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October 26, 2006

Trigger and Allocation for Asbestos, Other Bodily Injury, and Property Damage: Recent Cases and the Policyholders' Winning Argument

“Who pays” and “how much” continue to be central questions in insurance-recovery litigation by policyholders for asbestos, environmental clean up, pharmaceutical, lead-paint, toxic-tort and other conditions that produce loss over time. Because insurance contracts are governed by state law, the coverage wars apparently will continue until each inch of turf is won or lost. Most recently, the Delaware Supreme Court has weighed in on the question of trigger of coverage (“who pays”) for asbestos- liability claims, the Minnesota Supreme Court has addressed allocation of loss (“how much”) among triggered policies, and the New Hampshire Supreme Court has now been asked to address the allocation question, too.

The Delaware and Minnesota cases suffer from an overly conceptualist approach to looking at the questions presented; instead of applying the contract language, these courts have applied “models” of how the coverage should apply. As these cases show, misframing the question to be answered results in answers that are not entirely satisfactory or coherent.

Starting with Delaware: The question presented in Shook & Fletcher Asbestos Settlement Trust v. Safety National Cas. Corp. (Del. Sept. 26, 2006) was what event must occur during the policy period in order for an occurrence policy to be activated (triggered). An insurer has no obligation to perform unless the claim against the insured triggers (or potentially triggers) its coverage. Shook & Fletcher was decided under Alabama law. As noted by the Delaware court, in prior coverage litigation “after full briefing and argument, the Alabama court held that the ‘exposure coverage theory’ would apply, instead of the ‘continuous trigger’ or ‘triple trigger’ theory.” Slip op. at 3-4.

The Delaware Supreme Court in trying to predict Alabama law sought to resolve the question in part by counting noses among state Supreme Courts and federal appellate courts. As the court explained: “We have analyzed the cases where the parties disagreed upon which trigger theory the court actually adopted. Our analysis shows that the exposure trigger is the majority rule.” Slip op. at 9. The court found that Pennsylvania, New Jersey, Delaware, and the Third and D.C. Circuit’s have adopted a continuous trigger; but the Court’s analysis of the other cases led it to conclude that the following jurisdictions have adopted an exposure trigger for asbestos bodily injury claims: Louisiana, Massachusetts, Maryland, Illinois, Fourth Circuit, Fifth Circuit (Texas), Fifth Circuit (Louisiana), Sixth Circuit (Ohio), Sixth Circuit (Michigan), Eleventh Circuit (Alabama), and the First Circuit.

Holding aside that I quarrel with the court’s table and analysis of cases, the court thus concluded: “We rely on the rationale of those cases and the fact that the exposure trigger is the majority rule.” Slip op at 11.

The Delaware court offers no analysis of the issue on its own but rather tries to predict what the Alabama Supreme Court might do. In this context, it is passing strange that the court does not address on the merits its own prior continuing-injury trigger decisions or come to grips with the rule of construction – applicable in Alabama – that if the policy language admits of more than one reasonable construction the court is to construe the language in favor of coverage. Compare Hercules Inc. v. AIU Ins. Co. (Del. Aug. 15, 2001) (finding plain language compels an “all sums” allocation as do equitable considerations). Is the Delaware court now saying that its own prior decision was unreasonable?

In Shook & Fletcher, no effort was made to look at the policy language. And the language is straightforward: insurance policies like those in Shook & Fletcher are triggered if injury occurs during the policy period. Trigger is the issue of what event must take place during the policy period, and the policy is clear – it is not the occurrence, the exposure, or the accident: trigger is “injury.” While “injury” may follow from “exposure,” the difference is one between cause and effect, and typically liability policies are triggered by the effect. (The number of occurrences is determined by causes, but that is a different legal and contractual issue.)

Policyholders should not argue, as I have sometimes seen them do, that there are as many as eight different trigger theories out there and the job of the court is to pick one. Rather, the policy language is absolutely clear that injury is the trigger, and the only question is whether, in the particular context before the court, can whatever happened during the policy year under scrutiny reasonably be construed to be “injury.”

So, the right way for policyholders to argue is not to serve up the question as “which trigger applies: exposure, manifestation, continuous”? The right question is: “Because the trigger is injury, did injury occur during this policy period?” For policies in effect during the period of exposure, one argues that following exposure the body suffers injury. For policies in the period after exposure but while the asbestos fibers persist in the body, one argues that the continued presence of asbestos in the body produces a reaction such that that further effect constitutes injury that year. For policies in effect during the period that an asbestos-related disease is diagnosed, one argues that under the definition of bodily injury – which includes “bodily injury [and] disease” – there is disease and thus injury during the policy period.

It doesn’t matter whether we are arguing about asbestos, or pharmaceutical, or lead paint, or toxic torts: the question of trigger under “occurrence” CGL policies is injury.

A policy’s being triggered does not answer the question of how much the triggered policy is required to pay for the insured’s loss. The “how much” question is known variously as “allocation” or “scope of coverage.” The Minnesota Supreme Court recently weighed in on allocation of coverage, but in doing so it had to deal with prior authority holding that a continuing-injury scenario triggered multiple policies across time and that presumptively each insurer’s obligation to perform was dependent on the quantum of injury that occurred in its policy year. So for illustration, if damage occurred in a steady-stream way for 10 years and caused $10 million in damages, then $1 million would be allocated per year, no matter that in some years the insured bought much more coverage or that in other years the primary layer was, e.g., $200,000 and in other years it was $50,000.

In Wooddale Builders, Inc. v. Maryland Cas. Co. (Minn. Oct. 8, 2006), the court confronted a number of questions concerning the implementation of this kind of scheme: if the damage occurs during only part of a year, does the carrier have to pay its full limit? What happens for years in which there is no coverage? Can the insured buy more coverage once it has knowledge of the problem?

The Court framed the basic issue as follows:

The relationship [among the policies] can be expressed – and perhaps best understood – in terms of a simple equation: A/B x C = D. In this equation, A is each insurer’s time on the risk, B is the total period over which liability is allocated, C is the total damages to be allocated, and D is the damages allocated to each individual insurer.

The court first addressed whether the coverage period is cut off at some moment due to the insured’s knowledge of the risk of liability. In Wooddale, the case involved damage to a number of homes that had been built, and the court ruled that once the insured had knowledge that a home had been damaged no further insurance available. The court ruled – in error – that damage was expected or intended (and thus excluded) once the insured had knowledge that some homes had been damage: “The practical effect of the policy language excluding expected damage and the rationale behind the known loss/loss in progress doctrine is that no additional insurance policies are triggered by continuing damage to homes for which claims had been made before those policies took effect. . . . We therefore hold that only insurers that provided coverage to Wooddale between the closing date of a particular home and Wooddale’s receipt of notice of claim with respect to that property are on the risk for that claim.” (fn. omitted).

(The court’s cutoff based on these theories is wrong because expected/intended damage is meant to stop the insured from acting or setting in motion the chain of events leading to damage rather than policing the insured’s knowledge of a ticking time bomb – the right mechanism to protect insurers on this point is nondisclosure; and known loss is not properly applied here either because from an insurance perspective there is insurable risk, and thus no known loss, so long as there is uncertainty as to whether, when or how much liability will be found – again, all subject to non disclosure rules. See Transamerica Ins. Group v. Meere, 694 P.2d 181, 186 (Ariz. 1984) (“"The exclusion 'is designed to prevent an insured from acting wrongfully with the security of knowing that his insurance company will "pay the piper" for the damages.'''); Bob Hedges, Back-Dated Coverage as Insurance, 34 CPCU J. 181, 181 (1981). And the court does not address equities such as whether the policyholder paid premium in effect for this risk exposure that the carrier gets to pocket under the court’s analysis.)

The court further examined the consequence on an insurer’s obligation to pay from the trigger cutting off during its policy period, or put differently is the insurer that provides coverage for only part of a policy year required to pay its full limit? Here, the court got the answer right, but because its rationale is embedded within the pro-rata-by-quantum-of-damage methodology its reasoning is a bit unsatisfactory. The court offered only the rationale that it was aware of no basis for concluding that a full limit does not apply. “Instead, each of the policies provides coverage for ‘property damage’ that ‘occurs during the policy period,’ indicating that the insurer has agreed to indemnify the insured for damages that occur during the entire policy period, including the part of the policy period that runs after notice of the claim.”

The court does not address the case law on “stub policies,” that is, the limits available in a part year policy by analogy (as opposed to a full year policy with only part damage). Stub policy case law uniformly recognizes that the carrier’s policy limits are at risk every day of the policy, and that the premium is paid for the availability of the full limits each day. See United States Mineral Products Co. v. American Ins. Co., 792 A.2d 500, 502 (N.J. Super. App. Div. 2002); Stonewall Ins. Co. v. ACMC, 73 F.2d 1178, 1216-17 (2d Cir. 1995); Cadet Mfg. Co. v. Am. Ins. Co., 391 F. Supp. 2d 884, 890 (W.D. Wash. 2005). More importantly, the allocation method that the court has previously embraced does suggest only a partial limit for part-year damage, and the court does little to explain other than offer its ipse dixit.

The court reached the parallel conclusion for policies in effect during the year in which damage first occurred, likewise holding that the full limits were available in the allocation formula.

Finally, the court considered whether periods of no insurance counted in the allocation formula, and the court divided periods of no insurance into (i) periods where the insured elected not to purchase insurance voluntarily (self-insurance) and (ii) periods where due to market forces there was no insurance to be purchased. The court concluded that allocating to periods of self-insurance was fair but that allocating to periods of no insurance was not, and so periods where there was no insurance get removed from the denominator of the allocation formula.

This has always been an unsatisfying approach, in part because it makes the contractual obligations of a party with a closed period dependent upon failures in insurance markets years later perhaps (because if a later period of no insurance is not included in the allocation formula each insurer’s relative share of the pie goes up). It accomplishes the objective of avoiding penalizing the insured for no “fault” of its own, but it also is somewhat naïve in its assessment of insurance markets and whether some underwriter somewhere might be willing to insure some risk for some ridiculous price (as the London market saying goes, there is no bad risk, just a bad price). So even though there was a worldwide conspiracy among insurers and reinsurers to cut off asbestos coverage in the mid 1980s, if an underwriter wanted to sell asbestos insurance doing so would not violate any positive law or prohibition against meretricious contracts. These are, to my way of thinking, too unstable of bases to support a rationale for how to apply an insurance contract that may have been written decades before.

Overall the Minnesota court made the following simplifying assumptions in its mathematical formula:

a. Each policy in effect during when any damage occurred is exposed for its whole limit.

b. Policies incepting after the insured expected claims have no obligation to perform.

c. A policyholder should be treated as if it were an insurance company if it voluntarily elected not to purchase insurance in the commercial markets.

d. A policyholder should not be treated as an insurer if the reason it did not purchase insurance is through no fault of its own.

Based on these elaborations, the court held that as to the duty to indemnify each carrier’s obligation to pay can be derived. (The court however embraced a per-capita allocation for defense.)

The Minnesota court recognized that its elaborations meant that its formulaic approach was becoming unmoored from the principles from which it derived. (No matter; such is the privilege of being the last word.) As the court said:

We are aware it is possible under our construction of factor B that an insurer is liable for more than those damages than would otherwise be deemed to have occurred during its policy period. This is possible because our definition of factor B, the period over which damages are to be allocated, excludes periods during which the insured lacks coverage because no such coverage was available. We are also aware that this result may be contrary to the broad language we used in [prior authority] to describe the ‘actual injury’ [trigger] rule, namely, that under this rule each insurer is liable ‘only for those damages which occurred during its policy period.’ [citation omitted] However, as we [there] indicated . . . ., the allocation of liability between insurers requires a flexible approach. [citation] Further, as we noted [previously], it is inaccurate to conclude that a CGL insurer can never be liable for damages occurring outside of a policy period. [citation] We deem the facts of this case to justify a departure from the typical ‘actual injury’ approach.

So is there a principled way to come to grips with the language of the insurance policy and figure out a principled manner to determine the obligation of each carrier where a single loss situation produces damage and injury both during and outside of its policy period? This is now the question that the New Hampshire Supreme Court has been asked in an environmental-coverage case. See EnergyNorth Natural Gas Inc. v. Certain Underwriters at Lloyd's Underwriters, 2006 U.S. Dist. LEXIS 73468 (D.N.H.)

I believe there is an approach to the contract language that takes the language seriously yet produces results that are (I submit) intellectually consistent.

The first principle is that insurance policies create rights in the insured, and it is the insured’s right to exercise. Insurance policies are not issued in dependence on the existence of coverage in other years; no credit is given on the premium from having more coverage in the past year than not or coverage from carriers with better credit ratings. Policyholders don’t promise carriers to purchase insurance policies in the future. And insurers are not understood to be third-party beneficiaries of each other’s contract, even though those contracts are with the same party, the policyholder. See Signal Co., Inc. v. Harbor Ins. Co., 27 Cal. 3d 359, 369 (1980); L.E. Myers Co. v. Harbor Ins. Co., 394 N.E. 2d 1200 (Ill. 1979).

The second, and more important, principle is that insurance policies insure against the risk that the insured will be held liable for injury or damage during the policy period; policies do not insure against the risk of injury or damage occurring per se. As one leading treatise explains, “[t]he hazard insured against under the liability feature is not injury or loss . . . but liability or responsibility of the insured for loss or injury.” 6B J. Appleman & J.A. Appleman, Insurance Law and Practice §4254 at 26-27 (Rev. ed. 1979). The policy language makes this plain. CGL policies contain a broad promise to pay “all sums” that “the insured shall become legally obligated to pay as damages because of bodily injury . . . to which this insurance applied caused by an occurrence.” In other words, subject to the applicable limit of liability, the policy covers the totality of damages incurred by an insured “because of,” i.e. “by reason of” or “on account of,” bodily injury within the policy period. The question then is, what is the insured’s liability because of the injury during the policy period. This is key and shows both where Minnesota law goes wrong and creates the hydraulic pressure on the court to backfill we see so clearly in Wooddale.

These two principles illuminate the right way to argue the point for policyholders (and I submit the right way for courts to resolve the question). Instead of the Minnesota court’s mathematical formula, one takes a single policy and asks the following question: Is there bodily injury or property damage that occurred during the policy period, and if so what is the insured’s liability for the bodily injury or property damage that happened? (Contrary to what some insurers have argued, the “Policy Period; Territory” provision does not alter the question, because that provision ensures that the trigger is damage, not the negligent act, see State v. Glens Falls Ins. Co., 609 P.2d 598, 600-01 (Ariz. App. 1980), and while the language in the insuring agreement referring to property damage “to which this insurance applies” refers implicitly to the “policy period; territory” provision, that does nothing to the question on which I focus, viz., what is the insured’s liability “because of” the property damage to which the insurance applies.) I don’t need to reflexively or exclusively rely on the insurance policy’s promise to pay “all sums” or “those sums” – that is handy language but is not the key issue. The key is always and only, what is the insured’s liability because of bodily injury/property damage during the policy period.

As a matter of tort (not insurance) law, in most of the situations we deal with the answer to that question is this: for bodily injury or property damage that occurred during the particular carrier’s policy period, the insured’s liability is equal to the entirety of the plaintiff’s claim. This is the result of the rule of tort law that imposes joint and several liability upon tort defendants. John Crane v. Scribner, 800 A.2d 727, 741 (Md. 2002) (“it is as impossible to ascertain which fiber ultimately caused which cell, over time, to escape the body’s defenses and turn cancerous, as it is to determine when that occurred”).

Note that I am not saying that insurers are jointly and severally liable under their policies; that would be to import a tort concept to the contract context, and I don’t think that is quite precise enough. But what is central is that the insured is jointly and severally liable, and such liability is imposed where the injury or damage at issue is indivisible from injury or damage that occurred in other policy periods (or from other tortfeasors). See United States v. Alcan Aluminum Corp., 964 F.2d 252, 268-69 (3d Cir. 1992); Matter of Bell Petroleum Services, Inc., 3 F. 3d 889-896 (5th Cir. 1993); O’Neil v. Piccillo, 883 F.2d 176 (1st Cir. 1989) (interesting discussions all re indivisible damage/injury and the imposition of joint-and-several liability under tort law).

Nothing in the policies reduces the carrier’s obligation to pay simply because injury may also have occurred outside the policy period; the sole determinant of the extent of coverage is what is the insured’s liability because of injury during the policy period. The policy language addressing the application of the policy limits for a covered claim nowhere confines the carrier’s obligation to pay to some aliquot share based on the quantum of injury occurring in its policy years. E.g., ACandS v. Aetna Cas. & Sur. Co., 764 F.2d 968, 974 (3d Cir. 1985) (Even where sums paid by the insured party are partly attributable to injury that occurred in another policy period, “the language of the policy makes [that fact] irrelevant.”).

This is made particularly clear in the “Limits” section of standard liability insurance policies. The “Limits of Liability” section of policies typically provides that, for a covered bodily-injury (or property damage) “occurrence,” the policy will pay for “all damages . . . because of bodily injury sustained by one or more persons as the result of any one occurrence.” The sole limitation on each policy’s obligation to pay is that the payout on the claim “shall not exceed the limit of bodily injury liability stated in the declarations as applicable to ‘each occurrence.’” The Limits provision further elaborates by stating:

For the purpose of determining the limit of the company’s liability [under the policy], all bodily injury . . . arising out of continuous or repeated exposures to substantially the same general conditions shall be considered as arising out of one occurrence.

Here the policy language unambiguously favors coverage: The amounts any given CGL policy pays are expressed in dollars “per occurrence.” The insuring agreement and the limits-of-liability provisions together teach that, where there is covered injury in the policy period, the policy pays “all sums” for “all damages sustained by one . . . person . . . as the result of any one occurrence,” subject only to the per-occurrence limit.

In fact, even if the policies were uncertain as to the proper method of allocation, a reasonable interpretation of the policies requires an “all sums” approach. And of course insurers have been in the position to protect themselves by drafting clear and explicit language that addresses how the obligation to perform should be measured where there is indivisible damage triggering their coverage. Compare Rochester German Ins. Co. v. Schmidt, 175 F. 720, 725-726 (4th Cir. 1909). Principles of insurance law, therefore, require that the interpretation of uncertain or ambiguous policy provisions favoring the insured must govern.

This contract-based approach to allocation also “solves” the question of horizontal versus vertical exhaustion: that is, where policies are triggered across time, must the insured collect first from all the primaries before tapping any excess coverage (and thus absorb cumulated deductibles and insolvent primary layers) or may the insured select a single year of coverage and access the triggered primary and overlying excess (either in a single year or in more than one). General-liability policies do not speak to this issue, and so we return to the principle that the contract rights belong to the insured; consequently, the insured has the option to select or target its triggered policies however it sees fit. In each instance, one asks the same questions: is the policy triggered, and if so how much does the policy pay per occurrence for the insured’s liability because of the (indivisible) damage/injury that year? Any targeted policy may seek to pursue equitable contribution against other carriers that could have been targeted but were not. Indeed, I submit that part of the peace of mind offered by broad CGL insurance is precisely the insured’s ability to collect its full per-occurrence limits and then go home – leaving further redistribution to the carriers to sort out.

This approach also gives the framework to address stacking or cumulation of policy limits, for looking at each contract the stacking or cumulation of policy limits again is straightforward. See United Services Automobile Ass’n v. Riley (Md. June 1, 2006). Until the insured is fully indemnified for its damages because of injury/damage during the policy year, the insured is entitled to collect on its coverage. In other words, stacking is only an issue if an insurer has clear anti-stacking language in its policy.

The bottom line of all of this is that policyholders should look hard at the contract without preconceived notions and see how each individual insurance contract’s obligation to perform is measured. Bearing in mind the crucial question of divisible versus indivisible harm and damage – and its impact on answering what is the insured’s liability for injury or damage during the policy period – insurance policies require insurers to perform if any “injury” occurred during the policy period and to pay their entire per-occurrence policy limit until such time as the insured has been fully indemnified or the insurance policy’s limits exhausted.

We confront the particular language of particular policies every time we settle a claim or file a complaint. Each contract should be analyzed using the toolkit I’ve sketched out here, and then you should move on to the next contract. Shampoo. Rinse. Repeat.

Posted by Marc Mayerson at 4:24 PM | Comments (4) | TrackBack

June 29, 2006

Equitas Financials -- 2006 Version

As part of the Reconstruction and Renewal of Lloyd’s in 1996, various participants in the Lloyd’s enterprise established several companies for the purpose of reinsuring the then-open syndicate years of account and managing the runoff of claims under those and prior years’ insurance policies. In 1997, the liabilities of a Lloyds’ owned-entity called Lioncover were reinsured into Equitas too.

Equitas issues an annual report and accompanying press release that discusses its results to date. Some of the highlights this year:

* Equitas’ retained surplus – that is, the amounts of its assets minus its expected liabilities – was reduced to £458 million.

* The retained surplus expressed as a percentage of net claims outstanding fell to 12 percent. In other words, Equitas expects its net claims to total roughly £3.8 billion. (p.6)

* Equitas paid £672 million in settlement of claims, including payment for 32 direct asbestos claims and 15 direct pollution claims. (p.4, 7) In this context, this means payments in commutation of policy obligations. (Some of these payments likely were to policyholders with both asbestos and pollution liabilities, and perhaps with more than one stream of liabilities, so one should not assume that Equitas did deals with 47 (32 + 15) different policyholders.) In the reporting period, Equitas completed more asbestos-driven policy buyouts than in any previous year (p.6) In these asbestos buyouts, Equitas is making payment on the assumption that Federal asbestos-reform legislation is not passed, but if such legislation does pass it will receive a give back from the settling policyholders totaling £280 million. (p. 43)

* Even considering these settlements, Equitas increased its asbestos reserves by £103 million, roughly the same amount that it increased reserves last year (£116 million), which makes up 53 percent of Equitas’s total reserves (with environmental and other health-hazards constituting another 24 percent of the reserves) (p. 41). The present value of the asbestos reserves is £2.2 billion, with a nominal value of £3.4 billion (p.5). For the first time in seven years, Equitas increased its reserves for environmental liabilities too. Equitas assumes it will be making payments for these classes of claims for at least another 40 years (p.41). Further, Equitas assumes that the mean term of its liabilities, “that is the weighted average period to settlement where the weights are the undiscounted expected cash flows in each future period,” will be approximately 11 years, one year longer than the assumption made a year ago.

* Equitas continues its aggressive liquidation of its reinsurance asset, with an undiscounted asset of £700 million and a discounted value of £360 million (p. 7, 14). Reinsurers’ share of claims paid was reduced from last year from £209 million to £190 million, a reduction that is not surprising given the reduction in claims payment from Equitas and the dwindling value of the remaining reinsurance. One can express sympathy with Equitas for its problems in collecting from its reinsurers: “We see a growing trend for some reinsurers to dispute claims for no other reason than to demand discounts in the hope we will be afraid of the costs of collecting these balances.” (p.7)

* Equitas identifies the amount of “profit” it has made on settlements, profit in this context being the amount of reserves freed from a settlement at a figure less than the reserved amount. £435 million of Equitas’ surplus is acknowledged by it to be attributable to settlements it has made over the past four years at amounts less than the reserves it had previously established for the claims. Last year, settlements contributed £81 million to Equitas’s bottom line. (p.4) In other words, 95 percent (!) of Equitas’s net surplus is attributable to these reserving-freeing settlements.

* There are several related threads to follow to grasp the significance of this figure. When Equitas was established in 1996, it is known that the money it raised was reverse engineered based on predictions on what it could collect in settlements with brokers, managing agencies, and the reinsured names. The initial Equitas premium indication was widely viewed as being unacceptable to the individual participants at Lloyd’s, so the Equitas premium number was reduced to a level that the “names” would accept. When Equitas began operations in 1996, it had a “solvency” margin of 5.6%, meaning its then projections of liabilities were 5.6% less than its assets. In order to open for business, Equitas could not be insolvent the first day, so its reserves had to be reduced to allow it to (barely) show a solvency margin.

* Equitas has since hiked its reserves substantially, particularly for asbestos. Reserve adjustments affect the year they are made (p. 35), so a settlement with policyholder X in 2003 that yielded a settlement profit of, e.g., $10 million should be recognized as yielding a settlement profit of a significantly greater amount if the associated reserves would have floated upwards with other reserve adjustments in subsequent years. So Equitas’s announcement of its settlement profit in the prior year understates the true profit amount, since the policyholder sold out its coverage for an even greater discount than it may have anticipated at the time of settlement.

* So, the reserve number for any given settling policyholder is likely to have been underestimated for either of two reasons: (i) all reserves were understated in the reverse engineering process to generate an acceptable Equitas “finality” premium and (ii) reserves subsequently have been adjusted upward either to compensate for that (conscious) underestimation or because then-unforeseen events yield higher valuations of the claim streams.

* Given that virtually all of Equitas’s solvency margin (and surplus) is attributable to policyholders’ settling out their coverage too cheaply, one can fairly say that the only thing keeping Equitas afloat is policyholders’ settling for too little (even from Equitas’s perspective).

* In this light, and perhaps in response to my constant harping on this issue (a theme I don’t see elsewhere), the CEO of Equitas offers the following defense of its claims-settlement practices:

“When we settle claims, whether those coming into us, or those we make on reinsurance policies, sometimes we pay or receive more than we had reserved, and other times less. . . . [S]ome deals were ‘winners’ (producing a contribution to surplus) while others were ‘losers’, but in the aggregate we achieved a win.” (p.4).

* I would challenge even the verity of the statement that some were ‘losers’ (for the reasons above) but at all events in the aggregate it is indisputable that Equitas’s effectiveness in snookering policyholders into settling for less than the reserve is Equitas’s margin.

* Given the tremendous success that Equitas has had in extinguishing major liabilities with its reinsureds’ direct policyholders (it has settled with all 10 of the largest direct asbestos policyholders identified in 2001 (p.2)), Equitas has now turned its attention to its “inwards” reinsurance with US insurance companies. (p. 10) Since the time of the annual report, Equitas has achieved a major settlement with The Hartford (and which resulted in Hartford’s realizing less than its booked reinsurance receivable). So perhaps policyholders can take solace that they are in good company.

Notes: My commentary is available for Equitas Financials 2005 and 2004.

On March 31, 2006, 1 pound equaled $1.74.

Posted by Marc Mayerson at 2:16 PM | Comments (0) | TrackBack

May 17, 2006

Taming the Lion(cover): Lioncover, Lloyd's, Equitas, and the Central Fund(s)

W. Mark Felt or Hal Holbrook playing him said to "follow the money," which has proven difficult in the instance of Lloyd's of London, and a task made all the more important as asbestos and environmental liabilities continue to fall upon corporate policyholders in the US that purchased broad insurance in the 1950s, 60s and 70s through the London market. While lawyers and policyholders may be familiar with Equitas, the reinsurance runoff and claims-handling vehicles set up in the late 1990s to deal with liabilities arising under historical Lloyd's policies, I have long believed that a key for litigators is something called Lioncover, a reinsurance vehicle originally set up to bailout important players at Lloyd's who were involved in Peter Cameron Webb "managed" syndicate years of account. Lioncover, which I understand to be a wholly owned subsidiary of the Corporation of Lloyd's and which houses the PCW business, initially was not reinsured into Equitas when Equitas was set up as part of the "Reconstruction and Renewal" of the Lloyd's operation. It was later poured into the Equitas structure but also is explicitly backed by the Lloyd's enterprise itself. Lioncover is a lever one can use to uncover the financial vehicles backing old Lloyd's policies (which contra to popular myth are not backed solely by the assets of Equitas or by the trust funds in the US). Lloyd's annual report for 2005 contains a few interesting crumbs worthy of note for Lloyd's/Equitas watchers.

First, Lioncover's liability payments in 2005 total slightly more than 525 million pounds or roughly $1 billion (US). These principally were attributable to asbestos, environmental, and health-hazard claims. (p. 114; note 14)

Second, this amount is not reflected on Lloyd's net balance sheet because the directors of Lioncover conclude that, because Equitas says it will pay the claims, it can take that reinsurance recoverable as an offset on its balance sheet. (p. 120) As Lloyd's annual report states:

At present, ERL [Equitas Reinsurance Ltd.] and its subsidiary undertaking, Equitas Limited, which is responsible for the run-off of the reinsured business, continue to pay claims in full and the directors of ERL have stated that they believe that the assets should be sufficient to meet all liabilities in full. Accordingly, the directors of Lioncover have considered it appropriate to recognise the amounts recoverable from ERL in full. Should ERL ever cease to meet in full its obligations in respect of the PCW syndicates, Lioncover would be responsible to its policyholders for meeting any amounts remaining unpaid.

The establishment of Lioncover and its reinsurance into Equitas does not cutoff the policyholder's right to make claim under the policy as against the Lloyd's enterprise. (This is consistent with what I have been counseling that one should not look at Equitas' assets alone when evaluating whether to include a credit-risk discount in a deal done with Equitas.)

Third, in the event Equitas does fail to perform, then Lioncover may seek to obtain payment from the "Central Fund," which helps back the policies issued through Lloyd's. As part of the Reconstruction and Renewal process, there is an "old" Central Fund and a "new" Central Fund, and Lioncover can claim under both, though the Council of Lloyd's purports to have discretion not to pay under the new fund unless the current membership agrees. As the report explains:

Following the implementation of ‘Reconstruction and Renewal’, Names underwriting in respect of 1992 and prior years, Lioncover and Centrewrite were reinsured into Equitas. If Equitas were unable to discharge in full the liabilities which it has reinsured, any resulting shortfall in respect of Lioncover or Centrewrite could be met out of both the ‘Old’ Central Fund and the New Central Fund under the terms of their respective Lloyd’s bond. Both the ‘Old’ Central Fund and the New Central Fund would also be available to meet the claims of policyholders of Names who are party to hardship agreements executed before 4 September 1996, to the extent that such an event resulted in a shortfall. However, unless the members of the Society resolve in a general meeting to make the New Central Fund available, only the ‘Old’ Central Fund would be available to meet the claims of policyholders of Names who are not party to hardship agreements executed before 4 September 1996. The Council has determined that any losses resulting from such indemnities will be met by the Lloyd’s Central Fund. (p. 132, note 29)

There certainly is an open question whether there really is discretion not to pay under the new Central Fund, but the reason we care about this is that it is the current membership of Lloyd's that would be responsible for topping up the fund in the event of a shortfall (and that there would be a shortfall is a likely result if the new fund were tapped).

Note that simultaneously Lioncover's liabilities would need to be shown on Lloyd's balance sheet and the capital of the members would be hit, thus doubly impairing the financial ratings of the Lloyd's enterprise.

Fourth, my sense continues to be that, if Equitas stops making payments or determines that it has more mouths to feed than money (or owns up to that reality), following what happened with Lioncover and how it has been intermingled with "new" Lloyd's will be a key focus for discovery and trial when policyholders seek payment on their old Lloyd's policies and are shunted off to the admittedly penurious Equitas. The story of insiders being bailed out through Lioncover and new Lloyd's assumption of those liabilities and seeming manipulation of its own financial statements (by taking the reinsurance recoverable as a full, undiscounted offset while Equitas otherwise is proclaiming its own credit risk) will be the stuff of trial. The promises Lloyd's makes when selling policies are supposed to be backed up by the vaunted "chain of security," which means the assets of the current membership of the Lloyd's enterprise. Compare Industrial Guarantee Corp. v Lloyd's(1924) 19 Lloyd's List Law Reports 78 (Bailhache J).

The Lloyd's enterprise's efforts to "ringfence" the historic liabilities and to protect the current corporate members may yet prove successful -- at least to the extent that policyholderscooperate in obtaining less than the full value of their insurance; the chain of security will back the policies US companies purchased only once those companies bring litigation to force the Lloyd's enterprise to honor the promises made in the broad insurance policies sold to American companies (or in the unlikely event that regulators step in). Certainly, the halcyon days of Cuthbert Heath saying "pay all our policyholders in full" are long, long gone.

A somewhat expanded version of this commentary appears in 17 Mealey's Litigation Reports: Reinsurance (June 15, 2006).

Posted by Marc Mayerson at 12:54 PM | Comments (1) | TrackBack

February 4, 2006

Fettering the Insurer’s Privilege to Control the Defense It Is Duty Bound to Provide

For more than fifty years, policyholders and their insurers have been struggling over the insurer’s promise to defend and the insurer’s control the defense. Policyholders properly have been concerned that an insurance company that controls the defense of an action potentially covered by the carrier’s duty to indemnify will use that control to avoid that very same indemnity obligation. While in egregious cases where a lawyer hired by the carrier has abused his or her relationship with the insured, the client, so as to favor the lawyer’s source of income – the insurance company – the courts have responded to protect the insured’s interests. But most courts have ruled that such after-the-fact remedies are insufficient: they do not adequately compensate for the injury; meritorious claims are not pursued (in part because insureds may not discover the abuse); and the potential for this abuse alone undermines the dominant purpose of the insurance relationship to afford protection and peace of mind for the insured.

As a result, most jurisdictions have fashioned a number of rules affording remedies in cases of actual abuse – by allowing bad-faith actions to proceed against insurers, by barring insurers from using the fruits of the poisonous tree, by allowing malpractice claims against the lawyer, and other measures. But most furthermore have held that where there is a situation of potential abuse a prophylactic approach is appropriate; thus the insured is permitted to select the lawyer to defend it and the carrier continues to have the obligation to pay for that defense. This is usually referred to as the "independent counsel" rule (or in California, the Cumis or 2860 rule).

Rarely do I see as a policyholder lawyer a insurance provision that expressly addresses this problem – something that is incomprehensible given that for more than two generations this struggle has been waged. Since at least the 1950s, the courts have made clear to insurers that, because their policies do not set out how these circumstances should be handled, the courts themselves will fashion rules designed to balance the interests of policyholders and their insurers. In general, the courts have looked to the dominant promise of the insurance contract to defend (and to indemnify) the insured and held that the correlative responsibility of the insurer to defend can yield to safeguarding that dominant purpose of the insurance contract. In part this stems from the contract drafting in which two words – “right and” -- in the insurance policy are what carriers rely on: they have the “right and duty to defend” (plus the insured’s duty to cooperate set out in the boilerplate portion of the policy).

Because insurers are well aware of the rule that uncertainties in the contract will be construed against them and the rule in the overwhelming majority of jurisdictions that their right to defend and its entailed privilege of selection and control of counsel has to yield to protect the benefit of the bargain the insured struck to obtain both defense and indemnity, the courts generally have held that insurers forfeit their privilege of control.

The paradigmatic circumstance where the insurer’s privilege of control yields to its duty to defend, to protecting the insured’s expectations of coverage, and to subordination to the insured’s interest is where a complaint alleges more than one claim arising out of a single event and the case can be lost on either a covered basis or an uncovered one. Take as an example where an during a pickup basketball game an elbow is thrown: if that occurred because of gross negligence, there will be coverage, but if it occurred because the player sought to intentionally injure the recipient, there won’t be. Trial of the case involves the same facts and testimony either way, and ultimately it’s up to the jury to weigh the testimony and the facts. The insurer if it is to lose the case would prefer to lose it on intentional-injury grounds, for then it won’t have to pay the judgment.

Another example: assume there is a technical defense available to the covered claim; should the lawyer file a motion for summary judgment on the covered claim, which will effectively pretermit the carrier’s ongoing obligation to defend (since the case no longer can eventuate in a judgment covered by the duty to indemnify)? Does the lawyer have an obligation to leave the weak claim hanging around just to preserve the defense or does the lawyer – whose bills are being paid by the insurer – have the obligation to clean out the dross and thus allow the carrier off the hook?

Insurers have pooh-poohed such concerns by contending that lawyers act ethically so the courts’ concerns are unfounded. And the United States Court of Appeals for the Fourth Circuit – a court that has a penchant for mispredicting state insurance law by siding with insurance companies – recently agreed with the insurers in what should become carrier-side lawyers’ favorite case to cite on these issues. In a well-written, well-analyzed, but erroneous ruling, Twin City Fire Ins. Co. v. Ben Arnold-Sunbelt Beverage Co. (4th Cir. Dec. 27, 2005), the Fourth Circuit rejected the argument that an insurer’s reservation of the right to deny coverage called for prophylactic protection of the interest of the insured by allowing it to select counsel of it choice to defend at the insurer’s expense.

Of course, Ben Arnold involves reasonably favorable set of facts for carriers and overbroad argument by the policyholder, but the court’s ruling is not so confined. The court sets up the question presented as follows:

When a party with insurance coverage is sued, the insured notifies the insurance company of the suit. The insurance company, in turn,typically chooses, retains, and pays private counsel to represent the insured as to all claims. If the suit involves some claims that are covered under the insurance policy and some claims that are not covered, the insurance company typically will send a reservation of rights letter to the insured stating what claims the insurance company believes are covered and what claims it believes are not covered. In this case, we examine whether, under South Carolina law, such a reservation of rights letter automatically triggers a conflict of interest entitling the insured to reject counsel tendered by the insurance company and instead to choose and retain its own counsel and to have the insurance company pay for that counsel.

Slip op. at 1. The proposition offered by the insured was that any time an insurer issues a reservation-of-rights letter it is still required to provide a defense but the policyholder gets to select counsel to defend it and control the course of the defense.

The Fourth Circuit rejected the policyholder’s argument, noting correctly that courts tend to require that the insured show there to be a conflict of interest between it and the insurance company before wresting the defense from the carrier. This is sensible, of course, given that in the insurance policy the policyholder delegated to the insurance company the right to defend the case. Insurance companies issue reservation-of-rights letters in response to case law in the 1950s and 1960s that a carrier that defends a suit cannot turn around at the end of the case and tell the insured that it won’t pay for the judgment – at least without alerting the insured of this possibility earlier; as a result, insurance companies issue reservations of rights to prevent the insured from having detrimental reliance (or claiming waiver). National Mut. Ins. Co. v. McMahon & Sons, 356 S.E. 2d 488, 493 (W. Va. 1987); Safeco Ins. Co. v. Elllingshouse, 725 P.2d 217, 221 (Mont. 1986); Richmond v. Georgia Farm Bureau Mut. Ins. Co., 231 S.E.2d 245 (Ga. 1976); Royal Ins. Co. v. Process Design Associates, 582 N.E.2d 1234, 1239 (1st Dist. 1991).

But it is not the insurance company’s fault that a suit may involve both covered and uncovered amounts, and coverage is not to be expanded beyond the terms of the policy through application of principles of waiver. As a result, it is entirely appropriate for an insurance company that is contractually obligated to provide a defense to a policyholder to alert it to the possibility that the judgment in the case might not be covered. D.E.M. v. Allickson (North Star Mut. Ins. Co.), 555 N.W.2d 596 (N.D. 1996). In this way, the policyholder can act to protect its own interest, including in some states choosing to settle the lawsuit against it in a fashion that camouflages whether the payment is also on account of uncovered amounts or claims. See generally Miller v. Shugart, 316 N.W.2d 729 (Minn. 1982).

So, unless some other interest or question is involved, the mere fact that an insurer sends a reservation-of-rights letter should not alter the parties’ preexisting rights and powers (since all the insurer is trying to do is to avoid waiver/estoppel from its assuming the defense).

Against this background, the Fourth Circuit rejected the notion that a reservation-of-rights letter per se creates some sort of conflict between the interests of the insured and its insurer such that the insurer is divested of its contractually bargained-for right to defend. But the court went on to recognize that there are circumstances where the interest of the insured and the insurer in the development of the defense can diverge, which has led most courts to express concern about insurer-appointed and insurer-directed counsel.

The Ben Arnold court reviews the law in a number of jurisdictions (having found that South Carolina law applies and was without governing precedent) and concludes that some courts allow the insured to select counsel paid contemporaneously by the insurer whereas other courts permit the insurer to select “independent” counsel who in turn may have heightened professional duties to safeguard the insured’s interest. Because a strong undercurrent in those cases vesting the choice of counsel in the hands of the insured questions the ethical integrity of the insurance-defense bar, e.g., Howard v. Russell Stover Candies, Inc., 649 F.2d 620, 625 (8th Cir. 1981) (requiring independent counsel for fear that counsel for insurer “would be inclined, albeit acting in good faith, to bend his efforts, however unconsciously” in insurer’s favor), the Fourth Circuit was highly reluctant to impugn with such a broad brush the integrity of an entire swath of the bar. Slip op. at 11 (“We are equally unable to conclude that the Supreme Court of South Carolina would profess so little confidence in the integrity of the members of the South Carolina Bar. Rigorous ethical standards govern South Carolina attorneys.”).

The Fourth Circuit concluded that the ethical rules and discipline, “coupled with the threat of bad faith actions or malpractice actions if a lawyer violates these rules, provide strong external incentives for attorneys to comply with their ethical obligations.” Slip op. at 12. Accordingly, the Ben Arnold court refused to find that, where there was a conflict of interest between the insured and the insurer in the development of the facts at issue in the liability case, the insured had a right to counsel of its choice, paid for contemporaneously by the insurer.

The court furthermore adopted a strict forfeiture rule in this regard, finding that if an insured rejected counsel tendered by an insurance company it forfeits the right to defense coverage. In other words, the policyholder is precluded from seeking coverage even if the insurance company cannot show that it was in any way was harmed by the policyholder’s selection of counsel (e.g., competent counsel at the same rate, for example, who obtains an outstanding result). The court rejected the policyholder’s contention that the insurers must show substantial injury or prejudice or at least some detriment in order to be excused from providing the policyholder any of the benefit of the bargain. Slip op. at 13-15.

Ben Arnold is sure to be relied on by insurance companies as a cogent statement of their position in favor of rejecting the policyholder’s selection of counsel of its choice. Nevertheless, the court need not have reached out to proclaim its own, pro-insurer prophylactic rule because the facts of the case and the conduct of the insurers at issue merit no such prolegomenon.

In Ben Arnold, the insurers retained qualified counsel to defend the covered counts and in addition offered to pay for separate counsel to represent the insured’s interests with respect to uncovered counts. Moreover, with respect to a different insured in the case where there was a conflict of interest in the development of the facts, both the trial court and the Fourth Circuit found that independent counsel was required to be appointed at the carriers’ expense. And even with respect to the principal insured for which there was no conflict at issue in the development of the underlying facts, the trial court recognized that at the time of settlement independent counsel might be required due to the conflict that then would be manifest. 2004 WL 2165971 (D.S.C. July 26, 2004), at n. 14.

What is lamentable about the Fourth Circuit’s opinion is that the court could easily and more properly have held that, given the absence of a conflict of interest between the insured and insurer in the development of the underlying facts, independent counsel was not required and in any event the insurers satisfied their obligations by offering to pay for two sets of counsel. This is the rule in “independent counsel” states where most courts recognize that merely sending a reservation-of-rights letter – without more – is insufficient to oust the insurer of the control of the defense. National Union Fire Ins. Co. v. Hilton Hotels Corp., 1991 WL 405182 (N.D. Cal. 1991). In fact, wresting control whenever a reservation of rights is sent ironically defeats the purpose for why such reservations were sent in the first place.

But Ben Arnold should not be rejected just because it is overly broad, for even were the facts to match the very broad rule adopted that rule still would be ill advised and erroneous under principles both of insurance law and of contract law. Perhaps because the issue has been in dispute for so long (half-a-century), the footings of the independent-counsel rule seem to have become beclouded.

Let’s look first at the consequences of the Ben Arnold court position. The court makes clear that, while there might a perception of discomfort by the policyholder in the carrier’s selected lawyer being in charge (and thus having the ability to steer the defense toward uncovered grounds), the insured’s interest is adequately protected because of legal-ethics rules, attorney-malpractice liability, and insurance bad-faith principles. This rejoinder to the policyholder position really does not withstand scrutiny.

The Fourth Circuit’s remedies render nugatory the peace of mind and security the insured is supposed to receive by paying a premium to the insurance company for the broad protection afforded by insurance policies. See Rawlings v. Apodaca, 151 Ariz. 149, 154-55 (1986) (“Although the insured is not without remedies if he disagrees with the insurer, the very invocation of those remedies detracts significantly from the protection or security which was the objection of the transaction.”). The court envisions requiring policyholders to endure bad faith or ethical breaches, and then seeking recovery only at the end of the underlying litigation by suing for legal malpractice or bad faith. Ben Arnold thus replaces the security that insurance is supposed to provide with a chose in action against the insurer-appointed lawyer, requiring the policyholder to (a) sue for legal malpractice, requiring a showing both of breach of the standard of care and a showing that the outcome would have been different (the “trial within the trial” of such malpractice actions), (b) undertake that action at its own expense (since the insurer is not paying, and there’s no attorneys’ fees recovery in malpractice cases), (c) in the meantime front the money for the adverse judgment in excess of policy limits or even the entire judgment if it is based on an uncovered claim (and subsequently, if successful, refund to the carrier in subrogation any amounts recovered after the policyholder was made whole), and (d) expose itself to an uncollectible judgment because the lawyer may not have assets sufficient to cover the judgment that resulted from his malpractice.

The Ben Arnold solution to the conundrum of insurer-appointed counsel further would do substantial injury to the attorney-client relationship; not only would the insured find it difficult to confide in counsel assigned to it, but counsel’s effectiveness would be undermined by its knowledge that the carrier has set it up for an impending malpractice action. And the same problems apply regarding suing the carrier for bad faith for some misconduct of the insurer-appointed lawyer or suing for negligent performance of the duty to defend by providing inadequate counsel.

The proposed remedy that the Ben Arnold court contemplates is a feeble substitution for the security and protection that the policyholder thought it was paying for. And if one looks at the cases decided forty or fifty years ago, these courts found it salient that the insurers’ policies did not spell out how this conflict situation would be handled. Standard insurance policies then (as now) were not written to state plainly and unambiguously that (i) interference with the right to defend forfeits coverage or (ii) the right to defend constitutes a material part of the consideration of the overall insurance transaction (which would be an overreach anyway given the aleatory nature of insurance contracts, that is, that the policyholder has fully performed its principal obligation of paying the premium).

Thus, the courts have applied the ordinary rules that where the policy language was uncertain and the insurer was in a position to clarify by drafting a provision clearly, the policy is construed in favor of coverage to achieve its purpose of indemnifying the insured, especially bearing in mind the reasonable expectations of insureds and avoiding the appearance of unseemliness from insurer-appointed counsel’s being in the position to steer the case to favor his or her source of future business. E.g., Employers' Fire Ins. Co. v. Beals, 240 A.2d 397, 402 (R.I. 1968); Magoun v. Liberty Mut. Ins. Co., 195 N.E.2d 514 (Mass. 1964); Prashker v. United States Guarantee Co., 136 N.E.2d 871 (N.Y. 1956); see also CHI of Alaska, Inc. v. Employers Reinsurance Corp., 844 P.2d 1113, 1116 (Alaska 1993). As a result, most courts ruled that the carriers’ right to control the defense – an ancillary part of the insurance contract – must yield to the predominate purpose of the contract to provide the policyholder a defense and to safeguard the policyholder’s peace of mind. See Jacobs & Youngs, Inc., 129 N.E. 889, 891 (N.Y. 1921) (Cardozo, J.) (“There will be no assumption of a purpose to visit venial faults with oppressive retribution.”). That carriers have not fixed their policy language after 50 years of litigation and instead require that the law be developed in each state and locality smacks of ineptitude or bad faith or some synergistic combination of the two.

Nevertheless, one dissembling rejoinder to this would be to contemplate a situation where the policyholder does erroneously reject the carrier’s offered defense (which approximates the actual facts in Ben Arnold). In that circumstance, so the argument goes, if the carrier remains responsible for funding the defense, the carrier that offers to perform properly is no better off than is the carrier that breaches its contract by refusing to provide a defense at all. In other words, a carrier that breaches its duty to defend by erroneously denying coverage is liable to pay the reasonable costs of defense; and according to this argument a carrier that offers counsel that is rejected by the policyholder is still obligated to pay the reasonable costs of defense.

This is a false counter, because it misstates the damages that are to be paid by a breaching carrier (that is, the contract-law damages it owes for breach of the duty to defend). It is not precise to say that a breaching insurer owes the reasonable costs of defense; rather, under Hadley v. Baxendale, the insurer owes all foreseeable damages. In the circumstances, the policyholder proffers in its prima facie case all defense costs it incurred (that were caused in fact by the carrier’s failure to perform), and the carrier may argue by way of affirmative defense (and for which it has the burden of proof) that the costs were so unreasonable as to constitute unforeseeable damages ( which when framed correctly is a difficult standard for the carrier to meet, especially in the light of the fact that the insured had every economic incentive to incur only reasonable costs since, at the time, it was paying them out of its own pocket with no certainty of recovery from the carrier). Moreover, a breaching carrier is not just liable for defense costs, it is liable for all damages incurred by the insured from the breach. Beck v. Farmers Insurance Exchange, 701 P.2d 795, 801 (Utah 1985).

Contrast this situation to that of the carrier that does offer a defense but which is rejected by the policyholder on the ground that independent counsel is required – though in this illustration the policyholder is wrong to do that. In that circumstance, the concepts of material versus immaterial breach are key (as are dependent versus independent covenants). Here, the carrier has not breached, but the policyholder has. But the policyholder’s breach – by interfering with the carrier’s right of control – exposes the policyholder to the carrier’s set-off claim because it is an immaterial breach of the overall contract. In other words, the carrier is still required to perform its contract – for the policyholder’s breach is not a material breach of the contract excusing the carrier’s obligation (especially when the policyholder has probably already paid the full premium). See generally Steakhouse, Inc. v. Barnett, 65 So.2d 736, 738 (Fla.1953)(defining dependent covenants). But because the policyholder did breach the contract, the carrier is entitled to show its damages from the policyholder’s breach. In this context, what that means is the additional cost of the defense that would not have been incurred had the policyholder not breached (i.e., not been in charged). So, if the defense counsel the insurer would have appointed charged only $300 an hour (because of say a bulk deal with the carrier) and the policyholder’s selected lawyer charges $400 an hour, the carrier is not obligated to pay the $100 an hour difference. (Unlike Ben Arnold where the carriers' to their mirth owe nothing.) Importantly, this is in contrast to the breaching carrier which is unlikely to be able to show that the $100 an hour delta is such an unreasonable cost differential as to constitute unforeseeable damages under Hadley v. Baxendale. Moreover, the carrier that properly offered counsel is not exposed to paying the insured’s full damages (sometimes pejoratively characterized as “consequential damages” (Machan v. Unum Provident Ins. Co., 2005 UT 37 (Utah June 17, 2005)), because it did not breach.

Thus, a carrier that properly tenders performance that is incorrectly rejected is not in the same (disadvantaged) position as is a carrier that breaches its contract. Accordingly, under this analysis, everyone is put in the position they would be in had the contract been properly performed – the benefit of the bargain is preserved.

Until such time, therefore, that insurers revise their contracts to specify that even in a conflict of interest situation the insurer still gets to appoint counsel (or whatever method it would propose, such as allowing the insured to pick from a list of five counsel suggested by the insurer), the uncertainty of the contract, and the disproportionality of the proposed remedy contemplated by the Ben Arnold court, confirms the rightness of the independent-counsel rule. See generally Restatement (2d) Contracts Sections 197, 229 (2004). If insurers do revise their contacts, then (i) insurance regulators would be in the position to weigh in, (ii) policyholders would know expressly what the process is for dealing with a conflict situation if it purchases the particular insurance policy, and (iii) policyholders could choose to purchase policies from other insurers that offer more generous terms. But it is folly to believe that policyholders contemplate the remedial scheme adopted by the Ben Arnold court. See Restatement (2d) Contracts Section 211(3).

Note: A version of this commentary was published in 5 Insurance Coverage Law Bulletin (May 2006) at 1

Posted by Marc Mayerson at 11:39 PM | Comments (0) | TrackBack

January 20, 2006

Insurance Industry Spared from Bankruptcy: Asbestos 524(g) Settlements

The California Court of Appeal has reversed a ruling holding that liability insurers of an asbestos company had immediate obligations to perform in full once a trust was established through section 524(g) of the bankruptcy code that concurrently extinguished the liability of the policyholder vis a vis the asbestos claimant creditors. Fuller-Austin v. Highlands Ins. (Cal. App. Jan. 19, 2006). The "acceleration" of insurers' obligations that these 524(g) trusts might create has caused apoplexy in the insurance industry, and the California court's reversal of the insurance ruling that the creation of the trust meant the insurers had immediate obligations to perform for the total (non-bankruptcy) value of the future claim stream no doubt produced a collective sigh of relief from the insurance industry (and their reinsurers).

There are two bankruptcy elements in these modern asbestos-driven bankruptcies that, when combined with prior rulings of courts dealing with bankruptcy effects on insurance, yielded an extraordinary result: immediate obligations of insurers to pay the future asbestos obligations of the policyholder-debtor immediately and in full. Before turning to the Fuller-Austin decision itself, it is important to understand what debtors like Fuller-Austin were trying to achieve.

The first step in an asbestos-driven bankruptcy is to take the asbestos claims stream and estimate its value. The debtor then needs to satisfy that creditor claim in the bankruptcy, which it does by setting up a trust and funding it with cash (from itself and sometimes its corporate parent), stock, and preexisting insurance rights. The debtor receives a channeling injunction that bars the assertion of any asbestos-related claim against itself (and sometimes against non-debtors, see Susan Power Johnston and Katherine Porter, Extension of Section 524(g) of the Bankruptcy Code to Nondebtor Parents, Affiliates, and Transaction Parties, 59 Business Lawyer 511-12 (2004)), and the injunction furthermore funnels all claims to the trust. In other words, the debtor is able to emerge from bankruptcy shorn of its asbestos liabilities without fear of any future claims.

The trust in turn is charged with resolving the asbestos claims and sets up an administrative compensation process, usually with relaxed standards of proof, to “adjudicate” the tort claims. The claimant may have the right further to bring an action in court, though with no ability to seek punitive damages for example.

This is the model that was used in the Manville bankruptcy and was confirmed, expanded, and modified by Congress in 1994 when the bankruptcy code was amended with the addition of section 524(g), 11 U.S.C. § 524(g), a provision specially designed to deal with asbestos-driven bankruptcies. While certain procedural and substantive changes were implemented in 524(g), from the debtor’s perspective one key was that 524(g) made clear that future claims, claims by persons exposed to asbestos but who at the time of the bankruptcy filing had no legal claim, would have their claims channeled to the trust as well. Dealing with “futures” has been the Achilles heel of several non-bankruptcy deals in the class-action context, Ortiz v. Fibreboard Corp., 527 U.S. 815 (1999); Amchem v. Windsor, 521 U.S. 591 (1997), so the express conferral of power on bankruptcy courts to limit the right to sue of future claimants was quite significant.

How did all this impact insurance companies? In most jurisdictions, the court have adopted a model of asbestos insurance recoveries where insurers from the 1940s through the mid-1980s together are liable to pay the policyholder’s defense costs and costs of settlements and judgments. There remained key questions in the insurance cases concerning the order of payment by insurers, which principally was an issue for the excess insurance carriers. The question is whether, if one were an excess insurer in 1970 that wrote coverage excess of $50 million, an amount that would represent about one-quarter of one year’s asbestos expense for a major defendant, that insurer is required to perform once the insured/asbestos-defendant pays $50 million or whether that insurer is effectively excess to the sum total of all primary and excess coverage, both before and after its policy period, that attaches lower than $50 million. E.g., United States Gypsum Co. v. Admiral Insurance Co., 643 N.E.2d 1226 (1991) (holding that an umbrella carrier was excess to policies before and after its policy year). If one assumes a constant level of $50 million annual coverage, the 1970 excess carrier might than be excess to hundreds of millions of dollars in “underlying” coverage. The key point is that the objective of excess carriers was to defer as long as possible the time at which they were required to perform; given the size of excess policy limits, the likelihood that asbestos liability will suck dry an entire insurance program, and the value of holding onto money as long as possible so as to “earn out” the value of claims, excess insurers have been banking on deferring their obligations to pay.

In this context, the developments in the bankruptcy cases took on added importance to excess insurers. Under a key decision more than a decade ago in the Seventh Circuit, UNR Indus., Inc. v. Continental Cas. Co., 942 F.2d 1101 (7th Cir. 1991), two crucial issues were resolved: (1) the debtor/insured’s establishment of the trust in exchange for the release of the asbestos claims against it (which were channeled and funneled to the trust) constituted a “judgment” as to which the insurers had a mature obligation to indemnify (even though payment to any individual claimant might not occur for decades); and (2) while a claimant might receive only a percentage payment from the insured/debtor/trust due to its limited funds, the value of the claim for insurance-indemnification purposes was the face value (not the end-of-the-day paid value) of the claimant’s damages. As to the second point, even though an individual settlement is paid in “bankruptcy dollars” in calculating the duty to indemnify the value of the claim extinguished is determinative (not the value paid to extinguish the claim, an amount that takes into account the insured’s insolvency).

The consequence of the UNR decision for excess insurers was frightful: they could be required to immediately perform calculated against the full value of the debtor’s claim portfolio, even though the trust itself might not pay out the individual claims for years to come.

The situation became more acute for excess insurers after 524(g) was passed by Congress in 1994. Section 524(g) requires 75 percent approval by creditors, typically the asbestos claimants (and commercial bondholders). Utilizing the pre-packaging structure under the bankruptcy code, through which debtors may negotiate the plan of reorganization prefiling, debtors began to file section 524(g) “pre-pack” bankruptcies wherein the debtor/insured/defendant would strike an agreement with the asbestos plaintiffs (in reality, their contingency-fee-paid lawyers) to establish a value of the portfolio of asbestos claims and payment values. This informal estimation process (with the asbestos-plaintiffs’ lawyer taking a percentage recovery) yielded huge nominal values, since they include asbestos claims that will be asserted for the next thirty years.

Thus, insured/debtors/defendants would negotiate a pre-pack bankruptcy plan where often the key asset that would be used to fund the massive asbestos liabilities driving the bankruptcy was insurance rights. E.g., In re Johns-Manville Corp., 40 B.R. 219, 229 (S.D.N.Y. 1984) (insurance among “the most important assets of the estate”). Moreover, the creditors’ committee (the asbestos-plaintiffs’ lawyers) would be in charge of the trust – which insurers likened to the fox guarding the hen house. (This also resulted in strange reversals of roles where some policyholder lawyers, who for years worked for asbestos defendants, suddenly became the lawyers for the trusts/creditors, working for the asbestos claimants who were suing the asbestos-defendants who had formerly been their clients – a situation that produced intriguing professional ethics and bankruptcy issues.)

Fearing that they were being set up in these pre-pack 524(g) deals (and insurers were not alone in being critical of these pre-pack, 524(g) arrangement), insurers sought to protect their interests by intervening in the bankruptcy proceedings, leading to fights over the insurers’ standing to object to a plan (given that insurers were debtors to the estate not creditors). In Re Combustion Engineering, (3d Cir. Dec. 2, 2004); In Re A.P.I. Inc., 331 B.R. 828, 842 (Bankr. D. Minn. 2005); Barron & Budd, P.C. v. Unsecured Asbestos Claimants (321 B.R. 147, 157-52 (D.N.J. 2005); Metropolitan Life Ins. Co. v. Alside Supply Center (In Re Clemmer), 78 B.R. 160 (Bankr. E.D. Tenn. 1995). Insurers (and others) fought against each other where one insurer settled the coverage with the debtor/insured. In Re Dow Corning, 192 B.R. 415, 421 (Bankr. E.D. Mich. 1996); MacArthur Co. v. Johns-Manville Corp., 837 F.2d 89 (2d Cir. 1988); see also In Re FortyEight Insulations Inc., 133 B.R. 973 (Bankr. N.D. Ill. 1991), aff’d, 1149 B.R. 860 (N.D. Ill. 1992). Insurers sometimes would seek to litigate coverage questions against their insured in bankruptcy (though those courts often were thought to be favorable fora for the debtor/policyholder), presenting questions of core/non-core proceedings, removal, and withdrawals of reference as well as questions whether the insured must satisfy deductibles or retentions as a pre-condition to accessing coverage or whether the deductible is an affirmative claim by the insurer that gets resolved at the end of the line in the bankruptcy with other unsecured claims against the estate. E.g., Amatex Corp. v. Aetna Cas. & Sur. Co., 107 B.R. 856, 871-72 (Bankr. E.D. Pa. 1989); Kleban v. National Union Fire Ins. Co., 2001 Pa. Super. 92 (2001); Columbia Cas. V. Federal Press, 104 B.R. 56, 62-64 (Bankr. N.D. Ind. 1989); Home Ins. Co. v. Hooper, 691 N.E. 2d 65 (Ill. App. 1998); Haisten v. Grass Valley Reimbursement Fund, Ltd., 784 F.2d 1392, 1403 (9th Cir. 1986)). Some carriers sought to litigate the coverage outside of the bankruptcy, but those ran into the rule that coverage actions (including “defensive” affirmative claims) outside of the bankruptcy court may not be initiated by insurers, due to the protections of the automatic stay. ACandS, Inc. v. Travelers Cas. & Sur. Co., (3d Cir. Jan. 19, 2006); Minoco Group v. First State Underwriters Agency, 799 F.2d 517, 519 (9th Cir. 1986).

This brings us to Fuller-Austin, a company that filed a pre-pack 524(g) bankruptcy that was confirmed in September 1998. Though it had commenced coverage litigation in 1994, the case suffered litigation interruptus due to the bankruptcy filing; the case picked up again with bench trials in December 2000 and September 2001, and a jury trial in November 2002. In May 2003, the jury returned a verdict in favor of Fuller-Austin awarding $188 million in damages. The jury further found that the value of Fuller-Austin’s asbestos stream exceeded $966 million. Following that trial loss, the insurers appealed, largely challenging the jury instructions formulated by the trial judge. As crushing a defeat that the trial court judgment was, the appellate decision was equally a vindication for the insurers. The insurers won virtually every issue on appeal. The appellate court was unequivocal in its rejection and criticism of the policyholder’s arguments.

The first question presented was whether the bankruptcy court’s confirmation of the plan constituted was a binding determination of the insured’s liability to the asbestos claimants. In other words, does the amount determined in the bankruptcy court constitute the amount to which the insurer’s duty to indemnify applies? The Fuller-Austin court ruled that the determination of the insured’s liability to the class in the bankruptcy proceeding was not sufficient to constitute an actual “adjudication” of the insured’s liability. There was no actual, adversarial process of factfinding such that would effectively bind the insurer by finally establishing the insured’s liability. Compare Hamilton v. Maryland Cas. Co., 27 Cal. 4th 718 (Cal. 2002).

The California court found that the bankruptcy-confirmation process, including the formulation of a plan, was a “settlement” of the insured’s liability, which presented the question whether the insurers had the right to refuse to consent to the settlement. While the insurers did not consent in fact to the plan, the court embraced the notion that insurers did not have the power to withhold consent unreasonably. In other words, so long as the settlement is reasonable, the question of the insurers’ consent vel non is academic. Because the insurers did not establish a lack of good faith by Fuller-Austin in the process leading to the plan, the court held that the insurers were permitted to object to the settlement only to the extent they could show that, as to them, the bankruptcy plan is “unfair, unreasonable or the product of fraud or collusion.” (slip op. at 34; 52-54)

The court next turned to the key question of acceleration, whether the coverage-trial jury could “estimate the aggregate sum of an insured’s liability for present and potential future asbestos claims for the purpose of accelerating [the] insurers’ obligations;” the court concluded that the estimation of the value of the claim portfolio did not “represent the amount that Fuller-Austin is legally obligated to pay.” Slip op. at 41. The court’s discussion, on this point, is not entirely focused. The issue (at least as I understand it) is whether the claim-estimation process in bankruptcy when combined with the discharge of the debtor and funneling of all claims to the separately established trust, constitutes a then-present release of the insured’s liability to the class. If so, then the plan-confirmation process results in an immediately indemnifiable judgment as against the insured (and concurrent assignment of the choses in action under the policies to the trust). In other words, rather than a claim-by-claim exhaustion of coverage as they are adjudicated (or settled) in the ordinary course, the bankruptcy process results in the equivalent of a class-action judgment against the debtor/insured. If like a class-action the claims are resolved en masse, it matters not that the payments for the individuals will occur over time. Relative to the insured, it has extinguished its liability, not as of the time that any individual claimant receives his or her money but when the judgment is entered (which the insured/debtor satisfies by establishing the trust).

The Fuller-Austin court does not frame the question this way, and it is unclear to me whether procedurally this is precisely how the issue was served up. But the court is unequivocal in declining the follow the Seventh Circuit’s UNR decision on this point, which concededly was decided prior to the enactment of 524(g). (Notably, there is no evidence of which I am aware that Congress in enacting 524(g) intended to overturn the UNR decision.) For future bankruptcies, the Fuller-Austin decision may be inapposite or at least unpersuasive on this point.

Relatedly, the court concluded that the value of the claims of the asbestos claimants were measured by the percentage recovery they obtain from the trust rather than the “full” value of their claims. In other words, because of the limited assets of the debtor-insured, the asbestos claimants were to receive only a percentage of the value of their claims (say, 45¢ on the dollar). The court paid little heed to the standard policy provision and statutorily imposed term that the insured’s bankruptcy or insolvency was not to reduce the insurer’s obligation. This policy provision was intended expressly to overcome decisions early last century where an insurer skated out of its obligations because its insured was (otherwise) impecunious and thus was not obligated to pay for the claimant’s full damages. The California court again declined to follow the UNR decision on this point. Excusing the insurers on this basis improperly favors their interests over that of the tort claimants and indeed other asbestos defendants, which will be exposed to the shortfall under joint-and-several liability principles.

The court further addressed issues dealing with the fairness of the trial-court’s jury instructions, including one that effectively presumed the existence of coverage and required the insurers to disprove that their policies were triggered or provided coverage.

What are the implications of Fuller-Austin for asbestos and mass-tort driven bankruptcies? First, it seems likely that the case will stand within the California court system because review by the California Supreme Court seems unlikely. Second, the parties upon retrial will be litigating whether the plan was a fair estimate of the insured’s liability. Assuming the settlement will be found to reasonably approximate the insured’s liability, the insurers will be required to perform only as and to the extent that claims are resolved by the trust. The likely finality of the appellate court’s ruling that the insurers’ obligations are not accelerated and are measured only by the actual payouts are the twin pillars of the excess insurers’ victory.

It’s fair to say the Fuller-Austin decision represents a major win for insurers, but the losers are the asbestos claimants (and their lawyers). The policyholder has received its discharge through the bankruptcy process and under 524(g) is protected against future asbestos-liability claims. The insurers have become increasingly aggressive and litigious in all the spate of asbestos-driven bankruptcies, and Fuller-Austin will not quell their enthusiasm for battle.

Posted by Marc Mayerson at 10:37 AM | Comments (1) | TrackBack

December 15, 2005

Triggering Asbestos Coverage: Creating Gaps

Asbestos coverage cases continue to wend their way through the appellate courts. The Massachusetts Supreme Judicial Court recently weighed in on the question of trigger, nondisclosure, and the obligations of guaranty funds that back now-insolvent insurance companies. AW Chesterton Co. v. Massachusetts Insurers Insolvency Fund (Mass. Dec. 12, 2005).

States sponsor guaranty funds to step in the shoes of insolvent insurance companies with respect to “covered claims.” In Chesterton, the insolvent carrier was Midland, which had issued four insurance policies to a Massachusetts company, Chesterton, that manufactured and distributed products that included asbestos.

Although the court held that Chesterton had not intentionally defrauded Midland into selling it insurance in the 1980s as the asbestos liability wave was gathering strength, the court nonetheless ruled that the fourth policy that Chesterton purchased was void because it failed to affirmatively bring to Midland’s attention the increasing number of claims against it and its overall concern over asbestos-related liability. The court found this nondisclosure to be material in part because, when Chesterton had sought a renewal of the fourth policy from Midland and at that time disclosed its increasing profile as an asbestos defendant Midland declined to renew. While the ruling on these points in Chesterton is largely fact specific, of general import are the rulings that the guaranty fund has standing to assert such a claim on behalf of the now-defunct carrier and that laches would not lie to bar the nondisclosure defense (absent some extraordinary circumstance).

The Supreme Judicial Court’s ruling on trigger of coverage has broader implications, a ruling that is a mixed bag for policyholders. The court recognized that the prevailing approach is to consider any of initial exposure, persistence of asbestos fibers in the body, and manifestation of actual asbestos-related disease or impairment all to be triggering events – i.e., the court sided with the “injury” or continuing-injury trigger that the plain language of standard policies contemplate. But the Chesterton court departed from this rule regarding one Midland policy, joining another case involving Midland and some other, uncited cases (including a Sixth Circuit case decided this year) and held that the cause of the injury must occur during the policy period for the policy to be triggered.

The court focused on an insuring agreement that provided that the insurer will pay ultimate net loss in excess of the underlying limit for damages because of bodily injury “caused by an occurrence anywhere during the policy period.” The court ruled that the event that must take place during the policy period in order to activate coverage was the “occurrence.”

Ruling that the occurrence was the cause of the injury, the Chesterton court held that what triggered coverage was exposure to asbestos during the policy period; accordingly, unless a plaintiff suffered (new) exposure during the policy period, the Midland policy did not apply.

The court followed the decision of a New York court, In Matter of the Liquidation of Midland Ins. Co. 164 Misc. 2d 363 (N.Y. sup. Ct. 1994), aff’d, 269 A.D. 30, 71 (N.Y. 2000). The Massachusetts high court rejected Chesterton’s ambiguity arguments, including the holding of the First Circuit on this point in Eagle-Picher Indus., Inc. v. Liberty Mut. Ins. Co., 682 F.2d 12, 24 (1st Cir. 1982).

As the court held: “We conclude that the trigger event under the . .. . Midland policies is the exposure to, or inhalation of asbestos, which results in the injury, and not the injury itself. The continuing progression of the asbestos-related disease, without some initial, or subsequent, exposure to asbestos during the effective dates of those policies, will not trigger coverage.” The court further rejected Chesterton’s argument that the continuing assault on the body internally from the presence of asbestos fibers amounted to exposure of new cells to injury, thus triggering the coverage. Id. at n. 12.

In addition to the New York decision in Midland and the new Massachusetts ruling in Chesterton, a handful of courts have ruled policies were triggered not by injury during the policy period but rather from the occurrence during the policy period of the cause of injury. State Farm Ins. Co. v. McGowan, (6th Cir. Aug. 31, 2005) (rejecting argument that occurrence requires “actionable” negligence, which entails the existence of injury as an element of proof); Babcock & Wilcox Co. v. Arkwright-Boston Mfr. Mut. Ins. Co.., 53 F.3d 762 (6th Cir. 1995); Public Serv. Elec. & Gas Co. v. Certain Underwriters at Lloyd's of London, 1994 U.S. Dist. LEXIS 21072 (D.N.J. 1994); Ins. Co. of N. Am. v. Sam Harris Constr. Inc., 22 Cal.3d 409 (1978)(where “occurrence” was undefined, “negligent maintenance of the plane within the policy period was an occurrence covered by the policy even though the accident caused thereby did not happen until after the policy period had expire”).

Some of these rulings on trigger are favorable to the policyholder and the court finding that the uncertainty of the policy language compels in the coverage-promoting construction. Some of these rulings, however, like Chesterton, are contra coverage; what the courts fail to grapple with is the substantial disruption in the coverage program that these “event” trigger rulings create. In other words, instead of a comprehensive coverage program with annual primary and excess policies that together respond, these event-trigger rulings create gaps in the coverage – gaps that are largely unexpected ex ante by the policyholder. Given the overwhelming custom and usage in the insurance industry and the structure of most corporate insurance programs, courts should be highly reluctant to find that a one set of policies within a coherent purchasing program has a different trigger, unless (i) there is contemporaneous evidence that this different result was disclosed/discussed at the time of policy purchase and (ii) some pricing difference is palpable to confirm the underwriting intent and the policyholder’s assuming of the risk of the disjunction in trigger. There is no indication in Chesterton that there was an affirmative intention by either Midland or Chesterton to change the trigger in the final policy. In the absence of such confirmatory evidence, the event-trigger arguments of carriers in service of a denial of coverage should not be found to be persuasive.

Posted by Marc Mayerson at 11:52 AM | Comments (0) | TrackBack

December 1, 2005

E Pluribus Plures: More on Number of Occurrences

Courts continue to confront the question of the “number of occurrences” involved in mass-tort situations. The issue is important because policy limits are expressed in dollars per occurrence, with some policies having unlimited or uncapped retentions on a per-occurrence basis. For a policyholder with a large and uncapped per-occurrence retention, a ruling that each claim against the policyholder is a separate occurrence results in multiplying the amounts retained by the policyholder, oft times pushing insurance out of reach. On the other hand, for a policyholder with no or low retentions, a finding of multiple occurrences can multiply the available coverage.

The number-of-occurrences questions also will determine the responsibility of the primary- versus the excess-layer carriers. A single occurrence in a mass tort situation means that the primary will pay one policy limit (plus defense costs) and the remaining claims will be pushed up to the excess carriers. Sometimes, a single-occurrence ruling can result in the policyholder’s picking up the cost of loss in excess of the top line of its coverage. On the other hand, if more than one occurrence is found, the policyholder may be able to wring more money out of the insurance program, depending on the aggregate limits of the coverage it purchased.

Recent cases continue to reach divergent results, even though the courts involved all purport to apply the same “cause” test, that is, the number of occurrences is determined by the cause(s) of the loss. (Some courts from time to time have found that the number of occurrences is determined by the “effects” that is, how many victims there are; this is not the majority approach, and most jurisdictions for at least the past 80 years have employed the cause test. Hyer v. Inter-Insurance Exchange of Automobile Club, 77 Cal. App. 343 (1926)).

One case arises in the asbestos bodily injury context, Uniroyal, Inc. v. American Re-Insurance Co., No. A-6718-02T1(N.J. App. Div. Sept. 13, 2005). In that case, the policyholder had spent well over $300 million in responding to asbestos claims arising from its products. The court found that “occurrence” means an “unfortunate event,” and the question presented was whether each exposed-worker constituted a separate occurrence (in which event the excess insurer would have no obligation to perform in view of the large, uncapped retention borne by Uniroyal). The appellate court reversed the trial court decision and elected not a follow a decision by a federal court in prior case involving Uniroyal, dealing with Agent Orange, which held that the mass-liability injury claims there arose from a single occurrence. In a lengthy opinion construing New York law, the New Jersey court held that “the [defining] event is not the corporate decision to engage in the product line but rather it is the individual exposure of each claimant to the product that resulted in the injury.” (p. 30-31)

(The whole Uniroyal decision was a train wreck for the policyholder – or whatever its opposite is for the insurance carriers: (i) the court also ruled that only one per-occurrence limit is available under a three-year policy, whereas separate annual limits would have applied had the policyholder purchased successive one-year policies; (ii) the court held that an excess carrier owes no obligation to reimburse defense costs except as an incident to a covered indemnity claim, meaning that unlike primary policies potentially covered claims are not covered by the defense obligation but only actually covered claims are and that successfully defended cases are not covered at all; (iii) the court held that a “stub” policy did not afford separate policy limits but instead merely extended the policy period of the expiring policy; (iv) the court ruled that amounts should be allocated to Uniroyal as a self-insurer beginning in the mid 1970s because asbestos coverage was still “available” in theory and thus Uniroyal was deemed to have consciously self-insured its multi-hundred million dollar asbestos exposures and should therefore be allocated a share as if it were a commercial insurer; and (v) the court largely reversed the trial-court’s award of attorneys’ fees to Uniroyal, remanding for further evaluation and substantial reduction of the trial-court’s original award. Uniroyal lost every single issue on appeal in the court’s 65-page opinion.)

In contrast to the Uniroyal court’s multiple-occurrence ruling, the South Carolina Supreme Court recently addressed the number-of-occurrence question not in the context of asbestos bodily injury claims but in connection with another mass-tort: the exterior insulation finishing systems (EIFS) cases. EIFS is a fake stucco used to decorate the exterior of buildings, mainly houses; this finish was quite popular for a while last century, but many EIFS installations allowed water to penetrate in a manner where it was trapped, leading to rot and mold. Fixing buildings with faulty EIFS requires significant remediation and significant expense, spawning an entire mass-tort cottage industry and naturally follow-on insurance-coverage disputes.

The question presented in Owners Ins. Co. v. Salmonsen (S.C. Nov. 7, 2005), was whether a company that distributed Parex, one of the EIFS systems, was entitled to coverage for one limit only or whether it could collect for as many occurrences as the aggregate limit permits. The federal district court ruled that coverage applied generally, but certified the number-of-occurrences question to the South Carolina Supreme Court.

Reframing the question from whether state law applies the majority (cause) or minority (effect) rule for determining the number of occurrence, the South Carolina high court identified the issue as “Is each individual sale of a defective product an occurrence or is the general act of distribution a single occurrence.”

The court rejected articulating any single rule and instead focused “narrowly on the issue at hand.” The court characterized the facts as involving the “distribution of inherently defective goods” and not the “defective distribution of otherwise satisfactory goods.” In the latter instance, each defective distribution – or independent act of negligence – would constitute a separate occurrence (as in Michigan Chem. Corp. v. American Home Assur. Co., 728 F.2d 374 (6th Cir. 1984), where a distributor shipped the wrong product on several, unrelated occasion producing losses to its customers). Reasoning that “the distributor has taken no distinct action giving rise to liability for each sale, we conclude . . . . that placing a defective product into the stream of commerce is one occurrence.”

Accordingly, the insurer carrier was liable only for one per-occurrence limit of $1 million rather than being exposed to pay its entire aggregate limit.

In both the Uniroyal and Salmonsen cases, the courts reached opposite number-of-occurrence rulings but in each instance the ruling favored the insurance companies. The appellate decision from the Third Circuit earlier this year in Treesdale was a one-occurrence result for asbestos bodily injury claims and had the result, like the opposite holding in Uniroyal, of favoring the insurance company. In the World Trade Center litigation, the court concluded that there was but one occurrence, again a result favoring the insurance carriers. In these cases, the policyholder has already run the gantlet of coverage defenses and has proved that coverage applies -- only to find no or little (or less-than-expected) coverage based on the court’s number-of-occurrences ruling. While I am not prepared to pronounce a trend that the carrier always wins, for many years the assumed result among insurance-coverage practitioners (both carrier-side and policyholder attorneys) was that the court would adopt the number-of-occurrence result that would maximize coverage for the policyholder. Surely that assumption can no longer be made so facilely.

Posted by Marc Mayerson at 12:52 PM | Comments (3) | TrackBack

October 15, 2005

Targeting Policyholder Counsel in Asbestos Bankruptcy Cases

Asbestos liabilities have caused a number of companies to seek the protection of the bankruptcy laws to manage the present and future stream of tort claims and to facilitate insurance recovery. A special provision of the bankruptcy code was added in 1994 to facilitate the resolution of asbestos claims in bankruptcy, 11 USC 524(g).

A more recent wrinkle in the asbestos-driven bankruptcies has been use of “pre-packaging” or “pre-pack” wherein before the bankruptcy filing the debtor and its principal creditors negotiate the resolution and then go to bankruptcy court to obtain judicial imprimatur. For several reasons, the insurers have begun to pull out all stops in fighting against asbestos bankruptcies, most recently attacking counsel for the policyholder, where that insurance counsel was too involved in pre- and post-bankruptcy matters.

One of the major issues for carriers in these asbestos bankruptcies is the potential for radical acceleration of their obligation to pay. Whether in a pre-pack or in a traditional bankruptcy, the asbestos claims are funneled into a trust, which thenceforth makes payment. An important issue from the perspective of insurance companies is that some courts have held, following a Seventh Circuit decision, UNR Indus. Inc. v. Continental Cas. Co., 942 F.2d 1101 (7th Cir. 1991), that upon the creation of the trust the obligations of the insurance companies become due immediately. But cf. Amatex Corp. v. Aetna Cas. & Sur. Co., 97 B.R. 220 (Bankr. E.D. Pa.), aff’d, 102 B.R. 411 (E.D. Pa.), aff’d, 908 F.2d 961 (3d Cir.). So, if the policyholder-debtor anticipates $250 million of claims in the future, once the trust is created the carriers have a present obligation to perform and pay the $250 million, even though the trust itself won’t make immediate payment to individual claimants. For example, a carrier who sits above $200 million in underlying coverage could expect that given an asbestos claim burden of say $25 million a year, it would not be called upon to pay until another decade passes. However, under the Seventh Circuit’s theory, because the insured’s obligation to the creditor class of tort claimants is satisfied and extinguished upon the creation of the trust, that excess carrier’s obligation to pay becomes immediately due.

Because the stakes for insurers in these asbestos bankruptcies are so high, it is in the insurers’ interest to object to the plan and to engage in various tactics designed to gum up the works, including recently challenging whether insurance counsel for the insured can properly represent it.

The Third Circuit in a recent case, In Re Congoleum (3d Cir. Oct. 13, 2005), held that a lawfirm would not be able to continue to serve as counsel, holding that (i) it was important to allow early appellate review of such questions because after a plan was confirmed it would not be likely that the proceeding would be sent back to square one due to the improper selection of counsel and (ii) counsel for the insurance companies had adequate standing to raise questions of conflict of interest of the policyholder’s counsel, due to their independent duty to the court and as members of the bar. The court did not find it necessary to reach the question whether the insurance companies themselves had standing to object to counsel selected by the debtor/policyholder and approved by the principal creditors (the tort claimants).

In the particular case, the lawfirm had been involved in negotiating the claims resolutions and claim-value matrix pre-petition and worked ultimately as co-counsel with the asbestos-plaintiffs’ counsel, due to the shared objective of wringing the maximum amount of money out of the insurance program. Nevertheless, because the settlement permitted the tort claimants to renew their claims against the debtor in the event that insurance money was unavailable and the close ties between the debtor's coverage counsel and the plaintiffs’ lawyers led the court to conclude that counsel had a conflict of interest.

The lawfirm had sought to disclose its differing relationships in its retention letter, but the court questioned whether the disclosures were adequate and whether it had received appropriate and knowing waivers from all concerned. Moreover, the court found that given counsel’s broad-ranging role the conflicts questions could not necessarily be resolved by private waivers, due to the bankruptcy code’s requirement that counsel be disinterested (an objective standard policed by the courts).

The court did not reach the question whether counsel’s fees would need to be disgorged, but noted that in other bankruptcies the same counsel had been found to be ineligible to collect its agreed-upon fees. While it is clear in the circumstances that the debtor and the asbestos-claimant creditors were seeking a resolution that was efficient and that would bring maximal value to the estate, the Third Circuit plainly was concerned with the appearances of integrity, professionalism, and disinterestedness by those involved, especially because in a pre-pack the parties negotiate the “reorganization” in private and seek to clothe their private deal with the blessing of the court. The Third Circuit found it more pressing in those circumstances to be mindful of the appearance of conflicts, and so it ruled that the firm could not serve as debtor’s counsel.

Of course, this detour does not change the business reality of the company's having only limited assets and a large stream of asbestos claims – and the insurance assets being the sole realistic vehicle for resolving the asbestos claims. But since most companies that enter bankruptcy in these circumstances seek to establish a ringfence around their liabilities in part to assure investors of their being in control of their finances, it undermines the goal of establishing certainty to allow these detours and fights over counsel. But given the success insurers have had in challenging counsel the best strategy for debtors is to reduce the likelihood that insurers will be in a position to question the selection of counsel in the first place.

Posted by Marc Mayerson at 1:47 PM | Comments (2) | TrackBack

July 26, 2005

Dissolving Solvent Schemes of Arrangement

Bankruptcy is one option for insolvent companies to manage their obligations to creditors and to provide an efficient mechanism to marshall assets for their benefit; an insolvent insurance company similarly may enter a bankruptcy-like process and pay the claims of its creditors – its policyholders – and marshall its assets (typically reinsurance). Over the past few years, however, we have seen increasing numbers of solvent insurance companies seek to ring fence their liabilities – and lock in profits or at least circumscribe losses – by entering into bankruptcy-like processes by which they forcibly commute their obligations to their policyholders. In 2002, Rhode Island established legislation permitting this type of solvent runoff, but most of the action in this area has been in England for London-market insurers that wrote substantial North American (especially US) risks under broad occurrence policy forms and that now wish to extinguish the long-tail liabilities that naturally follow. Because of a new English decision, however, the ability of London market insurance companies to forcibly terminate their obligations to their policyholders is now in substantial doubt.

London market insurance companies enter what are called “schemes of arrangement” – akin to US Chapter 11 proceedings – in which they seek to reorganize their debts (that is, obligations to policyholders). The advantages for the insurance company from such a scheme are obvious: they achieve finality and potentially release capital back to the company or its parent. The process involves formal application with courts and the division of creditors into classes who have meetings and vote on the proposed scheme. Usually, an application will be made in US bankruptcy court for a section 304 injunction (11 USC § 304), which enjoins US litigation against the company, notwithstanding service-of-suit clauses, and funnels all claims to the English reorganization proceeding. Creditors such as policyholders submit claims by a set bar date, which is the basis for a liquidation of their coverage rights.

Claims of policyholders fall into three basic categories: mature, unpaid claims where the amount of loss is known; mature claims where the policyholder’s liability has yet to be established; and incurred-but-not-reported (“IBNR”) claims which involve injury occurring in the period of the carrier’s coverage but which have yet to be asserted against the policyholder. This all echoes Donald Rumsfield’s famous quatrain:

As we know,

There are known knowns.
There are things we know we know.

We also know
There are known unknowns.
That is to say
We know there are some things
We do not know.

But there are also unknown unknowns,
The ones we don't know
We don't know.

(Feb. 12, 2002, Department of Defense news briefing) The Secretary’s trenchant categorization applies with equal force to characterizing the nature of claims against policyholders covered by occurrence coverage and that are unasserted and unliquidated. Guarding against the risk of future of liability of course is the purpose of the policyholder’s purchase of insurance, and one crucial advantage of occurrence-based coverage is that it applies no matter when the claim is eventually asserted against the policyholder, so long as injury or damage occurred in the period of the carrier’s coverage.

Solvent schemes of arrangement seek to cut off the “inconvenience” of the long tail of claims under occurrence policies by forcing the policyholder into a compulsory commutation (buy-back) of its coverage. Therein lies their vice (from the perspective of policyholders), and the High Court of Justice recently invalidated a solvent scheme of arrangement. The case, In the Matter of the British Aviation Insurance Company Ltd., 2005 EWHC 1621 (Ch.), invalidates the scheme on various technical grounds, such how the voting classes were constituted (see paragraphs 83, 92, 93), and thus the court found itself without jurisdiction to uphold the scheme. More significant, however, is its ruling refusing to sanction solvent schemes of arrangement more broadly on the ground that they unfairly force policyholders to liquidate unknown asbestos and other health hazard claims that may or may not come to fruition. (One remains free always to commute policies voluntarily with an insurer for the known-unknowns and the unknown-unknowns; in a solvent scheme, policyholders are forced to liquidate coverage for their IBNR claims.)

In refusing to uphold the scheme essentially on the grounds of fundamental unfairness, Mr. Justice Lewison distinguished the situation of ordinary policyholders from that of insurance companies that may have inwards and outwards reinsurance with British Aviation Insurance Company (BAIC).

“Unlike the direct insureds, the insurers are in the risk business. Given the uncertainties of the extent of potential exposure to asbestos and other long-tail claims, it makes perfect sense for them to be keen to cap their liabilities. If the Company’s liabilities are capped, so are their liabilities as reinsurers. Their mutual liabilities are set off under the scheme. This does not apply to the direct insureds, who remain liable to those who contract asbestos-related diseases.”

(Paragraph 121) The direct insureds, the policyholders, thus face the prospect (were the scheme approved) of facing greater liabilities than were the basis for the claims estimation, yielding a gap in coverage to which they otherwise would have been entitled had the insurer simply continued in its solvent runoff. As the court explains, “So far as policyholders with IBNR claims are concerned, their right in a solvent run-off is to wait and see whether a claim materializes, and if it does, to have full indemnity against the claim. They have already paid their premiums for the insurance cover, so they are at risk of no further expenditure in relation to a valid claim.” (Paragraph 90). There is no risk of the insureds receiving less than that to which they are entitled if the insurance company simply pays claims as they come due.

In contrast, in the proposed solvent scheme of arrangement, in which the policyholders’ rights are cut off and liquidated, the very risk transfer the policyholder sought to achieve may be turned back to the policyholder involuntarily. As Mr. Justice Lewison explains:

“[It is] unfair to require the manufacturers who have bought insurance policies designed to cast the risk of exposure to asbestos claims on insurers to have that risk compulsorily retransferred to them. The Company is in the risk business; and they are not. This is not a case of an insolvent company to which quite different considerations apply. . . .[T]he Company is able to meet its liabilities under such policies as and when they fall due. The purpose of the scheme is to allow surplus funds to be returned to shareholders in preference to satisfying the legitimate claims of creditors. No matter how useable and reasonable [a claims] estimate may be, the very fact that it is an estimate is likely to make it an inaccurate forecast of the actual liabilities of policyholders. If individual policyholders wish to compound the Company’s contingent liabilities to them, and to accept payment in full of an estimate of their claims, there is nothing to stop them doing so. But to compel dissentients to do so would . . . require them to do that which it is unreasonable to require them to do.”

(Paragraph 143) Although the discussion of the fundamental unfairness of solvent schemes technically may be an alternative holding of the court, the breadth and power of the court’s analysis surely casts a pall on their continued popularity. On a going-forward basis, policyholders receiving notice of a solvent scheme of arrangement should arrange to vote in the creditors’ meeting and object on grounds of fundamental unfairness (and consider whether it is appropriate to object to the constitution of the creditor classes). For those solvent schemes that have been approved by a majority, the court retains continuing jurisdiction, and previous objectors presumably may be able to renew their objections. (For a recommended treatise about the English insurance insolvency process, see here.)

A solvent scheme is a mechanism that is too clever by half. Mr. Justice Lewison's decision has become final, and no appeal was taken. Time will tell whether we’ll continue to see this particular form of scheming by solvent companies to cauterize their liabilities under the very broad coverage they sold to US policyholders.

A version of this article was published in 22 Tolley's Insolvency Law & Practice 23(London 2006).

Posted by Marc Mayerson at 5:29 PM | Comments (3) | TrackBack