Returning Contra Proferentem to Its Roots

This article focuses on the law of New York ' often chosen to govern insurance contracts ' to illustrate how the proper application of basic contract principles can and should address those different circumstances. As shown below, a careful review of whether to invoke contra proferentem at all involves an analysis of which party actually drafted the provision in question.

Serial Steps in the Application of Principles of Contract Interpretation

New York, like most jurisdictions, prescribes a multi-step approach for the interpretation of contracts. First, the court must assess whether the language at issue is open to competing, reasonable interpretations. In doing so, the court looks to the four corners of the contract, rather than to outside sources, and interprets the relevant language in the context of the contract as a whole. Discovision Assocs. v. Toshiba Corp., 08cv3693(HB), 2009 U.S. Dist. LEXIS 41662, at *13 (S.D.N.Y. May 18, 2009). The court need not consider the words of the contract in an absolute vacuum. New York has long and consistently acknowledged that the court may bring its common sense to the task, considering terms in the context of the entire agreement, including the motives and respective positions of the contracting parties. Atwater & Co. v. Panama R.R. Co., 246 N.Y. 519, 524 (1927), Collins v. Harrison-Bode, 303 F.3d 429, 433 (2d Cir. 2002) (citing the Atwater framework). This does not mean, however, that canons of contract construction such as contra proferentem may be invoked at this first stage. If a court determines that the language of the contract and common sense compel the conclusion that provisions at issue are unambiguous, its analysis ends there: The plain language is applied as written.

As a second step, in the process of evaluating whether contract language is ambiguous, the court may clarify industry conventions through an examination of extrinsic evidence. See Law Debenture Trust Co. v. Maverick Tube Corp., 595 F.3d 458, 466 (2d Cir. 2010); World Trade Ctr. Props., L.L.C. v. Hartford Fire Ins. Co., 345 F.3d 154, 185-86 (2d Cir. 2003) (affirming district court's denial of summary judgment to insurers after finding the term “occurrence” ambiguous based, in part, on testimony regarding industry custom and usage).

If and when the court has determined that the language remains susceptible to more than one reasonable interpretation, the court's third step is to consider relevant evidence of the parties' intent. Morgan Stanley Group, Inc. v. New England Ins. Co., 225 F.3d 270, 275-76 (2d Cir. 2000). Typically, courts will turn to documents contemporaneous to the drafting that show the parties' exchanges at the time of contracting. See e.g., Eastern Air Lines, Inc. v. Ins. Co. of the State of Pa., 96 Civ. 7113 (MGC), 2001 U.S. Dist. LEXIS 14734, at *18'21 (S.D.N.Y. Sept. 21, 2001). Courts will not consider uncommunicated expressions of subjective intent or post hoc interpretations of ambiguous language. Faulkner v. National Geographic Soc'y, 452 F. Supp. 2d 369, 377-81 (S.D.N.Y. 2006). In addition to drafting history of the contract the parties' course of dealing after the contract is in place and under its terms is “highly relevant” for determining their intent at the time of contracting. Id. If there is evidence of the parties' intent but it is conflicting or gives rise to a genuine dispute of material fact, the matter must be put to the finder of fact.

Only if and when extrinsic evidence cannot resolve the contractual ambiguity or is wholly unavailable may the court invoke a fourth step in the analysis: turning to canons of contract construction. See Morgan Stanley, 225 F.3d at 275-76; see also Nouveau Elevator Indus., Inc. v. Cont'l Cas. Ins. Co., No. 05-CV-0813 (JFB) (RLM), 2006 U.S. Dist. LEXIS 41495, at *21-22 (E.D.N.Y. June 21, 2006) (resorting to canons of construction after finding that the “record before the Court [did] not contain a scintilla of extrinsic evidence regarding the intent of the parties”). Courts applying New York law look to rules of construction only as a matter of “last resort” and only after every other aid for discerning intent has failed to produce a satisfactory result. United States Fire Ins. Co. v. General Reinsurance Corp., 949 F.2d 569, 573 (2d Cir. 1991) (quoting Schering Corp. v. Home Ins. Co., 712 F.2d 4, 10 n.2 (2d Cir. 1983)).

Contra Proferentem: Among the Canons

The canons of contract construction include principles such as construing to avoid rendering terms meaningless, and allowing specific provisions to control over general ones, which must be considered alongside the canon of contra proferentem. Although contra proferentem is a frequently invoked canon of construction, it should be applied in context.

Moreover, properly considered, the canon of contra proferentem requires analysis of both who drafted (or offered) the language, and the relative sophistication and bargaining power of the parties, which bears on whether the language could have been clarified through negotiation of the contract language.

Foundation for Contra Proferentem in the Insurance Context

In its early jurisprudence, the New York Court of Appeals explicitly recognized that applying contra proferentem against an insurer was premised on the insurer having prepared and executed the agreement and therefore being responsible for its terms and any subsequent ambiguity. Janneck v. Metro. Life Ins. Co., 57 N.E. 182 (N.Y. 1900) (stating that ambiguous language should be construed against the insurer because the insurer drafted the contract); see also Kratzenstein v. W. Assurance Co., 22 N.E. 221 (N.Y. 1889).

Despite this foundation, some later decisions used a shorthand that some practitioners improperly characterize as an absolute rule always operating to the detriment of the insurer in the event of any ambiguity of the contract. E.g., Hartol Prods. Corp. v. Prudential Ins. Co. of America, 47 N.E.2d 687, 690 (N.Y. 1943).

Emerging Focus on Relative Sophistication

A contest between two insurers highlighted the fact that uses of the canon had begun to deviate from the principles behind it.

In Standard Marine Insurance Co. v. Federal Insurance Co., 336 N.Y.S.2d 692, 695 (App. Div. 1972), the court held that the canon was inapplicable following the Ninth Circuit Court of Appeal's assessment in New Amsterdam Casualty Co. v. Fidelity & Casualty Co., 400 F.2d 237, 239 (9th Cir. 1968). The opinion focused, however, on the fact that both parties were insurers, rather than more broadly reconsidering underlying principles.

Further progress was made in Loblaw, Inc. v. Employers' Liability Assurance Corp., 446 N.Y.S.2d 743, 745 (App. Div. 1981). There, the policyholder was not an insurer, but was found to be “more akin to that of an insurance company than to that of an individual who is inexperienced in matters of insurance coverage for whose benefit the rule was promulgated.” The Loblaw court premised its finding on a record showing the policyholder acted as a “self-insurer” with respect to Workers Compensation claims through an insurance adjusting company and therefore had sufficient sophistication for the court to deny application of contra proferentem.

The Loblaw court's reliance on the insured's sophistication as a touchstone for application of the contra proferentem doctrine recognizes one of the purposes of the rules is to protect parties who lack the resources or knowledge to play a real role in negotiating the contract. More recent cases acknowledge that many types of policyholders ' not just those who also act as insurers ' may have relative bargaining power equivalent to that of an insurer. In Schering Corp. v. Home Insurance Co., 712 F.2d 4, 10 n.2 (2d Cir. 1983), the Second Circuit Court of Appeals addressed the “unresolved” question of the appropriateness of construing an ambiguous contract in favor of “a large, sophisticated, counseled entity.” Id. The court held that, in such cases, the underlying adhesion-contract rationale was inapposite. Id. Though dependent on the party putting forward the contract language, many commercial insureds are represented by sophisticated brokers and employ a knowledgeable risk manager, and should fail to qualify as beneficiaries of contra proferentem.

Emerging Focus on Ascertaining the Drafter

More recently, the Second Circuit has noted that “there is no general rule in New York denying sophisticated businesses the benefit of contra proferentem.” Morgan Stanley Group, Inc. v. New England Ins. Co., 225 F.3d 270, 279 (2d Cir. 2000). There, the court held that the doctrine requires focus not solely on the identity of the parties involved or their relative bargaining position, but also on the actual drafting and negotiation of the policy wording. Morgan Stanley involved a dispute over errors and omissions coverage for service as “an investment counselor” and whether the policy provided coverage when Morgan Stanley had been alleged to have acted as in that capacity when, in fact, it had not. In remanding to resolve this question, the Second Circuit instructed the district court to apply contra proferentem only in the event extrinsic evidence did not shed light on the ambiguity. Id. at 280. To reach this conclusion, the court reasoned that although Morgan Stanley was undeniably a sophisticated party, the record established that it “did not negotiate its coverage terms” and apparently had no real opportunity to do so. Id. (“[Insurer's agent] who participated in the insurance transaction testified that it was a 'standard policy' that [the insurer] 'didn't amend for anybody.'”).

An Even-Handed Application of Contra Proferentem

Following the same logic articulated in Loblaw and Morgan Stanley, both federal and state courts in New York have returned to a proper focus on both relative sophistication and actual negotiating history. See e.g., Eastern Air Lines, Inc. v. Ins. Co. of the State of Pa., 96 Civ. 7113 (MGC), 2001 U.S. Dist. LEXIS 14734, at *16 (S.D.N.Y. Sept. 21, 2001) (contra proferentem not applicable in circumstances where the insured negotiated key part of its insurance contract through an experienced insurance broker). See Cummins, Inc. v. Atlantic Mutual Ins. Co., 867 N.Y.S.2d 81, 83 (App. Div. 2008) (contra proferentem not applicable where the insured was a sophisticated entity that played a major role in preparing various parts of the agreement and had equivalent bargaining power to the insurer). As these decisions illustrate, a focus on both relative sophistication and actual negotiating history often leads to a more even-handed application of the canon which is rooted in the public policy considerations that underlie it.

It is possible, of course, that facts could be presented establishing that despite equivalent bargaining power, the insured prepared the language it wanted with the superior knowledge it held of its operations and the risks presented, and the wording was presented to insurers on a take-it-or-leave-it basis. In that scenario, the principles underlying the doctrine of contra proferentem mandate that any ambiguities be construed in favor of the insurer, and against the insured who offered the language in question. That logic would hold regardless of whether the insured drafted the provision at issue starting with a blank sheet of paper, or worked with its broker to prepare the particular language for the provision by referencing a selection of forms and models. Although New York decisions have not yet squarely addressed such a set of facts, it is the next logical step in returning the doctrine of contra proferentem to its roots.

Catherine Mondell, a member of this newsletter's Board of Editors, is a partner at Ropes & Gray LLP, and has handled a wide range of complex insurance coverage disputes and other commercial litigation matters. She has litigated in multiple jurisdictions cases involving first-party property claims with substantial time element and contingent time element components. Seth Harrington is a litigation associate at Ropes & Gray, with experience in both insurance and other commercial litigation, including multiple matters involving first-party property insurance claims made following Hurricanes Katrina, Rita and Wilma. Megan Easley was a summer associate at the firm in 2011.

In addressing disputes involving contracts of insurance, insureds often argue that the court is obligated to construe any perceived ambiguity against insurers. The rules governing contract interpretation are, however, far more nuanced, and more even-handed.

Of course, there are cases where the insurer is the sole drafter of the contract, the insured is an individual unaccustomed to drafting and applying policy terms, and there is no negotiation of the wording ' as in many disputes involving homeowners policies. In such a context, the doctrine of contra proferentem ' the canon of contract construction providing that provisions must be construed “against the offeror” ' may support the argument that genuinely ambiguous language should be construed against the insurer who actually drafted the policy.

That is not often the case, however, in commercial insurance contexts. Consider, for example, the case of a commercial first-party property policy, where so-called “manuscript” policy wordings are common. The insured company may have a full-time risk manager, who, in turn, has retained a professional insurance broker. Working together on behalf of the insured, the risk manager and broker may develop policy wording, often drawing on provisions the broker has developed or used for its clients in the past, and tailor them to the insured's specific needs. The wording is presented to multiple insurers, whose efforts to change the wording are rejected by the broker and/or the insured. In this context, the insured and its agent, the broker, are the principal drafters of the contract, and likely far better informed than insurers as to how the policy provisions will apply to its business. To construe policy wording against the insurers in such a context turns the canon of contra proferentem on its head.

This article focuses on the law of New York ' often chosen to govern insurance contracts ' to illustrate how the proper application of basic contract principles can and should address those different circumstances. As shown below, a careful review of whether to invoke contra proferentem at all involves an analysis of which party actually drafted the provision in question.

Serial Steps in the Application of Principles of Contract Interpretation

New York, like most jurisdictions, prescribes a multi-step approach for the interpretation of contracts. First, the court must assess whether the language at issue is open to competing, reasonable interpretations. In doing so, the court looks to the four corners of the contract, rather than to outside sources, and interprets the relevant language in the context of the contract as a whole. Discovision Assocs. v. Toshiba Corp., 08cv3693(HB), 2009 U.S. Dist. LEXIS 41662, at *13 (S.D.N.Y. May 18, 2009). The court need not consider the words of the contract in an absolute vacuum. New York has long and consistently acknowledged that the court may bring its common sense to the task, considering terms in the context of the entire agreement, including the motives and respective positions of the contracting parties. Atwater & Co. v. Panama R.R. Co. , 246 N.Y. 519, 524 (1927), Collins v. Harrison-Bode , 303 F.3d 429, 433 (2d Cir. 2002) (citing the Atwater framework). This does not mean, however, that canons of contract construction such as contra proferentem may be invoked at this first stage. If a court determines that the language of the contract and common sense compel the conclusion that provisions at issue are unambiguous, its analysis ends there: The plain language is applied as written.

As a second step, in the process of evaluating whether contract language is ambiguous, the court may clarify industry conventions through an examination of extrinsic evidence. See Law Debenture Trust Co. v. Maverick Tube Corp. , 595 F.3d 458, 466 (2d Cir. 2010); World Trade Ctr. Props., L.L.C. v. Hartford Fire Ins. Co. , 345 F.3d 154, 185-86 (2d Cir. 2003) (affirming district court's denial of summary judgment to insurers after finding the term “occurrence” ambiguous based, in part, on testimony regarding industry custom and usage).

If and when the court has determined that the language remains susceptible to more than one reasonable interpretation, the court's third step is to consider relevant evidence of the parties' intent. Morgan Stanley Group, Inc. v. New England Ins. Co. , 225 F.3d 270, 275-76 (2d Cir. 2000). Typically, courts will turn to documents contemporaneous to the drafting that show the parties' exchanges at the time of contracting. See e.g., Eastern Air Lines, Inc. v. Ins. Co. of the State of Pa., 96 Civ. 7113 (MGC), 2001 U.S. Dist. LEXIS 14734, at *18'21 (S.D.N.Y. Sept. 21, 2001). Courts will not consider uncommunicated expressions of subjective intent or post hoc interpretations of ambiguous language. Faulkner v. National Geographic Soc'y , 452 F. Supp. 2d 369, 377-81 (S.D.N.Y. 2006). In addition to drafting history of the contract the parties' course of dealing after the contract is in place and under its terms is “highly relevant” for determining their intent at the time of contracting. Id. If there is evidence of the parties' intent but it is conflicting or gives rise to a genuine dispute of material fact, the matter must be put to the finder of fact.

Only if and when extrinsic evidence cannot resolve the contractual ambiguity or is wholly unavailable may the court invoke a fourth step in the analysis: turning to canons of contract construction. See Morgan Stanley, 225 F.3d at 275-76; see also Nouveau Elevator Indus., Inc. v. Cont'l Cas. Ins. Co., No. 05-CV-0813 (JFB) (RLM), 2006 U.S. Dist. LEXIS 41495, at *21-22 (E.D.N.Y. June 21, 2006) (resorting to canons of construction after finding that the “record before the Court [did] not contain a scintilla of extrinsic evidence regarding the intent of the parties”). Courts applying New York law look to rules of construction only as a matter of “last resort” and only after every other aid for discerning intent has failed to produce a satisfactory result. United States Fire Ins. Co. v. General Reinsurance Corp. , 949 F.2d 569, 573 (2d Cir. 1991) (quoting Schering Corp. v. Home Ins. Co. , 712 F.2d 4, 10 n.2 (2d Cir. 1983)).

Contra Proferentem: Among the Canons

The canons of contract construction include principles such as construing to avoid rendering terms meaningless, and allowing specific provisions to control over general ones, which must be considered alongside the canon of contra proferentem. Although contra proferentem is a frequently invoked canon of construction, it should be applied in context.

Moreover, properly considered, the canon of contra proferentem requires analysis of both who drafted (or offered) the language, and the relative sophistication and bargaining power of the parties, which bears on whether the language could have been clarified through negotiation of the contract language.

Foundation for Contra Proferentem in the Insurance Context

In its early jurisprudence, the New York Court of Appeals explicitly recognized that applying contra proferentem against an insurer was premised on the insurer having prepared and executed the agreement and therefore being responsible for its terms and any subsequent ambiguity. Janneck v. Metro. Life Ins. Co. , 57 N.E. 182 (N.Y. 1900) (stating that ambiguous language should be construed against the insurer because the insurer drafted the contract); see also Kratzenstein v. W. Assurance Co. , 22 N.E. 221 (N.Y. 1889).

Despite this foundation, some later decisions used a shorthand that some practitioners improperly characterize as an absolute rule always operating to the detriment of the insurer in the event of any ambiguity of the contract. E.g., Hartol Prods. Corp. v. Prudential Ins. Co. of America , 47 N.E.2d 687, 690 (N.Y. 1943).

Emerging Focus on Relative Sophistication

A contest between two insurers highlighted the fact that uses of the canon had begun to deviate from the principles behind it.

In Standard Marine Insurance Co. v. Federal Insurance Co. , 336 N.Y.S.2d 692, 695 (App. Div. 1972), the court held that the canon was inapplicable following the Ninth Circuit Court of Appeal's assessment in New Amsterdam Casualty Co. v. Fidelity & Casualty Co. , 400 F.2d 237, 239 (9th Cir. 1968). The opinion focused, however, on the fact that both parties were insurers, rather than more broadly reconsidering underlying principles.

Further progress was made in Loblaw, Inc. v. Employers' Liability Assurance Corp. , 446 N.Y.S.2d 743, 745 (App. Div. 1981). There, the policyholder was not an insurer, but was found to be “more akin to that of an insurance company than to that of an individual who is inexperienced in matters of insurance coverage for whose benefit the rule was promulgated.” The Loblaw court premised its finding on a record showing the policyholder acted as a “self-insurer” with respect to Workers Compensation claims through an insurance adjusting company and therefore had sufficient sophistication for the court to deny application of contra proferentem.

The Loblaw court's reliance on the insured's sophistication as a touchstone for application of the contra proferentem doctrine recognizes one of the purposes of the rules is to protect parties who lack the resources or knowledge to play a real role in negotiating the contract. More recent cases acknowledge that many types of policyholders ' not just those who also act as insurers ' may have relative bargaining power equivalent to that of an insurer. In Schering Corp. v. Home Insurance Co. , 712 F.2d 4, 10 n.2 (2d Cir. 1983), the Second Circuit Court of Appeals addressed the “unresolved” question of the appropriateness of construing an ambiguous contract in favor of “a large, sophisticated, counseled entity.” Id. The court held that, in such cases, the underlying adhesion-contract rationale was inapposite. Id. Though dependent on the party putting forward the contract language, many commercial insureds are represented by sophisticated brokers and employ a knowledgeable risk manager, and should fail to qualify as beneficiaries of contra proferentem.

Emerging Focus on Ascertaining the Drafter

More recently, the Second Circuit has noted that “there is no general rule in New York denying sophisticated businesses the benefit of contra proferentem .” Morgan Stanley Group, Inc. v. New England Ins. Co. , 225 F.3d 270, 279 (2d Cir. 2000). There, the court held that the doctrine requires focus not solely on the identity of the parties involved or their relative bargaining position, but also on the actual drafting and negotiation of the policy wording. Morgan Stanley involved a dispute over errors and omissions coverage for service as “an investment counselor” and whether the policy provided coverage when Morgan Stanley had been alleged to have acted as in that capacity when, in fact, it had not. In remanding to resolve this question, the Second Circuit instructed the district court to apply contra proferentem only in the event extrinsic evidence did not shed light on the ambiguity. Id. at 280. To reach this conclusion, the court reasoned that although Morgan Stanley was undeniably a sophisticated party, the record established that it “did not negotiate its coverage terms” and apparently had no real opportunity to do so. Id. (“[Insurer's agent] who participated in the insurance transaction testified that it was a 'standard policy' that [the insurer] 'didn't amend for anybody.'”).

An Even-Handed Application of Contra Proferentem

Following the same logic articulated in Loblaw and Morgan Stanley, both federal and state courts in New York have returned to a proper focus on both relative sophistication and actual negotiating history. See e.g., Eastern Air Lines, Inc. v. Ins. Co. of the State of Pa., 96 Civ. 7113 (MGC), 2001 U.S. Dist. LEXIS 14734, at *16 (S.D.N.Y. Sept. 21, 2001) (contra proferentem not applicable in circumstances where the insured negotiated key part of its insurance contract through an experienced insurance broker). See Cummins, Inc. v. Atlantic Mutual Ins. Co. , 867 N.Y.S.2d 81, 83 (App. Div. 2008) ( contra proferentem not applicable where the insured was a sophisticated entity that played a major role in preparing various parts of the agreement and had equivalent bargaining power to the insurer). As these decisions illustrate, a focus on both relative sophistication and actual negotiating history often leads to a more even-handed application of the canon which is rooted in the public policy considerations that underlie it.

It is possible, of course, that facts could be presented establishing that despite equivalent bargaining power, the insured prepared the language it wanted with the superior knowledge it held of its operations and the risks presented, and the wording was presented to insurers on a take-it-or-leave-it basis. In that scenario, the principles underlying the doctrine of contra proferentem mandate that any ambiguities be construed in favor of the insurer, and against the insured who offered the language in question. That logic would hold regardless of whether the insured drafted the provision at issue starting with a blank sheet of paper, or worked with its broker to prepare the particular language for the provision by referencing a selection of forms and models. Although New York decisions have not yet squarely addressed such a set of facts, it is the next logical step in returning the doctrine of contra proferentem to its roots.

Catherine Mondell, a member of this newsletter's Board of Editors, is a partner at Ropes & Gray LLP, and has handled a wide range of complex insurance coverage disputes and other commercial litigation matters. She has litigated in multiple jurisdictions cases involving first-party property claims with substantial time element and contingent time element components. Seth Harrington is a litigation associate at Ropes & Gray, with experience in both insurance and other commercial litigation, including multiple matters involving first-party property insurance claims made following Hurricanes Katrina, Rita and Wilma. Megan Easley was a summer associate at the firm in 2011.