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Policyholders Beware: Actions May Indeed Speak Louder Than Words

By: Kurt W. Melchior

It has long been the law in California that "course of performance" evidence can be used as an aid in interpreting an ambiguous contract—not only to resolve an obvious ambiguity, but also to expose an ambiguity in a provision that may appear, at first glance, to be clear. Insurance contracts have special features, but they are still contracts to which the ordinary rules of contract interpretation apply. Course of performance interpretations of insurance contracts are rare, but earlier this month, the Second District Court of Appeal applied and slightly expanded this settled principle, explaining that course of performance evidence can be used not only to resolve ambiguities in insurance contracts but also to supplement or qualify policy terms or to show waiver or modification of a term that is inconsistent with the parties’ course of performance.

In Employers Reinsurance Co. v. Superior Court (Thorpe Insulation Co.), 2008 Cal. App. LEXIS 482, the court held that the trial court erred in excluding some (but not all) claims handling history that showed how insurers allocated payments made on asbestos claims.

Thorpe, a distributor and installer of asbestos insulation at industrial facilities, faced thousands of lawsuits alleging personal injuries caused by the company’s historical operations. Thorpe began submitting asbestos claims to its insurers in 1978. Many of Thorpe’s liability insurance policies included "products/completed operations" coverage as well as non-products "operations" coverage. The policies’ aggregate limits applied only to products/completed operations claims. Other coverages had no aggregate limits, meaning that claims under them were covered (within the per-claim limits) ad infinitum.

In 1984, Thorpe and ten of its primary insurers entered into a Claim Handling and Settlement Agreement. Under that agreement (which appears to have been less thorough than other asbestos coverage policy handling agreements of that era), the insurers covered asbestos claims and charged them against the aggregate limits of the products/completed operations coverages of the policies. To what extent this was done with Thorpe’s consent (or even its active review) is not apparent from the opinion.

In 1998, Thorpe and seven of its first-level excess insurers entered into an Interim Excess Insurance Claims Handling Agreement under which those insurers covered asbestos claims and similarly treated them as products/completed operations claims charged against the aggregate limits of the policies.

Over a 30-year period, Thorpe recovered more than $150 million from its insurers. In 1999, with its policies nearly exhausted and with new asbestos personal injury suits continuing to be filed against it, Thorpe asserted that at least some asbestos claims should be treated as non-products operations claims, that would not exhaust the policies. Claiming to rely on 30 years’ of claims handling history, Thorpe’s insurers disagreed. The trial court ruled that course of performance evidence was inadmissible to interpret the policies unless it concerned the performance of those who actually negotiated and signed the agreements.

The Court of Appeal granted insurers’ request for writ relief, holding that evidence of the parties’ course of performance under the policies—but not under the two settlement agreements (which in this case governed the bulk of the parties’ performance)—was admissible to show how the parties understood the contract. The court held that the course of performance of all persons performing under the policy—not only those who negotiated and signed it—is relevant.

The very purpose of the admission of course of performance is the common sense belief that when the parties perform under a contract, without objection or dispute, they are fulfilling their understanding of the terms of the contract. This is true regardless of the actual language of the contract, as long as the parties’ interpretation is reasonable. If the parties to a contract have, for years, harmoniously performed the contract in a way that reflects a particular, reasonable, understanding of the terms of the contract, that performance is relevant to determining the meaning of the contract…. Indeed, if parties harmoniously performed for years under a particular understanding of the contract, there is no reason why that performance should be considered irrelevant to the meaning of the contract even if the contract was drafted by the parties’ predecessors-in-interest or was a pre-printed standard form contract. Moreover, under Commercial Code section 1303, course of performance evidence can supplement, qualify, or modify contrary terms in the contract. (bold italics added).

The ruling that evidence of a course of conduct by those who actually perform a contract on behalf of a corporation or similar entity is sensible enough. But in our experience, policyholders are—at least at the onset of a problem that may generate a multitude of claims—far more interested in obtaining coverage than in how the insurance company charges those claims against particular coverages. In the mid-1980s, insurers and policyholders highly contested far more basic questions like trigger and duty. To our understanding (having studied the subject extensively, albeit after the fact) questions about which class of risk to charge a particular claim against were barely, if at all, on policyholders’ agenda.

Policyholders should, therefore, challenge any attempt by their insurers to claim "consensual" allocation to exhausting aggregates, because such allocation may well be insurers’ unilateral and self-serving action to which the policyholders never knowingly consented. In this regard, the court’s ruling that allocations under settlement agreements cannot be used to divine how the parties intended to allocate the claims is very helpful, since the great majority of allocations come about after such settlements, not before.

In short, this case—including its surprising conclusion that Commercial Code §1303 applies to insurance contracts—should signal policyholders worried about exhausting coverage that they need to carefully monitor how their insurers are allocating payments, to avoid any argument that they acquiesced in a course of performance that may later be used against them.

Kurt W. Melchior is a partner at Nossaman with over 30 years' experience in complex litigation, including insurance coverage litigation. He can be reached at (415) 438-7279 or

Deborah E. Beck is a senior associate in the firm’s Litigation practice specializing in insurance coverage, environmental and appellate matters. She can be reached at (415) 438-7254 or

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