Making Sense of Contra Proferentum

One traditional rule of contract interpretation is to construe contact terms in appropriate circumstances against the drafter, a concept often referred to as contra proferentum. This doctrine sometimes fits uncomfortably with two other views expressed by American courts. On one hand, many decisions say that insurance contracts are interpreted just like any other commercial contract. See, e.g., Sims v. Mulhearn Funeral Home, Inc., ___ So.2d ___, (La. 2007); Bear River Ins. Co. v. Williams, 153 P.2d 798, 801 (Utah Ct. App. 2006). On the other hand, some decisions say without qualification that insurance contracts should be construed strictly against the insurer. See, e.g., Carter v. Concord Gen. Mut. Ins. Co., ___ A.2d ___ (N.H. 2007); Cinergy Corp. v. Associated Elec. & Gas Ins. Servs., Ltd., 865 N.E.2d 571, 574 (Ind. 2007). And sometimes a single opinion tries to express both at the same time: 'It is well settled that a contract of insurance is no different from any other contract and must be construed in a fair and reasonable manner, having regard to the risk and subject matter of the policy, and that special rules such as liberal construction in favor of the insured and against the insurer who drew the contract apply.' In re New York Cent. Mut. Fire Ins. Co., 833 N.Y.S.2d 182, 183 (App. Div. 2007) (emphasis added).

Some commentators have endeavored without much success to reconcile these plainly distinct concepts. See, e.g., James M. Fischer, Why Are Insurance Contracts Subject to Special Rules of Interpretation?: Text Versus Context, 24 Ariz. St. L. J. 995, 1064 (1992) (arguing in favor of 'pro-insured' interpretational rules); and Carl A. Salisbury, Pollution Liability Ins. Coverage, the Standard-Form Pollution Exclusion, and the Insurance Industry: A Case Study in Collective Amnesia, 21 Envtl. L. J. 357, 362 n. 13 (1991). The only approach that sensibly reconciles these conflicting principles is based on the nature of the contracting parties and of the contract they made.

The Contra Proferentum Doctrine

First, the doctrine of contra proferentum originates with contracts of adhesion. See Carr v. Maryland Cas. Co., 388 N.Y.S.2d 196, 198 (N.Y. Civ. Ct. 1976); see also Phillips v. Lincoln Nat. Life Ins. Co., 978 F.2d 302, 313 (7th Cir. 1993); North Am. Phillps Corp. v. Aetna Cas. & Sur. Co., No. 88C-JA-155, 1995 WL 628441 (Del. Super. Mar. 10, 1995) (citing Carr). The facts matter. Where a party is presented with another's form on a 'take-it-or-leave-it' basis, without any option to seek changes, there may be sound policy reasons to make the drafter responsible for ambiguities in the form. This may be true, for example, of certain types of insurance involving individual consumers. But, it does not make sense where, for example, a commercial insured prepares and presents a wording to the insurer or where the insured, ably advised by risk managers, brokers, and lawyers, negotiates changes to a broker or insurer form.

Second, the cardinal principle of contract interpretation is to enforce the intent of the parties. Newmont Mines Ltd. v. Hanover Ins. Co., 784 F.2d 127, 135 (2d Cir. 1986). Rules of construction like contra proferentum are proxies for the parties' intent and should not supplant the terms and dealings of knowledgeable commercial parties, especially where they review and assess the proposed and agreed scope of insurance and the premium for that risk transfer. These parties have made a host of decisions about what they seek and where they are prepared to compromise, and there is no sound reason to look beyond their intent to presumptive construction.

Third, whatever arguments apply to spreading risk in the individual consumer context bear little weight when applied to insureds who have assets and market reach equal to or greater than the insurers with whom they deal. To invoke rules of interpretation in this context does not comport with the business reality in which the contracts were made.

A Seventh Circuit Decision

The U.S. Court of Appeals for the Seventh Circuit recently recognized and gave force to these factors in Farmers Automobile Insurance Association v. St. Paul Mercury Insurance Company, 482 F.3d 976, 977 (7th Cir. 2007). The plaintiff insurer was sued in an employee class action for overtime pay and requested coverage from the defendant under an employment practices liability policy. That policy insured claims alleging 'unlawful treatment of an employee' but excluded claims alleging violations of the Fair Labor Standards Act and 'other similar provisions of any federal, state or local law.' Id. at 976-77. Because the class action complaint alleged violation of the Illinois Minimum Wage Law, the defendant insurer denied coverage under the 'similar provisions' exclusion. Id. The coverage action followed.

The plaintiff sought to invoke the doctrine of contra proferentum, arguing that, as an insured, it was entitled to the same benefits as other insureds. The Seventh Circuit rejected that argument, reasoning that rules of construction must fit the circumstance. It is well established, for example, that contracts should be construed against the dafter, see Cooper Tire & Rubber Co. v. Farese, No. 3:02CV210-P-A, 2007 WL 108281 (N.D. Miss. Jan. 9, 2007), but this does not mean that insurance contracts should always be construed against the insurer. See, e.g., Salisbury, supra, at n. 13. Rather, even where the insurer prepares the form, 'the insured cannot be forced to accept the contract drafted by the insurance company.' Farmers Auto., 482 F.3d at 978. More fundamentally, there is no need for blanket assumptions about insurance contracts because, like all contracts, they are subject to review based on the facts of the contract and the general rules applicable to all contracts. In that regime, authorship of the contract wording is simply one factor to weigh.

The Seventh Circuit's view builds on earlier decisions recognizing that the contra proferentum is a principle of construction for all contracts and does not have special application to insurance contracts. The rule does not apply, for instance, where the parties negotiated the contract terms. See, e.g., MacNeilab, Inc. v. North River Ins. Co., 645 F. Supp. 525, 547 (D.N.J. 1986).

Moreover, contra proferentum should not apply where the contracting parties are sophisticated entities capable of looking after themselves ' a view endorsed by many decisions. See, e.g., Eagle Leasing Corp. v. Hartford Fire Ins. Co., 540 F.2d 1257, 1261 (5th Cir. 1976). Where the insurer and the insured have similar or equal bargaining power, the central justification for contra proferentum doctrine cannot be supported. See, e.g., I.U. N. Am., Inc. v. A.I.U. Ins. Co., 896 A.2d 860, 885-86 (Del. Super. 2006). Indeed, absent convincing evidence to the contrary, if sophisticated parties agree to use a form put forward by one of them, the logical inference is that the form accurately describes the agreement they made.

Sophisticated Business Entities

Finally, sophisticated business entities have substantial bargaining power and, while markets are harder in some years, they have the option and resources to accept risks and make deals they find advantageous. Through the use of brokers, these entities have access to worldwide capacity and specialized insurance products. They also have the leverage needed to negotiate manuscript contracts with foreign and domestic insurers and to access surplus lines insurance carriers offering products not available to smaller and less sophisticated entities. And, with increasing frequency they set up and operate their own captive insurance companies and use self-insurance structures to retain and spread risk in other ways, making business judgments about a host of financial options. In these circumstances, as the Seventh Circuit concluded, 'the argument for contra proferentum is pretty feeble when the policyholder is a sophisticated commercial enterprise rather than an individual consumer.' Farmers Auto., 482 F.3d at 977 (italics added).

Conclusion

These reasons and authorities point the way forward to a more rational and consistent view of insurance contracts. Courts need not do violence to cardinal principles of contract interpretation in order to protect consumers or create a system that allows powerful entities to disavow their contract intent and agreements. Rather, all insurance contracts should be approached in the same way and the relevance of the evidence and rules of construction judged on the facts of that contract. Where the record shows individuals or unsophisticated entities that had no choice but to accept policy wording from the insurer without any opportunity to negotiate, the predicates for applying rules of contract interpretation like contra proferentum may be met and, if so, the policy would be construed against the drafter under general contract law. However, where the facts show commercial parties on similar or equal footing, interpretation can and should be driven by the words the parties chose and the deal they made. There, the predicates for applying rules of construction do not exist, and the outcome should reflect the business reality of the parties' respective bargaining power.

Kenneth W. Erickson is a partner and Bryan R. Diederich is an associate at Ropes & Gray LLP in Boston. The views expressed in this article are those of the authors and not necessarily those of their law firm or the firm's clients.

One traditional rule of contract interpretation is to construe contact terms in appropriate circumstances against the drafter, a concept often referred to as contra proferentum. This doctrine sometimes fits uncomfortably with two other views expressed by American courts. On one hand, many decisions say that insurance contracts are interpreted just like any other commercial contract. See, e.g., Sims v. Mulhearn Funeral Home, Inc., ___ So.2d ___, (La. 2007); Bear River Ins. Co. v. Williams, 153 P.2d 798, 801 (Utah Ct. App. 2006). On the other hand, some decisions say without qualification that insurance contracts should be construed strictly against the insurer. See, e.g., Carter v. Concord Gen. Mut. Ins. Co., ___ A.2d ___ (N.H. 2007); Cinergy Corp. v. Associated Elec. & Gas Ins. Servs., Ltd., 865 N.E.2d 571, 574 (Ind. 2007). And sometimes a single opinion tries to express both at the same time: 'It is well settled that a contract of insurance is no different from any other contract and must be construed in a fair and reasonable manner, having regard to the risk and subject matter of the policy, and that special rules such as liberal construction in favor of the insured and against the insurer who drew the contract apply.' In re New York Cent. Mut. Fire Ins. Co., 833 N.Y.S.2d 182, 183 (App. Div. 2007) (emphasis added).

Some commentators have endeavored without much success to reconcile these plainly distinct concepts. See, e.g., James M. Fischer, Why Are Insurance Contracts Subject to Special Rules of Interpretation?: Text Versus Context, 24 Ariz. St. L. J. 995, 1064 (1992) (arguing in favor of 'pro-insured' interpretational rules); and Carl A. Salisbury, Pollution Liability Ins. Coverage, the Standard-Form Pollution Exclusion, and the Insurance Industry: A Case Study in Collective Amnesia, 21 Envtl. L. J. 357, 362 n. 13 (1991). The only approach that sensibly reconciles these conflicting principles is based on the nature of the contracting parties and of the contract they made.

The Contra Proferentum Doctrine

First, the doctrine of contra proferentum originates with contracts of adhesion. See Carr v. Maryland Cas. Co., 388 N.Y.S.2d 196, 198 (N.Y. Civ. Ct. 1976); see also Phillips v. Lincoln Nat. Life Ins. Co., 978 F.2d 302, 313 (7th Cir. 1993); North Am. Phillps Corp. v. Aetna Cas. & Sur. Co., No. 88C-JA-155, 1995 WL 628441 (Del. Super. Mar. 10, 1995) (citing Carr). The facts matter. Where a party is presented with another's form on a 'take-it-or-leave-it' basis, without any option to seek changes, there may be sound policy reasons to make the drafter responsible for ambiguities in the form. This may be true, for example, of certain types of insurance involving individual consumers. But, it does not make sense where, for example, a commercial insured prepares and presents a wording to the insurer or where the insured, ably advised by risk managers, brokers, and lawyers, negotiates changes to a broker or insurer form.

Second, the cardinal principle of contract interpretation is to enforce the intent of the parties. Newmont Mines Ltd. v. Hanover Ins. Co., 784 F.2d 127, 135 (2d Cir. 1986). Rules of construction like contra proferentum are proxies for the parties' intent and should not supplant the terms and dealings of knowledgeable commercial parties, especially where they review and assess the proposed and agreed scope of insurance and the premium for that risk transfer. These parties have made a host of decisions about what they seek and where they are prepared to compromise, and there is no sound reason to look beyond their intent to presumptive construction.

Third, whatever arguments apply to spreading risk in the individual consumer context bear little weight when applied to insureds who have assets and market reach equal to or greater than the insurers with whom they deal. To invoke rules of interpretation in this context does not comport with the business reality in which the contracts were made.

A Seventh Circuit Decision

The U.S. Court of Appeals for the Seventh Circuit recently recognized and gave force to these factors in Farmers Automobile Insurance Association v. St. Paul Mercury Insurance Company, 482 F.3d 976, 977 (7th Cir. 2007). The plaintiff insurer was sued in an employee class action for overtime pay and requested coverage from the defendant under an employment practices liability policy. That policy insured claims alleging 'unlawful treatment of an employee' but excluded claims alleging violations of the Fair Labor Standards Act and 'other similar provisions of any federal, state or local law.' Id. at 976-77. Because the class action complaint alleged violation of the Illinois Minimum Wage Law, the defendant insurer denied coverage under the 'similar provisions' exclusion. Id. The coverage action followed.

The plaintiff sought to invoke the doctrine of contra proferentum, arguing that, as an insured, it was entitled to the same benefits as other insureds. The Seventh Circuit rejected that argument, reasoning that rules of construction must fit the circumstance. It is well established, for example, that contracts should be construed against the dafter, see Cooper Tire & Rubber Co. v. Farese, No. 3:02CV210-P-A, 2007 WL 108281 (N.D. Miss. Jan. 9, 2007), but this does not mean that insurance contracts should always be construed against the insurer. See, e.g., Salisbury, supra, at n. 13. Rather, even where the insurer prepares the form, 'the insured cannot be forced to accept the contract drafted by the insurance company.' Farmers Auto., 482 F.3d at 978. More fundamentally, there is no need for blanket assumptions about insurance contracts because, like all contracts, they are subject to review based on the facts of the contract and the general rules applicable to all contracts. In that regime, authorship of the contract wording is simply one factor to weigh.

The Seventh Circuit's view builds on earlier decisions recognizing that the contra proferentum is a principle of construction for all contracts and does not have special application to insurance contracts. The rule does not apply, for instance, where the parties negotiated the contract terms. See, e.g., MacNeilab, Inc. v. North River Ins. Co., 645 F. Supp. 525, 547 (D.N.J. 1986).

Moreover, contra proferentum should not apply where the contracting parties are sophisticated entities capable of looking after themselves ' a view endorsed by many decisions. See, e.g., Eagle Leasing Corp. v. Hartford Fire Ins. Co., 540 F.2d 1257, 1261 (5th Cir. 1976). Where the insurer and the insured have similar or equal bargaining power, the central justification for contra proferentum doctrine cannot be supported. See, e.g., I.U. N. Am., Inc. v. A.I.U. Ins. Co., 896 A.2d 860, 885-86 (Del. Super. 2006). Indeed, absent convincing evidence to the contrary, if sophisticated parties agree to use a form put forward by one of them, the logical inference is that the form accurately describes the agreement they made.

Sophisticated Business Entities

Finally, sophisticated business entities have substantial bargaining power and, while markets are harder in some years, they have the option and resources to accept risks and make deals they find advantageous. Through the use of brokers, these entities have access to worldwide capacity and specialized insurance products. They also have the leverage needed to negotiate manuscript contracts with foreign and domestic insurers and to access surplus lines insurance carriers offering products not available to smaller and less sophisticated entities. And, with increasing frequency they set up and operate their own captive insurance companies and use self-insurance structures to retain and spread risk in other ways, making business judgments about a host of financial options. In these circumstances, as the Seventh Circuit concluded, 'the argument for contra proferentum is pretty feeble when the policyholder is a sophisticated commercial enterprise rather than an individual consumer.' Farmers Auto., 482 F.3d at 977 (italics added).

Conclusion

These reasons and authorities point the way forward to a more rational and consistent view of insurance contracts. Courts need not do violence to cardinal principles of contract interpretation in order to protect consumers or create a system that allows powerful entities to disavow their contract intent and agreements. Rather, all insurance contracts should be approached in the same way and the relevance of the evidence and rules of construction judged on the facts of that contract. Where the record shows individuals or unsophisticated entities that had no choice but to accept policy wording from the insurer without any opportunity to negotiate, the predicates for applying rules of contract interpretation like contra proferentum may be met and, if so, the policy would be construed against the drafter under general contract law. However, where the facts show commercial parties on similar or equal footing, interpretation can and should be driven by the words the parties chose and the deal they made. There, the predicates for applying rules of construction do not exist, and the outcome should reflect the business reality of the parties' respective bargaining power.

Kenneth W. Erickson is a partner and Bryan R. Diederich is an associate at Ropes & Gray LLP in Boston. The views expressed in this article are those of the authors and not necessarily those of their law firm or the firm's clients.