A Reformation Remedy for Educators Professional Liability Insurance Policies

• Publication year: 2016

A Reformation Remedy for Educators Professional Liability Insurance Policies

Caroline Wood

A REFORMATION REMEDY FOR EDUCATORS PROFESSIONAL LIABILITY INSURANCE POLICIES

Abstract

Third-party liability insurance held by public school districts, including educators professional liability insurance and general commercial liability insurance, occupies a unique economic and political role. Coverage of tort claims against school districts and the regulatory effect of the scope of such coverage are important public policy issues. Nevertheless, the application of traditional insurance doctrine to school districts has received little attention, either from advocates for changes to the law of liability insurance or from those analyzing trends in tort liability in the public education context.

In light of public policy concerns, courts have traditionally resisted the application of insurance policy rescission to cases of application misrepresentations by school districts. Without an alternative remedy available, courts have turned to other theories, such as waiver or contra proferentem, often going so far as to decline to engage in any doctrinal analysis of the misrepresentation at issue. Furthermore, courts' attempts to avoid rescission come at the expense of insurers, who at times do not recover any of the costs incurred by even a fraudulent or material misrepresentation.

This Comment will propose a reformation remedy that acknowledges the public interest in ensuring compensation for injuries sustained by children as a result of misconduct in the course of education. A reformation remedy would clarify the body of law that has grown around school district misrepresentations by allowing courts to avoid the strained application of alternative legal theories. It would allow insurers to recover their actual losses while also providing coverage for the vulnerable plaintiffs of educational misconduct. Finally, it would ensure a more efficient liability insurance market for school districts by improving the accuracy of pricing for individual school districts and cost spreading across districts with wide disparities in resources.

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Introduction

The Second Tentative Draft of the Principles of the Law of Liability Insurance was approved at the American Law Institute (ALI) Annual Meeting in May 2014.¹ In October 2014, the project was renamed the Restatement of the Law, Liability Insurance.² The ALI Council elected to rename the project because, as ALI Director Richard Revesz explained, Restatements "seek to provide guidance to courts . . . where there is a body of established positive law.³ The project's reporters revised the previously approved chapters to better reflect the nature of a Restatement as a distillation and refinement of existing common law, and circulated the revised draft for discussion at the ALI 2015 Annual Meeting.⁴

While not binding, ALI projects, including model codes, restatements, and principles, allow "leading representatives, from all parts of the country, of the bench, the bar, and the principal law schools,"⁵ to converse with courts and legislatures on the current state of the law and proposals for reform.⁶ While some ALI projects have been more widely adopted than others, ALI projects remain at the forefront of legal synthesis and reform.⁷

The Principles of the Law of Liability Insurance offered recommendations distilled from input across the industry: the Project's advisors include judges, professors, and practitioners representing the insurance industry and policyholders.⁸ Former ALI Director Lance Liebman stated that the goal of the Principles was to draft "coherent doctrinal statements based largely on current

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state law, but also grounded in economic efficiency and in fairness to both insureds and insurers."⁹ Additionally, the project sought to reduce litigation over insurance coverage by providing a streamlined approach to policy interpretation.¹⁰ In summarizing the revisions made to adapt the Principles into a Restatement, the Reporters noted that "a few of these changes may result in the Institute supporting rules that it would not support were it writing on a blank slate," but that these compromises were justified by the "persuasive" power of a Restatement "to contribute to the improvement of the law of liability insurance."¹¹ Despite their reliance on prevailing applications of the law, Restatements are not devoid of prescriptive power; the ALI has noted that Restatements are "intended to reflect the flexibility and capacity for development and growth of the common law" and that a Restatement's choice of individual rules "leads to more coherence in the law."¹²

The Restatement's Reporter, Tom Baker, and the Associate Reporter, Kyle Logue,¹³ have published extensively on the economic and policy contours of corporate Directors and Officers Liability (D&O) coverage,¹⁴ auto insurance,¹⁵ and legal malpractice, among other third-party insurance schemes, as well as on economic and political issues including the moral hazard effects of insurance¹⁶ and insurance discrimination.¹⁷ This Comment will analyze the relationship between the Restatement's proposals and a less-understood area of liability insurance: educators professional liability insurance and commercial general liability insurance held by school districts. There has been considerable recent discussion of policy concerns undergirding tort liability for educators and school districts in specific contexts, including supervision of disabled

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students and teachers' fiduciary duties to students.¹⁸ In contrast, existing scholarship on public education does not include an analysis of the application of third-party liability insurance principles to the unique economic and policy concerns inherent in public education.¹⁹

This Comment will address this gap by analyzing the application of liability insurance doctrine to school systems in the context of application misrepresentations. The Principles suggested a number of innovative approaches to traditional insurance doctrine, almost all of which were designed to foster economic efficiency and fairness in relationships between insurers and insureds, such as individual insureds in the case of auto insurance and large public companies in the case of D&O coverage.²⁰ Chapters 1 and 2, revised in 2015 and slated for consideration by the ALI's members at the 2016 annual meeting, cover Interpretation, Waiver and Estoppel, Misrepresentation, and the Insurer's Duty to Defend.²¹

This Comment addresses §§ 7-11 of the Principles and the corresponding §§ 7-9 of the Restatement, which set forth proposals for the treatment of misrepresentations made by insureds during the application process, particularly in regard to the availability of rescission as a remedy for insurers when the applicant has made a misrepresentation in the application for the

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insurance policy.²² Rescission, which has traditionally been available for a wide range of misrepresentations under state statutes and common law, is a comprehensive remedy; not only does it allow the insurer to "avoid any liability for benefits provided under the policy, even on pending claims," it also voids the policy's existence.²³ Sections 7 through 9 define the circumstances in which the Restatement would allow misrepresentation to permit the insurer to rescind the policy.²⁴ Section 11 of the Principles suggested a quasi-reformation remedy designed to "provide more transparent and predictable protection to insureds acting in good faith than the devices presently used to limit rescission."²⁵ While acknowledging the validity of this policy concern, the Reporters determined that such an innovative approach to innocent misrepresentations was beyond the scope of a Restatement, noting that "there is not yet sufficient common-law authority to that effect despite the longstanding recognition of the unfairness of the strict-liability approach and the power of common-law courts to change common-law rules."²⁶

The Principles originally argued that the availability of rescission when the insured has made an innocent misrepresentation that is not intentional or reckless was "unfair" and "draconian" because such a mistake is "among the sorts of risks for which the policyholder purchased insurance in the first place."²⁷ critics of the strict liability approach have pointed out that, in addition to the inherent unfairness of the approach, the "fact-driven and ad hoc" doctrines courts have developed to soften the harsh outcome of rescission in particular cases are inefficient and costly for parties.²⁸ This Comment will argue that the effects of this avoidance are particularly strong in the field of

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educators professional liability policies and school districts' commercial general liability insurance policies, for which compensating those injured by the public education system is a pressing policy priority.²⁹

The Principles limited the mandatory reformation remedy to small commercial policyholders, designating the remedy as a waivable default for policyholders with assets of more than $10 million.³⁰ The Principles explained that this exemption of large commercial policyholders was rooted in the sophistication of the parties, rather than the nature of the policyholder's business, noting that "[t]he vast majority of organizations, whether operated for profit or not, that have $10 million in assets should be able to hire reasonably sophisticated advisors."³¹ The Restatement abolished the large and small commercial policyholder distinction on the grounds that such "a bright-line distinction . . . is more appropriate for a legislature or a regulatory agency."³² The Restatement's rescission remedy for innocent misrepresentations now applies to all policyholders, regardless of size.³³

This Comment will argue that school systems have little else in common with the other commercial policyholders the Restatement primarily addresses. School...