In insurance, a follow form endorsement is typically understood to mean that an excess or umbrella insurance policy incorporates the terms of another underlying insurance policy. An excess carrier with such an endorsement might reasonably expect, then, that it could take advantage of an arbitration provision in the underlying policy. Not so fast, the Seventh Circuit recently ruled.
In State of Wisconsin Local Government Property Ins. Fund v. Lexington Ins. Co., No. 15-1973, 2016 WL 6134857 (7th Cir. October 21, 2016), the Seventh Circuit held that a follow form endorsement in an excess or reinsurance policy did not entitle the excess carrier to insert itself into an arbitration between two primary carriers.
The case started when a fire at the Milwaukee, Wisconsin County courthouse caused extensive property damage. The County had its primary policy through the State of Wisconsin Local Government Property Insurance Fund (the “Fund”). The Fund, in turn, had an excess or reinsurance policy (there was a dispute about the type of policy that the Court deemed immaterial to the issues decided) through Lexington Insurance Company (“Lexington”). The County also had a separate policy with Cincinnati Insurance Company (“Cincinnati”) that covered machinery and equipment.
After the fire, the County filed a claim with the Fund, which paid most of the losses but argued that the remaining losses (totaling approximately $1.6 million) should be paid by Cincinnati. Both the Fund and Cincinnati policies contained a Joint Loss Agreement with the County that contained an arbitration provision. This provision generally provided that upon written request of the County, the Fund and Cincinnati would each pay one-half of the disputed loss to the County and that those payments and the acceptance of them by the County would signify the agreement of the insurers to submit to and proceed with arbitration within 90 days of such payments. The Fund and Cincinnati triggered the provision by paying the County $800,000 each and then proceeding to arbitration on their dispute about the correct amounts owed by each carrier.
The Fund also made a claim against the Lexington policy, which paid the Fund $5 million but disputed that it owed more. When the Fund filed a declaratory judgment action against Lexington, Lexington sought to compel arbitration. Lexington argued that because its policy followed the form of the Fund’s policy with the County, Lexington should be allowed to participate in the arbitration already pending between the Fund and Cincinnati.
Both the District Court and the Court of Appeals agreed that the Lexington policy followed form, but neither thought that entitled Lexington to arbitrate. To the contrary, the Seventh Circuit held, the Fund did not even agree to arbitrate in its policy. It merely agreed to a procedure whereby the parties can potentially agree to arbitrate. 2016 WL 6134857, at *5 (court’s emphasis). In order to agree, the parties had to receive a written request from the County and make a payment of one-half the disputed sum to the County. Because Lexington did no such thing, it had no agreement to arbitrate.
Significantly, the court ruled that it had to read the terms of the arbitration provision literally. This meant that, although it was incorporated into the policy between the Fund and Lexington (to which the County was not a party), the arbitration provisions requiring a request from, and payment to, the County as insured could not be changed to reflect a payment by Lexington to the Fund. In other words, although technically incorporated into the Lexington policy, on the court’s reading there was really no way for Lexington to invoke arbitration.
On one level, this may seem unfair. What, after all, is the point of incorporating the provisions of another policy if there is no way to invoke them? But the court’s ruling is perhaps best explained by two principles about which courts have been very firm. First, courts will not rewrite a follow form endorsement to create ambiguity where there was no ambiguity in the underlying policy. Second, courts are reluctant to allow parties to arbitrate who were not parties to the original arbitration agreement. Policyholders, insurers and their lawyers should take note of these principles in deciding where their next dispute will be litigated.