Choice of Law in Insurance Coverage Disputes

Choice of Law Insurance Disputes

Choice of law is often an important issue in insurance coverage disputes.  Both policy holders and insurers will argue for application of the law of a State that they deem most favorable to their position.  Judge Gale of the North Carolina Business Court recently had an opportunity to consider that issue in American Realty Advisors, et al. v. Lexington Insurance Company, et al., No. 18CVS5171, Wake County. 

The Plaintiff in American Realty Advisors owned property in Cary, North Carolina.  Four insurers, including Lexington, provided coverage for the property. 

Construction of the property was completed in early 2007, and the plaintiff purchased the property shortly before construction was complete.  Upon purchase of the property in 2007, it was covered by a 2006-2007 “All Risk” commercial property insurance policy from Lexington, as well as substantially similar follow-form excess policies, combining for a total of $25 million in coverage.  The 2006-2007 policies — which were the policies at issue in the case — did not include a mandatory choice of law provision.  The policies for the following years did include a mandatory choice of law provision, providing for the application of California law.

In December, 2013, widespread water intrusion was discovered at the property, ultimately resulting in a multi-million-dollar loss and litigation.  The plaintiff in American Realty filed a motion for partial summary judgment, seeking a determination that N.C.G.S. §58-3-1 required that insurance coverage under the 2006-2007-year policies be determined by the law of North Carolina.  The insurers argued that California law should apply.  Judge Gale granted the plaintiff’s motion for partial summary judgment.

The issue in American Realty turned on the interpretation of §58-3-1, which provides as follows:

All contracts of insurance on property, lives or interests in this State shall be deemed to be made therein, and all contracts of insurance, the applications for which are taken within this State, shall be deemed to have been made within this State and are subject to the laws thereof.

§58-3-1 thus mandates that for any policy to which it applies, the policy is deemed to have been made in North Carolina as a matter of law, thereby requiring application of North Carolina law in interpreting coverage under the policy.  While the statute’s language is broad, constitutional due process considerations require that North Carolina have a “close connection” to the interests insured before §58-3-1 may be applied.  See Collins & Aikman Corp. v. Hartford Accident & Indemnity Company, 335 N.C. 91, 94-95, 436 S.E. 2d 243, 245-46 (1993). 

Judge Gale observed that the “close connection” test is simply stated, but not so simply applied, because its application revolves around the facts of particular cases from which no particular  formula may be easily derived.  Judge Gale examined eighteen (18) decisions where the question of §58-3-1’s application was at issue.  That examination revealed that a characteristic example of a case with no close connection is a personal injury claim brought in North Carolina from an accident occurring in North Carolina, but where the litigants have no other connection to the state.  By contrast, an example of a close connection is where a company has an overwhelming majority of its operations in North Carolina and buys its insurance policy from a North Carolina broker. 

The cases recognize other factors which appear to be relevant, but are not necessarily controlling, including (1) whether the policy is a commercial policy; (2) the insurer’s actual awareness that it is insuring North Carolina based operations; (3) the absence of a mandatory choice of law provision in a policy providing coverage for interstate operations; and (4) an insurer’s registration to do business in the forum state. 

Judge Gale found no single fact determinative in American Realty, but in granting the plaintiff’s motion for partial summary judgment and concluding that North Carolina law would be applied to determine coverage, he observed that:  (1) the insurers were aware that they were insuring properties located in various states, including North Carolina; (2) they consented to suit in the various states without requiring a mandatory choice of law provision in the 2006-2007 year policies; (3) the damages for which coverage was sought were based on losses that occurred in North Carolina; (4) those losses arose from the property being constructed and operated in North Carolina; (5) the properties housed North Carolina residents; and (6) facts necessary to determine the cause and extent of the losses depended largely on documents and witnesses located in North Carolina.

In so holding, Judge Gale was careful to note that the “close connection” test to be applied to § 58-3-1 was to be distinguished from the separate conflict of law principle commonly referred to as the “most significant relationship” test, which may be applied to other claims.  Judge Gale stated that it was uncertain whether the most significant relationship test should control the plaintiff’s unfair or deceptive trade practice claim, and because that issue was before the court, it was not addressed in the decision.

The takeaway is that just because the insured, or the insured property, is in North Carolina, does not necessarily mean that North Carolina law applies to determine coverage.  North Carolina must still have a close connection to the interest insured.  Moreover, claims other than coverage — for example, unfair trade practices — may also be governed by the law of another state, and will require a conflicts of law analysis as well.