Poorly Drafted Choice of Law Provision Has Unintended Consequences

A choice of law provision allows parties to agree that the law of a particular state will apply to the interpretation of a contract and any conflict arising therefrom. Choice of law provisions are particularly important when the parties are from different states and there are significant differences between the laws of the differing states. A recent decision by the United States Court of Appeals for the First Circuit illustrates the pitfalls of a poorly drafted choice-of-law provision. The Court held an insurance policy’s choice-of-law provision requiring application of New York law was limited to contractual claims between the parties (i.e., interpretation of the policy) and, therefore, did not preclude the insured from asserting against the insurer a claim for bad faith settlement practices under Massachusetts law.

The case concerned an insurance policy (the “Policy”) for a forty-seven-foot sailing vessel (the “Boat”) containing the following choice-of-law provision:

It is hereby agreed that any dispute arising hereunder shall be adjudicated according to well
established, entrenched principles and precedents of substantive United States Federal
Admiralty law and practice but where no such well-established, entrenched precedent exists,
this insuring agreement is subject to the substantive laws of the State of New York (emphasis
added).

After the boat was badly damaged in international waters, the insured brought a claim against the insurer for allegedly engaging in bad faith settlement practices in violation of Massachusetts state law. The insurer responded by arguing the policy’s choice-of-law provision requiring application of New York law prohibited the insured’s Massachusetts state law claim. The insured responded, in turn, by arguing that the policy’s choice-of-law provision applied solely to disputes concerning the interpretation of the policy itself, but not to claims entirely distinct from a breach of the policy.

In resolving the issue in favor of the insured, the Court first concluded the insured’s claim for bad faith settlement practices was “extra-contractual” because it was entirely distinct from a breach of the policy itself. In other words, the insured’s bad faith settlement claim was not based on the terms of the policy or any allegation the insurer violated the terms of the policy.

Focusing then on the contractual language of the policy, and specifically noting the choice-of-law provisions’ differential wording – “any dispute arising hereunder” versus “this insuring agreement” – the Court concluded the provision was ambiguous because it could reasonably be interpreted in two conflicting manners. The Court then construed the ambiguity in favor of the insured and against the insurer. In so doing, the Court held that only claims related to the terms and/or interpretation of the policy were subject to the substantive laws of New York. Although the decision in this case was controlled by the precise contractual language of the policy, it nevertheless underscores the importance of a carefully drafted choice-of-law provision.