The United States Legal System

Objective

Evaluate United States civil law and common law systems and classifications.

Many risk management and insurance job functions are influenced by the need to follow the law. For example, an agent or a broker must disclose information about premiums, deductibles, and required coverages to a prospective insured. A claims representative must handle a claim with good faith, and an underwriter must ensure he or she is not unfairly discriminatory when selecting insureds. 

So it stands to reason that if you work in the risk management and insurance industry, you should understand the legal system. But how do you accomplish that? 

Learning about the prevailing legal principles that affect your work is a good place to start. 

In this section, we’ll focus on understanding the United States legal system. Keep in mind that U.S. law has been greatly affected by other legal systems—particularly the Roman Empire’s civil law system as adopted by continental European countries and Great Britain’s common law system. Although these two systems differ significantly in origin and form, features of both are found in the U.S., with the common law system serving as the foundation of the U.S. legal system.

What Do You Know?

The U.S. legal system can be divided into civil and criminal law. What are the main differences between the two?

Feedback

Criminal law applies to acts society deems so harmful to public welfare that the government is responsible for prosecuting and punishing the perpetrators. Civil law applies to legal matters that are not governed by criminal law, protecting rights and providing remedies for breaches of duties owed to others.

Civil Law System 

The civil law system, one of the two basic western legal systems, is the foundation of law in continental Europe, Latin America, Scotland, the state of Louisiana, and some other parts of the world. 

Civil law systems, such as the French Code of Napoleon, have comprehensive codes of written laws (statutes) that apply to all legal questions. These systems rely on scholarly interpretations of their codes and constitutions rather than on court decisions, which are the basis of the common law system. 

Common Law System 

People who are not lawyers often refer to “the law” with a belief that there are written laws to answer all legal questions. U.S. law, however, is not so simple. 

Written laws (statutes) form much of the law, but U.S. law can also be based on precedent—rulings from prior cases that relate to the facts of current cases. Many cases, in fact, may end up only involving such “common law” and no statutory law at all. For example, most states have common law elements of bad-faith claims.

The History of Common Law

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The U.S. common law system applies precedent through the doctrine of stare decisis (“to stand by things decided”), following earlier court decisions when the same issues arise again in lawsuits. 

Precedent includes both mandatory (binding) authority and persuasive authority. Mandatory authority is law that a court must follow. If no mandatory authority applies, a court may look for persuasive authority, which can include a ruling from another jurisdiction or a discussion in a legal treatise. Courts do not necessarily decide all similar cases exactly the same as previous courts have, but they must provide strong reasons to depart from precedents.

In common law countries, solving a new legal problem in a current case often involves a process called synthesis, combining rulings from several legal authorities into a new rule of law, which is applied to the new legal problem. Consulting authorities typically consider relevant statutes, prior cases that interpret the statutes, and prior cases that establish common-law precedents. 

When developing a new rule of law using synthesis, courts analyze the reasoning and facts of the relevant prior cases as controlled by the language of a governing statute, if any. Then they compare the facts of the prior cases to those of the current case. 

This example illustrates how the common law can evolve through the process of synthesis: If an insured sues an insurer in a state court over a disagreement about the meaning of a policy provision, the court analyzes prior cases in which courts have ruled on the meaning of the same or similar provisions. The court first seeks similar cases in its own state or province; if no such cases apply, the court then seeks similar cases in other states or provinces. If no cases on point are found, the court might analyze general contractual principles and court rulings in somewhat similar cases. 

Courts often encounter situations for which they can find no prior case or previous law that directly applies. Such unprecedented situations are called “threshold cases” because they present new legal questions. When encountering threshold cases, judges summon all applicable law in an attempt to arrive at fair decisions. 

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Methods of selecting judges, as well as individual judges’ views and values, can influence judicial decisions. Judicial selection methods include election and appointment, and they vary by state. 

Although courts strive for objectivity in their decisions, individual judges’ political beliefs, views, values, and biases can affect decisions. This means that newly elected judges can change the direction of a court. Some judicial appointments, particularly at the federal level, are for life. For example, through the appointment of U.S. Supreme Court justices, a president can influence the law for many years into the future. 

The legal system has built-in controls for promoting fair outcomes in disputes. A party that loses in trial court may have grounds to appeal the decision to a higher court, in some cases all the way to the U.S. Supreme Court. Because the Supreme Court is the country’s highest court, the views of the court’s justices have a profound influence on the law, particularly when justices decide threshold questions. 

The Evolution of Common Law 

Common law is not an absolute; it reflects the evolution of society’s values and attitudes. What was acceptable law in the U.S. a century ago may be unacceptable today. A court can find a prior decision clearly wrong and discard it as precedent. 

Courts generally do not follow precedent when the earlier rule of law has lost its usefulness or when the original reasons for the rule no longer exist. Courts may also overrule prior decisions solely for sound judicial reasons. This approach helps prevent legal capriciousness and gives stability to society and business. The U.S. Congress or a state legislature can pass new legislation that changes a common law principle. 

The common law also changes with landmark decisions: historic court rulings that significantly change or add to prior law with far-reaching societal effects. 

One of the most well-known examples is the U.S. Supreme Court decision in Brown v. Board of Education,¹ which overruled previous cases condoning racial segregation in schools. Another example is Miranda v. Arizona,² which requires police to inform suspects in criminal cases of their constitutional right against self-incrimination before questioning them. 

Common Law, Congress, and Insurance Regulation

The Supreme Court made a landmark decision in 1869 affecting insurance regulation. Paul v. Virginia³ established that insurance is a contract delivered locally and governed by state law rather than federal law. In other words, insurance transactions were not considered interstate commerce.

That decision was modified by another landmark insurance decision in 1944, the South-Eastern Underwriters Association, et al.,⁴ (SEUA) in which the Supreme Court ruled that insurers conducting their activities across state lines are within the regulatory power of Congress under the commerce clause of the U.S. Constitution. 

In the SEUA case, the court upheld an indictment brought by the federal government under Sections 1 and 2 of the Sherman Antitrust Act. Some insurers were indicted for fixing and maintaining arbitrary and noncompetitive rates on fire and specified allied lines of insurance, as well as for monopolizing trade between the states of Alabama, Florida, Georgia, North Carolina, South Carolina, and Virginia. The SEUA decision opened the door for federal regulation of the insurance industry.

Congress quickly moved to close this door by reversing the SEUA decision through the McCarran-Ferguson Act, allowing insurers to be generally exempt from federal antitrust laws. The McCarran-Ferguson Act provides, in part, that the Sherman Antitrust Act “shall be applicable to the business of insurance to the extent that such business is not regulated by state law.” Enactment of the McCarran-Ferguson Act has largely left regulating insurance companies to individual states.

Since that time, Congress moved toward retaking some of the power it relinquished in passing the McCarran-Ferguson Act. In 1999, it passed the Gramm-Leach-Bliley Act (GLB) to create financial services reform. GLB created new opportunities for financial services organizations by allowing companies to offer bank, insurance, and securities products within the same corporate structure.

GLB, while promoting uniform producer licensing laws, reaffirmed the McCarran-Ferguson Act. It aimed to reconcile federal banking and security laws with a state regulatory system for the insurance industry. 

GLB provides a framework to determine what financial products are banking or security products subject to federal oversight and what products are insurance products subject to state regulation. 

It should be noted that the McCarran-Ferguson Act does not always mandate state law supremacy over federal law to regulate insurance. Federal law may preempt state law if the state law does not relate to the regulation or taxation of insurance or if the federal law specifically relates to the business of insurance.

Equity 

Common law courts historically determined legal rights and remedies and awarded money damages. Courts of equity arose in England to ensure adequate remedies in all cases. These courts complemented law courts by recognizing many rights that common law courts did not recognize.

Equitable remedies seek fair solutions beyond what traditional legal remedies can offer. For example, the usual legal remedy for breach of contract for the sale of a unique item, such as a one-of-a-kind antique, would be monetary damages. However, a court of equity would consider this an inadequate remedy because the item is irreplaceable, instead possibly ordering the breaching party to fulfill the contract by transferring the antique to the injured party.

Although some states still have separate law and equity courts, many states have unified them into a single system. In some states, one court might sit as a court of equity on one occasion and as a court of law on another. In the federal system and some state systems, the same courts provide both equitable and legal remedies. In civil cases before federal courts and many state courts, parties are entitled to a trial by jury on questions with which the court is operating as a court of law, but equity court decisions are made by judges. 

Classifications of U.S. Law 

The U.S. legal system of civil law and common law can be further classified, most commonly as either criminal or civil law, by subject matter, and as either substantive or procedural law.

Classification as Criminal or Civil Law 

Criminal law applies to acts that society deems so harmful to the public welfare that government is responsible for prosecuting and punishing the perpetrators. Criminal law covers offenses ranging from major crimes, such as murder, to minor offenses, such as traffic violations. A felony is a major crime involving long-term punishment. A misdemeanor is a minor crime punishable by a fine or short-term imprisonment. Summary offenses are crimes that are neither felonies nor misdemeanors under state law; they usually result in fines but not imprisonment. In criminal law, the government acts as the prosecutor, representing the public. 

Civil law applies to legal matters that are not governed by criminal law. Essentially, it provides remedies for breaches of duties owed to others. The term “civil law” is not, within this classification context, the same as the civil law system discussed previously. 

In a civil action, the injured party usually seeks reimbursement, in the form of monetary damages, for harm. Cases in equity courts, or those having equitable remedies, also fall under civil law. In a civil equity case, a court can order a specific action—for example, directing an insurance company to honor policy terms. 

One distinguishing factor between civil and criminal law is the burden of proof. The prosecution in a criminal case must establish guilt beyond a reasonable doubt. The burden of proof in a civil case is less strict in most instances, with the injured party only required to establish that its evidence is greater than the counterevidence. 

Keep in mind that a single act can be both a crime and a civil wrong. Suppose an insurance agent has defrauded an insured with misleading information about coverage. This action can constitute both a civil misrepresentation and fraud and could result in separate civil and criminal trials. The injured party could sue for the civil wrong, and the government could prosecute for the crime. 

Classification by Subject Matter 

Beyond classification as either civil or criminal law, U.S. law can be classified by subject matter. Subject-matter classifications group cases by type, defined by parties’ rights and liabilities. Examples of subject-matter classifications are criminal law and contracts, torts, agency, and property law (all of which also fall into the civil law classification). Each type of law has its own rules and precedents. 

Classification as Substantive or Procedural Law 

Within the classifications of law as civil or criminal, U.S. law is also either substantive law or procedural law.

Substantive law includes rules of legislative and judicial law. For example, it is involved in how contract law applies to an insurance policy. Procedural law involves the procedures, or mechanics, of court processes and the methods used to enforce substantive law. 

Procedural law also specifies the means by which courts can apply substantive law. For example, a state’s procedural rule can set a maximum period within which a criminal defendant must come to trial. Substantive law would describe the crime itself and establish criteria for determining the defendant’s guilt. 

Check Your Understanding

Loretta’s insurance agent deliberately misled several customers, including Loretta, saying that they had insurance coverage for some exposures that are excluded in the policy. Loretta suffered damages because of this misinformation and wants to be compensated. Explain whether the insurance agent’s act is a crime or a civil wrong and what actions could be taken.

Check Answer

The insurance agent’s act can constitute both a civil misrepresentation and fraud and could result in separate civil and criminal trials. Loretta could sue the insurance agent for a civil wrong because civil law provides remedies for breaches of duties owed to others. In addition, the government could prosecute the insurance agent for a crime.

Summary

The law affects risk management and insurance professionals on a daily basis. The U.S. legal system originated from the English common law system, which differs from the European civil law system that is founded exclusively on codified laws rather than case law. However, features of both systems exist in the U.S. In addition, U.S. law can be classified as either criminal or civil law, by subject matter, and as either substantive or procedural law. 

Glossary

Doctrine of stare decisis -The principle that lower courts must follow precedents set by higher courts.

Criminal law-The branch of the law that imposes penalties for wrongs against society.

Civil law-A classification of law that applies to legal matters not governed by criminal law and that protects rights and provides remedies for breaches of duties owed to others.

Substantive law-A classification of law that creates, defines, and regulates parties’ rights, duties, and powers. 

Procedural law-A classification of law that prescribes the steps, or processes, for enforcing the rights and duties defined by substantive law. 

Sources of U.S. Law 

Evaluate the role and characteristics of these sources of U.S. law: 

• Constitutions 
• Legislative bodies 
• Courts 
• Executive branches 
• Administrative agencies

Insurance and risk management professionals doing business in the United States need to thoroughly understand how federal and state laws affect insurers, insureds, other businesses, and individuals. While there is similarity in structure, each of the 50 states, Puerto Rico and other U.S. territories, and Washington, D.C. have separate and distinct legal systems.

Each of the two legal systems (federal and state) has five sources of law: a constitution, the legislative branch, the judicial branch, the executive branch, and administrative agencies. Take a look at how these sources interconnect, then we’ll go into detail about each one.

Source of U.S. Law (Federal and State)

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What Do You Know?

Did you know that some provisions in the U.S. and individual state constitutions determine the rights and responsibilities of individuals, insurers, and government actors in regard to insurance?

You may be familiar with the part of the Fifth Amendment known as the Due Process Clause, which prohibits arbitrary taking of life, liberty, or property by the government. Many state constitutions also have a due process clause. So, for example, if a state insurance department compels an insurer to reduce rates without a hearing, the insurer may appeal that it didn’t get an opportunity to protect its interests. Other parts of the constitution that apply to insurance include the delegation of powers to Congress, the Commerce Clause, and the Equal Protection Clause.

Constitutions

A constitution, whether federal or state, specifies a government’s powers and the limitations on those powers. The federal U.S. Constitution defines itself as the “supreme Law of the Land.” Each state has its own constitution, which is the supreme law of that state. 

In the case of a conflict, the U.S. Constitution always prevails over a state constitution. Any law that violates the U.S. Constitution, whether state or federal, is void. Since its adoption in 1789, the Constitution has survived many significant social and economic developments to become the oldest constitution in the world today. 

Separation of Powers

The U.S. Constitution provides for separation of powers among three co-equal branches of government: legislative, judicial, and executive. State constitutions, and most local government charters, follow this model. Inherent in the U.S. legal system is the concept of checks and balances, designed to ensure that no single branch of government can become too powerful. 

Provisions Relevant to Insurance

Several provisions of the U.S. Constitution are particularly relevant to the insurance business:

Delegation of powers to Congress

You may be familiar with the part of the Fifth Amendment known as the Due Process Clause, which prohibits arbitrary taking of life, liberty, or property by the government. Many state constitutions also have a due process clause. So, for example, if a state insurance department compels an insurer to reduce rates without a hearing, the insurer may appeal that it didn’t get an opportunity to protect its interests. Other parts of the constitution that apply to insurance include the delegation of powers to Congress, the Commerce Clause, and the Equal Protection Clause.

Commerce Clause

The Constitution’s Commerce Clause gives Congress the power to regulate trade with foreign nations and among U.S. states (interstate commerce). Interstate commerce includes any commercial activity that has any appreciable direct or indirect effect on trade among states. Any state law or action that interferes with interstate commerce (including underwriting and selling insurance) is therefore unconstitutional. An insurer that conducts business in more than one state is subject to federal law.

Due Process Clause

The Fifth Amendment’s Due Process Clause guarantees notice and a hearing before the federal government can deprive any person of life, liberty, or property. The Fourteenth Amendment extends the same protection in state government actions, and under it, corporations are protected as people. An example of a state due process case is an insurer’s complaint against the Department of Insurance for attempting to lower the insurer’s rates without notifying the insurer or giving it an opportunity to be heard. In such an instance the insurer can charge that it was adversely affected because it had no opportunity to protect its interests.

Equal Protection Clause

The Fourteenth Amendment’s Equal Protection Clause also addresses individual rights by prohibiting state laws that discriminate unfairly or arbitrarily and requiring equal treatment of all people under like circumstances and conditions, in terms of both privileges and liabilities. It also protects both individuals and corporations. Many state constitutions contain equal protection clauses.

Legislative Bodies 

The legislative branch includes Congress, which is a federal institution, and state legislatures, which have the power to pass state laws. The legislative branch has the power to approve or deny many of the executive’s appointments (such as judges) and to pass constitutional laws negating judicial opinions.

The U.S. Congress is bicameral, meaning that it has two chambers: the Senate and the House of Representatives. Each state has two senators, but a state’s number of representatives in the House depends on that state’s population. Only Congress can enact legislation regarding powers granted exclusively to the federal government by the Constitution. In areas that are primarily the concern of individual states, only the respective states’ legislatures can enact legislation. 

MMost states have bicameral legislatures, or assemblies, mirroring the federal Congressional structure. A few states and U.S. territories have unicameral—single house—legislatures. At the city, county, township, and village levels, thousands of local legislative bodies enact written ordinances governing their citizens. A state or local legislative body can clarify or change the common law and bar unacceptable conduct as long as it doesn’t violate the U.S. Constitution and federal law or the state constitution and laws in the process.

With federal, state, and territorial governments—as well as thousands of local governments—enacting laws, confusion and conflict can result. Business law can be complicated by laws that vary by state and local government. To minimize such difficulties, many states have adopted uniform laws. For example, all states have adopted the Uniform Commercial Code (UCC), which regulates the sale of goods and other commercial transactions. The UCC has created uniformity in commercial transactions throughout the country. 

States and regulators have made efforts to promote uniformity among states’ insurance laws. Insurance companies are subject to a multitude of state statutes, rules, and regulations. As early as 1871, states recognized the need to establish an organization to promote uniformity in state regulation and exchange regulatory information—resulting in the creation of the National Association of Insurance Commissioners (NAIC). The NAIC pools information to help regulators coordinate responses to changes in the insurance marketplace. The NAIC also develops model laws, regulations, and guidelines. 

Courts 

The judicial branch (the courts) interprets, affirms, or negates laws. Supreme courts at both the federal and state levels also interpret their respective constitutions. The judicial branch’s checks on the other two branches of government include the power to declare laws—and sometimes actions or regulations of the executive branch—unconstitutional or unlawful.

The federal government has its own court system, as does each state government. The state and federal court systems are separate in most respects. A party can appeal from a state to a federal court, but only in cases involving a violation of the U.S. Constitution or a federal statute. 

The scope of a court’s authority depends on its jurisdiction, which establishes either the types of cases a court can decide or the geographical area it has authority over. For example, a state trial court has territorial jurisdiction over cases involving state law. The court in which a case is initiated has original jurisdiction. Courts that hear appeals from other courts have appellate jurisdiction. Courts that hear a variety of types of cases have general jurisdiction. 

Federal Court System 

The U.S. Constitution provides that “the judicial power of the United States shall be vested in one Supreme Court, and in such inferior courts as Congress may from time to time ordain and establish.” Congress has created many U.S. district courts, which are federal trial courts and courts of appeal in 11 multistate judicial circuits; a District of Columbia circuit; and a federal circuit, which has nationwide jurisdiction to hear appeals in specialized cases. Special federal courts, such as the Court of Military Appeals, hear particular kinds of cases. Federal courts handle cases that raise federal questions, such as those involving the U.S. Constitution or federal laws, as well as those that name the U.S. as either plaintiff or defendant. 

The U.S. District Courts are the trial courts of the federal system, so anyone accused of a federal crime would stand trial in a U.S. District Court. District courts hear lawsuits for damages involving federal law and also try cases involving diversity jurisdiction, such as cases between a claimant in one state and an insurer in another. 

A party that is dissatisfied with the outcome of a case heard by a federal district court—and that has a properly preserved appealable issue—can appeal to the appropriate U.S. Circuit Court of Appeals. For example, a party that loses a lawsuit in the U.S. District Court in Maine can appeal to the U.S. Circuit Court of Appeals for the First Circuit, which serves as the federal appellate court for Maine, Massachusetts, New Hampshire, Puerto Rico, and Rhode Island. 

A party that does not prevail on appeal in a circuit court of appeals but has a properly preserved legal issue can take the case to the U.S. Supreme Court by filing a petition for a writ of certiorari. The U.S. Supreme Court has sole discretion regarding whether to hear a case, and it is not required to explain its reasons for granting or denying a petition. 

State Court Systems 

The state court systems are similar to the federal court system. However, the use of court names at various levels is not uniform.

State Court Systems

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Conflicts often arise when a dispute may be subject to the laws of more than one jurisdiction. In tort cases (which involve wrongs between parties), the law in force where the injury occurred generally applies. In contrast, courts in contract cases use the center-of-gravity rule, applying the law of the state with the most significant relationship to the case. To attempt to avoid conflicts of law, parties to a contract may stipulate in their contract which state’s laws will apply if a dispute arises.

Executive Branches 

The executive branch (led by the president at the federal level and governors at the state level) has power to recommend, approve, or veto laws and to administer and carry out many laws through administrative agencies. This branch’s checks on the other two branches of government include the power to appoint certain judges and the power to veto laws passed by the legislative branch. The executive (president, governor, or mayor) can often appoint the heads of administrative agencies. 

The executive branch can influence the numerous rules and regulations that administrative agencies issue. For example, some state governors appoint the insurance commissioner, allowing those governors to influence the insurance industry. 

Administrative Agencies 

While technically part of the executive branch, administrative agencies can be considered a separate source of law. The legislative branch, whether Congress or a state legislature, creates administrative agencies by statute. These agencies implement and enforce the law, and federal agencies affect thousands of organizations and all citizens. Agencies regulate specific areas, such as taxation, health, and labor, and the scope of their functions, purposes, and powers varies. 

Agency rules, regulations, and rulings constitute the body of administrative law. Federal agencies initiate and finalize formal rules and make them known through formal public announcements. The legislative delegation of rulemaking power to an administrative agency is constitutional as long as it meets these three conditions: 

• The legislation carefully defines the scope of the delegated power. 
• The agency exercises its rulemaking power within the defined scope. 
• The rules are subject to court (judicial) review.

Few businesses, if any, escape administrative-agency supervision. To be valid, business regulations must apply uniformly to all members within the same business class. The federal government can impose regulations on any aspect of business necessary for the nation’s economic needs. The states can regulate business as long as they do not impose unreasonable burdens on interstate commerce or on any federal government activity. 

Check Your Understanding

Cindy has just started working for an insurer. She is confused when she hears that a case involving a claim against the insurer will be heard by a U.S. district court rather than the state court where the insurer is located. Explain why this case will be heard by the district court.

Check Answer

District courts hear lawsuits for damages involving federal law and also try cases involving diversity jurisdiction when parties from different states have a dispute regarding an amount over a legal minimum. This could apply to a case between a claimant in one state and an insurer in another.

Summary

To understand the insurance business, insurance and risk management professionals should have a basic understanding of the sources of U.S. law and how they affect one another. There are five sources of U.S. law: constitutions, legislative bodies, courts, executive branches, and administrative agencies. 

Glossary

National Association of Insurance Commissioners (NAIC) – An association of insurance commissioners from the fifty U.S. states, the District of Columbia, and the five U.S. territories and possessions, whose purpose is to coordinate insurance regulation activities among the various state insurance departments.

Diversity jurisdiction – The authority of federal district courts to hear cases involving parties from different states that involve amounts in controversy over a legal minimum.

Civil Trial Procedures

Objective

Through examples, illustrate the steps, motions, rules, and other phases of:

• Pretrial procedures
• Trial procedures
• Appeals

When individuals or businesses cannot resolve their differences privately, they can go to court. Cases involving insurers and insureds are common, and as someone working in the insurance and risk management field, you will need to understand the procedures followed in most federal and state courts.

Litigation can be costly and time-consuming, often proceeding for several years. The legal process can involve meticulous pretrial preparation by lawyers, carefully plotted trial tactics, and procedural complexities. At any point during litigation (the process of carrying on a lawsuit), parties can settle a case by agreeing to terms—a process the legal system encourages. Let’s look at the phases of litigation and the many different directions a lawsuit can take.

What Do You Know?

Explain the purpose of pretrial discovery and some of the tools used during discovery.

Feedback

The purpose of discovery is for lawyers on both sides to gather as much information as possible about all allegations and evidence the parties might present. This enables the parties to know as much as possible before trial and prevents surprises. If testimony at trial contradicts an earlier deposition or an answer to a written interrogatory, lawyers can use the pretrial evidence to challenge the evidence presented at trial. Discovery can sometimes lead to settlement; once the parties know all the evidence, they may decide to settle rather than go to trial.

Pretrial Procedure

Although trials may be the best-known part of the legal process, the pretrial stage is arguably the most important. Through substantial pretrial preparation, lawyers gather as much information as possible about all allegations and evidence the parties might present. 

Pretrial Procedure

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Whether an individual or organization, a party starts a lawsuit by filing a complaint in the court that has jurisdiction over the dispute. The party who files the complaint is the plaintiff, and the party defending against that complaint is the defendant. The complaint is the first pleading filed with the court. 

In small claims or municipal courts that handle cases involving small amounts of damages, parties can usually file a complaint without a lawyer’s assistance. Typically, lawyers must file cases in courts of general jurisdiction.

After a complaint has been filed, the court issues a summons notifying the defendant of the lawsuit, with a copy of the complaint attached. The defendant has several options, shown in the exhibit, for how to answer. 

After receiving the defendant’s answer, the plaintiff files a reply. Taken together, all pleadings—the complaint, answer, and reply—constitute a written dialogue between the parties that informs the court about the substance of the dispute. Given that information, the parties can respond by filing motions.

Another pretrial option for either party is to request a pretrial conference with the judge. Courts use pretrial conferences to encourage settlements—agreements between both parties to end a case rather than proceed to trial. The pretrial stage also includes discovery.

Need More Information?

In cases involving complex business questions, such as insurance antitrust cases, discovery can span months or even years and involve tedious examination of thousands of documents and records. 

A party can object to a request for discovery and ask the court to rule on whether the evidence is required. However, barring such an objection or if the objection is denied, parties must provide everything requested in discovery. 

Information is often stored electronically, representing great volumes of discoverable material; a single case may involve tens of thousands of emails. Lawyers may therefore employ specialized electronic discovery (e-discovery) experts, who use data science techniques to comb for relevant information.

Discovered information enables the parties to know as much as possible before trial and prevents surprises. If testimony at trial contradicts an earlier deposition or an answer to a written interrogatory, lawyers can use the pretrial evidence to challenge the evidence presented at trial. 

Discovery can sometimes lead to settlement; once the parties know all the evidence, they may decide to settle rather than go to trial.

Trial Procedure

Trials are costly but are arguably the best way to determine truth and provide justice. They give judges or juries the opportunity to observe witnesses, hear subjective arguments, and evaluate both (in addition to written or other tangible evidence) to reach decisions.

Trial Procedure

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In a jury trial, the jury decides all questions of fact, and the judge decides all questions of law. If the parties choose not to have a jury, the judge makes all decisions about both facts and law. For example, a question of law in an insurance coverage case is whether the insurance policy covers the loss. A question of fact in the same case might be whether the insured actually bought the policy.

The attorneys follow the rules of evidence in presenting their evidence and challenging the evidence and testimony presented by the opposing party. Rules of evidence require evidence to meet three conditions: 

• Relevant—Evidence must have relevance to the case. For example, evidence of the dollar limits of a defendant’s liability insurance would not be relevant to determining whether a defendant was negligent in an auto accident case, but evidence that the driver was talking on a cell phone might be. 
• Material—A fact can be relevant but might have no legal significance in a case, rendering it immaterial. For example, evidence that the car in an automobile accident was a recent model, with abundant safety features, is immaterial unless that model had a defect that might have caused the accident.
• Competent—The source of evidence must be reliable and the evidence adequate. Hearsay, or evidence of witnesses who repeat a statement but do not have personal knowledge of whether that statement is true, may not be admitted. For example, Shanay, an expert in insurance, is testifying about underwriting practices or policy coverage. Before she can be considered an expert witness, her credibility must be established through detailed questioning about her background and qualifications. 

The parties make their closing arguments after both sides present their evidence. The judge instructs the jury about applicable law, and the jury retires, or confers, to reach its final decision, or verdict. Jurisdictions may allow either a general verdict, a special verdict, or both. The judge can decide to take the case from the jury using a directed verdict, mistrial, or nonsuit.

All lower-court decisions can be appealed to higher courts. However, parties cannot relitigate claims in the lower courts based on transactions or on issues already decided by a lower court. Two doctrines evolved in the common law to prevent relitigation: 

• The doctrine of res judicata (sometimes called claim preclusion) prevents parties from relitigating issues that were or could have been raised in the original action. For example, if judgment was against Aliyah in her lawsuit against Paradox Contractors for negligence that caused damage to her kitchen, she cannot bring another lawsuit against Paradox for the same act of negligence that caused damage to her living room at the same time the kitchen was damaged. 
• Collateral estoppel (sometimes called issue preclusion) bars parties from relitigating an issue on which a court has already ruled, even if the second lawsuit differs significantly from the first. For example, if a court has ruled that Marco’s insurance policy did not cover fire damage to his outbuilding, Marco cannot sue the insurer for loss from a later fire in the same building under the same policy. 

Let’s Hear From an Expert: Paul Rosner

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Appeals 

An appeal is a request for a higher court to review a case. The appellant is the losing party in a court case, who appeals the case to a higher court. The nonappealing party, usually the winner of the original lawsuit, is the appellee. 

Appeals must be filed with the appropriate court within a prescribed period. Appeals courts do not conduct new trials; instead, they decide whether law was applied appropriately to a case in the lower court. 

To decide whether the trial court’s decision was correct, the appeals court relies on a transcript of the lower court’s proceedings and on briefs and arguments made by the lawyers for both parties. A brief is a lawyer’s written statement submitted on appeal to establish legal and factual arguments and provide supportive authoritative sources, such as statutes and case precedents. Briefs are mandatory in appeals, and courts prescribe their format and content. Rarely do appellate courts hear oral arguments. 

An appellate court can affirm the trial court outcome, reverse it, or send the case back (remand it) to the trial court for a new trial. For example, if an appellate court finds that the trial court improperly admitted prejudicial, or harmful, evidence to the appellant’s case, the court can send the case back to the lower court for a new trial. However, an appellate court might determine that the improper evidence did not harm the appellant. 

A new trial is not necessarily a victory for the appellant because the same verdict may be reached. Plus, in the time that passed before the new trial, testimony may have become stale or unavailable. Losing parties in lawsuits must weigh the probability of an ultimate victory against the high costs of appeal.

Check Your Understanding

Chris is handling an auto liability claim for Jennifer. Settlement seems unlikely, so Chris is talking to her about her side of the story in case the claim goes to court. Jennifer tells Chris that she plans on testifying that she cannot be at fault in the accident because she has valid auto insurance and was driving a brand-new car with crash-avoidance features, and her husband will testify that she is an excellent driver. Identify the rules of evidence that Chris should discuss with Jennifer.

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Evidence must have relevance to the case. Evidence regarding her insurance policy is not relevant to determining whether Jennifer was negligent in the accident. Evidence must also be material. The fact that Jennifer had a brand-new car when the accident occurred is immaterial unless there was a physical defect in that model that caused or contributed to the accident. Finally, the evidence must have competence. If Jennifer’s husband was not present at the time of the accident, he has no personal knowledge of it.

Summary

Court legal procedures fall into different phases, including pretrial, trial, and appellate procedures. Substantial pretrial preparation provides parties with information about allegations and evidence and gives them an opportunity to settle. If a case goes to trial, the parties can only present evidence that is relevant, material, and competent. If the court reaches a verdict, the appellant may appeal to a higher court for a review of the case, although the losing party must decide whether the potential for a favorable appellate decision outweighs the high cost of an appeal.

Glossary

AllegationA claim made in the complaint by the plaintiff, specifying what the plaintiff expects to prove to obtain a judgment against the defendant.ComplaintThe allegations made by a plaintiff in a lawsuit.PleadingA formal written statement of the facts and claims of each party to a lawsuit.MotionA formal request for the court to take a particular action.DiscoveryA pretrial exchange of all relevant information between the plaintiff and defendant.RelevanceA quality of evidence that is likely to prove or disprove an element of the case.General verdictA kind of verdict that entails a complete finding and a single conclusion by a jury on all issues presented.Special verdictA kind of verdict reached by a jury that makes findings of fact by answering specific questions posed by the judge. The judge then applies the law to the facts as the jury has found them. Res judicataA doctrine that bars parties to a lawsuit on which final judgment has been rendered from bringing a second lawsuit on the same claim or on related transactions. 

Alternative Dispute Resolution

Objective

Describe each of these alternative dispute resolution procedures:

• Arbitration
• Mediation 
• Negotiation

As the number of lawsuits filed in the United States continues to increase, congested court dockets (calendars), long delays, and additional costs result. While the judicial system handles thousands of disputes, most controversies are resolved by compromise or settlement agreements. 

Alternative dispute resolution (ADR) procedures, including arbitration, mediation, and negotiation, are methods that help settle disputes without litigation.

What Do You Know?

What are the advantages of settling disputes out of court?

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Out-of-court settlements offer the advantages of economy, quicker resolutions and less hostility between the parties than in litigation, and some degree of privacy.

Arbitration

Arbitration involves taking a dispute to an impartial third party (an arbiter or arbitration panel) for a decision the parties agree will be final and binding. Arbitration has become a major means of handling disputes in contracts, labor-management relations, and insurance. Some states’ laws and court rules mandate court-administered arbitration for some types of cases.

Arbitration is frequently used for settling insurance disputes. Many insurance policies specifically provide for arbitration. For example, uninsured motorist coverage in automobile policies may include a provision requiring arbitration of policy disputes. Insurers use special arbitration agreements to allocate costs of settlements when coinsurers are involved and to resolve disputes resulting from overlapping coverages. Use of arbitration has also increased under no-fault automobile statutes, under which people involved in automobile accidents seek benefits payments from their own insurers.

Most states have enacted laws that cover all aspects of arbitration procedures. Both the Uniform Arbitration Act, drafted by the National Conference of Commissioners of Uniform State Laws, and the Federal Arbitration Act, passed in 1925, provide specific remedies if one of the parties refuses to arbitrate or denies the existence of an arbitration agreement.

The American Arbitration Association, which provides arbitration services, designs arbitration systems, and provides training about ADR, has developed the following procedure for selecting an arbitrator: Each party receives a list of proposed arbitrators from which they must select several preferred arbitrators within 10 days. The association then appoints an arbitrator acceptable to both parties. Alternatively, each party can appoint an arbitrator, and those arbitrators, in turn, can appoint a third arbitrator.

Most states allow parties to call witnesses in arbitration proceedings, but strict adherence to rules of evidence and procedure is not required. An arbitrator’s award or judgment is filed with the appropriate court and is as valid and enforceable as any court judgment. Parties have limited grounds for appealing an arbitrator’s award and must do so within a legally prescribed period.

Let’s Hear From an Expert: Paul Rosner

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Mediation

Another ADR procedure is mediation. The mediator is a neutral third party who acts as a catalyst to help parties analyze their dispute, consider possible solutions, and devise a compromise formula. Mediation is nonbinding. Judges often try to mediate during settlement conferences in court cases, but formal mediation involves submitting a dispute to an outside mediator. Mediators are often experienced trial lawyers or retired judges.

Negotiation

Using the ADR procedure of negotiation, parties to a dispute discuss all issues and determine a mutually satisfactory resolution. Negotiation is often the most direct route to dispute resolution. Because negotiations can end at any time, they do not limit opportunities to pursue other dispute resolution methods. 

Private mini-trials and court-sponsored mock summary jury trials can lead to negotiation of major disputes. In a mini-trial, lawyers or others familiar with the dispute present evidence and arguments to a panel that may include business executives or other professionals. A neutral party, such as a retired judge or another expert, can act as mediator or issue an advisory opinion after the presentation of evidence and arguments. Because the mini-trial presents the issues to both parties in a dispute, it can encourage negotiation and settlement. Summary jury trials are brief mock trials before juries. The parties can accept the jury’s advisory verdict, or the verdict can provide the basis for further negotiations toward settlement.

Apply Your Knowledge

How have you seen arbitration used in the insurance industry?

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Insurers will often use arbitration to settle coverage disputes. Auto policies may include provisions that require arbitration of policy disputes. There may also be arbitration agreements that allocate costs of settlements when multiple insurers are involved or to resolve disputes resulting from overlapping coverages. 

Summary

ADR methods, such as arbitration, mediation, and negotiation, are ways to resolve disputes more efficiently than through the overloaded court system. 

Glossary

Alternative dispute resolution (ADR)Procedures to help settle disputes without litigation, including arbitration, mediation, and negotiation.MediationAn alternative dispute resolution (ADR) method by which disputing parties use a neutral outside party to examine the issues and develop a mutually agreeable settlement.

Administrative Agency Procedures

Objective

Examine these aspects of administrative agency procedures: 

• Rulemaking function 
• Adjudicatory function 
• Investigative powers 
• Judicial review 

Administrative law is pervasive in the activities of people and organizations. The legislative output of administrative agencies far exceeds that of legislatures, and the number of administrative decisions far exceeds the number of court decisions.

Let’s learn more about the role of administrative agencies and the legal procedures they interact with.

What Do You Know?

Can you list the legal procedures of administrative agencies? 

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Administrative agencies’ legal procedures include the rulemaking function, the adjudicatory function, investigative powers, and judicial review.

Role of Administrative Agencies

Legislators at the federal and state levels delegate responsibilities to administrative agencies in much the same way that a supervisor delegates responsibilities to an employee. Legislators do not have the time to pass all the rules and regulations necessary to implement legislation; to develop expertise in every area regulated; or to settle disputes arising from legislation, rules, and regulations. For example, a state legislature that passes a law prohibiting excessive insurance rates delegates the power to administer and enforce the law to its state department of insurance (DOI), which has the insurance expertise to set standards for and examine insurance rates.

Courts generally have upheld legislative delegation to administrative agencies. Although legislators cannot delegate their ultimate power and responsibility, they can delegate the duty to fill in the details of legislation by allowing agencies to make rules and regulations and to resolve disputes. “Enabling legislation” creates an administrative agency and states its purpose.

Administrative agencies have two primary functions: rulemaking and adjudication. Rulemaking is the process by which agencies promulgate rules to implement legislative policies. Adjudication is the process by which agencies decide cases and settle disputes.

To illustrate DOI rulemaking and adjudication, after a state legislature passes a law prohibiting excessive insurance rates, the DOI makes rules about insurance rate review and creates guidelines to determine whether rates are excessive. The insurance commissioner, a private citizen, or a group of citizens might contest an insurance rate as excessive. The DOI then holds a hearing to adjudicate the rate in question. This adjudication affects only the insurer involved and the insureds who would pay the new rate.

Agencies’ Rulemaking Function

Agencies promulgate three types of rules:

• Legislative rules (also known as substantive rules) come from a statutory delegation of authority and have the same force as a law enacted by Congress or a legislature. The development and passage of legislative rules require adherence to rulemaking procedures.
• Interpretative rules interpret statutes, providing guidance for agency staff or regulated parties. However, these rules lack the force and effect of law, and, therefore, are not binding on individuals.
• Procedural rules, which are primarily internal, prescribe procedures for agency operations, legislative rulemaking, and adjudication proceedings. 

The Administrative Procedure Act (APA) prescribes the procedure for administrative agency rulemaking at the federal level. Most states follow the rulemaking procedures of the Model State Administrative Procedure Act (MSAPA), which requires agencies to adhere to three basic steps:

1. Publish a notice of intent to adopt a regulation.
2. Provide opportunity for public comment.
3. Publish the final regulation.

Federal agencies publish notices of proposed regulations in the weekly Federal Register. States usually have similar publications for state agency notices. Notice in one of these official publications usually suffices as official notice to all interested parties that the agency is considering an action that will affect them. For example, a state DOI notice of its plan to adopt a regulation about an aspect of the insurance business, published in the state’s official publication for agency notices, is legally sufficient notice to insurers and consumers.

Need More Information?

Typically, the published notice of a proposed regulation invites comments by a certain date, usually within a month. Public hearings are required for some, but not all, proposed regulations. The MSAPA requires a public hearing if either a governmental agency or 25 interested individuals request it. If no hearing is required, interested organizations and individuals can submit written comments on a proposed regulation.

Interested individuals and representatives of organizations can speak at public hearings; they can also submit comments in writing. A presiding hearing examiner usually has discretion about who testifies. If large groups of people attend, the examiner can require that only their chosen representatives testify.

If the proposed regulation is controversial, the examiner can require advance registration of those who will testify. After the agency has reviewed all comments about the proposed rule, it can take one of these actions:

• Adopt the originally proposed rule.
• Make minimal or extensive changes.
• Nullify the proposed rule.

If the agency decides to adopt the rule, it must publish the final version. A rule usually becomes effective thirty days after publication, giving affected parties time to conform to the new rule or to challenge its legality. Agencies can publish emergency rules with immediate effective dates when necessary for public health and welfare.

Agencies’ Adjudicatory Function

In addition to rulemaking, agencies have an adjudicatory function. Adjudicatory proceedings are similar to court cases. They affect the rights of an individual or a limited number of people. As in court, people in an agency adjudicatory process have a constitutional right to due process of law. The specific requirements for due process can vary by the nature of the proceeding.

The Due Process Clause of the U.S. Constitution grants parties whose rights are affected by an agency decision the right to be heard. Not every case requires a hearing. However, the agency must provide reasonable notice of the opportunity for a fair hearing. If the party does not waive the right to a hearing, the agency must hold a fair hearing and render a decision supported by the evidence. Denying due process can be grounds for reversing a decision if the party was harmed by denial.

Importance of Appropriate Notice

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Many disputes, such as pension or Social Security claims, do not warrant full hearings and are too numerous to make formal proceedings practical. However, any party faced with deprivation of an alleged property or liberty right can demand a hearing before action is taken. Such hearings are often informal. Agencies can use informal hearings when time, the nature of the proceedings, and the public interest permit. Adjudication, complete with a full hearing, is necessary only if the law specifically requires it or if either party demands it. A hearing examiner or an administrative law judge (ALJ), who is usually both an agency employee and a lawyer, presides.

Generally, any person compelled to appear before an agency and every party to a dispute have the right to counsel. Counsel need not be a lawyer, but can be a qualified representative (that is, any trusted person). The government is not required to provide counsel to a party for an administrative hearing.

As in court proceedings, expert witnesses can testify in agency cases. Generally, the rules governing witnesses in court proceedings apply in agency hearings, but agency rules are not as strict. Agency cases do not have juries; the hearing examiner decides factual and legal matters. Generally, evidence in an agency hearing must be relevant, but the rules of evidence are much more relaxed than those in a court trial.

Counsel in an adjudicatory hearing can make arguments relating to both fact and law. Most arguments are relatively short and often written instead of oral. Parties have no inherent right or duty to present formal written briefs arguing the law. The hearing examiner or ALJ considers the parties’ arguments and makes findings of fact and law. Such decisions may accept, reject, or modify the parties’ arguments.

An Example of Adjudication

To illustrate an adjudication, a hearing examiner’s findings in a case challenging an insurer’s rates might include these:

• The insurer kept statistics properly.
• The insurer interpreted those statistics properly.
• The statistics indicated the insurer had a loss ratio of 55 percent.
• The insurer can make a fair profit for that line of business with a loss ratio of 85 percent.

From these facts, the hearing officer could conclude that the 55 percent loss ratio (which means that for each premium dollar the insurer earned, it spent only 55 cents for insured losses and loss adjustment expenses) was achieved by rates that are unfairly high. The hearing officer’s decision, based on a statute prohibiting excessive rates, could require the insurer to lower rates to produce an 85 percent loss ratio.

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Agencies can impose fines or grant, revoke, or suspend licenses. Enabling legislation for an agency usually defines appeal rights and whether they involve a court or the agency. Most agencies have at least one, and sometimes three or four, tiers of appeal. Once a case has gone through all levels of the agency adjudication and appeals process, the party has exhausted all administrative remedies and can seek judicial review in a court of law.

Administrative agencies can give advisory opinions, unlike courts, which, with very limited exceptions, do not indicate in advance how they would decide a case based on a given set of facts. Although agency advisory opinions are not binding either on the agency or on any parties, the recipient of an advisory opinion can usually rely on it.

Agencies’ Investigative Powers

Many federal and state laws contain provisions authorizing agency investigations, which typically relate to rulemaking, ratemaking, adjudicating, licensing, prosecuting, establishing general policy, or recommending legislation. 

Agencies may need information and evidence for administrative proceedings and may use subpoenas to gather such information. A subpoena is a legal order to a witness to appear at a certain place and time to testify or to produce documents. Those who disobey subpoenas are subject to penalties.

Agencies receive the power to use subpoenas from legislation. Not all agencies are given the power. If authorized by law, an agency can issue a subpoena on its own behalf or at a party’s request. For example, a policyholder alleging an insurer’s discriminatory practice can request the DOI to subpoena the insurer’s records for a hearing to resolve the dispute.

A party to a dispute has the right to not only testify personally, but also to obtain relevant testimony and records from others. If the other parties refuse to cooperate, then due process requires compelling them to cooperate by subpoena. A subpoena to compel a witness to testify is a subpoena ad testificandum (command to testify), usually termed, simply, subpoena. A subpoena to compel production of documents or records is a subpoena duces tecum (literally, a command to “bring things with you”).

Violations of constitutional rights can defeat an investigation. The U.S. Constitution places these limitations on agency investigations:

• Fourth Amendment protection against unreasonable searches and seizures—In administrative law, the Fourth Amendment prohibition against unreasonable searches and seizures applies primarily to inspecting records. Records demanded must be relevant to the investigation. However, the connection between the requested records and the subject of the investigation can be slight; courts usually find such records relevant and require their production.

For example, a government agency may ask an insurer to provide all automobile insurance accident records for the past 20 years. Even though these records may be voluminous and require many hours to produce, the agency can request them if it can demonstrate that they are relevant to the investigation. Some courts have held that, when record retrieval and production are very expensive, the burden is on the agency to establish the records’ relevance to the investigation. Regulatory agencies sometimes request records only to fish through them for possible legal violations.

• Fifth Amendment protection against self-incrimination—According to the Fifth Amendment, no person “shall be compelled in any criminal case to be a witness against himself.” Court decisions have broadened the term “criminal case” to include almost any type of investigation or proceeding from which legal sanctions might arise. The term “witness” includes not only oral testimony but also the production of records and documents.

A legislative body can require organizations to keep certain records and can delegate the power to enforce this requirement to an agency. An agency’s inspection power is not limited to records required by law; it also extends to other relevant records. Agencies do not have a general unlimited right to investigate beyond what is necessary, and any agency request must be reasonably relevant to the investigation.

The Privacy Act and the Freedom of Information Act protect the public from agency misuse of the vast amounts of information they collect, including insurance information. The Privacy Act prohibits the government and its agencies from releasing any information that would violate individual privacy. The Freedom of Information Act guarantees public access to some government and agency records and documents to prevent abuse of information collection.

Judicial Review

Generally, federal courts review actions of federal agencies, and state courts review actions of state agencies. As the actions of agencies increasingly affect personal interests, the courts seek to protect those interests more vigorously by insisting on strict judicial scrutiny of agency action. Judicial review is available as long as it is not precluded by statute or the action reviewed is not left by statute solely to administrative agency discretion. Judicial review is not limited to agency adjudications; it can also apply to agency rulemaking.

To take an administrative action to a court for judicial review, a plaintiff must have standing to sue. Additionally, these two requirements must be met:

• The agency has issued a final order.
• The doctrine called exhaustion of administrative remedies has been satisfied. A court will make exceptions to this doctrine only when the available administrative remedy is inadequate or when it would be futile to require the party to exhaust administrative remedies.

On appeal, parties often allege that an administrative agency’s action was arbitrary and capricious or an abuse of discretion. An action is arbitrary and capricious if it is so clearly erroneous that it has no rational basis or if it is willful and unreasonable. Generally, courts give great deference to agency conclusions on questions of fact because of the agencies’ assumed special knowledge and expertise. If a reviewing court determines that it needs more facts to make a judgment, it can send a case back (remand it) to the agency for another hearing.

Judicial Review

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Summary

Administrative agencies have investigatory powers but are also subject to constitutional limitations. Their legal procedures include the rulemaking function, the adjudicatory function, investigative powers, and judicial review. Agencies promulgate three types of rules: legislative rules, interpretative rules, and procedural rules. Agency adjudicatory procedure is similar to court procedures, requiring notice, hearing, and adjudication. Judicial review of agency decisions involves issues of standing to sue and exhaustion of administrative remedies, as well as standards of review, such as determining the existence of agency abuse of discretion.

Glossary

Legislative rule – A type of substantive administrative agency rule that comes from a statutory delegation of authority and that has the same force as a law enacted by Congress or a legislature. 

Interpretative rule – A type of administrative agency rule that interprets statutes, providing guidance for agency staff or regulated parties, but that lacks the force and effect of law and therefore is not binding on individuals. 

Procedural rule – A type of administrative agency rule that prescribes procedures for agency operations, legislative rulemaking, and adjudication proceedings. 

Standing to sue – A party’s right to sue, as one who has suffered or will suffer a legal wrong or an adverse effect from an action.

Final order – An administrative agency’s final conclusion or disposition of any material private right of a party, terminating an agency proceeding. 

Exhaustion of administrative remedies – The completion of all possible administrative procedures and appeals in a case; required before a party can appeal an agency action to a court.