RLLI Section 4

(1) An insurance policy term is ambiguous if there is more than one meaning to which the language of the term is reasonably susceptible when applied to the facts of the claim at issue in the context of the entire insurance policy.

  (2) When an insurance policy term is ambiguous as defined in subsection (1), the term is interpreted against the party that supplied the term, unless that party persuades the court that a reasonable person in the policyholder’s position would not give the term that interpretation.

Comment:

a. Definition of ambiguity. An ambiguous policy term is a term that has at least two interpretations to which the language of the term is reasonably susceptible when applied to the facts of the claim in question. This definition follows the traditional insurance-law approach pursuant to which the competing interpretations need not be equally reasonable for a term to be ambiguous. All that is required is that the language of the policy be reasonably susceptible to the proposed alternative. The concept of ambiguity in insurance law can include what is sometimes called vagueness: a lack of clarity in application that does not easily reduce to multiple competing interpretations. A term that has a plain meaning when applied to one claim may not have a plain meaning when applied to another claim. See Comment f to § 3.

b. Using external sources of meaning to determine whether a term is ambiguous. Courts that follow a plain-meaning rule may consider the external sources of meaning described in Comments b and c to § 3 when determining whether a term is ambiguous (including custom, practice, and usage in appropriate circumstances), but they may not consider precontractual negotiations, course of dealing, or other similar forms of extrinsic evidence that pertain to interactions of the parties regarding the particular insurance contract at issue. These latter sources of meaning may be considered only if the court first makes the threshold determination that the insurance policy term is ambiguous when applied to the facts of the claim at issue. This more restrictive rule reflects a judgment by courts that the additional costs of considering such evidence when making the threshold ambiguity determination (such as the increased costs of discovery and a reduced likelihood that the case will be resolved before discovery) outweigh the benefits of considering such evidence (such as an increase in the accuracy of the court’s assessment of a term’s meaning). Although courts rarely make such a cost-benefit calculation explicitly, the implicit judgment is that the costs will be incurred in many cases, whereas the benefits will be realized only in a small fraction of those cases.

Courts in some states have articulated a broad “latent ambiguity” rule that, unlike the rule followed in this Section, permits courts to consider a similarly broad range of circumstances at the threshold, ambiguity-determination stage, reasoning that this approach better protects the reasonable expectations of insurance purchasers and that the additional administrative costs are worth incurring as a result. This Restatement does not adopt this latent-ambiguity rule.

c. Using external sources of meaning to resolve an ambiguity. Courts generally agree that, once a court determines that a term is ambiguous, it may consider a wide range of potential sources of meaning in the effort to resolve the ambiguity. Commonly considered sources of meaning include: precontractual negotiations; the parties’ course of performance under the policy at issue; the course of dealing between the parties with regard to other policies; the drafting history of insurance policy terms at issue; documents filed with state administrative agencies regarding an insurance policy or term at issue; other versions of the relevant term available on the market; other forms of insurance available on the market; publications and expert testimony regarding the history, purpose, and function of policy terms and forms of insurance coverage; and publications and expert testimony regarding custom, practice, and usage in the business or trade being insured and in the insurance industry. (Note that custom, practice, and usage can also be a relevant consideration at the initial, plain-meaning stage of interpretation. See § 3, Comments c and d.) Courts differ on whether these types of evidence should be discoverable before the court has determined that the term at issue is ambiguous. Because discoverability implicates civil-procedure concerns that are beyond the scope of this Restatement, this Section does not state a rule regarding discovery of such evidence. Courts agree that a party’s unilateral subjective understanding of an insurance policy term is generally not relevant to the interpretation of the policy. See Comment i.

Because the objective of using these sources of meaning is to understand the meaning that a reasonable person in this policyholder’s position would ascribe to the term, such evidence may be used against an insured only when the policyholder could reasonably be expected to have been aware of it. There are differences among policyholders in this regard based on the knowledge that they reasonably should have regarding the form of insurance in question. For example, a large commercial policyholder that employs a risk manager, uses a broker (who can identify how a term varies from other versions of the term available on the market), has access to counsel (who can identify how the term has been applied by courts), and has purchased similar policies in the past may be considered to have such knowledge and understanding of the meaning of standard-form terms of insurance policies within the insurance trade as could be obtained by these agents through reasonable investigation, commensurate with the risks transferred. By contrast, individual consumer and small commercial policyholders ordinarily would not be expected to have been aware of such specialized meanings.

Extrinsic evidence can likewise be used against the insurer only when the insurer could reasonably be expected to have been aware of it. Insurers are presumed to be sophisticated and knowledgeable about matters of insurance, including the drafting history of standard-form terms, even if the particular insurer involved was not itself involved in the drafting of that term. This presumption is consistent with how contra proferentem is applied, as ambiguous terms in standard-form policies are construed against insurers even if the particular insurer did not supply the term. Some extrinsic evidence—such as prior negotiations and course of dealing between the parties—may go to the intent of both the insurer and the policyholder and may reveal a controlling mutual intent supporting reformation of the policy. See Comment i.

  Illustrations:

  1. Insurer issues a general liability policy to Named Insured that designates “Acme, 123 Main Street” as an additional insured. Acme Logistics, which has been sued in connection with an accident caused by Named Insured, requests coverage under the policy. Insurer denies coverage on the ground that Acme Logistics is not an insured under the policy. In a coverage action, Acme Logistics introduces evidence showing it has had an office at that address for 20 years and, therefore, it is the additional insured under the policy issued by Insurer. Insurer introduces undisputed evidence showing that (a) Acme Products also has an office at that same address, (b) Acme Products has a commercial relationship with Named Insured pursuant to which Named Insured was obligated to obtain liability insurance coverage for Acme Products, and (c) Acme Logistics has no such commercial relationship with Named Insured. The additional-insured term is ambiguous when applied to the facts of the claim for coverage because, on its face, the term could reasonably be read to refer to either of two entities. The court nevertheless issues a judgment for Insurer because the extrinsic evidence shows that no reasonable policyholder would interpret the additional-insured term to refer to Acme Logistics.

  2. An insured restaurant owner is sued by a patron who was injured when a waiter accidentally splashed hot-pepper oil in the patron’s eye. The insurer denies coverage under the pollution exclusion in the policy, which states that the policy “does not apply to … bodily injury or property damage arising out of the actual, alleged, or threatened discharge, dispersal or release or escape of ‘pollutants’ ….” The term “pollutants” is defined in the policy to mean:

Any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste. Waste includes materials to be recycled, reconditioned or reclaimed.

The court determines that the word “irritant” contained in the exclusion is ambiguous when applied to hot-pepper oil, because it is capable of being read narrowly so that it does not include food items spilled on a patron in a restaurant and broadly so that it includes such items. Considering extrinsic evidence indicating that the purpose of the exclusion is to avoid coverage for liability for environmental damage and toxic torts, the court determines that a reasonable policyholder in the restaurant’s position would not interpret the term “irritant” to include hot-pepper oil accidentally splashed in a restaurant patron’s eye.

d. Interpretation against the supplier of the term. The rule that an ambiguous contract term should be interpreted against the party that supplied the term is commonly referred to in insurance-law sources by its Latin name, contra proferentem, which means “against the offeror.” In the context of standard-form insurance policy terms, the insurer is so regularly the party supplying the form that courts often describe the contra proferentem rule as meaning that an ambiguous policy is interpreted in favor of coverage. The standard justification for the contra proferentem rule builds on the idea that the supplier of a term in a contract is generally in the best position to avoid ambiguity in the wording of the term, because the supplier drafted or, at the very least, chose to offer a contract containing that term. This rationale applies especially to situations involving standard-form terms, when one party supplies the terms and the other party either accepts or rejects them but is not given the option of suggesting alternative wording. The contra proferentem rule gives the supplier of the terms the incentive to take all reasonable steps to eliminate ambiguity in the drafting of terms.

It should be noted, however, that the aim of the rule is not the elimination of all ambiguity. Here the analogy to tort law is helpful. Just as it is not possible for the incentive provided by a tort-liability rule to eliminate all possibility of accidents, it is not possible for the incentive provided by a contra proferentem rule to eliminate all possibility of ambiguity. Even insurance policy terms that are relatively simple and clear on their face can become ambiguous when applied to a particular claim. The cost, to insurers and policyholders, of attempting to draft policies that specifically and unambiguously address every conceivable contingency would be prohibitive. Over time, insurance policies would become unacceptably long and, by their very length and complexity, inhibit rather than promote clear meaning. Thus, the contra proferentem rule, even when creating positive drafting incentives, should not be expected to eliminate all ambiguity.

e. Residual risk of unavoidable ambiguity. In addition to creating positive drafting incentives, the contra proferentem rule allocates to the party supplying the term the residual risk of unavoidable ambiguity. This allocation of risk is especially appropriate in the insurance context, when the parties supplying terms generally are insurance companies whose primary function is the spreading of risks. Thus, the risk of unavoidable ambiguity in insurance policy terms is, through the application of the contra proferentem rule, ultimately spread over all policyholders rather than borne by any individual insured. There is also a fairness argument that supports imposing the costs of ambiguity upon the party that benefited from having its preferred term in the insurance policy. This fairness argument applies even when the doctrine works against the insured and, thus, against risk spreading.

f. The mechanical application of the contra proferentem rule. Some courts apply a more mechanical version of the contra proferentem rule, in which the insurer that drafted or supplied the policy always loses whenever a term is found to be facially ambiguous when applied to the claim in question. This mechanical version of the rule is problematic because it sometimes produces outcomes that the policyholder could not have reasonably expected, in circumstances in which the insurer could not reasonably have eliminated the ambiguity. Under the rule in this Section, an insurer has the opportunity to use extrinsic evidence to demonstrate to the court that the coverage-promoting interpretation of an ambiguous term is unreasonable in the circumstances, meaning that a reasonable person in the policyholder’s position would not give the term that interpretation. In addition to being more likely to result in outcomes that are consistent with the reasonable expectations of the policyholder, this approach to contra proferentem is also consistent with what many courts in fact do, by engaging in the analytical effort needed to identify whether the coverage-promoting interpretation is unreasonable in the circumstances.

g. A reasonable person in this policyholder’s position. When the question is plain meaning, the inquiry focuses on identifying the single meaning that a reasonable person would assign to the language if that person had read the term and the insurance policy reasonably carefully. The rule in this Section applies only when the term in question has no single plain meaning when applied to the claim in question; rather, the term is ambiguous. In that case, the question becomes whether the coverage-promoting interpretation is one that a reasonable person in the policyholder’s position would give to the term in the circumstances. The legally relevant circumstances include the observable, objective characteristics of the policyholder that identify the policyholder as a member of a relevant class of insurance purchasers, with greater or lesser experience and expertise in the insurance market (or greater or lesser capacity to obtain expert advice in that regard). Taking these circumstances into account assists the court in arriving at the traditional objective of contract interpretation in general, giving a term in a contract the meaning that a reasonable person would ascribe to it under the circumstances. This tailored objective standard takes into account the level of sophistication and insurance-purchasing experience expected of the party buying the policy, but not that party’s subjective understanding.

It is important to emphasize that the concept of “a reasonable person in this policyholder’s position” is no less a legal construct than the “reasonable person” concept that courts employ when determining the plain meaning. Hence, interpreting an ambiguous insurance policy term in light of the circumstances is ordinarily just as much a question of law as determining the plain meaning of an insurance policy term. The exception would be the unusual situation in which there is an outcome-determinative factual dispute about the circumstances that the court cannot resolve through summary proceedings. A determination that an insurance policy term is ambiguous does not ineluctably lead to the conclusion that the meaning of the term is a question for the trier of fact to determine.

h. No sophisticated-policyholder exception. Some courts have suggested, and some commentators have recommended, that the contra proferentem doctrine not be applied to insurance policies entered into by sophisticated commercial policyholders—for example, large corporations that are represented by counsel. This Section does not endorse the idea of a sophisticated-policyholder exception to the contra proferentem doctrine. By placing the responsibility for residual ambiguity on the party that is most in control of the language of the policy, the contra proferentem rule provides an important incentive to draft terms clearly regardless of the sophistication of the policyholder. The rule that an ambiguous insurance policy term is given the meaning that a reasonable person in the position of the policyholder would give the term takes the sophistication of the policyholder into account, while preserving contra proferentem as the residual decision rule. See Comments d and e.

i. The subjective understanding of the policyholder. Because the meaning of an insurance policy is determined on an objective basis, the subjective understanding of the policyholder ordinarily does not have any significance for the interpretation of an insurance policy term. By definition, the plain meaning of an insurance policy term is independent of any individual person’s situation or understanding. Similarly, the understanding of a reasonable person in this policyholder’s position is an objective determination. This does not mean that subjective knowledge of the policyholder could never have relevance for determining legal rights and duties under an insurance policy. If the court determines that both the policyholder and the insurer subjectively intended a specific meaning of a particular, ambiguous term, that term could be reformed to reflect that shared understanding. Alternatively, a policyholder that expressed that specific meaning to the insurer could be estopped from asserting an alternative meaning, provided that the requirements of § 6 are met. Finally, a policyholder’s actual knowledge of a trade usage or some other circumstance could be taken into account in determining whether that usage or circumstance could be used to resolve the ambiguity in situations in which a reasonable person in that policyholder’s position would not ordinarily possess such knowledge.

j. Purpose. As explained in Comment e to § 3, a policy term that might otherwise be subject to a wide range of meanings can sometimes be given greater precision by reference to the purpose of the term in the context of the insurance policy as a whole. When the purpose of a standard-form term can be determined from the sources listed in Comments b and c to § 3, that purpose can inform the court’s determination of the plain meaning of the policy term. Purpose is also an important consideration when a term is ambiguous. Considering the objective purpose of an insurance policy term may help a court determine that one or more of the proposed meanings of the term is unreasonable in the circumstances.

k. When a term could have been more clearly drafted. In determining the meaning of an ambiguous term, it is appropriate to consider the difficulty of redrafting the insurance policy to more plainly express the meaning urged by the drafting party, ordinarily the insurer, taking into account that some residual risk of ambiguity is to be expected. The easier it would be for the drafter to state that meaning more plainly, the more likely it is that the other party’s proposed meaning is the meaning that a reasonable policyholder would give to the term. This approach creates an incentive for insurers to draft insurance policy terms that provide clear guidance regarding the scope of the risks insured under their policies. This approach does not apply to the language of a term that is legally mandated to appear in an insurance policy, however, because the insurer does not have the option of redrafting such a term.

  Illustration:

  3. A state environmental-protection agency issues an order requiring the policyholder to remedy hazardous conditions at a waste site. The policyholder requests coverage for these remediation expenses under a liability insurance policy that obligates the insurer “to pay on behalf of the insured all sums which the insured shall become legally obligated to pay as damages because of … property damage to which this insurance applies, caused by an occurrence.” The term “damages” is not defined in the policy. The insurer denies coverage on the ground that the obligation to incur remediation expenses does not constitute an obligation to pay “damages.” The insurer asserts that the term “sums which the insured shall become legally obligated to pay as damages,” when used in the liability insurance policy, refers to amounts paid as monetary compensation for injuries to third parties and not to amounts paid to comply with injunctive orders such as the remediation order at issue. The policyholder files a breach-of-contract action against the insurer, alleging that the legal action should be covered because the term “damages” can reasonably be interpreted to cover any legal action asserted against the insured arising out of property damage that requires the expenditure of money, regardless of whether the action can be characterized as legal or equitable in nature. In determining the meaning of the term “damages,” the court should take into account the fact that the term is not defined in the policy and that the insurer could have included a definition that incorporated the distinction between legal and equitable remedies urged by the insurer.

l. When a policyholder requests an insurer to use a different standard-form term available in the market. Commercial liability insurers compete, among other ways, on the basis of their willingness to match terms provided by other insurers in the market. A standard-form insurance policy term should not ordinarily have a different meaning depending on which party supplied or requested the term for use in the insurance policy in question, because the insurance market benefits when an insurance policy term develops a uniform meaning. Moreover, when an insurer competes for business, in whole or in part, on the basis of its willingness to match a policy term offered by another insurer, it would be unreasonable for the insurer to later assert that it can give that term a different meaning than the term would have in a policy purchased from the insurer that drafted the term.

Thus, for example, the fact that a policyholder requested that one insurer use a standard-form term taken from an insurance policy drafted by another insurer should not as a matter of course result in the application of the contra proferentem rule against the policyholder in the event of a dispute regarding the meaning of that term. Doing so in every such case would defeat the purpose of the inclusion of such terms in insurance policies, which is to obtain the coverage that the terms are understood in the insurance market to provide. Although it is possible that the replacement of the insurer’s ordinary term in an insurance policy with another standard-form term could produce an ambiguity in some circumstances, the insurer ordinarily will have more experience with and a better understanding of the policy than the policyholder and, thus, is in a better position to anticipate and avoid such ambiguity. This is the primary justification for the contra proferentem rule.

When a policyholder assembles an insurance policy out of standard-form terms that are not ordinarily combined in a single policy, however, any ambiguities resulting from the combination of those terms can fairly be attributed to the policyholder, who should be regarded as the drafter or supplier of the policy. If a policyholder requests an insurer to use a standard-form term that the insurer does not ordinarily use, the parties can choose to apply the ordinary contract-law contra proferentem rule to that term, pursuant to which the term would be interpreted against the policyholder. To avoid dispute, the parties’ intention to adopt such a different interpretive rule for a standard-form term selected by the policyholder should be incorporated in the endorsement to the insurance policy or in another writing clearly assented to by the parties. In no event should the contra proferentem rule be applied against an insured unless the policyholder in fact drafted or supplied the term. With respect to a term that is created for a specific policy, the doctrine of contra proferentem applies against whichever party, if either, created the term. If the term was jointly created (such as if one party modified a term supplied by another), then the rule of contra proferentem would not apply against either party.

While courts have not explicitly recognized this rule, neither have they rejected it. For example, the fact that the traditional practice in certain markets is for the broker to assemble the form using standard terms available in the market and present it to the underwriters for approval does not ordinarily change the rule that ambiguities are interpreted in favor of the policyholder. The circumstances in which courts have interpreted a policy provision against an insured are ones in which the provision was drafted by the policyholder or its broker.

  Illustrations:

  4. A D&O liability insurance policy issued to a publicly traded corporation contains an endorsement that, at the policyholder’s request, replaces the “prior and pending litigation” exclusion in the insurer’s standard policy with a version of the exclusion taken from a standard policy sold by another company. Neither the liability insurance policy, nor any communication between the parties in relation to this insurance policy, refers to rules regarding how to interpret the policy. The prior-and-pending-litigation exclusion in this policy is a standard-form term that is interpreted as if it were supplied by the insurer.

  5. Same facts as Illustration 4, except that, at the insurer’s request, the endorsement requested by the policyholder is amended to contain the following term:

The terms of this endorsement are included in the Policy at the request of the Named Insured. The Named Insured is deemed to be the drafter of the terms of this endorsement, which are subject to the general contract-law rule of interpretation against the drafter in the event of ambiguity.

The endorsement is to be interpreted according to this term. Because the policyholder supplied the endorsement, the parties were free to contract so that the ordinary contra proferentem rule would be applied against the policyholder.

m. Relationship to reasonable expectations. See Comment h to § 3.