Ambiguity: The Policyholder’s Best Friend

The Restatement

The Restatement addresses the common rules of insurance policy interpretation, including those pertaining to ambiguous terms in section 4, which states the following:

Topic 1 – Interpretation

(1) An insurance-policy term is ambiguous if there is more than one meaning to which the language of the term is reasonably susceptible when applied to the claim in question, without reference to extrinsic evidence regarding the meaning of the term.

(2) When an insurance-policy term is ambiguous, the term is interpreted in favor of the party that did not supply the term, unless the other party persuades the court that this interpretation is unreasonable in light of extrinsic evidence.

(3) A standard-form insurance-policy term is interpreted as if it were supplied by the insurer, without regard to which party actually supplied the term, unless the policyholder has agreed in writing to a contrary interpretive rule, in which case any term actually supplied by the policyholder will be interpreted using that contrary interpretive rule.

The comments to the section explain how this rule of interpretation should work in practice. Comment a states the oft-recited maxim that

[a]n ambiguous policy term is a term that has at least two interpretations to which the language of the term is reasonably susceptible when applied to the claim in question, without regard to extrinsic evidence. An ambiguous policy term, therefore, is a term that does not have a plain meaning in relation to the claim in question. This definition follows the traditional insurance-law approach pursuant to which the competing interpretations need not be equally reasonable. All that is required is that the language of the policy be reasonably susceptible on its face to the coverage-promoting interpretation urged by the insured.

The Restatement notes the concept of ambiguity “can include what is sometimes called vagueness,” meaning “a lack of clarity in application that does not easily reduce to multiple competing interpretations”[1] Thus, a term might have a plain meaning when applied to one claim, but not another.[2]

The Restatement notes the relationship of the rules of interpretation of ambiguous terms and the reasonable expectations doctrine. But unlike the “strong” version of the reasonable expectations doctrine—which as a rule of enforcement requires an insurance policy to be interpreted consistent with a policyholder’s reasonable expectations, even when contradicted by the insurance policy language itself—the Restatement articulation of the rule pertaining to ambiguous insurance policy language is one of interpretation, not enforcement.[3]

Under The Restatement, whether language is ambiguous must be determined without resort to extrinsic evidence or “context.” As stated in The Restatement, “[i]f there is a plain meaning, the term is not ambiguous. Extrinsic evidence may be used to rebut the presumption in favor of the plain meaning, but not in the pro-policyholder manner that can occur when a term is ambiguous on its face.”[4]

Comment d on extrinsic evidence incorporates comment f from section 3, which is about favoring plain meaning when interpreting standard-form insurance policies, and that states as follows:

Extrinsic evidence is always relevant to the determination of whether to displace the plain meaning of a term. Commonly permitted categories of extrinsic evidence relevant to the interpretation of insurance-policy terms include pre-contractual negotiations, the parties’ course of performance under the policy at issue, the course of dealing between the parties with regard to other policies, the drafting history of insurance policies, documents filed with state administrative agencies regarding an insurance policy or term, other versions of the relevant term available on the market, other forms of insurance available on the market, and expert testimony regarding topics such as the custom and practice in the insurance industry and the history, purpose, and function of policy terms and forms of insurance coverage. Because the objective of using the extrinsic evidence is to understand the meaning that a reasonable person in this policyholder’s position would ascribe to the term, such evidence may only be used against an insured when the policyholder could reasonably be expected to have been aware of it. There are differences among policyholders in this regard based on the knowledge that they reasonably should have regarding the form of insurance in question. For example, a large commercial policyholder that employs a risk manager, uses a broker (who can identify how a term varies from other versions of the term available on the market), has access to counsel (who can identify how the term has been applied by courts), and has purchased similar policies in the past may be considered to have such knowledge and understanding of the meaning of standard-form terms of insurance policies within the insurance trade as could be obtained by these agents through reasonable investigation, commensurate with the risks transferred. By contrast, individual consumer and small commercial policyholders ordinarily would not be expected to have been aware of such meanings.

Extrinsic evidence can likewise only be used against the insurer when the insurer could reasonably be expected to have been aware of it. Insurers are presumed to be sophisticated and knowledgeable about matters of insurance, including the drafting history of standard-form terms, even if the particular insurer involved was not itself involved in the drafting of that term. This presumption is consistent with how contra proferentem is applied, as ambiguous terms in standard-form policies are construed against insurers even if the particular insurer did not supply the term. Some extrinsic evidence—such as prior negotiations and course of dealing between the parties—may go to the intent of both the insurer and the policyholder and may reveal a controlling mutual intent. Extrinsic evidence of the policyholder’s subjective understanding may also be relevant to the question of whether a particular meaning urged by the insured is reasonable. For example, if the meaning proposed by the policyholder in an insurance-coverage litigation is contrary to what the policyholder subjectively understood the meaning to be when purchasing the policy, that meaning would ordinarily not be considered a reasonable meaning in the circumstances.

Comment e of The Restatement sets forth some not-uncomplicated criteria for when and how to account for the “reasonable person” during the interpretive process, and it also (unfortunately) introduces the notion of the so-called “sophisticated policyholder” into that process:

When the question is plain meaning, the inquiry focuses on identifying the single meaning that a reasonable person would assign to the language if that person had read the term reasonably carefully, recognizing that the “reasonable person” is a legal construct. See § 3, Comment e. The rules in this Section apply only when the term in question has no single plain meaning when applied to the claim in question; rather, the term is ambiguous. In this case, the question becomes whether the coverage-promoting interpretation is one that would be given to the term by a reasonable person in this policyholder’s position. With respect to this question, the court may take into account the commercial sophistication of the parties and what information such parties ought reasonably to have. Thus, for example, if a particular trade usage cuts against the policyholder’s interpretation of a term, the question ordinarily would be whether an average policyholder in this policyholder’s position would have been aware of the trade usage. If so, then the trade usage should be taken into account in the interpretive exercise; if not, then it should not be taken into account. The knowledge of the particular policyholder ought to be taken into account in some circumstances as a matter of fairness, however, so that a policyholder that actually was aware of the trade usage cannot take advantage of the fact that an average policyholder would not have been aware of it.

Although the same section will later go on to disavow the so-called “sophisticated policyholder” concept, the damage might already have been done.

Comment f talks more about “[t]he subjective understanding of the policyholder.” It notes that interpretation generally asks objective questions, such as the plain meaning of a term (although query whether this is objective—is meaning ever “plain”) or what a “reasonable” policyholder would believe about the meaning of a term. But there are exceptions. One exception is that if “both the policyholder and the insurer subjectively intended a specific meaning of a particular, ambiguous term,” then “that term could be reformed to reflect that shared understanding.” Another is that “a policyholder that expressed that specific meaning to the insurer could be estopped from asserting an alternative meaning,” And, last, “a policyholder’s actual knowledge of extrinsic evidence could be taken into account in determining whether that evidence could be used to resolve the ambiguity in situations in which a reasonable person in that policyholder’s position would not ordinarily possess such knowledge.”

After explaining the relationship to the rules of waiver and estoppel in comment g, The Restatement in comment h focuses on interpreting the term “against the supplier,” which is akin to interpreting against the drafter, but an acknowledgement that so few of the terms used in insurance policies are actually drafted fresh and anew by the parties; instead, they are supplied from an electronic database (previously a shelf) of standard terms. This is of course the rule of contra proferentem, which is justified generally as follows:

The standard justification for the contra proferentem rule builds on the idea that the supplier of a term in a contract is generally in the best position to avoid ambiguity in the wording of the term, since the supplier drafted or, at the very least, chose to offer a contract containing that term. This rationale applies especially to situations involving standard-form terms, when one party supplies the terms and the other party either accepts or rejects them but is not given the option of suggesting alternative wording. The contra proferentem rule gives the supplier of the terms the incentive to take all reasonable steps to eliminate ambiguity in the drafting of terms.

The final comments to The Restatement section discuss allocating the “risk of ambiguous terms” to insurance companies, which not only supply the terms but are in the business of spreading risk;[5] discouraging “[t]he mechanical application of” contra proferentem;[6] eliminating any “sophisticated policyholder exception,” despite what is otherwise included in comment e;[7] and the purpose of the section, which is to encourage “greater precision” in drafting terms.[8]

All in all, Restatement section 4 sets forth important and largely well-established rules of interpretation for ambiguous insurance policy terms. No doubt courts and practitioners will continue to grapple with this critical issue as they continue to attempt to discern the meaning of insurance policy terms as applied to real-life events and losses.

Recent Decisions

Whether informed by the Restatement adoption or on its own, 2018–2019 witnessed an explosion of cases finding for the policyholder on the basis of ambiguity:

· “smoke” held ambiguous in Allied Property & Casualty Insurance Co. v. Zenith Aviation, Inc.;[9]

· “indoor air” held ambiguous in Siloam Springs Hotel, LLC v. Century Surety Co.;[10]

·  “contamination” and “vandalism” held ambiguous in Cochran v. State Farm Fire & Casualty Co.;[11]

· “that particular part” held ambiguous in MTI, Inc. v. Employers Insurance of Wausau;[12]

· “majority interest rule” held ambiguous in Charter Oak Fire Insurance Co. v. American Capital, Ltd.;[13]

·  “in addition” held ambiguous in My Left Foot Children’s Therapy, LLC v. Certain Underwriters at Lloyds, London;[14]

· “arising out of” held ambiguous in AIG Property Casualty Co. v. Cosby;[15]

· pollution exclusion and hazardous or toxic materials exclusions held ambiguous in Evanston Insurance Co. v. Xytex Tissue Services;[16]

· “decay” held ambiguous in Feenix Parkside LLC v. Berkley North Pacific;[17]  

· “surface water” held ambiguous in Sosa v. Massachusetts Bay Insurance Co.;[18]

· “resident” held ambiguous in American National Property & Casualty Co. v. Burns;[19]

· “occurrence” held ambiguous in Scott Fetzer Co. v. Zurich American Insurance Co.;[20]

· “violation of statute” exclusion held ambiguous in Bullseye Restaurant, Inc. v. James River Insurance Co.;[21] and

· “policy period” held ambiguous in Attorneys Insurance Mutual Risk Retention Group, Inc. v. Liberty Surplus Insurance Corp.[22]

Of these 14 cases (and it is likely there are more; these are only cases reported nationally), seven are from federal courts of appeals, most of which reverse lower courts’ findings of unambiguity.

Allied Property & Casualty Insurance Co. v. Zenith Aviation, Inc.[23] is an illustrative case. It concerned a first-party policy and a release of concrete dust by a third party that damaged the insured’s property. The insurance policy had a pollution exclusion that applied to irritants and contaminants but did not apply to specified causes of loss, which included smoke. As a result, the insurance company asserted that the concrete dust was an irritant or contaminant, while the insured alleged that it was smoke. The argument that concrete dust is smoke may not at first blush seem like a winner.

The court commenced by citing the rules of insurance policy construction, including, as noted above, that ambiguities must be construed in favor of coverage. The insured contended that “smoke” was ambiguous because the policy did not define it. The lack of a definition is often the foundation for a finding of ambiguity. The court resorted to a dictionary, as courts frequently do, in determining the interpretation of an ambiguous term. This was not fully helpful because both parties chose definitions of “smoke” that favored their position. Based on the dictionary definitions, the court concluded, “The issue, then, is whether ‘smoke’ as used in the Pollution Exclusion is limited to smoke caused by ‘the gaseous products of burning materials’ [insurer’s position], or more generally to all visible ‘suspensions of particles in a gas’ [insured’s position].”[24]

The insurance company argued that its definition was the term’s more common usage. Most people would probably consider the term “smoke” to be “the gaseous products of burning materials.” However, the court found that “[t]he applicable definition of ‘smoke’ as used in the Pollution Exclusion is unclear, with more than one reasonable definition.”[25] The court therefore held that it would adopt the definition favoring coverage and that the concrete dust was smoke.[26]

Siloam Springs Hotel, LLC v. Century Surety Co.[27] is another instructive case. It concerned a situation where several guests at a hotel were injured as a result of carbon monoxide poisoning arising from the indoor swimming pool. The insurance company denied coverage based on an exclusion for “qualities or characteristics of indoor air.” The district court held that the exclusion unambiguously precluded coverage. The Tenth Circuit reversed on the ground of ambiguity.

That court found that “[p]erhaps the exclusion could be interpreted to refer to any substance that is ever found in the air. . . .”[28] However, the court also found that “the exclusion may also be reasonably interpreted to refer only to an inherent feature or other longer-lasting trait of the air.”[29] This is not necessarily a clear distinction. However, the court held that the exclusion was ambiguous and that the policyholder was entitled to coverage.

“Indoor air” is not an obviously ambiguous term. Neither is “smoke.” These cases underscore that policyholders must look creatively at policy language in the context of the facts before them.

In MTI, Inc. v. Employers Insurance of Wausau,[30] the appeals court reversed the district court’s finding that the phrase “that particular part” was unambiguous. The case concerned whether the “that particular part” clause in the insurance policy referred to the anchor bolts on which the insured was working or the entire structure. The Tenth Circuit recited Oklahoma’s law that “[a] provision is ambiguous if it is facially susceptible to two interpretations, considered from the standpoint of a reasonably prudent layperson.”[31] The court then found as follows:

Under Oklahoma law, it is the responsibility of the insurer desiring to limit liability to employ clear language in the contract. Haworth v. Jantzen, 172 P.3d 193, 197 (Okla. 2006). Wausau has failed to do so in this case. The phrase “that particular part” could be read to refer solely to the direct object on which the insured was operating. Alternatively, it could apply to those parts of the project directly impacted by the insured party’s work. We agree with those courts that have held the former interpretation is a reasonable one, although we acknowledge that the latter is also reasonable. Because both readings are permissible, the exclusions are facially ambiguous. Cranfill v. Aetna Life Ins. Co., 49 P.3d 703, 706 (Okla. 2002)].[32]

The court found that “interpreting ‘that particular part’ to refer to the distinct components upon which work is performed best comports with [Oklahoma’s] rules of interpretation.”[33] However, the court found that in other circumstances, the phrase would not be ambiguous.[34] The argument that the insurance company, and not the insured, should be penalized for unclear language is a foundation stone of the doctrine of ambiguity.

If the Policy Term Is Ambiguous, Does the Policyholder Automatically Win?

The general rule is that if a policy term is ambiguous, the court must adopt the meaning most favorable to coverage. However, this is not always the case.

Cochran v. State Farm Fire & Casualty Co.[35] concerned the aftermath of the operation of a methamphetamine lab by a renter of a house that left the house uninhabitable because of amphetamine residue. The insurance policy provided coverage for vandalism but excluded contamination. Not surprisingly, State Farm asserted that the residue constituted a contaminant, while the insured argued that the vandalism coverage applied.

In an order filed on August 22, 2018, the court found that the policy language was ambiguous and that the policy defined neither vandalism nor contamination. As a result, the court found “the classification of damages from the operation of a meth lab open to multiple interpretations.”[36] The court further stated that it would construe the policy strictly against the drafter, and that if State Farm meant to exclude this damage, it could have clearly defined vandalism and contamination.[37]

From a policyholder’s point of view, the court used all of the right “buzz words” but reached the wrong conclusion. The court concluded that it was unable to resolve the ambiguity and that neither party had conclusively established its position. The court therefore denied both parties’ motions for summary judgment and held that a jury had to decide the issue. Here, the court committed error. If a policy term is ambiguous and both sides proffer reasonable interpretations, then the court must choose the construction that favors coverage.[38]

Context is everything.

Policyholders should not just look at whether a particular word or term in and of itself is ambiguous. Courts have found that terms that appear unambiguous in most contexts and common usage are ambiguous in view of the structure of the insurance policy and the surrounding facts. As MTI found, a phrase can be unambiguous in certain contexts but ambiguous in others. In Sosa v. Massachusetts Bay Insurance Co.,[39] the New Jersey Appellate Division faced a broken water-main pipe that caused water to flow onto the street and then into the insured’s home. The insurance company denied coverage in part based on a surface water exclusion. “Surface water” may be unambiguous in many contexts, such as lakes, rivers, and streams. However, in the circumstances of water flowing above ground as the result of a water-main break, the court found the term “surface water” ambiguous.[40]

It is not only the factual context that matters. An insured can also rely on inconsistencies in the policy or even between the policy in issue and other policies. AIG Property Casualty Co. v. Cosby[41] concerned a primary insurance policy that contained a sexual misconduct exclusion that used the clause “arising out of. . . .” The coverage issue was whether the exclusion applied to claims of defamation that arose out of underlying allegations of sexual misconduct. The court found that Massachusetts law “did not supply an easy answer. . . .”[42] However, the umbrella policy issued by the same insurance company had a sexual misconduct exclusion that had the clause “arising out of, or in any way involving, directly or indirectly. . . .” The court found that “the presence of another, more broadly worded sexual-misconduct exclusion in the umbrella policy tips the scales in favor of finding ambiguity.”[43] Showing alternate language from another insurance policy that sets forth an exclusion in different, clearer language is an important tool in demonstrating ambiguity.

Conclusion

Ambiguity has always been a useful, indeed often dispositive, weapon for policyholders. The Restatement’s treatment of ambiguity and the large volume of recent case law increase its importance. It is imperative that in every case policyholder counsel carefully and creatively analyze the language of the insurance policy in the context of the particular facts of the case to determine whether an ambiguity exists.

Robert Chesler and Nicholas Insua are with Anderson Kill, Newark, New Jersey.

[1] Restatement of the Law of Liab. Ins. § 4 cmt. a.

[2] Restatement of the Law of Liab. Ins. § 4 cmt. a.

[3] Restatement of the Law of Liab. Ins. § 4 cmt. b.

[4] Restatement of the Law of Liab. Ins. § 4 cmt. c.

[5] Restatement of the Law of Liab. Ins. § 4 cmt. i.

[6] Restatement of the Law of Liab. Ins. § 4 cmt. j.

[7] Restatement of the Law of Liab. Ins. § 4 cmt. k.

[8] Restatement of the Law of Liab. Ins. § 4 cmt. l.

[9] Allied Prop. & Cas. Ins. Co. v. Zenith Aviation, Inc., 336 F. Supp. 3d 607 (E.D. Va. 2018).

[10] Siloam Springs Hotel, LLC v. Century Sur. Co., 906 F.3d 926 (10th Cir. 2018).

[11] Cochran v. State Farm Fire & Cas. Co., No. 1:17-cv-0984-SCJ (N.D. Ga. Aug. 22, 2018).

[12] MTI, Inc. v. Emp’s Ins. of Wausau, 913 F.3d 1245 (10th Cir. 2019).

[13] Charter Oak Fire Ins. Co. v. Am. Capital, Ltd., No. 17-2015, No. 17-2068, 2019 U.S. App. LEXIS 3687 (4th Cir. Feb. 6, 2019).

[14] My Left Foot Children’s Therapy, LLC v. Certain Underwriters at Lloyds, London, 731 F. App’x 659 (9th Cir. 2018).

[15] AIG Prop. Cas. Co. v. Cosby, 892 F.3d 25 (1st Cir. 2018).

[16] Evanston Ins. Co. v. Xytex Tissue Servs., No. CV 117-140, 2019 U.S. Dist. LEXIS 51668 (S.D. Ga. Mar. 27, 2019).

[17] Feenix Parkside LLC v. Berkley N. Pac., 438 P.3d 597 (Wash. Ct. App. 2019).

[18] Sosa v. Mass. Bay Ins. Co., No. A-5349-16T3, 2019 N.J. Super. LEXIS 52 (N.J. Super. Ct. App. Div. Apr. 24, 2019).

[19] Am. Nat’l Prop. & Cas. Co. v. Burns, No. 18-8006, 2019 U.S. App. LEXIS 11846 (10th Cir. Apr. 23, 2019).

[20] Scott Fetzer Co. v. Zurich Am. Ins. Co., No. 18-3057, 2019 U.S. App. LEXIS 13023 (6th Cir. Apr. 30, 2019).

[21] Bullseye Rest., Inc. v. James River Ins. Co., No. 17-CV-2996 (DRH)(GRB), 2019 U.S. Dist. LEXIS 77701 (E.D.N.Y. May 8, 2019).

[22] Attys. Ins. Mut. Risk Retention Grp., Inc. v. Liberty Surplus Ins. Corp., No. 17-55597, 2019 U.S. App. LEXIS 4661 (9th Cir. Feb. 15, 2019).

[23] Allied Prop. & Cas. Ins. Co. v. Zenith Aviation, Inc., 336 F. Supp. 3d 607 (E.D. Va. 2018).

[24] Zenith Aviation, Inc., 336 F. Supp. 3d at 613 (citation omitted).

[25] Zenith Aviation, Inc., 336 F. Supp. 3d at 613 (citation omitted).

[26] Zenith Aviation, Inc., 336 F. Supp. 3d at 614.

[27] Siloam Springs Hotel, LLC v. Century Sur. Co., 906 F.3d 926 (10th Cir. 2018).

[28] Siloam Springs Hotel, 906 F. 3d at 933.

[29] Siloam Springs Hotel, 906 F. 3d at 933.

[30] MTI, Inc. v. Emp’rs Ins. of Wausau, 913 F.3d 1245 (10th Cir. 2019).

[31] MTI, 913 F.3d at 1249.

[32] MTI, 913 F.3d at 1250.

[33] MTI, 913 F.3d at 1250.

[34] MTI, 913 F.3d at 1251.

[35] Cochran v. State Farm Fire & Cas. Co., No. 1:17-cv-00984-SCJ (N.D. Ga. Aug. 22, 2018).

[36] Cochran, No. 1:17-cv-00984-SCJ, slip op. at 10–11.

[37] Cochran, No. 1:17-cv-00984-SCJ, slip op. at 12.

[38] See, e.g., Allied Prop. & Cas. Ins. Co. v. Zenith Aviation, Inc., 336 F. Supp. 3d 607, 611 (E.D. Va. 2018) (applying Virginia law).

[39] Sosa v. Mass. Bay Ins. Co., No. A-5349-16T3, 2019 N.J. Super. LEXIS 52 (N.J. Super. Ct. App. Div. Apr. 24, 2019).

[40] Sosa, 2019 N.J. Super. LEXIS 52, at *13.

[41] AIG Prop. Cas. Co. v. Cosby, 892 F.3d 25 (1st Cir. 2018).

[42] Cosby, 892 F.3d at 28.

[43] Cosby, 892 F.3d at 28.

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