Port East Transfer, Inc. v. Liberty Mutual Insurance

McAULIFFE, Judge. The United States District Court for the District of Maryland has certified to this Court a question involving the required elements of a contract claim brought by an insurer against its insured for unpaid retrospective premiums and involving the allocation of burdens of proof and production of evidence in such an action. ³⁷⁸ I. Between 1 March 1986 and 25 April 1989, Port East Transfer (Port East) 1 entered into a number of contracts of insurance with Liberty Mutual Insurance Company (Liberty Mutual), some of which provided for retrospective premium adjustments. Under a retrospective policy, the parties establish an estimated premium at the inception of the period of coverage, but agree that this premium will be adjusted at stated intervals based upon specified factors. These factors commonly include the amount paid for losses under the policy, administrative expenses, and profit.

Although the precise terms of the retrospective contracts between these parties are somewhat complex, and differ from policy to policy, we shall endeavor to state in general terms the essence of the retrospective premium arrangement. Liberty Mutual was obliged to investigate, adjust, settle, or provide for the defense of all covered claims. Liberty Mutual initially paid, from its own funds, all claim-related expenses as well as the amount of settlement or judgment. When periodic accountings were made, Liberty Mutual was entitled to reimbursement for these expenses and advances of capital, plus an agreed upon percentage factor calculated to reimburse the insurer for the use of its funds and to provide for a profit.

If the total figure for the accounting period were less than the estimated premium paid, the insured was entitled to a refund. If the estimated premium proved insufficient, the insured was obligated to pay the difference to the insurer. During the period covered by the policies in question, Liberty Mutual responded to hundreds of claims, and kept Port East regularly apprised of the status of those claims. At the end of the period, Liberty Mutual calculated and ³⁷⁹ applied the retrospective adjustment for these policies and concluded that Port East owed additional premiums. 2 Port East declined to pay, and Liberty Mutual filed a two-count complaint in the United States District Court for the District of Maryland, alleging breach of contract and money due on an account stated between the parties.

Liberty Mutual alleged the existence of contracts between the parties, and attached to its complaint a copy of the account allegedly stated between them. It also alleged that Port East refused to pay the premiums in breach of the contracts. Liberty Mutual did not allege that it handled the claims under the retrospective premium insurance policies reasonably and in good faith. Port East answered, generally denying liability, and in the following language specifically denied performance of a condition precedent: Pursuant to Federal Rule of Civil Procedure 9(c), Defendants state Plaintiff Liberty Mutual must prove that it carried out the duties that it owed to its insureds in good faith and with reasonable competence as a condition precedent to any right of recovery it may have against its insureds under the policies at issue.

The policies carried with them an inherent conflict of interest, since the policy premiums are retrospective in nature. Defendants deny that Liberty Mutual acted in good faith and with reasonable competence in performing its duties to its insureds under these policies, and, therefore, they assert that Liberty Mutual has not fulfilled the conditions precedent to any right of recovery it may have from its insureds under these policies. Port East also filed a motion for judgment on the pleadings, contending that “Liberty Mutual has not alleged that the settlements it made, and upon which the premiums were based, were made in good faith and were reasonable.” Port ³⁸⁰ East contended that the contracts of insurance were made in Massachusetts, and that Massachusetts substantive law should apply. It argued that under Massachusetts law, the burden of proof is on the insurer to show compliance with an implied condition of good faith and reasonableness.

Port East further reasoned that because the insurer had the burden of proving good faith and reasonableness, those implied conditions were in fact elements of the cause of action for breach of contract, and must be affirmatively alleged in the complaint. Liberty Mutual responded to the motion, denying that Massachusetts law applied, and denying that it was obliged to affirmatively plead reasonable and good faith handling of each claim. In support of its reply, Liberty Mutual filed an affidavit of the senior account representative responsible for this account, in which she stated that claims made against Port East were “investigated, defended, and, where appropriate, reasonably settled” by Liberty Mutual, and that she had “no knowledge of any claim that was not handled reasonably and in good faith.” Judge Herbert F. Murray treated the defendants’ motion as a motion for summary judgment. After hearing argument on the motion, he determined that Maryland law governs the contracts in question.

In his opinion deferring ruling on the defendants’ motion, Judge Murray reviewed the contentions of the parties and the law from other jurisdictions, and concluded that certification of a question to this Court was appropriate. He said: Because no Maryland court ever has addressed the issue of the relative burdens of pleading and proof in cases involving cases of retrospective premiums directly, because the case law from other jurisdictions provides no clear, overriding, or well-accepted guiding principle, and because the issue lies at the center of the controversy presented by this law suit, this Court will avail itself of Maryland’s certification statute and certify the issue to ³⁸¹ the Maryland Court of Appeals.[ 3 ] He then certified the following question to this Court: Whether, in an insurer’s action for unpaid retrospective premiums, the reasonableness and good faith of the insurer in connection with claims subject to such retrospective premium adjustments is an essential element of the claim?[ 4 ] II. We are not asked to, nor will we, address the adequacy of Liberty Mutual’s complaint. Although state law may ultimately be applicable in the trial of the substantive issues in a diversity case, and governs the allocation of the burden of persuasion in such a case, the law is clear that the federal courts apply the Federal Rules of Civil Procedure in questions regarding pleadings and not state rules. 27 Federal Procedure § 62:17, at 204-5 (L.Ed.1984).

See also Hanna v. Plumer, 380 U.S. 460 , 85 S.Ct. 1136 , 14 L.Ed.2d 8 (1965); Thompson v. Allstate Insurance Company, 476 F.2d 746, 749 (5th Cir.1973). Rather, reading the question certified to us in light of the concerns expressed by Judge Murray in his written opinion, we confine our discussion to the nature of the action and allocation of burdens of proof and production that would apply if the case were being tried in a court of this State. Liberty Mutual does not dispute Port East’s contention that there is a condition implied by law in its retrospec ³⁸² tive contracts with Port East that it act in good faith when investigating, adjusting, or settling claims. It argues, however, that it should not be required to allege and prove that it acted reasonably and in good faith with respect to each of the hundreds of claims it handled for its insured.

Rather, Liberty Mutual says it should be permitted to allege and show the existence of the contract and a breach by Port East, and it should then be incumbent upon Port East to come forward with evidence of any claimed breach of the implied condition. Liberty Mutual argues that: 1) the breach of this implied condition must be specifically pleaded by the defendant as an affirmative defense, and that the burden of production and of persuasion are upon the defendant; or, alternatively, 2) the alleged breach of an implied condition is a matter about which the defendant should have the burden of coming forward with sufficient evidence to legitimately generate the issue. Port East contends that in order to recover in a contract action such as this, the plaintiff must allege and prove the performance of each covenant and condition by which it is bound, whether express or implied. In Transport Indemnity Co. v. Dahlen Transport, Inc., 281 Minn. 253 , 161 N.W.2d 546 (1968), the insurer sued for additional premiums claimed to be due under a retrospective premium policy.

The insured denied liability, contending that at least part of the amount claimed represented money unreasonably paid by the insurer in settlement of claims. The insurer took the position that it had the right to make the sole and exclusive determination as to the appropriateness or propriety of amounts paid for losses or expenses, and that the reasonableness of the payment and the good faith of the insurer could not be challenged. The Supreme Court of Minnesota disagreed. The court pointed out that under the retrospective terms of the policy the insurer was, in effect, setting claims with the insured’s money, thus placing the insurer in a position analogous to that of an agent advancing money for his principal in conformity with written authority.

Id. 161 N.W.2d at 548 . That being the ³⁸³ case, the court said, the agent could ordinarily recover the advancement unless the principal affirmatively established that the payments were made in violation of a duty of loyalty and good faith. In other words, the court said, if matters were that simple, the insured would have the affirmative duty of proving bad faith on the part of the insurer. The court went on, however, to note that the issue was made more complex by the existence of other non-retrospective insurance contracts between the parties.

The retrospective premium liability policy afforded coverage only up to $5,000 per occurrence. Other fixed premium policies provided coverage for claims between $5,000 and $1,000,000 for each occurrence. Accordingly, by settling a claim for $5,000 or less the insurer could charge the amount of the settlement to the insured as a retrospective premium, and at the same time avoid the potential of being required to make a non-recoverabie payment under one of the fixed premium policies if a verdict for more that $5,000 were entered. This added factor, the court said, created an inherent conflict of interest that entitled the insured “to have the insurer produce the information pertinent to the reasonableness and good faith of the settlement and assume the burden of proof on the issue.” Id. at 549.

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