Reprinted with permission from the May 13, 2016 edition of the The Legal Intelligencer.
In reviewing some of the major Pennsylvania Supreme Court decisions of the last few months, I was reminded of the old story Judge Learned Hand used to tell about his parting exchange with Supreme Court Justice Oliver Wendell Holmes one day after lunch.
“Do justice!” said Judge Hand as the pair separated.
“That is not my job,” replied Justice Holmes. “My job is to play the game according to the rules.”
Yet in three of the more significant contract decisions handed down recently, the Pennsylvania Supreme Court seemed more concerned with upholding its own brand of justice rather than applying the rules crafted by the parties themselves in their agreements. In fact, the Court repeatedly found ways not to apply the clear terms of the contract before it.
Each of the three cases also contained a telltale phrase that (it seemed to me) revealed the underlying policy concern that may have motivated the Court to disregard the contract’s actual language in favor of “justice.”
Wert v. Manorcare of Carlisle
In Wert, a nursing home and one of its residents entered into an agreement containing a dispute-resolution clause that mandated arbitration under the National Arbitration Forum’s
(NAF) Code of Procedure. The NAF Code provided, in turn, that the arbitration would be administered by the NAF. Unfortunately, the NAF had stopped accepting such arbitration cases by the time of the parties’ dispute.
Notwithstanding the presence of a standard severability clause relative to unenforceable provisions, the Court held that the involvement of the NAF itself was “integral” to the parties’ agreement. As a result, it declined to compel arbitration in any form and, instead, allowed the dispute to proceed in court. A dissent described this majority ruling, rather pithily, as “throw[ing] the baby out with the bathwater,” on the grounds that arbitration itself was far more integral to the parties’ agreement than any particular administrative entity. Yet the majority ruled otherwise, I suspect, because of what it described as a “lopsided balance of power” between the parties to the contract.
Socko v. Mid-Atlantic Systems
In Socko, an employee entered into a non-compete agreement with his existing employer. No new consideration was provided. The agreement did provide, however, that the parties “intended to be legally bound.” Under Pennsylvania’s Uniform Written Obligations Act (UWOA), contracts containing that phrase “shall not be invalid or unenforceable for lack of consideration.” 33 P.S. § 6. Nevertheless, the Court held that, in light of Pennsylvania’s common-law requirement of actual consideration for “historically disfavored” covenants in restraint of trade, the non-compete at issue was unenforceable. The Court reasoned that denying relief to an employee challenging a restrictive covenant for lack of consideration would “lead to an unreasonable result,” even though the parties had specifically invoked a statute that provided otherwise in their agreement.
Babcock & Wilcox v. American Nuclear Insurers
In Babcock, insureds Babcock & Wilcox and Atlantic Richfield paid $80 million in settlement to a class of plaintiffs alleging damages arising from living near a nuclear facility.
The insureds then brought suit against their insurer, which had defended the underlying action under a reservation of rights, to recover their settlement payment. In opposition, the insurer pointed to standard contractual language that gave the insurer control over settlement by providing that the insureds “shall not, except at [their] own cost, make any payment”; that any settlement must be “by written agreement of the insurer” as a prerequisite for bringing a coverage action; and that “liability assumed by the insured under contract” was expressly excluded from coverage.
Despite this clear contractual language, the Pennsylvania Supreme Court upheld the trial court judgment in favor of the insureds, finding that “if an insurer breaches its duty to settle while defending subject to a reservation of rights and the insured accepts a reasonable settlement offer, the insured need only demonstrate that the insurer breached its duty by failing to consent to a settlement that is fair, reasonable, and non-collusive.” The Court ruled that this determination does not, however, require any finding of insurer bad faith – only that the claim was covered, and the settlement reasonable.
The phrase that most seemed to capture the Court’s underlying motivation was the following: “[an] insurer who ‘reserves the right to deny the duty to pay should not be allowed to control the conditions of payment.’”
If the Court were tasked with crafting social policy on a blank slate, all three of the above outcomes would be at least defensible – indeed, maybe even desirable. That is, the Court makes fair points about what is “lopsided” or “an unreasonable result” or “should not be allowed.” And certainly it seems to have acted, in each instance, to protect the party that likely had less actual say over the precise terms of the contract.
The problem remains that none of the parties to the three contracts at issue could have predicted the Court’s ultimate rulings when they signed their agreements. On the contrary, reasonable parties would most likely have predicted the opposite outcomes if asked at the time of contracting – i.e., that the contracts would be enforced as written. Under that scenario, disputes would be arbitrated in Wert; the non-compete would be enforced in Socko; and any settlement would require the insurer’s consent in Babcock.
Business people value predictability. That’s why they enter into contracts in the first place. But judicial second-guessing makes it harder for them to be confident those contracts will be enforced. That uncertainty, in turn, then infects other elements of their deals, including pricing. And it encourages litigation afterwards whenever a bright lawyer can come up with a colorable policy argument for attacking an agreement.
Fortunately, it seems likely that the precise circumstances of Wert and Socko will rarely recur.
The factual setting in Wert – an arbitral forum abandoning a line of business – will not likely arise in many future cases.
As for Socko, no prudent lawyer will ever again rely on the UWOA language alone; rather, that language will simply become a fallback to actual consideration (and, to be safe, in a defensible amount to boot). So those cases may have little specific impact.
At a more general level, though, lawyers may nonetheless infer from those cases – and have to advise their clients – that our Court cannot necessarily be counted on to enforce particular contractual language that it deems unfair, unwise, or unduly favorable to the more powerful party.
By contrast, the situation in Babcock occurs all the time. Insurers routinely defend under reservations of rights, and also invariably want to control settlement decisions involving their insureds. But under the Babcock holding, an insured can now feel much more confident seizing the reins and entering into a settlement that it believes to be fair and reasonable. The case’s reasoning will thus allow insureds to wrest settlement control from their insurers in more cases, make it harder for insurers consistently to mount the hardball defenses they often favor, and also potentially generate more coverage litigation.
If the result is that the insurers’ costs of claims increase, which is quite plausible, then it seems likely they will pass those costs along to their Pennsylvania insureds via premium increases. And because the law applies across the board, such premium increases presumably would apply equally broadly – even to policyholders who would have been content to let their insurers control settlement in exchange for lower premium costs. Policyholders may also now find it more necessary than ever to engage independent coverage counsel to monitor settlement negotiations, both because of their greater opportunity to force a settlement, and also because they will no longer be able to claim, afterwards, that settlement rested solely in the hands of the insurer.
Indeed, policyholders may more often find that they are forced to engage independent counsel, if insurers respond to Babcock by filing more declaratory judgment actions against their policyholders as an aggressive means of adjudicating coverage as well as influencing the underlying settlement and its allocation between the insurer and insured.
What all this boils down to is that even the “right” decisions (if that is what they were) come with a price when reaching those decisions requires a court to override clear contractual language. Remember, these aren’t tort cases – where society must write fair rules to govern disputes arising between people who never even wished to interact. These are contract cases, between people who voluntarily elected to go into business together. Such people expect to be allowed to craft their own deals, and for the courts to enforce those deals. Those expectations are undermined when the courts apply their own ideas about justice rather than the “rules of the game” as originally crafted by the parties themselves.
Only time will tell whether the potential costs associated with imposing judicial policies on contracting parties – drafting uncertainty, unpredictable outcomes, price increases and litigation – outweigh the hoped-for benefits of those policies.
Reprinted with permission from the May 13, 2016 edition of the The Legal Intelligencer. Copyright 2016 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For further information, contact 877-257-3382 – [email protected] or visit www.almreprints.com.
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