Opinion ID: 697655
Heading Depth: 2
Heading Rank: 1

Heading: Facultative Underwriting

Text: 74 Plaintiffs argued, and the district court found, that the parties to the contract (including, it would seem, defendants themselves) understood the meaning of that term [facultative] in its standard and traditional sense, namely, underwriting on a risk-by-risk certificate basis, the classic meaning of the term. 825 F.Supp. at 382. According to the court, NERCO knew that plaintiffs understood  'facultative' in its standard and traditional sense of risk-by-risk certificate underwriting and was well aware that it, itself, was secretly using the term in a special sense without ever disclosing such special meaning to the Plaintiff reinsurers. Thus, the court concluded, the defendants' representation that the business would be underwritten on a risk-by-risk individual certificate basis was knowingly false when made. Id.
75 We hold that these findings are clearly erroneous insofar as they attribute to defendants an implicit or express representation that they would engage exclusively in classic risk-by-risk, individual certificate underwriting. The record is without evidence from which a court could find that defendants represented to plaintiffs that the facultative business underwritten by Graham Watson would be limited to individual certificate, risk-by-risk underwriting. 76 To be sure, as the court found, there was evidence that the overseas sub-brokers engaged to represent defendants by their broker, G.L. Hodson, understood facultative in the classic risk-by-risk individual certificate sense. Nigel Huntington-Whitely, the employee principally assigned to the SANS Treaty placements by defendants' sub-broker, Sedgwick-Payne, testified to having this understanding. But he indicated that it may have just been an assumption, and could not identify the source of his understanding beyond his sense of what the term facultative might mean. It was not established that the sub-brokers were told this by defendants nor that prior to the initial (1980) Treaties the sub-brokers communicated this view to plaintiffs or to defendants during negotiations. 77 To fill this gap, plaintiffs point to Huntington-Whitely's letter of June 24, 1981 (well over a year after the Treaties were entered into), wherein he states in passing that Graham Watson is underwriting each risk individually. However, this statement clearly did not induce the plaintiffs to enter into the 1980 and 1981 SANS Treaties, given its timing. Moreover, it is arguable that the semi-automatic facilities, because they allowed Graham Watson's underwriters to reject individual risks, were a form of individual risk underwriting and thus not necessarily inconsistent with this statement. 78 Plaintiffs also point to the 1982 Anniversary Information, which states that, on non-system business, Graham Watson is quoting their price and if a ceding commission is required by the original company, this is then added to the premium required by Graham Watson. Plaintiffs argue that this specifically describes individual risk negotiation. However, it could just as easily be read to refer to Graham Watson quoting a price during the initial negotiations leading to the formation of a semi-automatic facility. Thus, it is not an explicit promise to perform individual risk-by-risk certificate underwriting. Moreover, this representation, like the statement in Huntington-Whitely's letter, was made in 1981, and thus could not have fraudulently induced the plaintiffs to participate in the 1980 and 1981 SANS Treaties. 79 Defendants' chief executive, Graves Hewitt, testified at the trial to having told one of the lead underwriters, Bailey, in 1979, about his dissatisfaction with the method of using a separate certificate as to each risk, and his intention, in connection with the SANS Treaties, to use a single controlling facility for multiple risks, as was later done by means of the semi-automatic MFCs. Because the district court found--contrary to Hewitt's testimony--that defendants had not disclosed their intent to use semi-automatics, we must assume that it did not credit that testimony, although nowhere in its findings did the court mention and reject the testimony. We do not, in any case, rely upon Hewitt's testimony in determining that the court's fraud findings premised on the term facultative were erroneous. 80 Bailey himself did not attend the trial but was deposed and his deposition was read. He did not describe a meeting with Hewitt in 1979 nor any specific representations having been made to him prior to the execution of the Treaties on the character of the facultative underwriting. He testified generally to understanding that Graham Watson would assess and underwrite each risk separately, but did not refer to any conversation or occasion where any defendant so promised. Asked if he would have considered semi-automatic binding authorities to be facultative underwriting, he said that is not what I had intended and not what I had been told from my own recollection. This was the closest he came to suggesting that he was told by someone (defendants, brokers, or others?) that facultative meant what the judge found. We think this vague testimony, which makes no reference to specific sources, falls short of supporting a finding that defendants expressly promised to engage in risk-by-risk underwriting only or knew that plaintiffs misunderstood their intentions in this regard. 81
82 We similarly hold clearly erroneous the finding that defendants knew that plaintiffs understood facultative to be limited to risk-by-risk certificate underwriting. There is no evidence of statements or correspondence by plaintiffs or their representatives to defendants, prior to execution of the slips and treaties, informing defendants that the plaintiffs understood the meaning of facultative to be so limited. 83 Of course, if the court properly could have found, on the basis of the evidence, that the term facultative was unambiguous, referring only to individual certificate, risk-by-risk underwriting, then defendants would be charged with knowledge of that ordinary meaning. However, as the evidence clearly showed, that term, both standing alone and as used in the Placing Information, slips, and Treaty Wordings, encompasses a variety of underwriting methods, about the propriety of which the parties and their experts disagree. Whether or not a term as used by parties to a contract is ambiguous is a question of law subject to plenary review. ITT Corp. v. LTX Corp., 926 F.2d 1258, 1261 (1st Cir.1991) (citations omitted); see also In re Navigation Technology Corp., 880 F.2d 1491, 1495 (1st Cir.1989) (Contractual language is considered ambiguous where the contracting parties reasonably differ as to its meaning.). However, where a term is ambiguous, its meaning presents a question of fact, see Commercial Union Ins. Co. v. Boston Edison Co., 412 Mass. 545, 557, 591 N.E.2d 165, 172 (1992) (citations omitted), a finding on which may only be reversed if clearly erroneous. Fed.R.Civ.P. 52(a). 84 As noted, the district court found that the parties understood the meaning of the term facultative in its standard and traditional sense, namely, underwriting on a risk-by-risk certificate basis. If by this finding, and others like it, the district court meant that the term was legally unambiguous, being limited in meaning to only that one type of underwriting, it was wrong as a matter of law. Expert testimony and treatises presented by both sides support the view that the term, as used in the industry today, has been broadened beyond its classic roots, notwithstanding plaintiffs' insistence that the classic method is alone the proper one. 85 Most likely the court did not mean the term was unambiguous as a matter of law, but rather concluded, on the basis of all the evidence, that, as used in the present circumstances, it should be given the limited meaning ascribed. 18 Yet the district court offered no reasons why it gave the term the limited reading it did. Nor did it explain why it believed defendants knew that plaintiffs so restricted the term. On the latter point, it may have been influenced by testimony from defendants' principal, Graves Hewitt, who said he had as good an understanding of the London insurance market as any American. The judge may have felt that, possessing such insight, Hewitt knew that, as some English witnesses testified, facultative would be understood to mean risk-by-risk certificate underwriting in that market. But absent evidence that Hewitt actually knew and believed this, such a leap would be pure speculation given Hewitt's own contrary testimony. 86 Moreover, English treatises introduced into evidence by plaintiffs indicate that, notwithstanding plaintiffs' witnesses, the reinsurance industry in England recognizes types of facultative reinsurance other than the risk-by-risk certificate variety. A leading English writer on reinsurance, Golding, describes in his authoritative treatise (introduced by plaintiffs) various types of facultative reinsurance other than the risk-by-risk certificate variety. One variation Golding describes is the so-called cover in course of post. He states: 87 It will be clear that much of the labour involved in the facultative method is connected with getting the necessary initials on the slips. In modern practice this can be largely avoided by the system of what may be called giving cover in course of post--though the term nowadays extends to the use of telex communications as much as to the mail. The reinsured will arrange facilities with a number of reinsurers, whereby it may issue request notes by post, for one or more lines of a risk to be reinsured, as may be agreed. The reinsurers will then hold covered each up to the amount of its agreed share and remains so bound, unless and until it has signified its declinature in course of post. As a rule a limit is fixed, within which this must be notified say 48 hours after receipt, though sometimes this is extended up to as much as a fortnight to allow for possible delays in transmission. If no declinature is made within the period, the reinsurer is bound in the ordinary way. The system does save a great deal of work, and is much favored by reinsureds accordingly. Yet it may be emphasized that it still remains facultative reinsurance, for the reinsurer is in no way deprived of its power to decline, even though it must accept responsibility in the meantime. 88 C.E. Golding, Golding: The Law and Practice of Reinsurance 42 (K.V. Louw ed., 5th ed. 1987) (emphasis supplied); see also R.L. Carter, Reinsurance 234-35 (2nd ed. 1983) (detailing use of bordereau to report risks bound under the cover in course of post method, which he also classifies as facultative). 19 89 But even ignoring these indications that English custom and practice have gone beyond classic facultative methodology, it is the American, not the English, usage that seems to us key. The underwriters in London and Europe contracted in the slips with defendant NERCO, an American company, for reinsurance classified by the Reassured [NERCO] as Property and Casualty Facultative Assumed Business produced and underwritten by the Graham Watson division of Cameron & Colby, Inc. (Emphasis supplied.) 20 The facultative reinsurance NERCO was to classify covered risks in the American, not the English, market. NERCO was expressly delegated the right to classify the reinsurance. See supra note 20. In exercising that right, NERCO was, of course, held to a standard of reasonable classification. Salem Glass Co. v. Joseph Rugo, Inc., 343 Mass. 103, 106, 176 N.E.2d 30, 32-33 (1961) (where a contract leaves a certain discretion or power in the hands of one party, that party is under a duty to exercise that power reasonably); accord Johnson v. Educational Testing Serv., 754 F.2d 20, 26 (1st Cir.1985), cert. denied, 472 U.S. 1029, 105 S.Ct. 3504, 87 L.Ed.2d 635 (1985). Nonetheless, being an American company operating here, NERCO would obviously be expected to classify its business pursuant to American, not English, terminology. Hence, to the extent there is any difference between the prevailing English and American views of what kind of underwriting the market regards as facultative, the parties would have intended the American interpretation to control, absent evidence of some contrary intent. Cf. Hazard's Adm'r. v. New England Marine Ins. Co., 33 U.S. 557, 564, 8 L.Ed. 1043 (1834) (Underwriters are presumed to know the usages and customs of all of the places from or to which they make insurances.). 90 To be sure, plaintiffs' experts gave testimony tending to show that the American market understood the term facultative reinsurance to mean risk-by-risk certificate underwriting. One might argue that the district judge was entitled to believe plaintiffs' experts over defendants' (who testified to the opposite understanding), 21 and to infer that the ordinary meaning of the term facultative was, therefore, the traditional one of risk-by-risk certificate underwriting. 91 But the evidence that the term facultative, within the American market, embraces more than just the individual risk certificate method is simply too extensive for the court to have rejected. Normally, of course, we are bound by the district court's choice among competing experts. But it is hard to gainsay experts such as defendants' expert James Inzerillo, see supra note 21, when even plaintiffs' experts did not categorically deny the widespread use, within the facultative operations of American reinsurers, of facilities like the semi-automatics and automatics here in issue. Plaintiffs' experts did not, in fact, testify that the ordinary meaning of the term in the American reinsurance industry was limited to individual certificate risk-by-risk underwriting. Rather they intimated that this was what, in their own opinion, the term properly meant or should mean. Yet, the question is not the abstract use of language but whether NERCO--having discretion under the slips and Treaty Wordings--could reasonably classify the semi-automatic and other methods it used in its own operations as facultative and whether it committed fraud when it did so. 92 The best approach to answering this question lies in the realities of industry practice. Cf. Affiliated FM Ins., 416 Mass. at 845, 626 N.E.2d at 881 (Where, as here, the contract language is ambiguous, evidence of trade usage is admissible to determine the meaning of the agreement.). Plaintiffs' expert, Phelan, conceded that American companies commonly used facilities similar to defendants' semi-automatics and automatics within their facultative departments. He regarded this as anomalous, and pointed out practical considerations which had led to that development. But while disapproving, he admitted to the widespread use of facilities of this type within the industry under the facultative designation. 22 93 American treatise writers, moreover, like the English writers from whom we have quoted, acknowledge a substantial, even predominant, modern trend towards use of facultative facilities similar to the semi-automatics here in question. 23 We think it is substantially beyond cavil that, in recent times, the term facultative reinsurance includes methods, in addition to traditional risk-by-risk certificate underwriting, similar in concept to the semi-automatics. 94 Given this body of evidence, including plaintiffs' expert's concession as to the classification, we see no adequate basis, from the term facultative itself, for the judge to infer that defendants necessarily knew that plaintiffs would or should interpret facultative, as used in the slips and Treaty Wordings, as limited solely to risk-by-risk certificate underwriting. While the latter is the original and classic method, see Unigard, 4 F.3d at 1053-54, other streamlined forms are clearly now being utilized within the industry under the rubric of facultative, both here and abroad, including types in which the reinsurer can be bound on individual risks by the reinsured acting pursuant to the terms of a general authorizing contract. Such a contract requires the reinsured to report the placement of the reinsurance to the reinsurer via a bordereau; and it may give the reinsurer the right, within a specified time frame, to reject any particular risk thereafter--but not necessarily ab initio. The semi-automatics in issue here were designed along these lines. Facilities employing this method were developed to offset the paperwork and high costs associated with classic certificate facultative reinsurance individually negotiated in advance on a risk-by-risk basis. 24 The hallmark of facultative reinsurance--evaluation of each risk separately by the reinsurer's underwriter--is sought to be preserved by maintaining the right to cancel after the fact. Although a window of exposure is created during which the reinsurer is bound without his consent on what the latter may later decide is an unacceptable risk, the potential for damage is minimized by the relative shortness of the exposure and by contract conditions which prevent the reinsured from binding the reinsurer to predescribed types of risks the reinsurer does not wish to cover. 25 95 We conclude that there is insufficient support in the record for the court's key fraud finding that defendants knowingly misrepresented to plaintiffs that they would receive one type of reinsurance (the classic risk-by-risk certificate form of facultative), while intending all along to provide another type (semi-automatic and automatic). The evidence does, indeed, support the court's finding that defendants intended to supply reinsurance underwritten by the semi-automatic and (to a minor degree) automatic methods (although not to the complete exclusion of classic facultative, a small amount of which was also produced). But the record does not support the finding that the defendants knew that the plaintiffs expected to receive only the classic risk-by-risk certificate form of facultative reinsurance, nor does it support the finding that defendants made knowing misrepresentations with respect to the term facultative.
96 Before leaving this subject, we shall consider an alternate theory of fraud based on use of the term facultative, a theory which, arguably, might enable us to uphold the district court's result. 97 Defendants doubtless knew that the streamlined forms of facultative underwriting they intended to provide under the SANS Treaties were not the same as the traditional form of facultative underwriting. Graves Hewitt's testimony indicated as much. He testified that most of the facultative business in his company's NERFAC division had been underwritten in the classic individual certificate manner. He wanted Graham Watson to switch to the semi-automatic method in order to get rid of the paperwork and expense associated with the classic method. 26 The record also bears the inference (assuming, as we infer, supra, that the court discredited Hewitt's testimony that he so informed Bailey in 1979) that defendants not only did not inform plaintiffs--or their own sub-brokers--of their intention to streamline their underwriting, but kept this information to themselves. Does it follow from this that, while negotiating the SANS Treaties, defendants designedly failed to volunteer to plaintiffs facts material to the risk--i.e., their intention to use this type of facultative underwriting--which honesty, good faith and fair dealing require[d] that [they] should communicate to the insurer? 9 Couch Sec. 38:2. 98 Although argued by plaintiffs, the above theory was not adopted by the district court. Instead, the court found that defendants had misled plaintiffs by making the knowingly false representation that reinsurance underwriting would be individual risk certificate underwriting. While there is insufficient record support for such an express misrepresentation, it can be argued that defendants, being under the duty to exercise the utmost good faith, Unigard, 4 F.3d at 1066, were required to disclose, as a fact material to the risk, their proposed utilization of streamlined facultative underwriting procedures going beyond the traditional method. Couch states: 99 In effecting a contract of reinsurance, it is incumbent upon the original insurer to communicate to the reinsurer all facts of which it has knowledge which are material to the risk, and where it states as a fact something untrue, with intent to deceive, or where it states a fact positively as true without knowing it to be true, and which tends to mislead, the policy is avoided where such statement or fact materially affects the risk; also, any undue concealment or intentional withholding of facts material to the risk, which ought in good conscience to be communicated by the original insurer, avoids the contract, without regard to whether the knowledge or information with respect to material facts was acquired by the original insurer previously or subsequently to the writing of the original contract. 100 19 Couch Sec. 80:77. While the above speaks of the relationship between original insurer and reinsurer, we think the same general principles apply between a retrocedant and retrocessionares in a reinsurance treaty. The question boils down to whether a failure to disclose plans to deviate from traditional risk-by-risk underwriting, should be considered undue concealment or intentional withholding of facts material to the risk, which ought in good conscience to be communicated.... Id. We answer in the negative for two reasons. 101 First, in determining what information is so material as to require disclosure by the insured sua sponte, courts recognize that the insured need not disclose what the insurer already knows or ought to know. 9 Couch Sec. 38:15. It is said that [a] minute disclosure of every material circumstance is not required. Puritan Ins. Co. v. Eagle S.S. Co., S.A., 779 F.2d 866, 871 (2d Cir.1985). 102 Ordinarily the insured is not required to make more than a general statement of facts, and is not expected to go into the details about which the insurer manifests no interest and makes no inquiry.... 103 9 Couch Sec. 38:58. There is a wide distinction ... between [the insured's duties in] those cases where there is no inquiry and those where questions are propounded by the insurer. Id. 104 Here there is no indication that plaintiffs asked defendants during the negotiation of the first SANS Treaties to describe what types of facultative underwriting they proposed to engage in. To the contrary, the executed contracts expressly allowed defendants a reasonable discretion in this regard. And as we have just held, the type of underwriting methods they utilized, while not the classic form of facultative reinsurance, fell within industry parameters. 105 The parties here were of equal power and highly knowledgeable. The slips and Treaty Wordings were negotiated by and between sophisticated reinsurance professionals. Without first being asked by the other party, one would not expect defendants to volunteer a plethora of details on their proposed underwriting practices. Matters would have been different had defendants affirmatively misrepresented their intended underwriting practices or given incomplete, evasive or incorrect answers to questions asked. We see no basis to infer undue concealment from their failure to volunteer further information about facultative underwriting characteristics where, for all that appears, the subject was not broached. 106 The slips, as said, were worded so as to vest discretion in NERCO as to the business it would classify as facultative, indicating a willingness to leave this choice to NERCO. As previously discussed, NERCO's choice had to be reasonable and exercised in good faith. Salem Glass, 343 Mass. at 106, 176 N.E.2d at 32-33; Johnson, 754 F.2d at 26. But, within those limits, the decision was left in NERCO's hands. To say that NERCO had a duty to volunteer to plaintiffs, unasked, the nature of its proposed facultative underwriting facilities and, in effect, secure their advance approval, goes beyond the parties' bargain as written. If plaintiffs had wished to limit defendants to a particular facultative method, that requirement should have been inserted in the contract. It was not. The duty of utmost good faith should not enable a party, whose bargain later turns sour, to expand the terms of an original, fairly bargained contract. 27 Given the equal strength and sophistication of the parties, and the fact that underwriting considerations now in dispute were such obvious topics of inquiry had plaintiffs wanted to know more, we are not convinced that the record establishes that the intended methods of proposed facultative underwriting were material items of the type defendants were required, without inquiry, to disclose. 107 However, even if the materiality of the information were such that defendants should have volunteered it, the record lacks evidence from which to find that defendants, recognizing its materiality, withheld it deliberately rather than through oversight. Claims in fraud against non-marine reinsurers cannot rest on a showing of mere negligent concealment. Unigard, 4 F.3d at 1069. The semi-automatic and like methods employed were, as above indicated, within accepted parameters of facultative classification, and the contract left their use to defendants' discretion. Plans to use such facilities were not so abnormal as to imply fraudulent intent from the mere fact of non-disclosure. Any argument that plans to use semi-automatics had to be disclosed because that method of underwriting was especially risky is belied by the absence of evidence linking the SANS Treaty losses with the method of underwriting used. To the contrary, defendants presented evidence which, if believed, could indicate that the losses under the Treaties were less than the industry averages for the period. 28 It is undisputed, as the judge stated, that the market in which the losses occurred was disastrous generally. Substantial contrary evidence was not introduced, nor was there substantial evidence of large Treaty losses from risks of a type that would likely not have been reinsured under the more deliberate classic facultative procedures. We find the record inadequate to support a finding that in failing to disclose their plans to use semi-automatic and related underwriting methods, defendants were acting with fraudulent intent. 108 We thus reject, as an alternative means of affirming the court's facultative fraud finding, the fraudulent withholding theory above discussed. We conclude that the court clearly erred to the extent it based its finding of fraud on defendants' promise to produce and underwrite facultative reinsurance. 29 109