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UNIGARD SECURITY INS. v. NORTH RIVER INS.

April 23, 1991

UNIGARD SECURITY INSURANCE COMPANY, INC., SUCCESSOR TO UNIGARD MUTUAL INSURANCE COMPANY, INC., PLAINTIFF,
v.
NORTH RIVER INSURANCE COMPANY, DEFENDANT.



The opinion of the court was delivered by: Sweet, District Judge.

  MODIFIED OPINION

TABLE OF CONTENTS

Prior Proceedings ......................................   571
FINDINGS OF FACT .......................................   571
  1.  The Parties ......................................   571
  2.  The Underlying Insurance Involved ................   571
  3.  The Reinsurance Certificate Issued by Unigard
        to North River .................................   572
  4.  The Asbestos Injury Crisis .......................   573
      a.  Owens-Corning's Situation ....................   574
      b.  Crum & Forster's Situation ...................   574
  5.  The Wellington Agreement .........................   575
      a.  The Facility .................................   576
      b.  The Indemnity and Expense Percentage
            Allocation Formulas ........................   576

      c.  Confidentiality of the Facility's Data .......   577
      d.  The Trigger of Insurance Coverage Under
            the Facility ...............................   577
  6.  The Termination of the Asbestos Claims Facility ..   578
  7.  Reinsurance Claims Handling at Unigard ...........   578
  8.  Communications With Respect to the Facility ......   579
  9.  Insurance Industry Custom and Practice ...........   580
      a.  Setting of Reserves ..........................   580
          i.  In general ...............................   580
          ii. Excess insurers and reinsurers ...........   581
      b.  Notice .......................................   581
          i.  To direct insurers .......................   581
          ii. To reinsurers ............................   581
      c.  Reinsurer involvement in claims ..............   581
  10. North River's Involvement with the Facility ......   582
      a.  North River's Analysis of Its Exposure .......   582
      b.  The Aetna Exhaustion .........................   582
      c.  North River's Response to the Aetna
            Exhaustion .................................   583
  11. North River's Notice on the Certificate ..........   584
  12. North River's Reserves on XS-3672 ................   584
  13. Unigard's Response to the Notice on the
            Certificate ................................   585
  14. Claims Paid Under XS-3672 ........................   585
  15. The Costs of Defense .............................   586
  16. The Stub Period XS-3672(A) .......................   586
  17. The North Shore Audit ............................   586
CONCLUSIONS OF LAW .....................................   586
  1.  Jurisdiction .....................................   586
  2.  Unigard Must Follow the Fortunes of North River
            on XS-3672 .................................   586
  3.  North River's Consent to the Wellington Agreement
            Did Not Implicate Any of the Provisions of the
            Certificate ................................   587
    a.  North River Was Not Required to Issue Notice
            When It Signed the Wellington Agreement ....   588
    b.  North River's Failure to Notify Unigard of Its
            Intent to Sign the Wellington Agreement Was
            Not Intentional ............................   588
    c.  Neither the Producer Allocation Scheme Nor the
            Use of the Triple Trigger Altered the Risk
            of the Certificate .........................   589
  4.  Unigard Cannot Escape Liability on the Grounds
            of Untimely Notice .........................   590
      a.  Notice Was Not Required Prior to March,
            1987 .......................................   590
      b.  Notice Should Have Been Sent After the
            Aetna Exhaustion ...........................   591
      c.  The Timeliness of Notice Must be Judged Under
            an Objective Standard ......................   591
      d.  Under an Objective Test, North River's Notice
            was Untimely ...............................   591
      e.  Unigard's Inability to Show Prejudice from North
            River's Late Notice Prevents it From Escaping
            Liability ..................................   592
          i.    The "no prejudice" rule in the insurance
                  context ..............................   592
          ii.   The different needs of insurers
                  and reinsurers justify applying a
                  different rule in there
                  insurance context ....................   592
          iii.  Unigard has not shown prejudice from
                  North River's untimely notice ........   593
  5.  Under the Following Form Clause Unigard Must Pay
        Expenses in Excess of the Limits of the
        Certificate ....................................   594
  6.  Unigard Owes the Full Payment for the Policy
        Period on XS-3672(A) ...........................   595
CONCLUSION .............................................   596

This diversity action involves a facultative reinsurance certificate (the "Certificate") issued by plaintiff Unigard Security Insurance Company ("Unigard") to defendant North River Insurance Company ("North River"). Unigard seeks a declaratory judgment relieving it of any obligation to indemnify North River for losses paid by North River to its insured Owens-Corning Fiberglass Corporation ("Owens-Corning"). North River by way of counterclaim seeks to recover such indemnification. Based upon the findings of fact and conclusions of law set forth below, judgment will be entered granting relief to North River on its counterclaims in accordance with this opinion.

This action is significant not only because of North River's counterclaim for over $15 million in indemnity and related expenses but also because it raises, apparently for the first time, significant issues concerning reinsurance for losses suffered by a manufacturer of asbestos and its insurer. These issues include the effect upon the "follow the fortunes" and "right to associate" clauses of the Certificate and any Unigard reinsurance obligations of the participation of Owens-Corning and North River in the Asbestos Claims Facility (the "Facility"), an instrumentality which sought on behalf of insurers and manufacturers to handle asbestos bodily injuries claims. In addition, determinations are required as to the notice of coverage required to be given by the insurer North River to its reinsurer Unigard and the timeliness of such notice and the obligation of the reinsurer for defense costs and the coverage for a stub period of the policy.

These issues are presented against the complicated factual background arising out of the mass tort asbestos litigation, which has to date defied the efforts of the courts to provide a speedy and effective resolution of the hundreds of thousands of claims brought to recover damages by injured plaintiffs and their representatives against hundreds of manufacturers and users of asbestos products throughout the nation. Traditional litigation has been so far unsatisfactory in resolving this mass tort dispute in an efficient, cost-effective and equitable manner.*fn1 The potentially overwhelming nature of this litigation is well-recognized, and the ultimate resolution of the issues presented here has the potential to affect obligations in the billions of dollars.

Prior Proceedings

This action was filed by Unigard on February 3, 1988. Discovery was had, and on July 12, 1990 an opinion was filed denying the summary judgment sought by Unigard (the "July Opinion"). That opinion described the parties and issues, and the findings contained there remain unchanged but are supplemented as set forth below.

Following the July Opinion, additional discovery was conducted, and as if the action were not complicated enough, the parties concluded that North River would assume the role of plaintiff and Unigard the role of defendant for purposes of the presentation of evidence. A bench trial was held from November 8, through November 27, 1990. Final arguments and briefs were submitted on January 18, 1991.

FINDINGS OF FACT*fn*

1. The Parties

Unigard is the successor to Unigard Mutual Insurance Company, Inc. ("Unigard Mutual") and is a Washington corporation with its principal place of business in Seattle. In 1984, it was purchased by the John Hancock Mutual Life Insurance Company.

North River is a New Jersey corporation with its principal place of business there and is a subsidiary of Crum and Forster, Inc. ("Crum & Forster").

Owens-Corning is a Delaware corporation with its principal place of business in Toledo, Ohio.

2. The Underlying Insurance Involved

North River through its agent L.W. Biegler, Inc. ("Biegler") issued two excess insurance policies to Owens-Corning in July 1974. Those policies were XS-3619, a second-layer excess policy, and XS-3672, a third-layer excess policy. Unigard reinsured XS-3672. Both policies provided coverage for, among other things, claims for asbestos-related bodily injuries.

XS-3672 provided liability insurance to Owens-Corning during each of the following policy periods: (a) July 9, 1974 to October 22, 1974 ("XS-3672(A)"); (b) October 22, 1974 to October 22, 1975 ("XS-3672(B)"); and (c) October 22, 1975 to October 22, 1976 ("XS-3672(C)"). During the periods XS-3672(A) and XS-3672(B), the policy provided excess liability insurance coverage in the amount of $30 million, as part of a $50 million coverage layer in excess of $75 million in underlying excess insurance and $1 million in underlying primary insurance for Owens-Corning losses. During XS-3672(C), the policy provided $25 million in excess coverage, with similar underlying limits. The coverage for the period XS-3672(C) is not at issue in this action.

For the policy period XS-3672(A), the underlying insurance coverages consisted of: (a) Aetna Casualty & Surety Company ("Aetna") primary insurance in the amount of $1 million; (b) The Home Insurance Company ("The Home") first-layer excess insurance in the amount of $25 million; (c) First State Insurance Company ("First State") second-layer excess insurance in the amount of $15 million; (d) Midland Insurance Company ("Midland") second-layer excess insurance in the amount of $5 million; (e) National Union Fire Insurance Company ("National Union") second-layer excess insurance in the amount of $5 million; and (f) North River second-layer excess insurance policy number XS-3619 in the amount of $25 million.

For the policy period XS-3672(B), the underlying insurance coverages consisted of: (a) Aetna primary insurance in the amount of $1 million; (b) Aetna first-layer excess insurance in the amount of $25 million; (c) First State second-layer excess insurance in the amount of $15 million; (d) Midland second-layer excess insurance in the amount of $5 million; (e) National Union second-layer excess insurance in the amount of $5 million; and (f) North River second-layer excess insurance policy number XS-3619 in the amount of $25 million.

Overall, Crum & Forster wrote approximately $1 billion of liability insurance for Owens-Corning, consisting of $710 million for indemnity and $300 million for defense costs.

3.  The Reinsurance Certificate Issued by Unigard to North
    River

Allen Miller and Associates, Inc. ("AMAI") was a managing general agent for Unigard Mutual. In July 1974, AMAI issued to North River, on behalf of Unigard Mutual, a pre-printed, standard form certificate of facultative reinsurance,*fn2 drafted by AMAI, bearing policy number 1-5143, which has given rise to the obligations at issue here. It provided reinsurance coverage to North River in the principal amount of "$5,000,000 each occurrence and in the aggregate part of" the $30 million coverage under XS-3672 for the policy periods XS-3672(A) and XS-3672(B). Originally, the Certificate also provided coverage for XS-3672(C), but this coverage was cancelled by endorsement effective October 22, 1975.

The terms of the coverage under the Certificate were printed on the back of the form. The terms relevant to this dispute provided as follows:

  A. [T]he liability of [Unigard] shall follow that
  of [North River] and, except as otherwise provided
  in this Certificate, shall be subject in all
  respects to the terms and conditions of [XS-3672]
  except as such may purport to create a direct
  obligation of [Unigard] to the original insured or
  anyone other than [North River.]
  C. Prompt notice shall be given by [North River]
  to [AMAI] on behalf of [Unigard] of any occurrence
  or accident which appears likely to involve this
  reinsurance and . . . [AMAI], directly or through
  its representatives and/or counsel, shall . . .
  have the right and be given the opportunity to
  associate with [North River] and its
  representatives at [Unigard's] expense in the
  defense and control of any claim, suit or
  proceeding which may involve this reinsurance.
  D. All claims covered by this reinsurance when
  settled by [North River] shall be binding on
  [Unigard,] who shall be bound to pay [its]
  proportion of such settlements. In addition
  thereto, [Unigard] shall be bound to pay (1) [its]
  proportion of expenses . . . incurred by [North
  River] in the investigation and settlement of
  claims or suits, and (2) [its] proportion of court
  costs, interest on any judgment or award and
  litigation expenses . . . with respect to
  reinsurance provided on an excess of loss basis,
  in the ratio that [Unigard's] loss payment bears
  to [North River's] gross loss payment. . . .

These provisions are generally referred to in the reinsurance industry and this opinion as the "following form" clause (¶ A), the "notice of loss" and "right to associate" clauses (¶ C), and the "follow the fortunes" clause (¶ D).

Unigard received one-sixth of the premiums paid to North River under both XS-3672(A) and XS-3672(B), less a standard twenty-five percent reinsurance brokerage commission.

4. The Asbestos Injury Crisis

By the early 1980's, lawsuits alleging asbestos-related bodily injuries were pending in state and federal courts in virtually every state in the union. See I. Kakalik, P. Ebener, W. Felstiner & M. Shanley, Costs of Asbestos Litigation, Pub. No. R-3042-ICJ at 13-14 (The Rand Corp., Institute for Civil Justice 1983). By the end of 1982, it was estimated that approximately $1 billion had been spent in connection with these actions, with less than 40% of the funds ever reaching the injured victims.

By 1983, nearly 25,000 lawsuits had been filed against asbestos producers and manufacturers. Kakalik et al., supra. A group of asbestos producers began exploring ways to avoid the extensive litigation which characterized their efforts to deal with the asbestos problem. Realizing that any alternative system of resolving claims would hinge on an acceptable allocation of losses among themselves, the producers retained the firm of Peterson Consulting Limited Partnership ("Peterson") to help them develop an allocation formula. After exploring several possible methods for allocating liability, such as one based on each producer's market share, the producers agreed to develop a formula which reflected each producer's history of settling and litigating asbestos claims. The percentage allocation formula which was ultimately developed was based upon the average amount that each producer had paid to settle asbestos claims as of a date before the negotiations had commenced.

In 1984, the participants in the Peterson negotiations began to discuss the formation of a joint claims handling center for all asbestos bodily injury claims. This center came to be known as the Asbestos Claims Facility ("the Facility").

a. Owens-Corning's Situation

Owens-Corning's 1982 10-K report, released in March 1983, reported that there were 15,615 asbestos bodily injury claims pending against Owens-Corning, with an average settlement per claim, based on those claims which had already been closed, of $9,858. Following the release of this report, Biegler decided not to renew North River's excess casualty insurance of Owens-Corning.

In early 1984, Owens-Corning's 1983 10-K report reported 17,468 pending asbestos bodily injury claims against it, with an average settlement for all closed claims as of December 31, 1983 of $9,968.

By early 1985, Owens-Corning's 1984 10-K reported 19,131 asbestos-related bodily injury claims pending against it as of December 31, 1984, with an average settlement for all closed claims, including "no pay" claims, of $10,454 per claim. Owens-Corning's 1985 10-K reported an average settlement of $10,708 per claim as of December 31, 1985.

b. Crum & Forster's Situation

In 1983, Ian Heap ("Heap"), senior vice-president of Crum & Forster participated in establishing the Crum & Forster Environmental Claims Unit ("ECU") to take responsibility for environmental claims for all of Crum & Forster's insurance affiliates. One of the ECU's primary tasks was to monitor and deal with the growing number of asbestos claims. Robert Clare was assigned to organize the ECU, and James Meyers ("Meyers") was hired as its first manager.

As the Peterson negotiations progressed and the concept of the Facility became more developed, Crum & Forster asked its reinsurance intermediaries to advise its reinsurers that it was giving serious consideration to joining the Facility, and to request that the reinsurers report their reactions to such a move.

In July, 1984, Meyers produced an ECU Status Report on Asbestos-Related Claims (the "Status Report") for his superiors, including Heap, in which he attempted to calculate the exposure Crum & Forster faced on asbestos claims.

The Status Report stated that "total unverified claims reported by C & F insured accounts to one or more of the insured's carriers approximates 257,807. Our records to date indicate 69,631 claims of the 257,807 have been reported to C & F companies." The Status Report listed the Owens-Corning account underwritten by Biegler, which included XS-3672, with an account rating of 2. Status Report Exhibit 1 at 6. That rating was defined as:

  Account is being actively followed as there is
  either the probability of active participation in
  the near future and/or critical information is
  required which will either cause us to be involved
  or absolved. This rating would be applied under,
  but not limited to, the following circumstances:
    1. The policy periods are current and there is a
    question of the exposure date of the claimants.
    2. The primary level below is basic and the
    claimant population is minimal.
    3. The claimant population volume is high
    regardless of the level of the primary cover.
    4. The claimant volume and the coverage limits
    below are such that the probability of our
    having to participate in the future appears
    certain.

Status Report Exhibit 4 at 1 (emphasis in original).

The Status Report also summarized the amounts of coverage written by the various Crum & Forster profit centers for various producers at various layers, and contained a detailed reinsurance treaty matrix with the amounts of asbestos coverage retained by Crum & Forster companies net of reinsurance.

In the spring of 1985, a memo produced by the ECU stated:

  a. Our 6/18/74 to 9/1/76 excess policies are
    within the initial coverage block and could
    possibly become attached, especially at the 2nd
    excess levels if we deal with the claims within
    the Facility.
  b. Insured is also involved in P.D. and
    formaldehyde litigation.
  c. Per Dan Phillips of Owens Corning, most of the
    primary coverage has been exhausted although he
    doesn't have the exact breakdown.
    Three of our excess policies effective during
    the initial block years are over $26 million and
    stand a good chance of being attached if the
    claims are handled in the Facility when the
    payments previously made are reallocated from
    the post block years. This would result in a
    charge of about $7 million for each of the 24
    years. Thus, our layers could be reached in 2 to
    3 years.
    Those same policies would be reached in about 3
    to 5 years if handled outside of the Facility.
    This depends upon the [bodily injury] claim
    volume and the exposure periods alleged and also
    the impact of the P.D. and formaldehyde
    litigation and the application of retention on
    the primary level from 1977 and forward.
  d. Whether in or out of the Facility, this account
    has the potential for our policies to be
    impacted at some time in the future.

The only two North River policies in effect during the time period referred to were XS-3619, which was second-layer excess of $26 million, and XS-3672, third-layer excess of $76 million, thus the observation concerning "three of our excess policies" which are "over $26 million" appears to refer to the three separate policy periods of XS-3619.

In August 1985, Arthur P. Kirkner ("Kirkner") became assistant vice-president of the ECU, and in September 1986 became vice-president and manager of the ECU. Kirkner was responsible for handling claims paid by the Facility on behalf of Owens-Corning, for monitoring certain files within the ECU and for supervising all claims handling staff.

5. The Wellington Agreement

The discussions among insurers and manufacturers culminated on June 19, 1985 with the execution of the Agreement Concerning Asbestos-Related Claims (the "Wellington Agreement" or the "Agreement"), to which Crum & Forster and its subsidiaries, including North River, became signatories. In addition to Crum & Forster, forty-nine other companies executed the Wellington Agreement.

The producers of asbestos-containing products that executed the Agreement (the "Subscribing Producers") included the following:

Armstrong World Industries, Inc.

The Celotex Corporation

Eagle-Picher Industries, Inc.

Fibreboard Corporation

National Gypsum Company

Owens-Corning

Pittsburgh Corning Corporation

United States Gypsum Company

In addition, many of the largest insurance companies executed the Agreement (the "Subscribing Insurers"), including the following:

Aetna

Cigna Property & Casualty Insurance Companies

The Continental Insurance Company

Employers Insurance of Wausau

Fireman's Fund Insurance Company

First State

Hartford Insurance Group

Liberty Mutual Insurance Company

Lloyd's of London and Certain London Companies

Royal Insurance Company

However, several major insurers never joined the Facility, including The Travelers, AIG Companies, Commercial Union, The Home, The Highlands, CNA, General Accident, and Allstate.

Heap, Crum & Forster's senior representative in the Wellington negotiations, wrote a memorandum dated June 21, 1985, stating:

  It was not expected that there would be unanimity
  by reinsurers in acceptance of the Agreement, nor
  was it expected that any reinsurers would be
  willing to sign a blank check for recoveries on
  asbestos-related claims, but it was necessary that
  insurers attain an acceptance by reinsurers of the
  basic principles of the Agreement and agree that
  payments made by the Facility would be seen to be
  good payments for the purpose of reinsurance
  recoveries. It was always understood that
  reinsurance recoveries for [F]acility claim
  payments would be subject to the terms and
  conditions of the treaty or certificate language,
  and it is understood that with or without the
  Facility there will inevitably be differences of
  opinion between insurers and reinsurers on such
  matters as the definition of "occurrence" and
  other coverage issues.

The Wellington Agreement resolved many of the disputes between and among the Subscribing Producers and the Subscribing Insurers and expressly preserved certain additional disputes to be resolved by arbitration, thereby removing them from the jurisdiction of the courts. These disputes included the following:

a) the existence of a defense obligation;

b) the effect of missing or cancelled policies;

c) misrepresentations in the underwriting process;

d) failure to pay premiums;

  e) the application of asbestos and asbestosis
  ...

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