When the courts have a case involving contracts, it looks at the "rules of construction" to interpret the contract. The rules of construction help identify and establish the intent of the parties to the contract.
There are five major areas that the courts review in order to interpret the contract, establish the intent of the parties, and hand down a ruling.
Plain Language and Word Definitions
If the language of the contract is clear the courts do not have to interpret the meaning of the contract. The courts give the words in the contract their "ordinary meaning." In cases where ordinary words have been used in a technical capacity, the technical meaning of the word is accepted.
The Entire Contract
The courts look at the entire contract to determine the intent of the parties. It does not consider material added to the basic contract, nor does it take only parts of the contract to make a determination.
Interpretation in Favor of Valid Contract
Because the courts assume that when people make a contract they intend for it to be valid, the courts will, if possible, render an interpretation of the contract that makes it valid rather than invalid.
Unclear Contract of Adhesion Interpreted Against the Insurer
If a contract contains wording that is unclear the courts will interpret the language used against the writer of the contract, unless the wording used is required by law to be stated in a specific manner. Insurance contracts are contracts of adhesion, which means the insured had no part in determining the wording of the contract; therefore, the courts will interpret the contract in favor of the policyholder, insured, or beneficiary.
If a contract contains unclear or inconsistent material between printed, typed, or handwritten text in the contract, the typed or handwritten material will determine intent.
The insurance contract has certain characteristics not typically found in other types of contracts.
Utmost Good Faith
The insurance contract requires utmost good faith between the parties. This means that each party is entitled to rely on the representations of the other and each party should have a reasonable expectation that the other is acting in good faith without attempts to conceal or deceive. In a contact of utmost good faith, the parties have an affirmative duty to each other to disclose all material facts relating to the contract. That is not just a duty not to lie, but also a duty to speak up. Failure to do so usually gives the other party ground to void the contract.
An insurance contract is said to be aleatory, or dependent upon chance or uncertain outcome, because one party may receive much more in value than he or she gives in value under the contract. For example, an insured who has a loss may receive a greater payment from an insurer for the loss than he or she has paid in premiums. On the other hand, an insured might pay his or her premiums and have no loss, so the insurer pays nothing.
In insurance, the insurer writes the contract and the insured adheres to it. When a contract of adhesion is ambiguous in its terms, the courts will interpret the contract against the party who prepared it.
Insurance contracts are unilateral. This means that after the insured has completed the act of paying the premium, only the insurer promises to do anything further. The insurer has promised performance and is legally responsible. The insured has made no legally enforceable promises and cannot be held for breach of contract. For example, the insured may stop paying premium because he is not legally responsible to continue paying premium.
An insurance contract is an executory contract in that the promises described in the insurance contract are to be executed in the future, and only after certain events (losses) occur.
Insurance contracts are also conditional contracts because when the loss occurs certain conditions must be met to make the contract legally enforceable. For example, a policyholder might have to satisfy the test of having an insurable interest and satisfy the condition of submitting proof of loss.
Generally, insurance policies are personal contracts between the insured and insurer. Generally, insurance is not transferable to another person without the consent of the insurer. Fire insurance, for example, does not follow the property.
Warranties and Representations
A warranty is something that becomes part of the contract itself and is a statement that is considered to be guaranteed to be true. Any breach of warranty provides grounds for voiding the contract.
A representation is a statement believed to be true to the best of one's knowledge. An insurer seeking to void coverage on the basis of a misrepresentation usually has to prove that the misrepresentation is material to the risk.
An example would be a question on the application asking for your sex or date of birth. You represent yourself to the insurance company as being male or female and a certain age. The accuracy of these items is very important to the insurance company issuing the policy. If they are incorrect, they may be considered misrepresentations, and the policy may be voided as a result.
There is a difference between representation of a fact and an expression of opinion. A good example is a question on many applications: "Are you now to the best of your knowledge and belief in good health?" If the applicant answers "yes" while knowing in fact that he or she is not, there is a misrepresentation of actual fact. If, on the other hand, he or she has had no medical opinion and suffers from no symptoms recognizable to a layman, his or her answer is an opinion and thus not a misrepresentation.
Impersonation means assuming the name and identity of another person for the purpose of committing a fraud. The offense is also known as false pretenses. In the case of life insurance, an uninsurable individual applying for insurance may ask another person to substitute for him to take the physical examination.
Misrepresentation and Concealment
A misrepresentation is a written or oral statement that is false. Generally, in order for a misrepresentation to be grounds for voiding an insurance policy, it has to be material to the risk.
Concealment is the failure to disclose known facts. Generally, an insurer may be able to void the insurance if it can prove that the insured intentionally concealed a material fact.
Material information or a material fact is crucial to acceptance of the risk. For example, if the correct information about something would have caused the insurance company to deny a risk or issue a policy on a different basis, the information is material.
Fraud is an intentional act designed to deceive and induce another party to part with something of value.
Parol (Oral) Evidence Rule
The parol evidence rule limits the impact of waiver and estoppel on contract terms by disallowing oral evidence based on statements made before the contract was created. It is assumed that any oral agreements made before contract formation were incorporated into the written contract. After contract formation, earlier oral evidence will not be admitted in court to change or contradict the contract. An oral statement may waive contract provisions only when the statement occurs after the contract exists.