel is in, the

interpretation of insurance policy can be simple or it can be quite complex.

It's simple when the words are used in their plain and ordinary sense and their

meaning is unambiguous in the circumstances of the case. The minute words start being

used in a technical or specific sense and are not defined,

or the definitions themselves become ambiguous,

interpretation problems arise because the policy then is deemed to be ambiguous.

Then there's a lot of extrinsic evidence that may be useful to determining the

proper intention of the parties, or at least what the parties thought they were

agreeing to. And perhaps in all of this, where you have large insurers who deal

regularly with insurers, the custom and practice and past dealings become particularly

important. So that's it for this episode of Coverage Counsel is in.

Thank you for listening.