HNRK Coverage Corner

This week at the Coverage Corner, we take a quick look at a recent decision from the Southern District New York in which the Court, following a bench trial, ruled in favor of a policyholder and used the mutual mistake doctrine to reform the policy to provide coverage.

Background

The facts are relatively straightforward.  The policyholder, Systems 2000 Plumbing Service (“Systems 2000”) sought coverage from its primary (Travelers) and excess (GuideOne National) insurers in connection with claims against Systems 2000 arising from a fire at the Manhattan apartment building where it had been performing plumbing services. 

At the time of the fire, the primary policy contained an exclusion (the “Residential-Work Exclusion”) that excluded coverage for “work … on or for any project that…is …any residential condominium [or] any residential apartment….”  This exclusion language was not, however, in the primary proposal that Systems 2000 signed when it procured coverage.  The proposal had a list of “coverage and amendments” that said only the following: “EXC-HAZARD-CONNECTED DESIGNATED EXPOSURE.” 

The GuideOne excess policy was a “follow form” policy that was subject to the terms and exclusions of the primary policy.  It also had a clause by which GuideOne reserved the “right to refuse to follow . . . any change [made after the inception date of the policy] to the Scheduled Underlying Insurance, in which event this policy shall apply as if the changes had not been made.”

Citing the Residential-Work Exclusion, Travelers initially denied coverage but then reversed itself and, on its own, “reformed” the primary policy to remove the exclusion.  GuideOne, on the other hand, refused to do the same—arguing that Travelers’ decision to reform the primary policy was a change that was not binding on the excess coverage—and initiated this suit for a declaratory judgment that it was not obligated to provide coverage.  Systems 2000 asserted counterclaims and third-party claims against its broker and Travelers.  The court denied cross-motions for summary judgment and then, because dispute between Systems 2000 and GuideOne had the potential to render the claims involving Travelers and the broker moot, the Court bifurcated the case and held a bench trial to resolve whether GuideOne could rely on the Residential-Work Exclusion to deny coverage.

The Court’s Decision

The Court held that GuideOne must provide coverage for two independent but related reasons. 

First, the Court held that under the mutual mistake doctrine, the policy should be reformed to reflect both parties’ intent to enter into an agreement that covered residential work.  Under New York law, an unambiguous contract may be reformed if, because of mutual mistake, the written agreement does not reflect what the parties intended when they entered into the contract.  Reformation requires clear and convincing evidence and is naturally a fact-intensive inquiry.  Key to the Court’s ruling in this case were that:

• 100 percent of Systems 2000’s work was done in residential buildings;
• Systems 2000 intended to procure insurance that covered work in residential buildings;
• Systems 2000 thought it had procured insurance for residential work, as evidenced by documents and communications with GuideOne that included references to work in “apartment buildings” and “co-ops.”
• GuideOne knew Systems 2000 performed all of its work in residential buildings; and
• GuideOne’s decisionmaker – its Head of Excess and Surplus Casualty—intended to provide coverage for residential work and testified, among other things, that the premium for the policy was higher than it would have been otherwise specifically because Systems 2000 did work in residential buildings;

The Court concluded that these facts amounted to clear and convincing evidence that both Systems 2000 and GuideOne intended for the policy to cover residential work, and therefore the policy should be reformed to reflect that intention.

Second, the Court ruled that, independent of the mutual mistake doctrine, it would not enforce the Residential-Work Exclusion because it would render GuideOne’s coverage illusory.  The Court explained that the illusory coverage doctrine—while narrow—was nevertheless applicable because GuideOne knew that 100 percent of Systems 2000’s work was done in residential buildings—and therefore the Residential-Work Exclusion would defeat all coverage and leave the policyholder with “no effective protection.”