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UNITED FIRE & CAS. CO. v. ARKWRIGHT MUT. INS. CO.

June 30, 1999

UNITED FIRE & CASUALTY COMPANY; GUARANTY NATIONAL INSURANCE COMPANY; SPHERE DRAKE INSURANCE PUBLIC LIMITED COMPANY; TERRA NOVA INSURANCE COMPANY LIMITED; RIVER THAMES INSURANCE COMPANY LIMITED; UNI STOREBRAND INSURANCE COMPANY (U.S.) LIMITED; AND AXA REINSURANCE COMPANY, PLAINTIFFS,
v.
ARKWRIGHT MUTUAL INSURANCE COMPANY, DEFENDANT.



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

OPINION

Plaintiffs United Fire & Casualty Company, Guaranty National Insurance Company; Sphere Drake Insurance Public Limited Company, Terra Nova Insurance Company Limited, River Thames Insurance Company Limited, and Uni Storebrand Insurance Company (U.K.) Limited (the "Western Re Reinsurers"), and Axa Reinsurance Company (hereinafter "Axa Re" and collectively the "Plaintiffs"), have moved under Rule 56, Fed.R.Civ.P. for summary judgment to declare that the Certificates of Facultative Insurance do not reinsure the Extended Period of Indemnity Endorsement contained in the insurance policy issued by defendant Arkwright Mutual Insurance Company ("Arkwright") to the Warnaco Group Inc. ("Warnaco") and that the liability of the Plaintiffs is limited to $1,036,501. Upon the following findings of fact and conclusions of law, the Plaintiffs' motion is granted.

The Issue

Here the earthquake damages suffered by Warnaco, Arkwright's insured, require a resolution of the meaning and effect of the documents and practices governing the reinsurance obtained by Arkwright from the Plaintiffs as to whether or not Business Interruption endorsement to a policy ("BI") includes an Extended Period of Indorsement provision ("EPI"). Because there are no material facts at issue since the specific must control over the general, and because the duty of utmost good faith falls principally upon the ceding insurer, summary judgment in favor of the Plaintiffs, though not easily arrived at, is appropriate. Despite the difficulty of the issues, skilled counsel for both sides have made the task of resolution if not easy, at least comprehensible.

Prior Proceedings

This action was commenced on June 4, 1997 by the filing of a complaint by the Plaintiffs setting forth two causes of action, the first seeking rescission of the Certificates of Facultative Reinsurance which they had issued on the grounds that Arkwright obtained its reinsurance through the misrepresentation of material facts, and the second seeking a declaratory judgment that the Extended Period of Indemnity Endorsement contained in the Arkwright policy of insurance issued to Warnaco was not reinsured by Plaintiffs and that the Plaintiffs are not liable under their Certificates of Facultative Reinsurance. An answer was filed and discovery was taken.

On January 22, 1999, the Plaintiffs filed the instant motion seeking summary judgment on their second cause of action and a declaration that their liability is limited to $1,036,501. The motion was marked fully submitted on March 24, 1999.

FINDINGS OF FACT

The facts found below are based upon the statements submitted by the parties in accordance with Rule 56.1 of the Civil Rules of the Rules of the United States District Courts for the Southern and Eastern Districts and are not in dispute except as noted.

The Participants

Warnaco is a manufacturer and distributor of apparel. Warnaco's Olga Division manufactures and distributes women's undergarments. Its Olga Division's finishing and distribution center was located in Sylmar, California.

Arkwright issued to Warnaco a first-party property damage and business interruption insurance policy, No. 06020044, effective January 18, 1993 to January 18, 1996, covering Warnaco's property throughout the United States and Mexico, including its Sylmar, California location ("the Warnaco Policy").

Balis & Co., Inc. ("Balis") is a reinsurance intermediary whose function is to place facultative reinsurance with reinsurers on behalf of Arkwright. It placed facultative reinsurance for the Warnaco Policy with Western Re and Axe Re.

Axa Re is a reinsurer who issued to Arkwright a certificate of facultative reinsurance, No. P11260/93, effective March 1, 1993 to March 1, 1994, reinsuring portions of the Warnaco Policy (the "Axa Re Certificate of Facultative Reinsurance"). The Western Re Reinsurers, are reinsurers who issued to Arkwright a certificate of facultative reinsurance, No. WRE113435, effective March 1, 1993 to March 1, 1994, reinsuring portions of the Warnaco Policy (the "Western Re Certificate of Facultative Reinsurance").

Western Re/Managers ("Western Re") is the managing general agent for the Western Re Reinsurers for the purpose of underwriting facultative reinsurance and issuing certificates of facultative reinsurance on their behalf. Western Re issued the Western Re Certificate of Facultative Reinsurance on behalf of the Western Reinsurers.

The Warnaco Policy

The Warnaco Policy is an all-risk property insurance policy insuring property owned or operated by Warnaco at scheduled locations throughout the United States and Mexico. The Warnaco Policy covers property damage and business interruption loss caused by any insured peril, including fire, windstorm, vandalism, earthquake and flood.

Arkwright standard policy Form No. 3200-the Business Interruption Endorsement ("BI"), provided the basic business interruption coverage in the Warnaco Policy and covers the policyholder for its business interruption loss sustained during the "period of interruption," which is defined as the time necessary to repair or replace property damaged by an insured peril.

Arkwright standard policy Form No. 3213, the Extended Period of Indemnity Endorsement ("EPI"), was included in the Warnaco Policy and provided extended business interruption coverage.

EPI covers remote business interruption losses and losses of market share occurring beyond the basic period of interruption, losses which are not insured under Form No. 3200 of the Warnaco Policy. The EPI endorsement extended the period of interruption in the Warnaco Policy for an additional 270 consecutive days beyond the time afforded by the basic business interruption coverage in form No. 3200.

Arkwright charged Warnaco an additional premium of $51,793 for adding the EPI endorsement to the Warnaco Policy.

The Warnaco Earthquake Loss

The Northridge, California earthquake of January 17, 1994 damaged Warnaco's Sylmar, California location and as a result Warnaco sustained business interruption losses which were covered by the Warnaco Policy. The business interruption loss sustained by Warnaco under Arkwright standard policy Form No. 3200, the Business Interruption Endorsement was $12,664,243. This represents the amount of business interruption loss sustained by Warnaco during the seven months between the date of the earthquake (January 17, 1994) and the time that the Sylmar facility was ready to be reoccupied (July 1994). Warnaco's business interruption loss sustained under Arkwright Form No. 3213, the Extended Period of Indemnity Endorsement was $5,726,998. This represents the amount of business interruption loss sustained by Warnaco in the 270 days subsequent to July 1994, ending in April 1994 and resulted primarily from the difficulty in recategorizing stock and the consequent inability to fill orders and a resultant loss of market share.

The costs of the move, relocation, reestablishment of Warnaco's operations, loss of business, and lost profits, comprise the business interruption loss known as the "Warnaco Loss."

The extent of the Warnaco loss was unexpected. It took two major accounting firms (one hired by Warnaco and one by Arkwright), a team of adjusters, and numerous Warnaco and Arkwright staff over two years to calculate the extent of the business interruption loss sustained by Warnaco.

In recognition that the loss, although unforeseen, was covered by the Warnaco policy, Arkwright adjusted the loss and negotiated a settlement with Warnaco in which the loss was agreed to be $18,371,241, the deductible was negotiated to be $5,571,241, and Arkwright agreed to pay Warnaco $12,800,000. Certain of the Plaintiffs paid interim payments without objection prior to the time the extent of the Warnaco loss was known.

The Reinsurance Claim

By July 12, 1995, the Plaintiffs were provided with notice of a potential claim by Arkwright for payment of their share of the Warnaco Loss resulting from the Northridge earthquake.

By July 20, 1995, Plaintiffs had received loss estimates of the Warnaco Loss from Arkwright's adjusters, which noted the existence of the Warnaco Policy's extended period of indemnity for business interruption losses, and the potential for a loss within that period. They made no objection or statement that they did not reinsure EPI.

In September 1995, Plaintiffs received copies of loss adjusters' reports prepared a year earlier which specified that Warnaco's business interruption loss had an EPI component with a negative balance of $(570,129). By September 27, 1995, the Plaintiffs were sent proofs of loss and asked to pay their share of interim payments made by Arkwright to Warnaco for the business interruption loss, including its EPI component.

On October 19, 1995, the Arkwright report showed an estimated EPI loss of $2 million and in November 1995, Western Re approved the bills for payment, and Plaintiffs agreed to pay them. Western Re also recommended, through its claims agent, that the Western Re Plaintiffs reserve for their share of the full amount of potential loss to their layer, then $7 million.

In December 1995, as the loss predictions approached $12 million ($7 million to the reinsurance layer in which Plaintiffs provided 50% of the reinsurance), the Plaintiffs for the first time sent a reservation of rights letter raising objections to the billings for losses during the EPI.

Under their certificates of Facultative Reinsurance in effect at the time of the earthquake, the Western Re Reinsurers and Axa Re collectively reinsured $5 million part of $10 million of reinsured losses in excess of $5 million.

Arkwright made claim to the Plaintiffs under the Certificates of Facultative Reinsurance for their alleged 50 percent share of Arkwright's $12.8 million payment to Warnaco in excess of $5 million (i.e. 50 percent of $7.8 million, or $3.9 million), which payment includes compensation ...


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