SDV Insights

Contra proferentem is one of the few Latin phrases that lawyers remember from law school, in the ranks with res ipsa loquitur, prima facie, and ipso facto. Contra proferentem literally means “against the offeror” and the doctrine is used when courts interpret ambiguous contract language. The contra proferentem doctrine stands for the notion that if the meaning of a contract clause or word is ambiguous, it should be interpreted against the party that drafted the contract. Although the doctrine seems straightforward, its implementation is far from simple.

Although the doctrine has historically been used in many different types of contracts, it is most often used to interpret insurance policy language in disputes between insurers and policyholders.

Given our proximity to Halloween, contra proferentem is like the boogeyman that hides under the bed, waiting for that one dispute where the meaning of a word is unclear, and then, suddenly, it jumps out and catches the unsuspecting insurer who drafted the policy. However, more and more jurisdictions are refusing to apply the doctrine when the insurer and the insured are on the same footing.

When Should Contra Proferentem be Used?

Insurance contracts can be lengthy, complicated documents, consisting of many pages of long, confusing sentences, multiple sub-sections, complex terms, clauses, definitions, and exclusions. In an ideal world, every sentence in an insurance policy should have a purpose and be clear and unambiguous. In this world, the true, intended meaning of a word or clause is often disputed.

Contra proferentem is typically considered the argument of last resort in a dispute between an insurer and policyholder. When applying the doctrine, a court will undergo a series of steps in its analysis:

• Is the plain language reasonably susceptible to more than one interpretation or construction? In other words, are both parties offering reasonable interpretations under the written language of the contract?
• If a court finds both parties are offering differing, and reasonable, interpretations; the contract is ambiguous.
• If ambiguity is found, the court will attempt to determine the intent of both parties – which can be demonstrated by extrinsic evidence – regarding the ambiguous word or clause.
• If extrinsic evidence demonstrates an agreed upon intent which supports one offered interpretation over the other, then it is likely the contract will be enforced according to what that evidence provides.
• If the evidence does not solve the ambiguity, the contra proferentem doctrine will be applied and the court will interpret the clause against the drafter of the language.

Courts interpreting insurance policies apply contra proferentem because insurance policies are typically pre-drafted contracts offered to policyholders on a take-it or leave-it basis, commonly referred to as “contracts of adhesion.” Most policyholders are not able to negotiate the language of the contract. Because of this, the onus is on insurers to draft clear and unambiguous language and any failure to do is penalized by courts interpreting that language against the drafter. However, a question arises when business diverges from this archetype and both the insurance company and policyholder are sophisticated parties capable of negotiating the terms of the policy.

What if the Policyholder is a “Sophisticated Party”?

Insurers will attempt to avoid the implementation of contra proferentem by arguing that the policyholder is a sophisticated party. The contra proferentem doctrine was designed to protect a weaker party, one that did not have the knowledge, experience, or negotiating power to modify an insurance policy. However, when the policyholder has the knowledge, experience, and ability to negotiate terms of the policy, insurers will contend the doctrine should not be used. Under these facts, insurers frequently argue that the parties stand on equal footing and the policyholder is not a “weaker party” warranting the protections of contra proferentem.

The sophisticated party defense to contra proferentem varies by jurisdiction. Here are examples of some court decisions and how the sophisticated party defense has been used:

• In the 2002 case of Beanstalk Grp. V. AM Gen. Corp., the 7th Circuit Court of Appeals stated that most courts now agree that the principle that contracts are to be construed against the drafting party does not apply when both parties are sophisticated parties represented by counsel.
• In the 2000 case of Morgan Stanley v. New England Ins. Co., the 2nd Circuit Court of Appeals rejected the insurer’s defense and applied contra proferentem, holding that the determining factor was that the insured did not negotiate the policy’s terms and therefore it did not matter that Morgan Stanley is obviously a sophisticated party.
• In the 1997 case of Pittston Co. Ultramar Am. Ltd. V. Allianz Ins. Co., the 3rd Circuit Court of Appeals stated that, “the dispositive question is not merely whether the insured is a sophisticated corporate entity, but rather whether the insurance contract is negotiated, jointly drafted or drafted by the insured.”
• In the 2015 case of Certain Underwriters at Lloyds London v. Perraud, the 5th Circuit Court of Appeals refused to apply the sophisticated-insured exception to the contra proferentem rule absent any information about the content of the contract negotiations, how the contracts were prepared, or other indicators of relative bargaining power.

These cases beg the question of what makes an insured “sophisticated” enough such that it is on equal footing with an insurer?

What Makes a Policyholder Sophisticated?

What factors demonstrate whether a policyholder is sophisticated? Sometimes it is difficult to determine whether there was an arm’s-length transaction between a policyholder and insurance carrier in the insurance purchase. For example, in the above-referenced Morgan Stanley case, Morgan Stanley is clearly a sophisticated corporation, but the court found that the determining factor was that it did not negotiate the terms of the policy. So, what other factors could come into play when a court answers this question?

In the May 2022 case of Brooklyn Union Gas Co. v. Century Indemnity Co., a New York trial court addressed the issue of whether Brooklyn Union’s policies that were issued with multi-year terms were ambiguous as to whether the per-occurrence limits for the respective policies applied as annual per-occurrence limits or as per-occurrence limits for the entire term of the policies. The court first examined extrinsic evidence regarding the industry custom and practice with respect to per-occurrence limits but was unable to resolve the ambiguity by this method. Accordingly, the Court turned to contra proferentem and engaged in determining whether Brooklyn Union was sufficiently sophisticated to defeat application of the doctrine.

The Court decided not to apply contra proferentem because it determined Brooklyn Union was a sophisticated policyholder. The Court’s reasoning was based upon the fact that Brooklyn Union had a “separate internal insurance department, maintain[ed] of a large SIR and multiple layers of excess policies and used a well-known insurance broker and outside insurance counsel.” Accordingly, as a sophisticated policyholder, the Court determined Brooklyn Union “would have been aware of industry custom and practice about when per-occurrence limits would (and would not) be applied on an annual basis.” Notably, the industry custom and practice during the period of the policies at issue was that per-occurrence limits applied annually to a multi-year policy, only if the policy expressly provided so.

The factors analyzed in Brooklyn Union are logical but were applied specifically to demonstrate that Brooklyn Union knew or should have known about the industry custom relating to annual per-occurrence limits, thereby making its interpretation of the relevant policy language unreasonable.

So, what makes a sophisticated policyholder? This question is not one with a firm answer, as the factors analyzed by one court will undoubtedly differ from those used by another. Accordingly, both policyholders and insurers will have plenty of room to make arguments on this issue.

On the policyholder’s side, we would argue that no amount of risk managers, sophisticated brokers, or attorneys change the fact that no deal with an insurer is a transaction on equal footing, as there will always be language, provisions, or endorsements that insurers will simply refuse to amend/remove – no matter the “sophistication” of the policyholder.

On the other hand, insurers will continue to point to similar factors as those analyzed by the Brooklyn Union court as well as evidence of negotiations, the insured’s size, and endorsements that were removed or added to the policies.

Simply put, while there are factors which have been applied to defeat contra proferentem – by way of a sophisticated policyholder argument – there is not a hardline rule courts apply in making this determination.

SDV monitors decisions in this area and is well-versed in litigating the same. Hopefully this article aides you in determining whether the contra proferentem boogeyman may rise to haunt your insurer.

For more information, contact Avery Cantor at ACantor@sdvlaw.com or (951) 676-2152.