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Choice-of-Law Issues Regarding Coverage
JENNIFER K. GUST DAVID H. LEVITT Hinshaw & Culbertson LLP Chicago
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©COPYRIGHT 2012 BY DAVID H. LEVITT AND IICLE
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I. [4.1] Introduction II. [4.2] Standard of Review III. Explicit Choice-of-Law Provisions Incorporated Within Insurance Policies A. [4.3] Illinois Courts Follow the RESTATEMENT (SECOND) OF CONFLICT OF LAWS B. [4.4] Special Considerations for Group Policies C. [4.5] Invalid Express Choice-of-Law Provisions IV. No Choice-of-Law Provision in Insurance Policy A. [4.6] In General B. [4.7] The Evolution of the Factors Under Consideration 1. [4.8] The RESTATEMENT 2. [4.9] The Hofeld Factors C. [4.10] Location of the Insured Risk D. [4.11] Lapham-Hickey and Its Progeny Regarding Risks Located in Several States E. Other Alternatives 1. [4.12] Law of the Forum State 2. [4.13] Law of the State Where Insured Is Domiciled 3. [4.14] Choice of Law by Stipulation of the Parties V. [4.15] Conclusion
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I. [4.1] INTRODUCTION Under Illinois law, contracts of insurance are subject to the same rules of construction as other types of contracts. When construing an insurance contract, the primary objective is to give effect to the intent of the parties as expressed by the terms of the agreement. These rules of construction also apply when an insurance contract incorporates a choice-of-law provision within the policy. When the policy does not include a choice-of-law provision, however, the forum state’s choice-of-law rules apply to determine which state’s laws will govern the substantive interpretation of the policy terms. Diamond State Insurance Co. v. Chester-Jensen Co., 243 Ill.App.3d 471, 611 N.E.2d 1083, 183 Ill.Dec. 435 (1st Dist. 1993). This chapter discusses choice-of-law considerations for insurance coverage lawsuits filed in Illinois courts. Illinois courts have generally adopted the factors outlined in the RESTATEMENT (SECOND) OF CONFLICT OF LAWS (1989) but have not developed a bright-line test as to which of the factors, if any, hold greater weight. Old Republic Insurance Co. v. Ace Property & Casualty Insurance Co., 389 Ill.App.3d 356, 906 N.E.2d 630, 329 Ill.Dec. 432 (1st Dist. 2009). This inconsistency is especially prevalent when the insurance policy provides coverage for risks located in several states. While Illinois courts have held that the purpose behind Illinois’ choice-of-law rules is to promote consistency and predictability as to which state’s substantive law would be applied in each case, in actuality, because no bright-line standard has been adopted by the Illinois Supreme Court, the end results are often mixed. As evidenced by the cases referenced in this chapter, Illinois courts have chosen to apply various choice-of-law factors based primarily on the facts present in each case. It is important to note that a choice-of-law analysis needs to be conducted only when there is a conflict between the laws of two different states. Pekin Insurance Co. v. XData Solutions, Inc., 2011 IL App (1st) 102769, 958 N.E.2d 397, 354 Ill.Dec. 654. There is a “conflict” only when the difference in laws between the forum state and another state would result in a different outcome in the case. Eclipse Manufacturing Co. v. United States Compliance Co., 381 Ill.App.3d 127, 886 N.E.2d 349, 319 Ill.Dec. 586 (2d Dist. 2007). If no conflict exists between the laws of the different states, then a choice-of-law analysis does not need to be conducted, and the forum state’s substantive law applies. Pekin Insurance, supra.
II. [4.2] STANDARD OF REVIEW Both Illinois state and federal appellate courts utilize a de novo standard when analyzing choice-of-law issues. Auto-Owners Insurance Co. v. Websolv Computing, Inc., 580 F.3d 543, 546 (7th Cir. 2009); Westchester Fire Insurance Co. v. G. Heileman Brewing Co., 321 Ill.App.3d 622, 747 N.E.2d 955, 961, 254 Ill.Dec. 543 (1st Dist. 2001).
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III. EXPLICIT CHOICE-OF-LAW PROVISIONS INCORPORATED WITHIN INSURANCE POLICIES A. [4.3] Illinois Courts Follow the RESTATEMENT (SECOND) OF CONFLICT OF LAWS When the contract of insurance contains a choice-of-law provision, Illinois courts have determined that RESTATEMENT (SECOND) OF CONFLICT OF LAWS §187 (1989) applies: §187. Law Of The State Chosen By The Parties (1) The law of the state chosen by the parties to govern their contractual rights and duties will be applied if the particular issue is one which the parties could have resolved by an explicit provision in their agreement directed to that issue. (2) The law of the state chosen by the parties to govern their contractual rights and duties will be applied, even if the particular issue is one which the parties could not have resolved by an explicit provision in their agreement directed to that issue, unless either (a) the chosen state has no substantial relationship to the parties or the transaction and there is no other reasonable basis for the parties’ choice, or (b) application of the law of the chosen state would be contrary to a fundamental policy of a state which has a materially greater interest than the chosen state in the determination of the particular issue and which, under the rule of §188, would be the state of the applicable law in the absence of an effective choice of law by the parties. (3) In the absence of a contrary indication of intention, the reference is to the local law of the state of the chosen law. The RESTATEMENT essentially provides that the parties’ choice of law governs unless (1) the chosen state has no substantial relationship to the parties or the transaction or (2) application of the chosen law would be contrary to the fundamental public policy of a state with a materially greater interest in the issue in dispute. Old Republic Insurance Co v. Ace Property & Casualty Insurance Co., 389 Ill.App.3d 356, 906 N.E.2d 630, 329 Ill.Dec. 432 (1st Dist. 2009). In comment (f) to §187, the reasonable basis test in §187(2)(a) is satisfied if the chosen state was the state of incorporation or principal place of doing business of one or more of the parties unless that place was wholly fortuitous and bears no reasonable basis for the parties’ choice. As to §187(2)(b), Illinois courts have held that the public policy considerations must be of such a strong and fundamental nature as to justify the rejection of the chosen law of the parties. A court should not refuse to apply the chosen law of another jurisdiction, however unlike its own, unless it is contrary to the public morals or would be harmful to its citizens. International Surplus Lines Insurance Co. v. Pioneer Life Insurance Company of Illinois, 209 Ill.App.3d 144, 568 N.E.2d 9, 154 Ill.Dec. 9 (1st Dist. 1990).
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In International Surplus Lines, the First District considered whether the choice-of-law provision contained in the insurance policy should be applied when two states had an interest in the litigation and had different laws concerning the insurability of punitive damages. The First District determined that Illinois’ public policy regarding the insurability of punitive damages was not so strong as to defeat the choice-of-law language found in the insurance contract. Moreover, the court held that a stronger and more fundamental public policy of Illinois is that when payment of a premium is made by an insured and accepted by an insurance company, the insurer should be required to fulfill its contractual obligations. B. [4.4] Special Considerations for Group Policies Group policies are policies issued by an insurance company to a group policyholder, such as an employer, association, or union. Certificates are then issued to the participating insureds, such as employees or members. In most instances, a certificate of insurance merely summarizes the most important terms of the policy as they apply to the individual insured. Because the information on the individual certificates is so limited, choice-of-law provisions within group policies are usually only located in the master policy. In Hofeld v. Nationwide Life Insurance Co., 59 Ill.2d 522, 322 N.E.2d 454 (1975), the Illinois Supreme Court considered whether a choice-of-law provision contained in the master policy, but not included in the certificates issued to the insureds, should govern. The court determined that because there were no provisions in the certificate that conflicted with the basic policy provision that Georgia law should govern, and because none of the terms were contrary to Illinois public policy, the choice-of-law provision in the master policy was enforceable as to the suit involving an individual insured. C. [4.5] Invalid Express Choice-of-Law Provisions Illinois courts have determined that choice-of-law provisions contained in agreements involving third parties do not apply in the subsequent insurance coverage dispute. For example, in Maremont Corp. v. Cheshire, 288 Ill.App.3d 721, 681 N.E.2d 548, 224 Ill.Dec. 233 (1st Dist. 1997), the insured Maremont Corporation entered into a settlement agreement with a third-party corporation prior to the coverage dispute. In that agreement, the parties agreed that South Carolina law would govern the terms of the settlement. In the subsequent coverage lawsuit, the trial court cited to the settlement agreement and held that South Carolina law also applied to the coverage matter. On appeal, the First District reversed and remanded, holding that parties cannot enforce choice-of-law provisions contained in contracts against nonparties to the agreement. In the settlement agreement between Maremont and the third-party corporation, the settlement provisions were written solely to benefit Maremont and the corporation. The insurer did not have notice of nor was it a party to the agreement containing the choice-of-law provision. Therefore, the appellate court held that the choice-of-law provision did not apply.
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IV. NO CHOICE-OF-LAW PROVISION IN INSURANCE POLICY A. [4.6] In General Under Illinois choice-of-law rules, there is no bright-line test to determine which state’s substantive laws should apply when the policy contains no choice-of-law provision. Therefore, Illinois courts have enumerated certain factors to be considered in the choice-of-law analysis. Unfortunately, because no single factor can be determinative of every issue triggered in every case, Illinois courts have followed several different approaches. B. [4.7] The Evolution of the Factors Under Consideration The factors utilized by Illinois courts in the choice-of-law analysis were derived from two sources: the RESTATEMENT (SECOND) OF CONFLICT OF LAWS (1989) and the Illinois Supreme Court decision in Hofeld v. Nationwide Life Insurance Co., 59 Ill.2d 522, 322 N.E.2d 454 (1975). While the lists of factors are similar, Illinois courts are more apt to apply the factors as enumerated in Hofeld because they are broader in scope and are generally easier to apply. Applying the factors in the RESTATEMENT or in Hofeld can have varying results depending on whether the risk is located in one state or several states. In one line of cases supported by Society of Mount Carmel v. National Ben Franklin Insurance Company of Illinois, 268 Ill.App.3d 655, 643 N.E.2d 1280, 205 Ill.Dec. 673 (1st Dist. 1994), and Diamond State Insurance Co. v. Chester-Jensen Co., 243 Ill.App.3d 471, 611 N.E.2d 1083, 183 Ill.Dec. 435 (1st Dist. 1993), Illinois courts have determined that the location of the insured risk is the factor that affords the greatest weight in the choice-of-law analysis. Because of the confusion that may result in applying the location of the risk test in cases in which the insured risk is located in several states, some Illinois courts apply the factors enumerated in Lapham-Hickey Steel Corp. v. Protection Mutual Insurance Co., 166 Ill.2d 520, 655 N.E.2d 842, 211 Ill.Dec. 459 (1995), and its progeny, which favor where the policy was issued or delivered and the law of the place of the last act to give rise to a valid contract. Still other Illinois courts have attempted to avoid the confusion associated with the weighing of factors by choosing other, more predictable alternatives, such as applying the substantive law of the forum state unless the parties agree otherwise. Jadczak v. Modern Service Insurance Co., 151 Ill.App.3d 589, 503 N.E.2d 794, 104 Ill.Dec. 932 (1st Dist. 1987). See also Echo, Inc. v. Whitson Co., 52 F.3d 702, 707 (7th Cir. 1995). See §4.10 below. 1. [4.8] The RESTATEMENT Section 188 of the RESTATEMENT (SECOND) OF CONFLICT OF LAWS (1989) provides the following guidance when the insurance contract contains no choice-of-law designation:
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§188. Law Governing In Absence of Effective Choice By The Parties (1) The rights and duties of the parties with respect to an issue in contract are determined by the local law of the state which, with respect to that issue, has the most significant relationship to the transaction and the parties under the principles stated in §6. (2) In the absence of an effective choice of law by the parties (see §187), the contacts to be taken into account in applying the principles of §6 to determine the law applicable to an issue include: (a) the place of contracting, (b) the place of negotiation of the contract, (c) the place of performance, (d) the location of the subject matter of the contract, and (e) the domicile, residence, nationality, place of incorporation and place of business of the parties. These contacts are to be evaluated according to their relative importance with respect to the particular issue. (3) If the place of negotiating the contract and the place of performance are in the same state, the local law of this state will usually be applied, except as otherwise provided in §§189 – 199 and 203. 2. [4.9] The Hofeld Factors In Hofeld v. Nationwide Life Insurance Co., 59 Ill.2d 522, 322 N.E.2d 454 (1975), the Illinois Supreme Court listed several factors for courts to consider when performing a choice-of-law analysis: location of the subject matter; the place of delivery of the contract; the domicile of the insurer or insured; the place of the last act to give rise to a valid contract; the place of performance; or other place bearing a relationship to the general contract. Interestingly, several Illinois courts in subsequent cases have cited to the Hofeld factors despite the fact that the factors were essentially dicta; the policy in question in Hofeld contained a valid choice-of-law provision that was held to apply. C. [4.10] Location of the Insured Risk When the policy insures a risk located in only one state, Illinois courts are most apt to weigh the location of the insured risk as the most predominant factor in the choice-of-law analysis. Allen v. State Farm Mutual Automobile Insurance Co., 214 Ill.App.3d 729, 574 N.E.2d 55, 158 Ill.Dec. 261 (1st Dist. 1991). In Allen, this general rule was easy to apply because the insured automobile
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involved in the coverage dispute was to be garaged and principally located in Indiana. The location of the insured risk approach is also supported within the RESTATEMENT. RESTATEMENT (SECOND) OF CONFLICT OF LAWS §193, cmt. b (1989) requires that the principal location of the insured risk be given greater weight than any other choice-of-law factor. Applying the location of the insured risk test may be tricky when the policy covers risks located in many different states. Illinois courts have held that in this scenario, the place where the liability actually arises is considered the location of the insured risk. Society of Mount Carmel v. National Ben Franklin Insurance Company of Illinois, 268 Ill.App.3d 655, 643 N.E.2d 1280, 205 Ill.Dec. 673 (1st Dist. 1994). In that case, the court looked to many factors to determine whether California or Illinois law applied. Although the policies were executed in Illinois, the more significant factors occurred in California — the liability arose at a California high school, the plaintiff was a California resident, and the underlying action was brought in California. Therefore, the appellate court held that California substantive law applied. See also Diamond State Insurance Co. v. Chester-Jensen Co., 243 Ill.App.3d 471, 611 N.E.2d 1083, 183 Ill.Dec. 435 (1st Dist. 1993). But see Zurich Insurance Co. v. Sunclipse, Inc., 85 F.Supp.2d 842 (N.D.Ill. 2000) (noting that Illinois courts have not equated location of underlying lawsuit with location of subject matter or insured risk). See also American Builders & Contractors Supply Co. v. Home Insurance Co., No. 96 C 5041, 1997 WL 43017 (N.D.Ill. Jan. 28, 1997) (holding that location of insured risk test in Mt. Carmel does not impose unfair uncertainty on insurers because insurance companies could protect themselves by including choice-of-law provisions in their contracts). D. [4.11] Lapham-Hickey and Its Progeny Regarding Risks Located in Several States Lapham-Hickey Steel Corp. v. Protection Mutual Insurance Co., 166 Ill.2d 520, 655 N.E.2d 842, 211 Ill.Dec. 459 (1995), is often regarded as the leading authority on what factors are to be considered when the insured risks are located in several different states. The Illinois Supreme Court in Lapham-Hickey analyzed the Hofeld factors to determine which state’s substantive law should apply to interpret an insurance policy that covered environmentally contaminated sites in six different states. See Hofeld v. Nationwide Life Insurance Co., 59 Ill.2d 522, 322 N.E.2d 454 (1975). Because the location of the insured risk covered several states, the court focused on two factors in its analysis: (1) where the policy was issued or delivered; and (2) the law of the place of the last act to give rise to a valid contract. The court reasoned that concentrating on these factors would promote a consistent interpretation of the policy, consider the contracting parties’ justifiable expectations, and coincide with Illinois choice-of-law principles. Other cases have followed the analysis in Lapham-Hickey. For example, in Employers Insurance of Wausau v. Ehlco Liquidating Trust, 309 Ill.App.3d 730, 723 N.E.2d 687, 243 Ill.Dec. 384 (1st Dist. 1999), the appellate court held that the location of the insured risk covered by the insurance policy is entitled to little weight when the subject matter or risk is located in more than one state. Instead, Illinois courts often focus on the place of delivery of the contract, the place of performance, the place of the last act giving rise to a valid contract, and other places bearing a rational relationship to the general contract. Yessenow v. Executive Risk Indemnity, Inc.,
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2011 IL App. (1st) 102920, 953 N.E.2d 433, 352 Ill.Dec. 194; Household International, Inc. v. Liberty Mutual Insurance Co., 321 Ill.App.3d 859, 749 N.E.2d 1, 255 Ill.Dec. 221 (1st Dist. 2001). In Liberty Mutual Fire Insurance Co. v. Woodfield Mall, L.L.C., 407 Ill.App.3d 372, 941 N.E.2d 209, 218, 346 Ill.Dec. 651 (1st Dist. 2010), the court determined that because the insured had locations nationwide, the focus of the choice-of-law analysis was where the contract of insurance was delivered, where the contract of insurance was initially procured, where the premiums where paid, and where the “nerve center” of the corporation was domiciled. RESTATEMENT (SECOND) OF CONFLICT OF LAWS §193, cmt. b (1989), coincides with the Lapham-Hickey approach. While §193 requires that the principal location of the insured risk be given greater weight than any other choice-of-law factor, comment b states that the location of the insured risk has less significance (1) when the insured object will be more or less constantly on the move from state to state during the term of the policy or (2) when the policy covers a group of risks that are scattered throughout two or more states. The Lapham-Hickey factors do not always yield definitive results. Each of the LaphamHickey factors may be weighed and applied on a case-by-case basis, depending on the facts of each case. For example, in Westchester Fire Insurance Co. v. G. Heileman Brewing Co., 321 Ill.App.3d 622, 747 N.E.2d 955, 254 Ill.Dec. 543 (1st Dist. 2001), the last act giving rise to an enforceable contract occurred in Wisconsin, whereas the policy itself was delivered in Georgia. As a result, the Westchester court considered several other factors — the location of the principal place of business, the location of the insured risk, and the jurisdiction of the underlying lawsuit. None of these factors was considered dispositive of the choice-of-law issue. Consequently, the Westchester court held that Illinois substantive law should apply because it had more total contacts to the instant dispute than any other state. In United Farm Family Mutual Insurance Co. v. Frye, 381 Ill.App.3d 960, 887 N.E.2d 783, 320 Ill.Dec. 639 (4th Dist. 2008), the Fourth District considered the factors outlined in Westchester and Lapham-Hickey in its choice-of-law analysis to determine whether Illinois or Indiana law applied to a declaratory judgment action involving underinsured-motorist benefits under an auto policy. The coverage dispute arose from an auto accident that occurred in Illinois involving an Indiana driver of a car registered in Indiana and insured by an Indiana insurance company. In that case, the place of delivery of the contract, the location of the subject matter, and other significant contacts pointed to the application of Indiana law. In contrast, the insured argued that Illinois law applied because the exclusion relied on by the insurer to deny coverage was unenforceable under Illinois public policy. The Fourth District held that public policy considerations pertaining to the substantive interpretation of particular policy provisions did not hold any weight with respect to the choice-of-law analysis. Instead, the court held that the analysis of the state’s law pertaining to the most significant contacts should be conducted independent of any substantive coverage comparison. Using the most significant contacts analysis in Westchester, supra, the court held that Indiana law applied.
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E. Other Alternatives 1. [4.12] Law of the Forum State Some Illinois courts have applied the substantive law of Illinois when the parties have waived the argument that the court should apply the substantive law of another state. Jadczak v. Modern Service Insurance Co., 151 Ill.App.3d 589, 503 N.E.2d 794, 104 Ill.Dec. 932 (1st Dist. 1987). This approach avoids the analysis of the various factors listed in the RESTATEMENT (SECOND) OF CONFLICT OF LAWS (1989), Hofeld v. Nationwide Life Insurance Co., 59 Ill.2d 522, 322 N.E.2d 454 (1975), and Lapham-Hickey Steel Corp. v. Protection Mutual Insurance Co., 166 Ill.2d 520, 655 N.E.2d 842, 211 Ill.Dec. 459 (1995). Even though the First District court in Jadczak held that Illinois substantive law would apply because the parties essentially waived the choice-of-law issue, Jadczak is interesting because other Illinois courts have cited to it for the proposition that Illinois choice-of-law rules require courts to look to the laws of the state where the policy was issued or delivered or where the last act to give rise to a valid contract occurred. See, e.g., Lapham-Hickey, supra. The Jadczak court did consider these factors but eventually held that unless a court’s attention is directed to a decision of another state bearing on a question before it, the law will be presumed to be the same as the forum. Because the parties did not assert any foreign law, the Jadczak court determined that the law of the forum — Illinois — applied. See also Echo, Inc. v. Whitson Co., 52 F.3d 702, 707 (7th Cir. 1995), in which the Seventh Circuit held that because neither party argued that any state’s substantive law other than Illinois’ should apply, the choice of law defaulted to Illinois regardless of the terms contained in the agreement under dispute. 2. [4.13] Law of the State Where Insured Is Domiciled Other Illinois courts, when faced with the unpredictable nature of the choice-of-law analysis, have held that the state where the insured is domiciled should be the most dominant factor. Emerson Electric Co. v. Aetna Casualty & Surety Co., 319 Ill.App.3d 218, 743 N.E.2d 629, 252 Ill.Dec. 761 (1st Dist. 2001). In Emerson, the court was to determine which state’s law would provide guidance for the substantive interpretation of an insurance policy that covered polluted sites located in several different states. The court held that the jurisdiction where the insured was headquartered, which tied all of the sites together, appeared to be the most likely state contemplated by the parties as the source of law. The court found that this approach comported with the RESTATEMENT (SECOND) OF CONFLICT OF LAWS (1989) and its emphasis on predictability, uniformity of result, and ease of determination of the law to be applied. 3. [4.14] Choice of Law by Stipulation of the Parties Illinois courts will also honor reasonable stipulations by both parties in insurance coverage disputes regardless of whether the choice-of-law stipulation was made formally or informally, in writing or orally. Auto-Owners Insurance Co. v. Websolv Computing, Inc., 580 F.3d 543, 547 (7th Cir. 2009). For example, at the trial court level in Auto-Owners Insurance, the parties agreed that Iowa law should apply to interpret coverage during briefing on a motion for summary
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judgment. When the issue was raised during the appeal, the Seventh Circuit held that Iowa law should apply because the parties’ prior agreement at the trial court level as to the applicable choice of law amounted to a valid stipulation.
V. [4.15] CONCLUSION Illinois courts follow general rules of contract construction and interpretation with respect to insurance contracts that contain choice-of-law provisions. When the insurance contract does not contain a choice-of-law provision, however, the courts will weigh several factors to determine which state’s substantive laws should apply. Depending on the factual scenario of each individual case, one or more of the factors may hold greater weight in the ultimate choice-of-law analysis.
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