Argued October 13, 2004; decided December 2, 2004

Excess Ins. Co. v Factory Mut. Ins. Co., 2 AD3d 150, affirmed.

G.B. Smith, J.

The issue presented by this appeal is whether respondents' obligation to pay sums for certain loss adjustment expenses arising from a "follow the settlements" clause is subject to [*2]the indemnification limit stated in a reinsurance policy. Like the Appellate Division, we conclude that it is, and therefore affirm the order of the Appellate Division.

In December 1990, appellant Factory Mutual Insurance Company (formerly known as Allendale Mutual Insurance Company) entered into an agreement with Bull Data Systems Inc. to provide property insurance with an indemnification limit of $48 million. Specifically, the policy covered against the risk of loss or damage to Bull Data's personal computer inventory stored in a warehouse located in Seclin, France. In turn, Factory{**3 NY3d at 580} Mutual obtained facultative reinsurance^[FN1] from various London reinsurers which have severally subscribed to the reinsurance agreement at issue in this litigation. The reinsurance policy states, in pertinent part:

"REASSURED: ALLENDALE INSURANCE COMPANY

"ASSURED: BULL DATA CORPORATION and/or as original.

"PERIOD: Twelve months at 1st June, 1991 and/or as original. Both days inclusive.

"LOCATIONS: Bull Data Corporation, Seclin, France as original.

"INTEREST: Goods and/or Merchandise incidental to the Assured's business consisting principally of personal computers and/or as original.

"LIMIT: US$ 7,000,000 any one occurrence p/o US$ 13,500,000 any one occurrence excess of US$ 25,000,000 any one occurrence.

"CONDITIONS: As original and subject to same valuation, clauses and conditions as contained in the original policy or policies but only to cover risks of All Risks of Physical Loss or Damage but excluding Inventory Shortage. Including Strikes, Riots, Civil Commotions and Malicious Damage risks if and as [*3]original. Premium payable as in original. Reinsurers agree to follow the settlements of the Reassured in all respects and to bear their proportion of any expenses incurred, whether legal or otherwise, in the investigation and defence of any claim hereunder. Service of Suit Clause (U.S.A.). Insolvency Clause."

In June of 1991, a fire that generated a spate of litigation, in the {**3 NY3d at 581}United States and abroad, destroyed the warehouse. Bull Data presented a claim to Factory Mutual and, suspecting that the fire was the result of arson, Factory Mutual refused to satisfy it.

Bull Data brought suit in the courts of France to recover under its insurance policy. Factory Mutual also commenced an unsuccessful litigation against Bull Data in the United States District Court for the Northern District of Illinois, claiming that the loss was due to arson, and the limit of liability under the insurance policy was $48 million. After incurring approximately $35 million in litigation expenses, both lawsuits were terminated and Factory Mutual settled the claims with Bull Data for nearly $100 million.

Factory Mutual thereafter sought payment from respondent reinsurers. The reinsurers refused payment and filed an action in the courts of England seeking a declaration that the reinsurance contract was invalid. The English courts dismissed the case for lack of jurisdiction. During that period, Factory Mutual commenced a declaratory judgment action in the United States District Court for the District of Rhode Island seeking $7 million from the reinsurers and an additional $5 million in loss adjustment expenses, allegedly the proportionate share of expenses that the reinsurers owed Factory Mutual for having defended the Bull Data claim. Factory Mutual later discontinued the action upon stipulation and commenced a similar action in the United States District Court for the Southern District of New York.

District Judge Shira A. Scheindlin granted partial summary judgment to the reinsurers and dismissed Factory Mutual's claim for loss adjustment expenses (Allendale Mut. Ins. Co. v Excess Ins. Co. Ltd., 970 F Supp 265 [SD NY 1997], amended upon rearg 992 F Supp 271 [SD NY 1997]). During the pendency of Factory Mutual's appeal to the United States Court of Appeals for the Second Circuit, that court decided an unrelated case which affected the subject matter jurisdiction of the pending case, resulting in dismissal of the appeal and vacatur of the judgment of the District Court (Allendale Mut. Ins. Co. v Excess Ins. Co. Ltd., 62 F Supp 2d 1116 [SD NY 1999]). [*4]

The reinsurers thereafter commenced this declaratory judgment action in Supreme Court, New York County, seeking to annul the reinsurance agreement based on material nondisclosures and misrepresentations or, in the alternative, a judgment awarding {**3 NY3d at 582}damages.^[FN2] Factory Mutual interposed a counterclaim, seeking the $7 million indemnification limit under the reinsurance policy as well as $5 million in loss adjustment expenses incurred by Factory Mutual in the litigation of the original claim with Bull Data. Both Factory Mutual and the reinsurers moved for partial summary judgment on Factory Mutual's counterclaims seeking loss adjustment expenses in excess of the amount stated in the indemnification limit. Supreme Court denied the reinsurers' motion, granted Factory Mutual's cross motion and declared that the reinsurers' obligation to pay their proportionate share of the loss adjustment expenses was not subject to the stated indemnity limit of $7 million.

The Appellate Division reversed by granting the reinsurers' motion and denying Factory Mutual's cross motion. The Court thus declared that any portion of the loss adjustment expenses that the reinsurers were obligated to bear was subject to the $7 million limit stated in the reinsurance policy. The Appellate Division granted Factory Mutual leave to appeal to this Court. We now affirm the order of the Appellate Division.

In resolving the issue before us, we are mindful that in interpreting reinsurance agreements, as with all contracts, the intention of the parties should control. To discern the parties' intentions, the court should construe the agreements so as to give full meaning and effect to the material provisions (see Breed v Insurance Co. of N. Am., 46 NY2d 351, 355 [1978]; see also Greenfield v Philles Records, Inc., 98 NY2d 562, 569 [2002]; Slatt v Slatt, 64 NY2d 966, 967 [1985]). [*5]

Here, there is no dispute that the reinsurance agreements set the policy limit at $7 million per occurrence. The so-called "follow the settlements" clause is thereafter set forth in the section of the policy entitled "CONDITIONS."^[FN3] As provided in the agreement, the clause requires the reinsurers to pay their portion{**3 NY3d at 583} of expenses incurred in the investigation and defense of any claim under the agreement. The reinsurers, however, contend that their liability to pay is subject to the $7 million cap negotiated under the policy. By contrast, Factory Mutual argues that the reinsurers' liability to pay the defense expenses is separate and apart from the indemnification cap on the policy.

We agree with the reinsurers and hold that they cannot be required to pay loss adjustment expenses in excess of the stated limit in the reinsurance policy. Once the reinsurers have paid the maximum amount stated in the policy, they have no further obligation to pay Factory Mutual any costs related to loss adjustment expenses. In so holding, we follow the decisions of the United States Court of Appeals for the Second Circuit as expressed in Bellefonte Reins. Co. v Aetna Cas. & Sur. Co. (903 F2d 910 [2d Cir 1990]) and Unigard Sec. Ins. Co., Inc. v North Riv. Ins. Co. (4 F3d 1049 [1993]). In both cases, the ceding insurers claimed that a similar "follow the fortunes" clause required the reinsurers to reimburse litigation costs beyond the stated limit in the policy. The court in both cases concluded that such a reading of the policy would render meaningless the liability cap negotiated in the policy. According to the Bellefonte court, to "allow[ ] the 'follow the fortunes' clause to override the limitation on liability—would strip the limitation clause and other conditions of all meaning; the reinsurer would be obliged merely to reimburse the insurer for any and all funds paid. . . . The 'follow the fortunes' clauses in the certificates are structured so that they coexist with, rather than supplant, the liability cap. To construe the certificates otherwise would effectively eliminate the limitation on the reinsurers' liability to the stated amounts" (903 F2d at 913).

Likewise here, the parties negotiated an indemnity limit of $7 million per occurrence. Thus, any obligation on the part of the reinsurers to reimburse Factory Mutual, whether it be for settling the original insurance claim with Bull Data or for the loss adjustment [*6]expenses incurred in the protracted litigation that ensued, must be capped by the negotiated limit under the policy. Otherwise, the reinsurers would be subject to limitless liability. Indeed, this case well illustrates such an injustice as Factory Mutual now seeks to saddle the reinsurers with a portion of a litigation {**3 NY3d at 584}bill that exceeds the negotiated policy limit by more than 70%.^[FN4] To permit such a result would render the liability cap a nullity.

Factory Mutual asserts that this case is distinguishable from Bellefonte and Unigard in that those cases involved liability insurance while this case involves property insurance. According to Factory Mutual, a liability insurance product normally encompasses the obligation to pay the legal defense costs on behalf of the insured as well as the cost of the loss itself. Thus, the risk to be spread in reinsurance would already include loss adjustment expenses. However, a property insurance product would cover only the value of the property item to be insured. Under those circumstances, Factory Mutual contends, an insurer would have no contractual obligation to incur investigation or litigation costs and the risk of those costs is not already included in the reinsurance product. We find this argument unpersuasive and conclude that this distinction does not provide a sufficient basis to extend the reinsurers' liability beyond the limit stated in the reinsurance policy.

The limit clause in the policy is intended to cap the reinsurers' total risk exposure. Although Judge Scheindlin's decision in Allendale was vacated and is not binding, we find her reasoning persuasive, "Whether [the reinsurers] reimburse [Factory Mutual] for claims for property losses or defense costs makes no difference to them. Reinsurers of property insurance policies have the same interest in controlling their maximum exposure as do reinsurers of liability insurance policies. Thus, Bellefonte and Unigard's holdings that the limit clauses define the reinsurers' bargained-for maximum exposure to liability inclusive of all costs and expenses are applicable even where the underlying insurance policy does not oblige the insurer to cover the insured's defense costs" (992 F Supp at 277).

Of course, both parties were well aware of the type of product that was being reinsured. It would be far from unreasonable to expect that at the time of procuring reinsurance, Factory Mutual could anticipate the possibility of incurring loss adjustment expenses in settling a claim from Bull Data. Certainly, nothing prevented Factory Mutual from insuring that risk either [*7]by expressly stating that the defense costs were excluded from the indemnification {**3 NY3d at 585}limit or otherwise negotiating an additional limit for loss adjustment expenses that would have been separate and apart from the reinsurers' liability on the insured property. Failing this, the reinsurers were entitled to rely on the policy limit as setting their maximum risk exposure.

Accordingly, the order of the Appellate Division should be affirmed, with costs, and the certified question answered in the affirmative.

Read, J. (dissenting). I see no way to tell from the plain language of this certificate whether the parties intended for costs and expenses to be included in the reinsurance limit or excluded from it. Further, in my view the majority has misinterpreted Bellefonte Reins. Co. v Aetna Cas. & Sur. Co. (903 F2d 910 [2d Cir 1990]) in ways that augur further expansion of its much debated holding. Accordingly, I dissent.

The certificate pertains to reinsurance of a $13,500,000 layer ($25,000,000 to $38,500,000) of a $48,000,000 property insurance policy issued by Factory Mutual. Two provisions are at issue. The first provides that the "LIMIT" is "US$ 7,000,000 any one occurrence [part of] US$ 13,500,000 any one occurrence excess of US$ 25,000,000 any one occurrence."^[FN1] The second notes several "CONDITIONS," including one whereby the certificate is made "subject to same valuation, clauses and conditions as contained in the original policy" (a "following form" provision) and one whereby "[r]einsurers agree . . . to bear their proportion of any expenses incurred" (a "follow the settlements" provision).

In essence, the majority concludes that the only reasonable interpretation of these provisions is that the policy contains a $7,000,000 limit (any one occurrence) which is cost-inclusive. This conclusion rests too heavily on the "follow the settlements" provision of the certificate, and fails to consider the "following form" provision. An equally plausible reading is that the parties, who "conditioned"^[FN2] the certificate on the same "valuation, clauses and [*8]conditions" as exist in the primary property policy{**3 NY3d at 586}—where costs are commonly paid in addition to the policy limit^[FN3] —could have intended to create a cost-exclusive reinsurance limit. Moreover, the parties did not expressly state that the limit was "subject to" the conditions and therefore capped all liability under the certificate (see e.g. Bellefonte). Because the certificate may reasonably be interpreted in either of two ways, I conclude that it is ambiguous (see Evans v Famous Music Corp., 1 NY3d 452 [2004]).^[FN4]

Moreover, I disagree with the majority's apparent reading of Bellefonte. In Bellefonte, Aetna issued primary and excess liability policies to A.H. Robins Co., the manufacturer of the Dalkon Shield. Aetna reinsured the excess policies with various reinsurers. After an "explosion" of litigation over the device, Aetna and Robins disputed the extent of Aetna's liability for defense expenses under the excess policies, and ultimately reached a [*9]monetary settlement in excess of the limit stated in the excess policy. Aetna then looked to the reinsurers for the excess paid on the underlying policy. The reinsurers refused to pay, arguing that their liability was limited by the reinsurance certificate.

The certificate stated that the reinsurance was provided "subject to the . . . amount of liability set forth herein" (903 F2d at 911). The court concluded that this created a cap on the reinsurers' liability whether reached through payment of expenses or settlement of claims. The Second Circuit reasoned that "[a]ny other construction of the reinsurance certificates would negate" the "subject to" provision of the certificate (id. at 914; see also Unigard Sec. Ins. Co. v North Riv. Ins. Co., 4 F3d 1049{**3 NY3d at 587} [2d Cir 1993] [following Bellefonte as certificate included same "subject to" language]).

The Bellefonte court also considered and rejected a second argument made by Aetna, which the Appellate Division applied below (2 AD3d 150 [1st Dept 2003]) and the majority now adopts. Aetna argued that the "follow the fortunes" doctrine, as embodied in a clause in the certificate,^[FN5] obligated the reinsurers to pay all Aetna's settlements even if they were in excess of the liability limit in the reinsurance policy. The Bellefonte court rebuffed this argument, noting that "[t]he 'follow the fortunes' clauses in the certificates are structured so that they coexist with, rather than supplant, the liability cap. To construe the certificates otherwise would effectively eliminate the limitation on the reinsurers' liability to the stated amounts" (903 F2d at 913 [emphasis added]). Critically, this prong of the court's analysis was based on its conclusion that the certificate created a cap on liability through the "subject to" and the "limitation" clauses, and that "the 'follow the fortunes' doctrine does not allow Aetna to recover defense costs beyond the express cap stated in the certificates" (id.).

The Appellate Division disregarded the "subject to" analysis in Bellefonte, as does [*10]the majority, summarily concluding that "all contracts are subject to their terms and conditions" (2 AD3d at 152). Instead, the Appellate Division relied on Bellefonte's "follow the fortunes" analysis, and concluded that the "overriding determination in Bellefonte and Unigard was that the 'follow the fortunes' clauses of the reinsurance contracts considered there coexisted with, and did not supplant, the contract limitations" (id.). In my view, this was error.

Bellefonte's holding was not intended as a general rule applicable to any and all reinsurance certificates (see Goldstein, Bellefonte Lives, 8-10 Mealey's Litig Rep Reinsurance 9 [1997] [noting that Bellefonte should have been limited to "the specific contract language" in the certificate]). The holding relies on specific certificate language—"the first two provisions of the reinsurance{**3 NY3d at 588} certificates" (903 F2d at 913)—which the court determined contained a "cap" on the reinsurers' liability. Because the certificate had a cap, the "follow the fortunes" clause in the certificate could not supplant the cap, which therefore limited expenses.^[FN6]

The Appellate Division and now the majority have converted a rule unique to the specific certificate language in Bellefonte into a general principle that a "follow the fortunes" clause never supplants a policy limit. Thus, the majority, like the Appellate Division before it, expands Bellefonte from a contract-specific holding into a rule of general applicability.

When the holding of Bellefonte—that the reinsurance certificate's specific policy language controls whether costs are included or excluded from the limit—is applied here, it is easily distinguished. There is no "subject to" language in the reinsurance certificate at issue on this appeal. Rather, the certificate contains two discrete provisions—"LIMIT" and "CONDITIONS"—and neither offers any guidance as to whether the "CONDITIONS" are subject to the "LIMIT."

Further, it is worth observing that practitioners in the reinsurance industry have consistently criticized Bellefonte. Specifically, commentators have noted that in ruling "based [*11]solely on a textual interpretation of the language of the certificates," the Bellefonte court ignored important extrinsic evidence of industry custom and practice showing that the nature of the underlying policy often controlled whether the reinsurance limit was cost-inclusive or cost-exclusive (see Goldstein, Bellefonte Lives ["(n)otwithstanding Bellefonte . . . the industry for the most part has continued to follow the custom and practice of reinsurers providing coverage for expenses in addition to limits where the reinsured policy also covers expenses in addition to limits"]). There was a fear "that the Bellefonte rule would be applied to the same certificate language but where the reinsured policy covered defense costs in addition to limits" (id.).{**3 NY3d at 589}

When Unigard was decided, this fear was realized. There, the certificate language was nearly identical to that in Bellefonte. The Second Circuit rejected extrinsic evidence that the reinsurers covered expenses in addition to the policy limit, instead choosing to rely on its holding in Bellefonte and the similar certificate language (4 F3d at 1071).

Commentators have similarly faulted Allendale Mut. Ins. Co. v Excess Ins. Co. Ltd. (970 F Supp 265 [SD NY 1997], rearg granted and original decision adhered to 992 F Supp 271 [1997], vacated 172 F3d 37 [table, text at 1999 WL 55313, 1999 US App LEXIS 1735 (2d Cir 1999)]). The federal District Court in Allendale was the first court to rule on the case now before us, holding that the plain language of the certificate meant that expenses were included in the policy limit.^[FN7] Citing Bellefonte and Unigard, the court rejected Factory Mutual's request to distinguish these cases on the basis of the specific certificate language or the nature of the underlying policies (992 F Supp at 274-275). Allendale was thus judged to be "a significant extension" of Bellefonte on both fronts (see Goldstein, Bellefonte Lives; see also Goldstein, For Whom Does Bellefonte Toll? It Tolls for Thee, 9-7 Mealey's Litig Rep Reinsurance 12 [1998] ["Because Allendale involved reinsurance of a property policy, rather than a liability policy that provided a defense for the insured, and because the contract at issue lacked certain critical language contained in the Bellefonte and Unigard certificates, [*12]Allendale clearly expanded the breadth of the Bellefonte Rule"]).^[FN8] [*13]

{**3 NY3d at 590}Today, the majority adopts the Allendale rationale, and suggests that Factory Mutual should have negotiated language "expressly stating that the defense costs were excluded from the indemnification limit," or otherwise setting forth "an additional limit for loss adjustment expenses that would have been separate and apart from the reinsurers' liability on the insured property" (majority op at 584-585). But Factory Mutual first obtained the relevant certificate in London in December 1990, about eight months after the Second Circuit decided Bellefonte. It seems harsh and unrealistic for us to fault Factory Mutual for not having drafted this certificate to conform with a recently decided case whose potential future reach could hardly have been predicted at the time.

Here, both parties moved for summary judgment, arguing that the certificate was unambiguous. Although neither party argued that the certificate was ambiguous, ambiguity is an issue of law for the courts (Greenfield, 98 NY2d at 569). Factory Mutual opposed the reinsurers' motion for summary judgment with extrinsic evidence of industry custom and practice, and thereby created a question of fact concerning the parties' intent (Mallad Constr. Corp. v County Fed. Sav. & Loan Assn., 32 NY2d 285, 290-293 [1973]). Our precedent establishes that where there is ambiguity in a reinsurance certificate, the surrounding circumstances, {**3 NY3d at 591}including industry custom and practice, should be taken into consideration (see London Assur. Corp. v Thompson, 170 NY 94 [1902];^[FN9] see also Christiania Gen. Ins. Corp. of N.Y. v Great Am. Ins. Co., 979 F2d 268, 274 [2d Cir 1992] [citing London Assur.]; 1 Couch on Insurance 3d § 9:15, at 9-53).

Accordingly, I would modify the order of the Appellate Division by denying both motions, and remand the matter for further proceedings consistent with this opinion.

Chief Judge Kaye and Judges Ciparick, Rosenblatt, Graffeo and R.S. Smith concur with Judge G.B. Smith; Judge Read dissents and votes to modify by denying both motions for summary judgment in a separate opinion.

Order affirmed, etc.