The U.S. Court of Appeals for the Third Circuit has applied New York law in a case involving a reinsurer’s duty to indemnify, effectively reversing a district court ruling in favor of the Pennsylvania-based insured in a suit that sprang from $500,000 in asbestos-related claims.

The Third Circuit agreed with the lower court’s reading of the contract between an insurance company and its reinsurer but held the law of the state with the strongest tie to the contract would prevail in its interpretation.

“A New York reinsurer accepted in New York the terms and conditions proposed by a Minnesota broker, acting on behalf of the New York underwriting office of a California company located in Los Angeles,” Judge Thomas Ambro said of the 1980 reinsurance agreement. “At the time, there would have been simply no reason for the parties to expect that Pennsylvania law would govern whether particular provisions of the contract they were entering into were valid as written. Pennsylvania entered the picture, as a matter of pure happenstance, 19 years later when PEIC relocated to Pennsylvania.”

Ambro wrote the unanimous 45-page opinion in Pacific Employers Insurance Co. v. Global Reinsurance Corp. of America on behalf of a three-judge panel that included Judge Thomas Vanaskie and Senior Judge Franklin Van Antwerpen.

The panel considered a series of contracts beginning with a New York manufacturer’s purchase of a policy with a $1 million limit. It then bought excess insurance to cover it for an additional $9 million from PEIC, which spread some of its risk by purchasing a certificate for reinsurance from New York-based Constitution, which later was sold to Global.

That certificate included the disputed sentence: “As a condition precedent, the company shall promptly provide the reinsurer with a definitive statement of loss on any claim or occurrence reported to the company and brought under this certificate which involves a death, serious injury or lawsuit,” according to the opinion.

In the early 1990s, about 10 years after Buffalo Forge Co. bought its insurance, claimants from across the country began filing asbestos-related suits. It notified PEIC of the suits in 2001 and by 2004 had exhausted its primary insurance policy, according to the opinion. Although PEIC told its broker in 2005 to inform its reinsurers, Global wasn’t notified of the claims until 2008. Global responded that it wasn’t liable for the $559,000 that PEIC sought because it was not informed promptly by a definitive statement of loss, or DSOL, as is required by the contract.

New York law is deferential to contracts between “sophisticated” business entities and clearly allows for a reinsurance company to reject a claim based on late notice.

“New York’s rule is rooted in freedom of contract. ‘An express contract for indemnity,’ like the certificate, ‘remains a contract; hence, the parties are free within limits of public policy to agree upon conditions precedent to suit,’ ” Ambro said.

Pennsylvania law, however, is unsettled on the issue because its Supreme Court hasn’t addressed it, Ambro said. Although Ambro was wary of predicting how the Pennsylvania Supreme Court would rule, he wrote that its 1977 opinion in Brakeman v. Potomac is telling.

“Brakeman held that under a liability insurance policy late notice will not relieve an insurer of its coverage obligations unless it proves that breach of the notice provision caused it prejudice,” Ambro said.

He concluded, “Given our review of Pennsylvania law and our precedent, we assume without deciding, solely for the sake of our choice-of-law analysis, that Pennsylvania would apply a must-show-prejudice rule to reinsurance contracts even when the contract makes the notice provision an express condition precedent to coverage.”

The Third Circuit differed from the district court in ruling that New York law controlled, so it reversed and remanded the district court’s judgment in favor of PEIC, but it agreed with the lower court in its reading of the contract language. It ruled the contract required PEIC to notify Global promptly after it had received a claim, not as PEIC had argued promptly after it demanded payment from Global.

The disputed sentence, read in the context of the contract, “unambiguously requires PEIC to provide Global with a DSOL on any claim or occurrence that involves a death, serious injury or lawsuit promptly after such a claim or occurrence is reported to it under the excess policy,” Ambro said.

In this case, Global is released from its obligation to indemnify PEIC for the excess asbestos claims.

The court’s holding that the paragraph is a valid condition precedent is significant “for people who have our wording,” said Edward Krugman of Cahill Gordon & Reindel in New York, who represented Global, as is the court’s ruling on choice-of-law.

Carter Phillips of Sidley Austin in Washington represented PEIC and couldn’t be reached for comment.