PHILADELPHIA (Legal Newsline) - Insurance and business defense attorneys are sparring with the drafters of a powerful legal document that will influence the outcome of insurance liability cases.

The lawyers contend that the document, “Restatement of Law, Liability Insurance,” by the Philadelphia-based American Law Institute (ALI) will increase litigation, open the door for punitive damages against insurers, and lead to higher insurance premiums.

But, University of Pennsylvania law professor Tom Baker, one of two reporters (authors) on the project, said that the impact on price is going to be very difficult to “tease out.”

“We will be seeing a hard market in liability insurance within the next few years,” Baker said, “meaning that liability insurance prices will increase significantly – for reasons that have nothing to do with the Restatement. When that happens, people will point fingers in lots of directions.”

The ALI began the process four years ago as “Principles of the Law of Liability Insurance,” a declaration covering shortcomings in current law – where the law should be. A year and a half ago, the project was converted to a Restatement, a document intended to reflect common law, and used by judges as a guide, particularly when existing law is unclear.

Critics say that the drafts of the chapters (the fourth and final chapter was released on Sept. 12) contain too many provisions that are still aspirational, rather than a pure accounting of the law.

“There are sections in the drafts not found anywhere in the law,” said Laura A. Foggan, partner at Wiley Rein in Washington.

She points to Section 13, for instance, that says an insurer must defend any time an allegation in the legal action would be proven. It allows only three limited exceptions. The problem, Foggan says, is that other facts exist outside the complaint that have noting to do with the insured’s liability and the underlying claim, which the insurer should be allowed to consider. In these instances, the insurer would have to file a separate lawsuit that it has no duty to defend.

“The Reporters suggest their way is better than the way it works now, because there is ‘judicial supervision’ of the insurers’ decision whether to defend a policyholder,” Foggan said. “It would be similar to consumer law requiring a car rental company to get court approval to show there are no added fees before charging your credit card.”

Another Section, 19, states that an insurer that breaches the duty to defend “without a reasonable basis” loses the right to contest coverage for the action. The ALI said that the language adopts a “middle ground,” and is consistent with the rule that an insured is entitled to extra-contractual damages where the insured has acted in bad faith.

But the rationale disregards judicial findings, according to David G. Harris II, partner at Goldberg Segalla in St. Louis.

“The ALI fails to recognize that the majority of jurisdictions to have addressed the issue have held that an insurer does not automatically forfeit its coverage defenses if it is found to have wrongfully breached its duty to defend,” Harris said.

Of particular concern to insurance and business defense lawyers is the broadening of bad faith claims, and the proposed standard for and ready availability of punitive damages.

“If punitive damages are to be provided, the threshold for punitive damages plainly must be higher than that for other relief,” Foggan said. “While the Reporters purport to agree, I'm not convinced their standard for punitives accomplishes this important objective. Unless there are greater safeguards against their award, punitives will encourage unnecessary litigation for 'bonus" amounts and chill desirable (cost-saving and economically preferable) conduct by insurers.”

She added several states and the District of Columbia don’t allow punitive damages in insurance bad faith cases at all. Many states require deliberate misconduct demonstrating oppression, fraud, wantonness or malice.

“Under Section 53, at a minimum the Restatement should require proof of extreme deviation from reasonable conduct to justify punitive damages, instead its standard seems very loose,” she said.

At ALI’s 2016 annual meeting in May, the Reporters presented Tentative Draft No. 1, containing Chapter 1 on Basic Liability Insurance Contract Rules, Chapter 2 on Management of Potentially Insured Liability Claims, and Chapter 3 on General Principles Regarding the Risks Insured. Chapter 4 covers Remedies: Bad Faith and Punitive Damages.

In a meeting scheduled for Oct. 6- 7, ALI members plan to discuss preliminary Draft No. 3.

A final document isn’t expected until summer 2017, and could be delayed beyond that.

Noted civil justice reform attorney, Victor E. Schwartz, partner at Shook Hardy & Bacon in Washington, said that over the course of the project, the Reporters have added some balance, “especially where there has been no existing case law support for their position.”

“But there is still a long way to go to achieve a project that all would agree treats insurers equitably, is sensitive to the cost of insurance, and follows the most sound legal rules,” he said.

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