Commercial Union Insurance v. Swiss Reinsurance America Corp.

United States Court of Appeals
For the First Circuit
No. 04-1709

COMMERCIAL UNION INSURANCE COMPANY and
AMERICAN EMPLOYERS’ INSURANCE COMPANY,

Plaintiffs, Appellants,

v.

SWISS REINSURANCE AMERICA CORPORATION,

Defendant, Appellee.

APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS

[Hon. Douglas P. Woodlock, U.S. District Judge]

Before
Boudin, Chief Judge,
Torruella, Circuit Judge,
and DiClerico,* District Judge.

Carter G. Phillips with whom William M. Sneed, Stephen C.
Carlson, Sidley Austin Brown & Wood L.L.P., Richard A. Johnston and
Wilmer Cutler Pickering Hale and Dorr LLP were on brief for
appellants.
Edward P. Krugman, Cahill Gordon & Reindel LLP, Eric S.
Kobrick, Associate General Counsel, American International Group,
Inc., on brief for The Member and Affiliated Companies of American
International Group, Inc., Amici Curiae.
David A. Attisani with whom John A. Nadas, Robert A. Kole and
Choate, Hall & Stewart were on brief for appellee.

June 27, 2005

*
Of the District of New Hampshire, sitting by designation.
 BOUDIN, Chief Judge. This is a dispute between an

insurance company--Commercial Union Insurance Company ("Commercial

Union")--and one of its reinsurers, Swiss Reinsurance America

Corporation ("Swiss Re"). The principal issue is whether, under

several three-year reinsurance policies, Swiss Re was protected by

a single per-occurrence limit on its liability for the three-year

policy period or whether the limit applies separately for each

policy year, thereby enlarging Swiss Re's total exposure.

The background events involve three different tiers of

insurance, coverage periods that do not precisely overlap between

tiers, and pertinent clauses that are not even identical from one

policy to its successor. Accordingly, in setting the stage, some

oversimplification as to the policies and some postponement of

detail are both necessary. We begin at the ground floor with the

insured, W.R. Grace & Co. ("Grace"), a well-known company with many

different facilities at different locations, and then work up

through the tiers.

As to the sites at issue in this case, Grace's primary

insurer during the period in question (roughly 1962 to 1974) was

Maryland Casualty Co. (“Maryland”). With a one-year exception that

is not important to our case, that company provided coverage to

Grace under five successive one-year policies between June 30,

1962, and June 30, 1967, and two three-year policies from June 30,

1967, to June 30, 1973. The policies covered personal injury and

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property damage up to $1 million per occurrence but with much lower

limits ($25,000, later $100,000) for losses from "gradual

pollution."

Between October 20, 1962, and June 30, 1974, Commercial

Union's predecessors in interest provided excess liability coverage

to Grace--that is, coverage starting at the point that the Maryland

policies left off--in the form of four successive multi-year

umbrella policies. (The first, second and fourth policies each ran

for three years; the third ran for about two years and eight

months.) The policies provided coverage in the amount of $5

million for each "occurrence," defining "occurrence" to include “an

event, or continuous or repeated exposure to conditions, which

unexpectedly results in personal injury [or] property damage”

during the policy period, and continued:

[A]ll personal injury and property damage . .
. arising out of one event or continuous or
repeated exposure to substantially the same
general conditions existing at or emanating
from one premises location shall be deemed to
be one occurrence.

The Commercial Union policies also included clauses,

known as "follow-the-form" clauses, that are designed to make

coverage under a higher-tier policy (here, Commercial Union's)

conform--subject to certain qualifications--to the coverage

provided by the underlying policy (here, Maryland’s policies). See

2 Ostrager & Newman, Handbook on Insurance Coverage Disputes §

13.01[a], at 868 (12th ed. 2004). Thus, in the first two policies,

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the follow-the-form language provided that "the terms, conditions

and limitations of this policy will not be construed any more

restrictive [sic] than the terms, conditions and limitations of

Underlying Insurance.” The latter two provided:

[s]uch coverage as is afforded by this policy
shall apply to occurrences covered by the
terms and conditions of [the underlying
policy] or by the terms of conditions of this
policy except that the definition of Property
Damage as contained in this policy shall
apply.

The top tier of coverage in this case was provided by

Swiss Re, which offered not insurance for Grace but "reinsurance"

to Commercial Union. Swiss Re agreed, under specified conditions,

to indemnify Commercial Union for specified losses it might suffer

under its excess insurance policies. The form of reinsurance used,

called "facultative," covers risks that the "cedent" (here,

Commercial Union) bears under a specific policy or policies. 2

Ostrager & Newman, supra, § 15.03[a], at 996-97.

Swiss Re issued three multi-year "certificates" to

Commercial Union, corresponding to each of the last three (out of

a total of four) multi-year excess liability policies that

Commercial Union had written for Grace, i.e., roughly for the

period 1965 to 1974. Each Swiss Re certificate was skeletal,

identifying the Commercial Union excess liability policy in

question and agreeing to share a specified portion of Commercial

Union's liability to Grace. Specifically, under the first

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certificate Swiss Re agreed to share 50 percent of Commercial

Union's first $1 million in loss for "each occurrence"; under the

second, 50 percent of the first $500,000; under the third, 37.5

percent of the first $500,000.

Each certificate contained on the back side several

standard conditions. These included variously phrased follow-the-

form clauses saying that--except as “otherwise specifically

provided” in the certificate--Swiss Re’s liability would “follow”

or “be subject” to the “terms and conditions” of Commercial Union’s

policies. Thus, through follow-the-form clauses, Swiss Re's

policies looked back to Commercial Union's, and the latter's

policies looked back to Maryland's policies with Grace.

In addition, the Swiss Re certificates contained "follow-

the-fortunes" provisions, which--where the case involves

settlements--are sometimes called “follow-the-settlements” clauses.

Such provisions are designed to give the cedent reasonable latitude

to settle claims against it by the primary insured and to bind the

reinsurer (in some measure) from contesting the extent of the

cedent's liability to the primary insured. See Ostrager &

Vyskocil, Modern Reinsurance Law & Practice §§ 9.01-.02 (1996);

Travelers Cas. & Sur. Co. v. Certain Underwriters at Lloyd's of

London, 760 N.E.2d 319, 328 (N.Y. 2001). Here, the follow-the-

fortunes clause in each certificate reads as follows:

All claims involving this reinsurance, when
settled by [Commercial Union], shall be

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 binding on [Swiss Re], which shall be bound to
pay its proportion of such settlements
promptly following receipt of proof of loss.

In the 1980s, Grace began to notify Commercial Union of

potential property damage losses due to hazardous waste pollution

at various Grace sites. In 1988, Maryland filed a declaratory

judgment action in federal district court in New York against Grace

seeking to clarify Maryland's obligations under its primary

policies. See Md. Cas. Co. v. Cont’l Cas. Co., 332 F.3d 145, 148-

49 (2d Cir. 2003). Commercial Union and other insurers were added

to the suit, and eventually the case expanded to involve over 200

waste sites.

In October 1998, Commercial Union settled with Grace

based on information about nine “focus” waste sites (out of the

forty for which Grace claimed Commercial Union was liable), for a

single immediate payment of $57.6 million. The settlement was

premised on estimates of projected liability over a substantial

period due to damage at each site and on certain assumptions. Two

such assumptions were (1) that the hazardous waste liability at

each site should be allocated pro rata across the years of relevant

insurance coverage at each site and (2) that the $5 million per-

occurrence limit in each policy should be viewed as applying

separately to each policy year, i.e., $15 million for a three-year

policy.

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 When Commercial Union then sought indemnity from Swiss Re

for $13.7 million (out of the $57.6 million paid to Grace), Swiss

Re paid less than half that amount. It withheld part of the

balance (about $6 million) on the ground that its reinsurance

certificates protected it from any calculation of Commercial

Union's liability to Grace, or Swiss Re's to Commercial Union,

premised on the notion that the per-occurrence limit applied

separately to each policy year (as opposed to the entire multi-year

policy period). Swiss Re also disputed another aspect of the

demand but that issue was apparently settled.

On cross-motions for summary judgment, the district court

concluded that Swiss Re was correct on the "annualization" issue.

The court held that Swiss Re's liability should be based on the

premise that the per-occurrence limit applied once to a continuing

leakage at a site over the multi-year policy period and not once

for each year of the period. The court deemed this to be an

explicit limit in each certificate, overriding any follow-the-form

or follow-the-fortunes provision. This appeal by Commercial Union

followed.

We review a grant of summary judgment de novo.

Commercial Union Ins. Co. v. Walbrook Ins. Co., 7 F.3d 1047, 1050

(1st Cir. 1993). The present contract-interpretation dispute is

governed either by the substantive law of New York or

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Massachusetts.1 Further, interpretation of an insurance contract

is--at least absent extrinsic evidence--a question of law for the

court. See Fishman v. LaSalle Nat’l Bank, 247 F.3d 300, 303 n.2

(1st Cir. 2001). Accord Lumbermens Mut. Cas. Co. v. Offices

Unlimited, Inc., 645 N.E.2d 1165, 1168 (Mass. 1995); Sutton v. E.

River Sav. Bank, 435 N.E.2d 1075, 1077-78 (N.Y. 1982).

In a dispute between insurers and reinsurers, certain

canons of construction that protect purchasers of direct insurance

policies do not apply. Unigard Sec. Ins. Co. v. N. River Ins. Co.,

4 F.3d 1049, 1065 (2d Cir. 1993); Boston Ins. Co. v. Fawcett, 258

N.E.2d 771, 776 (Mass. 1970). Both New York and Massachusetts

authorities recognize the operation of follow-the-form and follow-

the-fortunes clauses. See Commercial Union Ins. Co. v. Seven

Provinces Ins. Co., 217 F.3d 33, 42 (1st Cir. 2000), cert. denied

531 U.S. 1146 (2001); Aetna Cas. & Sur. Co. v. Home Ins. Co., 882

F. Supp. 1328, 1337, 1345-46 (S.D.N.Y. 1995); Metro. Leasing, Inc.,

v. Pac. Employers Ins. Co., 633 N.E.2d 434, 439 & n.6 (Mass. App.

Ct. 1994). Against this background we turn to the merits of the

dispute.

1
The district court determined that the substantive law of
either Massachusetts or New York governed the dispute, and that the
two did not differ in any pertinent respect. The parties do not
dispute this assessment and, the approach being colorable, we
follow suit. See Royal Bus. Group, Inc. v. Realist, Inc., 933 F.2d
1056, 1064 (1st Cir. 1991); see also Lexington Ins. Co. v. Gen.
Accident Ins. Co. of Am., 338 F.3d 42, 46 (1st Cir. 2003).

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 A good deal about this case, in addition to the ill-

worded policies and certificates themselves, remains obscure.

Ordinarily, courts construe policy language in relation to specific

facts, the policy language drawing meaning in part through

interaction with a given fact pattern. Here, by contrast, the

briefs tell us very little about what went wrong at any site,

although the record modestly describes the actual conditions that

gave rise to liability.2 Seemingly the conditions varied.

On Swiss Re's view of the matter, the leakage at any one

site during the three-year period covered by its certificate

comprised a single "occurrence." The term "occurrence" is not

defined in the Swiss Re certificates but one plausible reading of

the term would treat the entire continuous leakage as a single,

albeit drawn out, occurrence; and, for such a reading Swiss Re can

point to the definition of "occurrence" in the Commercial Union

policies quoted above--namely, that continuous exposure to the same

condition "shall be deemed to be one occurrence."

If the leakage during the three-year period comprised one

occurrence, then Commercial Union's liability to Grace for a three-

year leak would be capped at $5 million and Swiss Re's liability to

2
These included landfills, leaking chemical drums,
contaminated lagoons and asbestos-contaminated soil, abandoned
drums of industrial waste and leaking storage tanks, plant
operations that involved ammonia wastewater being disposed of in
unlined pits or injected directly into the ground, improper
disposal of pesticide residue, inadvertent spreading of dry waste
particles, and buried radioactive rubble.

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Commercial Union would be $500,000 (50 percent of the first $1

million). By contrast, if leakage during each year in the three-

year period were treated as a separate occurrence, or (put

differently) the cap applied year by year, Swiss Re could be liable

for $1.5 million ($500,000 times three). The settlement with Grace

assumed the latter view of the matter.

If the question were considered as a mechanical exercise

in language--without the aid of “follow” clauses or policy

arguments--Swiss Re might well have the stronger argument, just as

the district court found. The policy period is three years, the

continuous release of the one pollutant at one site can easily be

described as one occurrence. So Swiss Re could be seen as merely

insisting--in reliance on its own certificate's "per occurrence"

language--on a cap of $500,000 in reinsurance for a single

occurrence.

A number of cases construing multi-year policies, and

applying varying language to different factual scenarios, have

construed caps in the fashion urged by Swiss Re and have rejected

"annualization" glosses of the kind pressed by Commercial Union.3

Only New Jersey has suggested an annualization approach may

3
See, e.g., Soc'y of Roman Catholic Church of Diocese of
Lafayette & Lake Charles, Inc. v. Interstate Fire & Cas. Co., 26
F.3d 1359, 1366 (5th Cir. 1994); Bd. of Trs. of Univ. of Ill. v.
Ins. Corp. of Ire., Ltd., 750 F. Supp. 1375, 1376, 1380-81 (N.D.
Ill. 1990); Hercules, Inc. v. AIU Ins. Co., 784 A.2d 481, 495-96
(Del. 2001).

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normally apply. See, e.g., Benjamin Moore & Co. v. Aetna Cas. &

Sur. Co., 843 A.2d 1094, 1103 (N.J. 2004); Owens-Illinois, Inc. v.

United Ins. Co., 650 A.2d 974, 995 (N.J. 1994). But for the most

part the “majority view” cases did not implicate follow-the-form

and follow-the-settlement clauses, and those clauses make a

difference in our case.

Let us start with Commercial Union’s liability to Grace.

Commercial Union’s own policies contained language in their

definition of occurrence quoted above, hostile to annualization.

Yet the multi-year Maryland policies explicitly provided for their

per occurrence limits to apply on an annual basis, as did the

earlier one-year policies. So Grace could argue in any litigation

with Commercial Union that the latter's obligations were governed

by the former's policy given that Commercial Union's excess

insurance policies contained a strong follow-the-form clause of its

own.

Specifically, the follow-the-form provisions in

Commercial Union’s excess liability policies state (in one form)

that the excess policy is no more restrictive than the Maryland

policy and (in the other) that Commercial Union would cover any

occurrences covered by the Maryland policy. Thus in Hatco Corp. v.

W.R. Grace & Co., 801 F. Supp. 1334, 1354-55 (D.N.J. 1992), the

court held that a particular exclusion in Commercial Union’s policy

was overridden by the follow-form provision as construed in favor

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the insured. So, although New Jersey law has no application here,

arguably Commercial Union’s policy language should be read to

dovetail with Maryland’s policy, i.e., by applying the caps on the

same annualized basis.4

Commercial Union’s outside coverage counsel conducted a

study of its excess liability policies and pertinent case law,

reaching various tentative conclusions (at times concluding that

annualization was unlikely, and at other times concluding that

variations in language made annualization likely under some of

Commercial Union’s policies but not under others). In the end,

counsel concluded in a settlement analysis and recommendation that

annualization was a likely outcome in the then-ongoing New York law

suit between the parties.

Whether this view of Commercial Union’s liability to

Grace is correct or not, it is binding upon Swiss Re under its

follow-the-fortunes clause so long as the settlement was reasonable

and made in good faith. The follow-the-fortunes doctrine, designed

in part to encourage settlement, see N. River Ins. Co. v. CIGNA

4
See, e.g., Associated Int’l Ins. Co. v. Blythe, 286 F.3d 780,
782 (5th Cir. 2002) (“The Associated Policy, as a ‘following form’
policy, adopted the coverage provisions and definitions of the
underlying Progressive Policy.”); Coleman Co. v. Cal. Union Ins.
Co., 960 F.2d 1529, 1533-34 (10th Cir. 1992) (noting that follow-
the-form clause “manifests an intent to consider the underlying
policy in determining the coverage under the umbrella policy,” and
concluding that the amount of loss in the excess policy should be
computed according to the method in the primary policy).

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Reinsurance Co., 52 F.3d 1194, 1206 (3d Cir. 1995), encompasses

settlements that are arguably beyond the strict limits of the

underlying cedent's policy (i.e., the Commercial Union policies).

The reinsurer must abide by cedent’s “good-faith payment” so long

as it is “arguably within the scope of the insurance coverage”.

Mentor Ins. Co. (U.K.) v. Brannkasse, 996 F.2d 506, 517 (2d Cir.

1993).5

The premise that the settlement was based on annualized

per-occurrence limits for Commercial Union, which could in theory

be debated, cf. Employers Reinsurance Corp. v. NewCap Ins. Co., 209

F. Supp. 2d 1184, 1190-91 (D. Kan. 2002), is supported by several

factors: testimony that some components in Grace's settlement

demands could not have been achieved without annualization,

testimony that Grace's representatives said during settlement that

their valuation used a "pro rata annualized" approach, and the use

of annualization as a premise in the ultimate settlement analysis

and recommendation by Commercial Union's coverage counsel. Swiss

Re apparently pursued the issue during discovery but has not

developed any objection on appeal.

5
N. River Ins. Co. v. ACE Am. Reinsurance Co., 361 F.3d 134,
139-40 (2d Cir. 2004); Christiania Gen. Ins. Corp. of N.Y. v. Great
Am. Ins. Co., 979 F.2d 268, 280 (2d Cir. 1992); Aetna, 882 F. Supp.
at 1346-47; Int’l Surplus Lines Ins. Co. v. Certain Underwriters &
Underwriting Syndicates at Lloyd’s of London, 868 F. Supp. 917,
920-21 (S.D. Ohio 1994).

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 Of course, if the settlement were flatly inconsistent

with the excess liability policy, Swiss Re would not be bound to

respect it by a follow-the-settlements clause in its own

certificate. N. River Ins. Co., 52 F.3d at 1212 (“Was the paid

risk clearly outside the scope of the original policy’s

coverage?”); Aetna, 882 F. Supp. at 1347 (“manifestly outside” the

cedent’s policy). But each Commercial Union policy as a whole

includes not only its own anti-annualization language but its own

follow-the-form clause, seemingly invoking the pro-annualization

language of the underlying Maryland policy. Further, the insured

would benefit from the usual canons of interpretation favoring the

policy holder.

This brings us to Swiss Re’s liability to Commercial

Union under the terms of the reinsurance certificates. Even if

Commercial Union were deemed liable to Grace, Commercial Union's

right to the indemnity from Swiss Re is only for a specified share

of Commercial Union's liability (e.g., 50 percent of the first $1

million) for "each occurrence." The "occurrence" language delimits

Swiss Re's liability; the question is what the "each occurrence"

language means.

The district court read the phrase as if it meant, for a

multi-year leak, that the leak was a single occurrence for the

entire policy period so that the $500,000 cap applied once for the

policy period. This is a defensible reading, as the cases cited

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above show, but one could also call the continuing leak a new

occurrence every day or every drop. Or one could, as New Jersey

seemingly does, adopt a prudential compromise reading that treated

it as an occurrence for each year regardless of policy period.

The Swiss Re certificates could have contained a

definition of "occurrence" in relation to continuing leaks,

expressly negating annualization, but Swiss Re chose to provide no

definition at all for this malleable word. Of course, one could

read the Swiss Re policy as adopting the Commercial Union

definition of the term via Swiss Re’s follow-the-form clauses--but

which Commercial Union’s definition? The explicit anti-

annualization reading based on the occurrence definition or the

pro-annualization follow-the-form version drawing on the Maryland

policies' annualization provisions?

Here, Commercial Union’s liability to Grace has been

established by a seemingly reasonable settlement made (so far as we

know) in good faith. Under Swiss Re’s follow-the-settlements

clause it is bound to accept this pro-annualization reading of the

Commercial Union policy for purposes of establishing Commercial

Union’s liability to Grace. In our view, Swiss Re’s follow-the-

form clause should be deemed to extend this reading into the

parallel language in Swiss Re's own certificates subject only to

any clear limitation to the contrary in the Swiss Re documents.

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 This view of the matter accords with the basic

presumption of concurrence that we think exists where there is a

skeleton reinsurance contract coupled with follow-the-form and

follow-the-settlements clauses. According to a New York case,

consistent with other authorities,

[w]here a following form clause is found in
the reinsurance contract, concurrency between
the policy of reinsurance and the reinsured
policy is presumed, such that a policy of
reinsurance will be construed as offering the
same terms, conditions and scope of coverage
as exist in the reinsured policy, i.e., in the
absence of explicit language in the policy of
reinsurance to the contrary.

Aetna, 882 F. Supp. at 1337. Accord Ostrager & Vyskocil, supra, §

2.03[a], at 2-9. Indeed, concurrence advances one of the basic

purposes of reinsurance, which is “[s]preading” risk to prevent “a

catastrophic loss from falling upon one insurer.” Unigard, 4 F.3d

at 1053.

Of course, if sufficiently clear, specific limits in the

certificate control over the general aim of concurrence and

ordinary "follow" clauses.6 Unfortunately for Swiss Re, the key

"reinsurance accepted" provision in the certificate--which reads

6
See, e.g., Unigard, 4 F.3d at 1070-71 (follow-the-form);
Bellefonte Reinsurance Co. v. Aetna Cas. & Sur. Co., 903 F.2d 910,
914 (2d Cir. 1990) (follow-the-fortunes); Travelers, 760 N.E.2d at
328 n.9 (“[A] ‘follow-the-fortunes’ clause does not supersede
specific language in a reinsurance contract . . . .”); see also
Ostrager & Vyskocil, supra, § 2.03[a], at 2-9 (following-form
reinsurance contract incorporates terms of the reinsured policy “to
the extent they are not inconsistent with the express terms of the
reinsurance contract”).

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"50% Quota Share part of first $1,000,000 each occurrence"--is

simply cryptic as applied to continuing leaks over a multi-year

period under a multi-year policy. In such a situation, the balance

is tipped in favor of making Swiss Re share liability on a basis

that conforms its liability to that of the cedent where the cedent

has settled reasonably and in good faith.

Neither side has pointed to extrinsic evidence--such as

premium comparisons, expert testimony, or pertinent negotiations--

that could illuminate this dispute. Nothing we have said in this

decision should be taken to control a case in which a similar

dispute is better illuminated by extrinsic evidence of any kind.

See, e.g., Nat’l Tax Inst., Inc. v. Topnotch at Stowe Resort & Spa,

388 F.3d 15, 20-21 (1st Cir. 2004).

It is unclear from the briefs and the record what

consequence our conclusions entail beyond a remand. For example,

we do not know if the question whether the settlement was made in

good faith is at issue, Aetna, 882 F. Supp. at 1351-52. Such

matters are for the parties and the district court to sort out on

remand.

The judgment of the district court is vacated and the

matter remanded for further proceedings consistent with this

decision.

It is so ordered.

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