Tentative Draft No. 1 of the American Law Institute's (“ALI”) Principles of the Law of Liability Insurance is likely to be approved on May 20, 2013.  Thomas Baker of the University of Pennsylvania Law School and Kyle Logue of the University of Michigan Law School were appointed as the Reporters, working with a team of 36 “Advisers” from academia, industry and law firms that represent both insurers and policyholders.  There is also a large “Members Consultative Group” that has offered comments and advice as the project progressed.

Unlike ALI “Restatements” that codify areas of the law as it exists, a “Principles” is a declaration of what the American Law Institute thinks the law should be.  The process is an attempt to establish uniformity and predictability, not necessarily to balance the interests of policyholders versus insurers.  The focus of Chapter One is on three topics:  policy interpretation, waiver and estoppel and the effect of insured misrepresentations.  The portion of Chapter Two that will be voted on relates to duty to defend principles and handling of insurance claims.  Among its more substantive holdings, but not necessarily surprising, are the following:

• Estoppel can create coverage when an insurer fails to defend and is estopped to contest its indemnity duties

• Extrinsic evidence can be submitted to reflect a latent ambiguity in language that may be clear on its face

• Contra Preferentem is defined as an interpretive principle of last resort, not as a “tie-breaker”

• If an insurer disputes the amount of fees from independent counsel, it must nonetheless pay the entire fee, subject to a subsequent law suit against the defense attorney (but not the insured).

• Right to independent counsel are only triggered if the reserved coverage issue could affect how case is defended.

• Insurer-appointed defense counsel has a duty to explain to the defendant insured the insurer's reservation of rights.

• Rescission is not allowed in cases of “innocent misrepresentation.”  Instead, alternative remedies are suggested, such as collecting additional premium from the policyholder or deducting the additional premium from the claim payment.

• When an insurer retains counsel to defend its policyholder, the insurer will be vicariously liable for any breach of professional obligation by defense counsel.

• Assumes a duty to defend exists in liability policies, if the policy is silent on the issue.