Choice of law and multiple choice - all of the above?

• Author: Cheng, Wen-Shin

EVERY claim requires, at the outset, a determination as to what state's law applies. There are vast differences in how states interpret the myriad of potential coverage issues ranging from what an insurer must consider to determine its duty to defend, what the substantive provisions of the policy mean, what are the insurer's settlement duties, and what an insurer must do to protect its rights to seek reimbursement for uncovered defense and/ or indemnity payments. This is exactly when and why choice of law is crucial when there is an actual conflict between how the potentially applicable state's laws would decide the issue. The first step for the insurer is to determine what state's law applies.

Oftentimes, a choice of law determination is made, and the insurer then proceeds to carry out its duties according to that state's laws. However, coverage issues can arise during the claims handling process, or facts might change during the claim, which can affect choice of law and which can result in application of a different state's law than the law the insurer had determined initially would apply. The insurer may be surprised to learn that courts have applied more than one state's laws to an insurer's obligations with respect to a single claim. While a comprehensive reservation of rights letter provides the insurer with a roadmap for the claim, the insurer should not assume that the choice of law determination made originally applies to other issues that arise during the case. The law that applies to interpret the insurer's duty to defend may not govern all the issues in the case, and the insurer should be aware that the place where it performs its claims handling may provide another set of applicable laws.

1. Preliminary Considerations

   The choice of law inquiry starts with determining whether the policy has an express choice of law provision. If it does, the insurer should determine whether the issue falls within the scope of the choice of law provision. If the choice of law provision is limited to matters that arise under the contract, there is a possibility it may not apply to issues that arise during the claim, which courts have characterized as place of performance, claims handling, and non-contract interpretation issues.

   If the policy does not have a governing law provision, the Restatement (Second) of Conflicts of Law [section] 6 notes, preliminarily, that "[a] court, subject to constitutional restrictions, will follow a statutory directive of its own state on choice of law." The insurer should next examine whether the state whose law might apply has a statutory directive on choice of law. There are two general types of statutory directives. The first type sets out the choice of law test to be applied. For example, California Civil Code [section] 1646 provides that "[a] contract is to be interpreted according to the law and usage of the place where it is to be performed; or, if it does not indicate a place of performance, according to the law and usage of the place where it is made." (1) California Civil Code [section] 1646 provides a statutory directive for choice of law with respect to contract interpretation issues.

   The second type of statutory directive is one that actually purports to select the governing law. An example of this type of statutory directive is found in Texas Insurance Code Article 21.42 Texas Laws Govern Policies, which provides "[a]ny contract of insurance payable to any citizen or inhabitant of this State by any insurance company or corporation doing business within this State shall be held to be a contract made and entered into under and by virtue of the laws of this State relating to insurance, and governed thereby, notwithstanding such policy or contract of insurance may provide that the contract was executed and the premiums and policy (in case it becomes a demand) should be payable without this State, or at the home office of the company or corporation issuing the same." (2) Similarly, Section 3861-10 of the South Carolina Code provides that "all contracts of insurance on property, lives, or interests in this state are considered to be made in the state ... and are subject to the laws of this state." (3)

2. The Restatement's Most Significant Relationship Test

   When there is no express choice of law provision or statutory directive, the majority of states default to a common law choice of law test, with the majority applying some form of the Restatement's test aimed at determining what state has the most significant relationship to the transaction and the parties. Notably, Section 193 of the Restatement provides that " [t] he validity of a contract of fire, surety or casualty insurance and the rights created thereby are determined by the local laws of the state which the parties understood was to be the principal location of the insured risk during the term of the policy, unless with respect to the particular issue, some other state has a more significant relationship under the principles stated in Section 6 to the transaction and the parties, in which event the local law of the other state will be applied." (4)

   While Section 193 provides that the "principal location of the insured risk" is the most important factor with respect to choice of law decisions for fire, surety or casualty insurance contracts, the insurer should still conduct an analysis that addresses other relevant factors because Section 193 contains an exception if another state has a more significant relationship with respect to the particular issue. The comments to Section 193 state that "[t]he location of the insured risk will be given greater weight than any other single contact in determining the state of the applicable law provided that the risk can be located, at least principally, in a single state." (5) Further, the comments to Section 193 note that the location of the insured risk may not be located in a single state "where the policy covers a group of risks that are scattered throughout two or more states." (6) Even under Section 193, an insurer must determine if another state has a more significant relationship to the particular issue than the state with the principal location of the insured risk and the principal location of the risk is accorded less weight if the policy covers risks in different states. Therefore, in many states, the insurer will be determining choice of law with reference to the following factors:

   (a) Place of contracting,

   (b) Place of negotiation of the contract,

   (c) Place of performance,

   (d) Location of the subject matter of the contract,

   (e) Domicile, residence, nationality, place of incorporation, and place of business of the parties. (7)

   The most significant relationship test has been described as a qualitative test and not a quantitative test. The results of the test depend upon the specific factors and the weight accorded the factors with regard to the particular issue. As the cases demonstrate, choice of law issues can be complicated when they arise during the claim and can result in an unexpected outcome because the court is being presented with a narrow issue and is looking at the factors at a discrete point in time.

   1. The Parties to the Dispute Can Affect Choice of Law

   To illustrate how choice of law can change during the claim, we examine the factor that considers the domicile, residence, nationality, place of incorporation, and place of business of the parties. The weight and balance of the most significant relationship test can change if, for example, the insured is defunct at the time of the choice of law determination.

   For example, the factors relating to the insured carried no weight to determine the law applicable to a bad faith claim when the named insured was defunct at the time the underlying claim was resolved. In American Guar. & Liability Ins. Co. v. United States Fidelity & Guar. Co., (8) the decedents' parents brought a wrongful death suit against the insured, a trucking company that operated a tractor-trailer involved in the accident. The underlying accident occurred in Missouri, but Washington law also could have applied to determine the insurer's duties and obligations because Washington was the place of contracting and negotiation, the policy had been issued to the insured in Washington, and the insured's nationwide operations were headquartered in Washington. However, at the...