DMC/INS/05/11

DMC Category: Developed

This case note has been prepared by David Jensen of Healy & Baillie, LLP in New York. Healy & Baillie are the International Contributors to this website for the United States

Background
In this case, the Second Circuit held that a federal district court could hear a suit based on an insurance policy that "primarily" concerned maritime commerce. In doing so, the Second Circuit reversed the district court’s conclusion that federal admiralty jurisdiction did not exist because the policy was not "wholly" maritime. The ruling is significant because federal courts have only limited jurisdiction over legal disputes, and disputes that are not within federal jurisdiction must be decided in state court. The decision suggests that the federal courts’ admiralty jurisdiction has expanded, and that federal courts can now hear and decide insurance disputes concerning shipping or other maritime commerce that previously had to be heard in state court. The Second Circuit encompasses federal courts located in the states of New York, Connecticut and Vermont.

Facts
The dispute arose when a contractor’s employee suffered injuries while cleaning a vessel’s tanks on behalf of the insured, Clean Water. Clean Water had purchased a policy providing two lines of coverage: Shiprepairer’s Legal Liability (SLL) and modified Commercial General Liability (CGL). The contractor’s employee sued Clean Water for negligence, and Clean Water submitted the claim under the CGL coverage of its policy. There were "over a dozen" named insureds under the policy, and all of their "business operations relate[d] entirely to either ship repair, marine oil transport, marine cargo transport, or . . . ship tank cleaning." Folksamerica, the insurer, claimed that Clean Water had failed to disclose the fact that it cleaned tanks on other parties’ vessels when it purchased the policy. On this ground, Folksamerica sought avoidance and rescission of the policy and a declaration that it was not obligated to defend or indemnify Clean Water. Folksamerica relied primarily on uberrimae fidei or "utmost good faith," an admiralty doctrine under which the insured is held to the highest degree of good faith in disclosing material circumstances to the insurer.

The lower court, the United States District Court for the Eastern District of New York, had concluded that the CGL policy was not "marine insurance" and did not have a "purely" or "wholly" maritime character. See the report of the case at 281 F. Supp. 2d 531, 532 (E.D.N.Y. 2003). The lower court reasoned that CGL coverage was a type of insurance used by many businesses to cover day-to-day business operations, and that any maritime risks under the policy were "merely incidental," especially when compared with more traditional hull, cargo, and protection and indemnity policies. Because the district court concluded that the policy was not wholly maritime, it dismissed the policyholder’s suit against the insurer.

Judgment of the Court of Appeals
The Court of Appeals for the Second Circuit first addressed its two established bases for asserting maritime jurisdiction over contracts that are not "wholly" maritime. First, a court can assert maritime jurisdiction if a claim arises from a breach of maritime obligations when the maritime obligations are severable from the non-maritime obligations. Second, a court can assert maritime jurisdiction where the non-maritime obligations are "merely incidental" to the maritime obligations.

However, the Second Circuit felt that the Supreme Court’s recent decision in Norfolk Southern Railway Co. v. James N. Kirby Pty Ltd. "suggested a shift in analysis." Under Kirby, the relevant inquiry is not whether the non-maritime obligations are "incidental," but rather, whether the primary object of the contract is maritime. The Second Circuit then reasoned that the policy before it was "primarily or principally concerned with maritime objectives."

The Second Circuit reasoned that whether a policy was "marine insurance," and thus properly within the maritime jurisdiction of the court, depended on the coverage provided by the policy, which was a function of both the policy’s terms and the insured’s business. The "predominant purpose" of the policy should be determined by "the dimensions of the contingency insured against and the risks assumed." The fact that the policy provided CGL coverage, as opposed to a more traditional form of marine insurance, was not dispositive.

Even though the CGL policy excluded some maritime risks, it insured against others. The Second Circuit observed that certain CGL risks - completed operations hazards, products hazards, pollution risks, and premises and operations risks - were "marine." The court analyzed each particular risk in light of the business operations of the insured. The ultimate inquiry was whether the policy "reach[es] maritime risks." In light of the coupling of the CGL and SLL coverage, the court concluded that the policy was (as a whole) "marine in nature." The court further stated: "Combined, the CGL and SLL provisions round out the insureds’ coverage for maritime transport operations and give fairly robust ship repair and maintenance coverage."

Comment
The Second Circuit’s decision is significant because it indicates that the Supreme Court’s 2004 decision in Norfolk Southern Railway Co. v. James N. Kirby Pty Ltd. has expanded federal courts’ admiralty jurisdiction over "marine" insurance disputes. While the result is not surprising when one considers the nature of both Clean Water’s business and the place at which the claim occurred, it is notable when one considers that the claim arose under the policy’s CGL coverage, a line of coverage that is in no way unique to maritime interests. In the past, federal courts have generally ruled that they have the power to hear contract disputes only when the contracts are "wholly maritime." The Second Circuit’s reversal of the district court indicates that this analysis is no longer good, and that whether the policy is "maritime" instead depends on whether its subject matter is "primarily" marine commerce, even if it is not wholly marine.

A corollary issue that likely made the dispute significant for the parties is the utmost good faith argument advanced by the insurer. While U.S. admiralty law looks to state law to resolve insurance disputes in most instances, certain admiralty doctrines apply even in the face of inconsistent state insurance law. The Second Circuit has ruled that utmost good faith is one such doctrine, and an insurance policy is thus subject to this admiralty doctrine if it is within the federal admiralty jurisdiction. While the court did not discuss the state law that would otherwise have been applicable, it would not be surprising to learn that the state rule on this point would have been quite different.

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