Insurance Scrawl: CGL Archives

February 18, 2008

Insurability of Punitive Damages -- Texas Style

It's not as if the only cases I read these days are from the former independent nation of Texas, but the Texas Supreme Court is on a roll in clearing out its backlog of important insurance cases, some involving additional insured coverage (and here), and a new important decision on the insurability of punitive damages.

One of the great myths in the insurance industry is that punitive damages are not insurable. This is false, particularly considering that the majority of US jurisdictions allow coverage for punitive damages at least in some circumstances. The argument against coverage in premised on the notion that it would undermine the deterrent effect of imposing punitive damages were the defendant able to in turn seek insurance recovery. A century ago the same debate in the same terms was had over whether liability insurance policies were themselves contracts violative of public policy, since it would undermine the deterrent effect of imposing tort liabiltiy were the defendant able to in turn seek insurance recovery. See Mary McNeely, Illegality as a Factor in Liability Insurance, 41 Col. L. Rev. 26 (1941) (an excellent early analysis of some of these questions). As McNeely wrote three score years ago, "Throughout its history the insurance device has been alternatively hailed as a promoter of communal welfare and damned as a generator of evil."

So too is framed the interesting recapitulation of these familiar polarities from the majority and (main) concurring opinions in Texas. Fairfield Ins. Co. v. Stephens Martin Paving LP (Texas Feb. 15, 2008).

What I would add is that the data and more rigorous theoretical analyses do not suggest there is a major "moral hazard" problem in liability insurance, see C. Heimer, Reactive Risk and Rational Action: Managing Moral Hazard in Insurance Contracts (1985). And courts should not assume a set of governing facts without evidence (for given the data here the easy assumption that allowing indemnification "encourages" misconduct is surely problematic and not a proper subject for judicial notice). This is not to suggest that there isn't lazy underwriting -- insurers should vet their potential insureds to see if they might be the kind of of folks or companies to engage in misdeeds. But as the Texas majority holds, the principle of freedom of contract should allow whatever coverage is provided by the contract terms -- and if insurers do not want to cover punitive damages in their policies, they can say that.

Posted by Marc Mayerson at 3:59 PM | Comments (0) | TrackBack

February 2, 2008

Cleaning Up the Mess in Texas: Insurer Funding Payment of Liability Claims When Coverage Is Doubted

In May 2005, the Texas Supreme Court unanimously held that a liability insurer that voluntarily settles a claim against an insured may recover the payment against its own insured if it proves that the claim is uncovered and it reserved its right to seek recoupment. The Texas Supreme Court, while unanimous in result, was badly splintered in rationale.

Two years ago, the Court granted rehearing. Yesterday, the Court changed course, with a majority ruling that an insurer does not have a unilateral right or an equitable claim to recover a settlement payment. Excess Underwriters v. Frank's Casing (Tex. Feb. 1, 2008). The court reaffirmed its prior decision in Matagorda County, which barred a primary insurer from seeking recoupment of defense cost. Recent case law in other jurisdictions have split on the issue, but the more robust recent opinions (Illinois, Massachusetts, Wyoming) line up with Texas.

I analyzed the Supreme Court’s original opinion from May 2005 at some length previously, criticizing it fairly strongly on a number of its points and approaches. In the new iteration issued yesterday, the three opinions (majority and two dissents) adopt three approaches: (i) the contract is silent and insurers should fix the drafting omission; (ii) the contract is silent but equity should balance out the resolution (and generally permit recoupment); and (iii) in this particular instance, the contract is not so silent that when combined with the facts there was created a new implied in fact or new implied in law agreement to reimburse.

The Frank's Casing case was challenging in that an undeserving insured stood before the court – the insurer owed no obligation to pay. Had the insurer refused to pay, it would not have breached its contract and would not (on this basis) be liable for any bad faith or extra-contractual obligation. And the policyholder did not settle the case in reliance on the insurers forfeiting whatever claim they may have possessed at the time to obtain reimbursement.

The majority, per Justice O’Neil, found there was no fundamental unfairness in allowing the insured to reap the benefit of the settlement even when the claim is shown not to be covered. Settlement paid by the insurer is a welcome relief for the policyholder – unless the “other shoe” drops and the carrier seeks to prove in a separate suit both (i) the tort plaintiff was right and the insured-defendant truly was liable, (ii) the insured’s liability was such that it was entirely excluded from coverage and (iii) the insurer alleges the insured must reimburse it for all the money it paid. This result is essentially worse for the insured than is “rolling the dice” at trial, because if the case is triable then a reasonable jury could rule in favor of the insured. By the insurer’s settling, the insured loses the opportunity to have an outcome whereby it walks scot free.

Faced with a reasonable settlement offer from the tort plaintiff, what is the carrier to do? An insurer surely has a privilege to reject an unreasonable settlement offer, but a reasonable settlement offer cast against doubtful coverage places the insurer in a difficult situation. If the insurer doubts the existence of coverage but later is proven wrong, and the settlement offer was reasonable but spurned, the insurer is at risk of being held liable for the entirety of the verdict against the insured even if the verdict exceeds policy limits. This is a consequence of the law of “third party” bad faith or what is called in Texas “Stowers.” An insurer that unreasonably fails to settle a third-party claim that results in a verdict adverse to the insured is potentially liable for all the damages stemming from its unreasonable conduct, i.e., the value of the verdict that could have been averted had the settlement been accepted.

The insurers and their backers in the Texas Supreme Court found it unfair that the insurer could be set up or pressured to make payment on behalf of an insured yet be unable to prove that coverage was not properly owed. The split between the majority and dissent might be thought of as a difference in opinion whether the insurers are required to put into the policy some sort of provision addressing the situation of a reasonable settlement that might or might not be covered. The majority holds the insurer that fails to clarify its contract on this point bears the consequences, that is, if it makes the payment to extinguish the insured’s liability it does so without recourse against the insured (unless the insured expressly agrees to a right of reimbursement). The articulate dissent by Justice Hecht reasons that because the policy is silent the insurer should be able to pay under protest (i.e., with a reservation) such that it can mount an equitable claim to recover the benefit conferred on the insured that was never owing to begin with (assuming that coverage does not apply).

Justice Hecht’s dissent argues cogently that principles of equity generally permit a party that doubts performance is owed to tendered performance subject to a reservation; the dissent then argues that there is no distinction between insurance companies and other contracting parties. Assuming Justice Hecht is right in his premise on what equity generally provides, policyholders need to fashion a persuasive response as to why insurance is different.

I think the difference lies in the fact that other kinds of contracting parties do something else in the world other than make contracts. If I make widgets and you are a supplier, and you then think that you don’t owe me some delivery, equity (apparently) will permit you to provide performance to me, subject to straightening it all out later. No doubt the parties’ contract does not address this situation, that is, of uncertain obligations to perform, and the law or equity seeks to ensure a fundamentally fair outcome and does not blame the parties for not accounting for this situation ex ante.

That widget makers and their suppliers do not lay out in their contracts what happens in these circumstances is understandable. They are in the business of widgets, and their making a contract is ancillary to what they do. But insurance companies are different.

Insurers are professional contract-writing companies; what they sell are not widgets but contracts. Insurers have the knowledge that there are many circumstances where coverage may be uncertain but a reasonable settlement will be presented. What the insurer may do or may be required to do might be deemed to be something in the insurer’s superior knowledge vis a vis a prospective insured, such that an omission in the contract can be considered to be deliberate by the insurer. Under this approach, an insurer’s failure to clarify what might happen in a situation that is not altogether unlikely to arise can be considered a species of sharp practice such that Justice Hecht’s equitable remedy will not lie. It is well established that he who seeks equity must do equity, and that doctrines such as unclean hands will preclude the exercise of equity power. Accordingly, while the dissent makes a powerful argument that in an ordinary circumstance payment under protest is allowable and equity will reallocate, an insurer that finds itself in this situation and has not clarified its intentions in its contract has only itself to blame, such that equity should not intervene.

Instead, insurers should write out how such claims will be handled, and allow insurance regulators and market forces to scrutinize and differentiate among insurance products. This is the essence of the holding of the new majority opinion in Frank’s Casing:

We resolved this quandary in Matagorda County, determining that the risk of coverage uncertainties was best placed with the insurer. Id. We reasoned that “[r]equiring the insurer, rather than the insured, to choose a course of action is appropriate because the insurer is in the business of analyzing and allocating risk and is in the best position to assess the viability of its coverage dispute.” Id. at 135. An insurer in this situation has a number of options. If the insurer assesses its coverage position as strong, it may refuse to participate in settlement and rely on its coverage action, leaving the insured to negotiate a settlement with its own resources. Or, an insurer may seek prompt resolution of its coverage dispute, a course we have encouraged insurers in this position to take. Id. at 135 (citing State Farm Fire & Cas. Co. v. Gandy, 925 S.W.2d 696, 714 (Tex. 1996); Farmers Tex. County Mut. Ins. Co. v. Griffin, 955 S.W.2d 81, 84 (Tex. 1997)). Or, if an insurer’s coverage position is difficult to assess, as is sometimes the case, the insurer can leverage the coverage dispute during settlement negotiations to lower the claimant’s demand; by paying the negotiated claim, the insurer eliminates its own potential bad-faith liability, saves defense costs, and avoids protracted coverage litigation with its insured. Or, at the outset, the insurer may include a reimbursement right in the policy, which may yield a lower premium than a policy that does not contain such a right.

Slip op. at 7. Texas joins the high courts of Massachusetts and Illinois, among others, in placing the initial onus on insurers to state their intentions ex ante and not to permit case by case adjudication after the tort claim is settled. An insurer that has a contract that is silent on the point can choose to settle the claim against the insured and fund the settlement, can arrange with the insured to provide it with a loan to fund a settlement while the coverage issues are worked out, or can refuse to pay for a settlement and hope to prove there is no coverage or that its refusal to perform at least was reasonable. There is no reason for courts to create one further remedy for insurers when they are well-positioned to protect themselves at the point of contract. The Texas Supreme Court in its majority opinion contributes to stability in contract relationships and cleans up what had been a real mess conceptually in the initial opinion in Frank’s Casing.

Posted by Marc Mayerson at 9:03 AM | Comments (0) | TrackBack

October 15, 2007

A Dog in the Fight: Policyholder Interest in Inter-Insurer Disputes

When an insurer pays a policyholder’s claim, the insurer sometimes seeks to off-load that payment “vertically”, that is, by suing other insurance companies that issued lower-layer coverage, or “horizontally”, that is, by suing other insurance companies that issued coverage in other policy periods.

When a performing insurer sues an underlying insurer, it typically does so on the theory of equitable subrogation. In those types of claims, the insurer “steps into the shoes” of the policyholder and pursues the policyholder’s chose in action against the nonperforming insurer. E.g., Greater New York Mut. Ins. Co. v. North River Ins. Co., 85 F.3d 1088, 1096 (3d Cir. 1996). The policyholder’s chose typically is assigned contractually or at equity by subrogation to the performing insurer

In any circumstance where one insurer is suing another entity for performance, the insured will have an interest in the policy proceeds to the extent that it has not been “made whole.” Under the “made whole” or “make whole” doctrine, an insurer pursuing a subrogation claim retain the recovery unless and until the policyholder’s loss has been fully indemnified. Thus, in the event the policyholder’s loss exceeds the combined limits of all its coverage, that an overlying insurer has performed and sued a recalcitrant underlying insurer does not mean that that insurer is able to pocket the money from the nonperforming insurer. Instead, as should be reasonably obvious, the policyholder would be entitled to receive the money from the non-performing carrier, even if the overlying performing carrier is the one that brought suit. If the performing carrier succeeds in this suit, then the only consequence to the policyholder should be that the underlying carrier’s payment is to be debited against its policy limits, and the limits of the performing carrier should be refreshed (to the extent that the policyholder has been fully indemnified and there is money left over from the proceeds from the underlying carrier). Cf. Alta California Regional Center v. Fremont Indemnity Co., 25 Cal. App. 4th 455, 466 (1994), overruled on other grounds, 11 Cal. 4th 1, 34 (1995). Once “made whole,” however, most courts are uncomfortable with allowing the prospect that an insured might obtain more than complete recovery, Burns v. Cal. Fair Plan, __ Cal. App. 4th __ (Ct. App. June 25, 2007), but this issue more properly is policed through the collateral-source rule.

When a performing carrier instead brings an action against other insurers that issued policies in successive or prior policy years, its claim can be brought as a subrogation claim (asserting the rights of the insured) or as a contribution or indemnity claim (depending on whether the insurer is seeking partial recovery or full recovery from the nonperforming carriers). Most courts will look to the insurer’s other-insurance clauses as guidance in determine the relative obligations of the different insurers.

The other-insurance clause does not limit the policyholder’s right in the first instance, see Aerojet-General Corp. v. Transport Indem. Co., 17 Cal. 4th 38, 72 (1997) (“Although insurers may be required to make an equitable contribution to defense costs among themselves, that is all: An insured is not required to make such a contribution together with insurers.”); Shade Foods, Inc. v. Innovative Products Sales & Marketing, Inc., 78 Cal. App. 4th 847, 909 (2000) (“The other-insurance clause . . . does not excuse the insurer from discharging its independent obligation to indemnify the insured up to policy limits.”). Indeed, there is authority holding that it is bad-faith for an insurer to deny performance to the insured by pointing to another insurer. Silberg v. California Life Ins. Co., 11 Cal. 3d 452, 460 (1974). An other-insurance clause is not a “sue other insurance” obligation on the insured. Rhone-Poulenc Inc. v. International Ins. Co., 71 F.3d 1299 (7th Cir. 1996).

When an insurer pays the insured’s claim, it may want to look around to other insurers to see whether the policies they issued also have an obligation to perform. Insureds may have an interest, however, in the dispute between one insurer and another. That it has an interest does not mean that the insured necessarily can preclude contribution actions.

Some states allow an insured to target its insurance coverage and in effect preclude one insurer from suing another horizontally. For example, in Casualty Indem. Exchange Ins. Co. v. Liberty National Fire Ins. Co., 902 F. Supp. 1235 (D. Mont. 1995), the insured failed to provide notice of a suit to one of its insurers yet obtained recovery from another. The performing insurer sought contribution but the court ruled that principles of equity did not allow it to force contribution from an insurer with a valid notice defense. Id. at 1239. Rather than simply failing to provide notice, sometimes insureds make the deliberate choice not to select an insurer to provide performance; in such circumstances, the question is whether that election precludes a contribution claim. In Illinois, for example, the answer clearly is yes. Under Institute of London Underwriters v. Hartford Fire Ins. Co., 234 Ill. App. 3d 70 (1992), the court upheld a “targeted tender” of the defense and insulated the non-targeted insurer from equitable contribution/indemnity claims.

Most courts, however, have found that one insurer should be permitted to seek recovery against another. E.g., Insurance Co. of North America v. Travelers Ins. Co., 118 Ohio App. 3d 302, 314 (1997) (“applying the principles of equity and natural justice, the secondary insurer possesses an equitable right to recover from the primary insurer, as well as a right to recover by way of subrogation under the policy.”). But does an insurer have any obligation relative to its own insured not to seek contribution? In Mitchell, Silberberg & Knupp v. Yosemite, 58 Cal. App. 4th 389 (1997), the insured had been sued and several of its insurers agreed to settle the claim, subject to a reservation of rights among the insurers. In the later contribution action, one of the insurers contended that its policy never provided coverage to begin with, and thus it was entitled to contribution/indemnification. The insurer against which contribution was sought at the same time also was providing coverage for other claims against the insured. If it paid the contribution claim, the insurer would not have any limits available to pay for these other claims. The insured in response brought suit against Yosemite (the carrier that sought contribution), contending that it had breached its duty of good faith and fair dealing by paying to settle and then contending it had no obligation whatsoever, with the result being that its other coverage was unduly impaired. The court rejected the contention that the excess insurer’s failure to reserve its rights against its own insured when paying the original settlement effected a waiver of its right to deny its coverage obligation ab initio in the subsequent litigation with the other carriers.

Consequently, an insurer in general breaches no duty to its insured when it seeks to pursue contribution against another insurance company issuing similar coverage at the same layer/risk. E.g., Illinois Emcasco Co. v. Continental Cas. Co., 487 N.E.2d 1110 (Ill. App. 1985); cf. Guaranty Nat’l Ins. Co. v. American Motorists Ins. Co., 981 F.2d 1108, 1109 (9th Cir. 1992) (discussing primary, true excess and “excess by coincidence” coverages). This is true when the effect on the policyholder from the contribution action is indirect, that is, a successful contribution action affects the policyholder’s ability to obtain performance with respect to other claims.

An insurer, however, may not obtain contribution from “other insurance” when if successful the contribution action would result in a money award that comes from the policyholder’s own pocket, at least in part. While it may not be bad faith for an insurer to pursue contribution, the insurer can obtain contribution only from “other insurance.” Many commercial policyholders have various forms of “fronting” arrangements with insurers, so the question arises whether an initially targeted insurer may obtain contribution from an insurer that in turn will demand reimbursement from the policyholder pursuant to a side indemnity agreement, captive reinsurance arrangement, or matching deductible program. See Gabe’s Constr. Co. v. United Capitol Ins. Co., 539 N.W.2d 144, 148 (Iowa 1995).

For example, a Florida appellate court held that an employer’s $1 million deductible was not “other insurance” subject to contribution from a performing insurer. State Farm Mut. Auto. Ins. Co. v. Universal Atlas Cement Co., 406 So.2d 1184 (Fla. Dist. Ct. App. 1981); see also Wake County Hospital System v. National Cas. Co., 804 F. Supp. 768 (E.D.N.C. 1992). This has been the result in a number of other jurisdictions, e.g., American Fam. Mut. Ins. Co. v. Missouri Power and Light Co., 517 S.W. 2d 110 (Mo. 1974); USX Corp. v. Liberty Mut. Ins. Co., 645 N.E.2d 396 (Ill. App. 1994); Physicians Ins. Co. v. Grandview Hosp. and Medical Center, 542 N.E.2d 706 (Ohio App. 1988); Hertz Corp. v. Robineau, 6 S.W.3d 332 (Tex. App. 1999). Courts have looked to the economic substance of transactions to determine whether these are insurance – and thus even within the purview of “other insurance” clauses. E.g., Lawyers Title Ins. Co. v. Norwest Corp., 493 S.E.2d 114 (Va. 1997); State v. Continental Cas. Co., 879 P.2d 111, 1116 (Idaho 1994). As the Idaho court explained, “[t]he nature of ‘self-insurance,’ and the fact that it is not a form of insurance, is well-established. . . . Because ‘self-insurance’ does not involve a transfer of the risk of loss, but a retention of that risk, it is not insurance. [A] payment of . . . losses [that] was a matter of ‘self-insurance’, rather than insurance, . . . did not trigger the ‘other insurance’ clause in Continental’s policy.” Id. at 1116. Cf. Clougherty Packing Co. v. Commissioner, 811 F.2d 1297 (9th Cir. 1987) (captive-issued policies are not insurance).

Thus, various forms of fronting arrangements are not considered “other and valid collectible insurance” within the meaning of an other-insurance clause. Citgo Petroleum Corp. v. Yeargin, Inc., 690 So.2d 154 (La. App. 1997). This is true even where the self-insurance or fronted component is administered by an entity other than the insured in the first instance. State Farm Mut. Auto. Ins. Co. v. Universal Atlas Cement Co., 406 So.2d 1184 (Fla. Dist. Ct. App. 1981). Accordingly, an insurer that is targeted for performance from the insured cannot pursue contribution from other insurance companies where the result of a successful contribution action would be for the policyholder to pay in part for the claim. Any other result would defeat the substance of the policyholder’s transaction with the originally targeted insurer, whereby it sought to transfer the risk of loss away from itself to its insurers.

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A Dog in the Fight: Policyholder Interest in Inter-Insurer Disputes

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May 21, 2007

Odoriferous Occurrence

Anaerobic decomposition produces among other things hydrogen sulfide gas. It is this gas that makes flatulents distinctive from, shall we say, the bouquet of a rose. This was illustrated in a recent coverage case involving a Minnesota pig farm that created a concrete lagoon with capacity to hold 1.5 million gallons of manure. Three-quarters of a mile away was a neighbor’s home.

The homeowners were none too pleased with the “extremely noxious and offensive odors and gases” that impeded their enjoyment of their home; so they sued the pig farmer for, among other things, creating a nuisance. The farmer turned to its insurer to defend arguing there was covered property damage – the homeowners’ loss of the use and enjoyment of their property (i.e., loss of use of tangible property that is not physically injured) arising from an occurrence.

Overturning part of the ruling of the trial court in favor of the insurance company, the Minnesota Court of Appeals held that the choice to locate the manure lagoon, while deliberate, resulted in an occurrence. Wakefield Pork, Inc. v. RAM Mut. Ins. Co., (Minn. App. May 15, 2007). The lagoon was in compliance with state environmental regulation and zoning ordinances. As a result the Minnesota court reasoned: “it would be inconsistent for this court to acknowledge, on the one hand, that appellant’s hog operation is legally operated and fully compliant with all applicable regulations, but to conclude, on the other hand, that appellant acted with a willful disregard or intent to harm its neighbors.” Slip op. Reasoning that the insurance company would have known at the time of underwriting that pig farms produced noxious gases, the court was reluctant to hold that the ordinary operations of the farm was uninsurable.

Nevertheless, the court held that the policy did not provide coverage because of the pollution exclusion, which barred coverage for liability on account of “fumes.” Because foul odors – or porcine odors – were gases released from the decomposition process, the Minnesota court held these were plainly encompassed within the pollution exclusion. As a result, the insurer had no duty to defend.

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Odoriferous Occurrence

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February 18, 2007

Does a Court's (Reversed) Disparagement of the Policyholder's Coverage Claim Alone Eviscerate Its Bad-Faith Claim?

A common enough scenario in a liability-insurance case: the parties file cross-motions for summary judgment, with the insurer arguing it has no duty to defend. In Acme United Corp. v. St. Paul Fire & Marine Ins. Co. (7th Cir. Jan. 9, 2007), the question presented was whether an advertising injury liability insurance policy provided coverage for a suit against the insured for product disparagement. In Acme, the district court accepted the argument of the insurer, thus cutting off the ability of the policyholder to obtain recovery of the defense costs it had run up. Where, as here, the appellate court reverses and finds coverage, does the district court's now-reversed ruling effectively impale the policyholder's bad-faith claim?

Acme manufacturers scissors and paper trimming products and advertised that its products were better because they contained titanium. The question naturally arises -- “better”? "better" than what? Fiskars, another scissors manufacturer, believed that Acme was dissing its products, and Fiskars sued on the ground that there really wasn’t titanium in Acme’s products or that it was negligible or not on the blade or didn’t keep Acme’s scissors extra sharp when tested against Fiskars' products that used only stainless steel. Acme turned to St. Paul and asked for a defense, which St. Paul denied.

St. Paul's policy provided coverage for “advertising injury offense” which was defined in part to be “[m]aking known . . . . material that disparages the . . . products of others.” The district court agreed with Acme that its promotional materials constituted advertising and were disparaging of stainless-steel blades, but granted summary judgment to St. Paul on the ground that the disparagement was not of Fiskars’ products specifically.

The Seventh Circuit agreed that the advertising by Acme was disparaging, finding that disparagement results when a “false comparison” is made or when advertising “bring[s] reproach . . . by comparing with something inferior.’” Slip op. at 6 (citing dictionaries). In looking at Fiskars’ complaint against Acme, the appeals court reasoned that “[w]hile Fiskars did not allege that Acme actually named Fiskars’ products in the text of its advertisement, Fiskars’ underlying complaint specifically alleged that Acme’s advertisements were directed at Fiskars’ products and that Fiskars lost sales to Acme as a result.” Slip op. at 7. Accordingly, “Acme disparaged Fiskars products through a false comparison between its products and [implicitly] Fiskars’ products.” Id. As a result, even assuming that the policy requires a specific “other” in the disparaging of “products of others,” the complaint alleged sufficient facts to indicate the disparagement was of Fiskars even without Fiskars being named. As a result, the Seventh Circuit reversed the grant of summary judgment in favor of St. Paul and directed that summary judgment on the duty to defend be instead granted to Acme. (Any further argument that the Acme's ads were not sufficiently focused on Fiskars instead of the broad class of paper-cutting devices presumably should be advanced in the underlying case that should be being defended by the insurer.)

When St. Paul won at the trial court on its motion for summary judgment, we can assume that the district judge endevored to construe the facts in the light most favorable to the nonmoving party, Acme, construed any uncertain or ambiguous policy language in favor of the insured, Acme, but concluded that St. Paul was entitled to judgment as a matter of law. The Seventh Circuit disagreed and not only found that summary judgment should not be granted in favor of St. Paul (such that the matter should be remanded for trial), but in reversing the district court ruling it directed that summary judgment should be entered in favor of Acme.

Yet, the question arises whether St. Paul is inoculated against a bad-faith claim on the ground that even though its coverage determination was wrong it was at least a reasonable one – given that the district court judge agreed with it and entered summary judgment in its favor. Putting the question more broadly, if an insurer wins a summary judgment ruling on coverage does it simultaneously show that there are no circumstances that would support the policyholder's bad-faith claim (with respect to the coverage decision itself).

In general, insurers face first-party bad-faith liability only if they deny a claim unreasonably and without proper cause. Here, St. Paul may argue that the district court’s decision in its favor perforce shows that its decision was reasonable. Accordingly, so the argument would go, it cannot be held liable for bad faith.

The California Court of Appeal has addressed the question whether a trial-court victory by an insurer insulates its from bad-faith liability on the ground that the decision alone demonstrates that there was a genuine issue as to coverage (and thus the insurer’s denial of coverage even if erroneously was reasonable). In Filippo Industries, Inc. v. Sun Ins. Co., 74 Cal.App.4th 1429 (Cal. App. 1999), the insurer argued that the trial-court ruling in its favor – though reversed on appeal – established that its interpretation had a sufficient basis as to evidence a genuine-issue as to whether coverage applied. In effect, the carrier argued that a trial court ruling in its favor alone precludes bad faith as a matter of law.

The California appellate court rejected this proposition, reasoning:

“We certainly have great faith in the sagacity and reasonableness of trial judges but we decline to impute infallibility to any court, trial or appellate. . . . . Mistakes happen, but . . . that mistake should [not] automatically result in depriving an insured of [its bad-faith claim].”

Insurers are required to construe uncertain policy language or unclear facts in favor of coverage; consequently, they may not rely on ambiguous policy language to argue there is a legitimate dispute and thus no bad faith. Employees Benefit Ass’n v. Grissett, 732 So.2d 968, 976 (Ala. 1998) (“[I]n a ‘normal’ case, the insurer cannot use ambiguity in the contracts as a basis for claiming a debatable reason not to pay the claim.”); Mixson, Inc. v. Am. Loyalty Ins. Co., 562 S.E.2d 659 (S.C. App. 2002) (Although no legal precedent on point, common meaning of disputed term indicated that insurer’s contrary construction was unreasonable.); Lucas v. State Farm Fire & Cas. Co., 963 P.2d 357 (Idaho 1998) (uncertain or disputed factual record insufficient to preclude bad faith claim).

A trial court’s erroneous ruling on the question of coverage is not sufficient to show that the insurer’s original coverage denial was reasonable at the time it was made. See generally Sobley v. S. Natural Gas Co., 210 F.3d 561 (5th Cir. 2000). Indeed, at trial of the bad-faith claim, the court should preclude the insurer even from offering into evidence the erroneous trial court ruling for a number of reasons, including: (i) because the court’s decision post-dates the coverage determination the decision itself is irrelevant as a matter of law; (ii) an erroneous ruling by a trial court does not establish the reasonableness of the carrier’s initial erroneous coverage determination; and (iii) it would be prejudicial to admit the ruling into evidence because it threatens to displace the role of the jury or risks the jurors overweighting the overruled decision.

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Does a Court's (Reversed) Disparagement of the Policyholder's Coverage Claim Alone Eviscerate Its Bad-Faith Claim?

The California appellate court rejected this proposition, reasoning:

“We certainly have great faith in the sagacity and reasonableness of trial judges but we decline to impute infallibility to any court, trial or appellate. . . . . Mistakes happen, but . . . that mistake should [not] automatically result in depriving an insured of [its bad-faith claim].”

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February 10, 2007

Insurers' Duty to Defend their Insureds Against Intentional Torts

The duty to defend undertaken by an insurance company is an essential component of the “peace of mind” coverage provided by liability insurance protection. Given the breadth with which the duty to defend is ordinarily construed by the courts, the defense-cost coverage of a policy is also referred to as “litigation insurance,” that is, insurance against the risk and burden of suits brought against the insured. Disputes have raged over whether that litigation insurance applies, however, to suits against the insured alleging an – or only – intentional tort.

In most states, the test for whether an insurer will have a duty to defend is whether the suit against the insured might eventuate in a judgment covered by the duty to indemnify, that is, the insurance company’s obligation to pay for the damages owed by the insured on account of bodily injury, property damage, or wrongful acts. If the claim against the insured permits proof of a covered indemnity claim, the insurer has a duty to defend. Thus, if a “lesser included offense” would be covered by the duty to indemnify, the insurer has the obligation to mount a defense. E.g., Abrams v. General Star Indem. Co., 67 P.3d 931 (Ore. 2003) (conversion claim).

Naturally, if an insurer has a duty to defend where the claim or suit against the insured (only) might result in a covered judgment, the insurer’s obligation to defend may apply even though the judgment ends up being uncovered. E.g., Tanner v. State Farm Fire & Cas. Co., 874 So.2d 1058 (Ala. 2003); Automobile Ins. Co. v. Cook (N.Y. July 26, 2006). (Note that public policy does not prevent the insurer from having a duty to defend even if that public policy would bar the insurer from indemnifying the insured for its deliberate misconduct. E.g., Horace Mann Ins. Co. v. Barbara B., 4 Cal. 4th 1076 (Cal. 1993).) In this way, the duty to defend is broader than is the duty to indemnify: a claim might need to be defended even if it need not be paid -- or it is uncertain whether initially the claim will need to be paid by the insurance company. E.g., Fresno Econ. Import Used Cars, Inc. v. United States F&G Co., 142 Cal. Rptr. 681, 685 (Cal. App. 1977). (Note if that certainty that there is no duty to indemnify comes into focus from the undisputed facts developed in the underlying case, the insurer may be able to terminate its defense, prospectively. See Firco Inc. v. Fireman's Fund Ins. Co., 343 P.2d 311 (Cal. App. 1959); Mayerson, Insurance Recovery of Litigation Costs, at 1000 & n. 16; see also Sterlite Corp. v. Continental Cas. Co., 458 N.E.2d 338, 344 (Mass. Ct. App. 1983) (holding that an insurer "can, by certain steps, get clear of the duty [to defend] from and after the time when it demonstrates with conclusive effect on the third party that as a matter of fact -- as distinguished from the appearances of the complaint and policy -- the third party cannot establish a claim within the insurance," but that "[w]hat is not permitted is that an insurer shall escape its duty to defend the insured against a liability arising on the face of the complaint and the policy by dint of its own assertion that there is no coverage in fact.") .

But what about the situation where the allegations of the complaint, if true, show there is no duty to indemnify and there is no covered lesser-included offense? Insurers typically argue, often with success, that there is no duty to defend such a complaint. E.g., Farmland Mut. Ins. Co. v. Scruggs, 886 So. 2d 714 (Miss. 2004). The paradigm case involves allegations of an intentional tort against the insured the essential elements of which negate coverage.

The intentional consequences of an intentional act may still be the basis for coverage, where the legal consequences are not anticipated by the insured. The Illinois Court of Appeal addressed a recurring fact pattern recently, where a contractor cut down trees on the wrong property. Finding it “immaterial that the underlying complaint alleges intentional torts,” the Illinois court found that the insured did not expect liability for the physical injury of cutting down the trees. Pekin Ins. Co. v. Miller, 854 N.E.2d 693, 696 (Ill. App. 2006).

Recently, the Eighth Circuit was called upon to get involved with a domestic love triangle, in which the insured had an affair with someone’s wife, and the cuckold filed suit for alienation of affections. The policy provided coverage for “loss,” defined as an “accident . . . which results in bodily injury.” The insurer conceded that the injury at issue was bodily injury (though without any physical harm being alleged, cf. Lavanant v. General Accident Ins. Co., 595 N.E.2d 819 (N.Y. 1992). The insurer denied coverage, however, on the ground that affairs of the heart (or body) are not accidents or, in this case, that the cuckold’s injury was “expected or intended” by the insured.

The Eighth Circuit in Pins v. State Farm Fire and Cas. Co. (8th Cir. Feb. 8, 2007) analyzed the elements of proof for the tort claim of alienation of affections under the applicable law (South Dakota). The court found that “intent to injure the marital relationship” was the sine qua non of the tort. As the court explained, “ ‘the acts must have been done for the very purpose of accomplishing this result.’” Slip op. at 4 (citation omitted). The policyholder argued that the record was not sufficient to find conclusively that he expected/intended injury; but distinguishing prior authority, the Eighth Circuit found there were no circumstances where an “accidental loss was even arguably possible.” Slip op. at 5. The court concluded that proof of the underlying tort ipso facto and ipso jure meant the injury was expected or intended, holding:

[T]he comfort and consortium injuries alleged by [the husband] were sufficient to state a claim for alienation of affections, and under South Dakota law, [the husband] could not recover on this claim unless he proved that Pins intended to cause those specific injuries. In these circumstances, any ‘loss’ to [the husband] was ‘expected or intended’ by Pins and could not be deemed an ‘accident.’ Therefore, State Farm had no contractual duty to defend.

Slip op. at 5. Put differently, the court found that State Farm issued a homeowner’s policy, not a home-wrecker’s policy.

The Eighth Circuit’s conclusion that there was no duty to defend where the elements of proof by definition negated coverage is consistent with a Tenth Circuit opinion decided two months before, Notwen Crop. v. American Economy Ins. Co. (10th Cir. Dec. 1, 2006). The gravamen of the underlying tort in Notwen was that trade secrets were misappropriated and the tortfeasor-insured allegedly used corporate and bankruptcy maneuvers to try to shield its misconduct. While recognizing that unintended consequences of an intentional act still may qualify as covered conduct, the court found that the complaint against Notwen admitted of no such possibility. Compare Cincinnati Ins. Co. v. Eastern Atl. Ins. Co., 260 F.3d 742 (7th Cir. 2001). As in Pins, the policyholder sought to argue that there was a dispute of fact whether it was culpable and that those facts should be aired out in the underlying action – which the insurer should be defending. The Tenth Circuit rejected this argument in part reasoning:

[T]he argument is patently circular, rendering the exclusion of intentional torts from the liability policy meaningless, at least under the circumstances presented here: it asserts, in effect, that a duty to defend against intentional-tort claims excluded under the policy is nevertheless triggered whenever the insured seeks to defend itself (with the insurer’s assistance) in a lawsuit alleging intentional-tort claims.

Cf. Evett v. Corbin, 305 S.E.2d 469, 472 (Mo. 1957). While courts are reluctant to confer on insureds the power to compel their insurers to defend solely by their incanting a denial of the allegations, policyholders reasonably do expect their insurers will protect them when they are wrongly accused of torts.

Many insurance-coverage lawyers are familiar with the California Supreme Court’s landmark decision in Gray v. Zurich Ins. Co., 419 P.2d 168 (Cal. 1966), but there is a lesser-known companion case to Gray decided concurrently that addresses the important issue of insurers’ duty to defend against intentional torts. Lowell v. Maryland Cas. Co., 65 Cal.2d 298 (1966). Standard liability policies provide that the insurer will defend an insured “even if such suit is groundless, false or fraudulent.” The California Supreme Court in Lowell found this "groundless, false or fraudulent" language to be key in giving rise to a reasonable expectation that the insurer will defend a suit that if the allegations were true would not be covered but where the insured also could obtain a defense verdict of non-liability. (This is different from an insured not being liable for intentional injury but being held liable of the lesser-included offense of negligently caused injury.) So long as there was a substantial basis for the insured’s contention of non-liability, the insurer is required to defend:

The insured could reasonably expect that the insurer would furnish him a defense against the “groundless” charge that the insured had committed an assault and battery against the third party. The insured would not expect that the insurer could avoid the obligation of defense on the ground that such obligation covered only ‘accidents” which were indemnifiable under the policy and that an assault and battery was not such an indemnifiable “accident.” The policy promised a defense “even if [the third party] suit is groundless.”

65 Cal. 2d at 301. Lowell was in some regards an easy case because the insured obtained a defense verdict in the tort case and the policy expressly afforded defense to "groundless, false or fraudulent" claims; the exclusion for assault and battery did not apply (since the insured was found “not guilty”). See Travelers Ins. Co. v. North Seattle Christian and Missionary Alliance, 650 P.2d 250, 254 (Wash. 1982). Thus, given that Lowell was -- if defense were not granted -- an insured who would be left with a gap in coverage for defense costs that inurred to the insurer's benefit (by avoiding a potentially larger loss or a change in the course of the mounting of the successful defense, cf. Arenson v. National Auto. & Cas. Ins. Co. , 48 Cal.2d 528 (1957) ), the court reached out to find an obligation to reimburse the cost of the successful defense. Nevertheless, forty years after Lowell insurers and insureds continue to tangle over the applicability of the duty to defend to cases of intentional torts.

Posted by Marc Mayerson at 11:52 PM | Comments (3) | TrackBack

Insurers' Duty to Defend their Insureds Against Intentional Torts

[T]he comfort and consortium injuries alleged by [the husband] were sufficient to state a claim for alienation of affections, and under South Dakota law, [the husband] could not recover on this claim unless he proved that Pins intended to cause those specific injuries. In these circumstances, any ‘loss’ to [the husband] was ‘expected or intended’ by Pins and could not be deemed an ‘accident.’ Therefore, State Farm had no contractual duty to defend.

[T]he argument is patently circular, rendering the exclusion of intentional torts from the liability policy meaningless, at least under the circumstances presented here: it asserts, in effect, that a duty to defend against intentional-tort claims excluded under the policy is nevertheless triggered whenever the insured seeks to defend itself (with the insurer’s assistance) in a lawsuit alleging intentional-tort claims.

The insured could reasonably expect that the insurer would furnish him a defense against the “groundless” charge that the insured had committed an assault and battery against the third party. The insured would not expect that the insurer could avoid the obligation of defense on the ground that such obligation covered only ‘accidents” which were indemnifiable under the policy and that an assault and battery was not such an indemnifiable “accident.” The policy promised a defense “even if [the third party] suit is groundless.”

Posted by Marc Mayerson at 11:52 PM | Comments (3) | TrackBack

December 26, 2006

‘Round and ‘Round the Tort Liability Goes – When It Stops, Whither the Insurance Chose?

Generally, the law allows “choses in action” to be alienated (sold). This is a change that has been adopted over the course of the last 100 years or more. See W.W. Cook, The Alienability of Choses in Action, 29 Harv. L. Rev. 816 (1916). Because claims under insurance contracts properly viewed are choses in action, (Black’s Law Dictionary (5th ed. 1979) at 219), most courts have allowed insurance claims to be sold, too, even when the transaction takes the form of an “assignment.”

This is different from assigning the policy. Policies cannot be assigned, but what we mean by that is to change the named insured under the policy. Let me give an example: I have a car that I want to sell, which is worth $800. And let’s assume that I have an auto insurance policy with four months left in the policy term. What I cannot do is say, “buy my car for $1000 and I’ll throw in my insurance coverage” (as if you can be covered for the remaining policy term). This is changing the “named insured” going forward; the insurers haven’t checked out the buyer’s driving record, who might be a worse driver or a driver with a slew of speeding tickets.

But let’s change the scenario a little: let’s assume the day before I’m supposed to meet with you to sell my car I run into a bollard, which dents my fender and causes $200 of damage. Is there anything wrong with the idea that (assuming the $200 repair bill would be covered by my auto insurance) I can sell you my car for $700 plus the receivable from my insurance company for $200?

Most insurance policies state that “assignment of interest under this Policy shall not bind the [insurer] without its prior written consent.” Is selling the receivable – the chose in action – something that violates the policy terms? Is the chose an “interest under this Policy”? And if I breach this provision, is coverage vitiated (i.e., is this anti-assignment clause a condition precedent to coverage or a term whose breach is considered to be material to the contract as a whole)?

A more common real-life scenario is this: an insured-defendant settles with the tort plaintiff where one element of the consideration is the receivable owed from the insurance company (the insured’s claim for reimbursement of its defense costs and ultimately the value of its settlement with the plaintiff). See generally Enserch Corp. v. Shand, Morahan & Co., Inc., 952 F.2d 1485 (5th Cir. 1992) (Wisdom, J.) (approving of a “two tier” settlement whereby plaintiffs received certain monies up front and then additional monies on the back end depending on the recovery against the defendant-insured’s carriers). In these circumstances, the courts typically have held that the assignment of the chose in action to the insurers has not expanded the carrier’s risk, that choses are freely assignable, that the insurer is not at risk of double payment, and that the plaintiff may proceed against the insurer to assert on behalf of the insured its (pre-existing) contractual claims against the insurer. See generally International Rediscount Corp. v. Hartford Acc. & Indem. Co., 425 F. Supp. 488 (D.Del. 1977); Ardon Constr. Corp. v. Firemen’s Ins. Co., 185 N.Y.S.2d 723 (1959). Courts have held similarly regarding whether a fire insurance policy applies after property transfer. National Am. Ins. Co. v. Jamison Agency, Inc., 501 F.2d 1125 (8th Cir. 1974); Imperial Enter., Inc. v. Fireman’s Fund Ins. Co., 535 F.2d 287 (5th Cir. 1976); University of Judaism v. Transamerica Ins. Co., 61 Cal. App. 3d 93 (1976).

As with my selling my car and throwing the auto insurance in, there are countervailing concerns: in the auto example, the insurance company – at least insofar as liability insurance – elected to insure me and set a premium based in part on my driving record (although zip codes nowadays may be a stronger determinant of premium); if my insurance could be transferred to a riskier driver then the insurance company’s risk has changed – and the courts will invalidate that transfer on any number of grounds including “prejudice” or expansion of the risk to the carrier. See Muslin v. Frelinghuysen Livestock Managers Inc., 777 F.2d 1230, 1233 (7th Cir. 1985) (first-party mortality insurance on a racehorse not assignable).

Note that the issue on which I am focused concerns the anti-assignment provision. Courts (and insurers) sometimes also focus on the “duty to cooperate” and the “no action” provision in disputes involving to some extent assignments of the chose in action under an insurance policy. Hamilton v. Maryland Casualty Co., 27 Cal. 4th 718 (2002); Miller v. Shugart, 316 N.W.2d 729 (Minn. 1982). Unique policy provisions or unique interests may affect whether a transfer of the right to collect from an insurance company is proper or whether pre-transfer insurance policies apply, but until the last few years the courts in virtually all states have allowed transfers of the insured’s chose in action, reasoning in part that an insurer has been paid to accept the transfer of risk, and if that risk has come to pass it matters not to whom the check is cut – the original insured or an assignee.

(In fact, it doesn’t matter who litigates against the insurer – an assignee or an assignor, so long as the absent party is bound to the result in the coverage case. See Greco v. Oregon Mut. Fire Ins. Co., 12 Cal. Rptr. 1802 (Cal. App. 1961); Clarkson Co. Ltd. v. Rockwell Int’l Corp., 441 F. Supp. 792 (N.D. Cal. 1977); Urrutia Aviation Enterprises, Inc. v. B.B. Burson & Assoc., Inc., 406 F.2d 769 (5th Cir. 1969); Icon Group, Inc. v. Mahogany Run. Dev. Corp., 829 F.2d 473, 478 (3d. Cir. 1987); Prosperity Realty, Inc. v. Haco-Canon, 724 Supp. 254, 258 (S.D.N.Y. 1989).)

And the reason for this consistent string of outcomes is that courts typically have found that there is no legitimate interest in allowing an insurance company to refuse to perform when its risk has not been (materially) altered and it has received payment for the transfer of that risk.

Nevertheless, there have been inconsistent results (spurring further litigation) regarding large-scale liability claims that came to rest on some corporate-successor-in-interest to the original tortfeasor-insured following a series of complex corporate transactions – which should cause serious concern for corporate-transactions lawyers who ignore the insurance consequences of the deals they put together. The Ohio Supreme Court just decided a case allowing insurers to get off the hook completely for mass lead-paint liability claims, not because the claims were not covered but rather because the insurance mysteriously evaporated along the way of a number of corporate transactions, leading to the tort liability flowing through to the successor but inadvertently stripped of the insurance protection that would have otherwise applied to the claims had the corporate transactions never occurred. See Glidden Cos. v. Lumberman’s Mut. Cas. Co. (Ohio Dec. 20, 2006).

Until the modern coverage wars broke out, however, the courts routinely allowed whoever ended up with the tort liability to tap the insurance coverage that would have applied before the later corporate transaction took place. See Ocean Acc. & Guar. Corp. v. Southern Bell Telephone Co., 100 F.2d 441 (8th Cir. 1939); Chatham Corp. v. Argonaut Ins. Co., 334 N.Y.S.2d 959 (N.Y. Supr. 1972); Aetna Life & Cas. v. United Pac. Reliance Ins. Cos., 580 P.2d 230 (Utah 1978); Paxton & Vierling Steel Co. v. Great American Ins. Co., 497 F. Supp. 673 (D. Neb. 1980); Brunswick Corp. v. St. Paul Fire and Marine Ins. Co., 509 F. Supp. 750 (E.D. Pa. 1981); Travelers Ins. Co. v. Western Fire Ins. Co., 709 P.2d 639 (Mont. 1985); Oklahoma Morris Plan Co. v. Security Mut. Cas. Co., 455 F.2d 1209 (8th Cir. 1972).

But the modern, large-dollar coverage cases often involve detours and frolics into corporate transactions, all ultimately concerned about whether the entity paying the liability of some historic predecessor somehow or another is naked as far as insurance coverage goes. Note that the issue does not involve any expansion of the insurers’ obligations beyond that which would exist had the original insured not been merged out of existence, sold its assets, or otherwise sliced, diced, chopped, and slawed. In each instance, the entity claiming the benefit of the coverage is paying for the historic insured’s liability, and the only question is whether the insurers somehow or another get off the hook – as in Glidden – because of the manner in which some legitimate post-injury corporate transaction took place. Indeed, in one of my coverage cases, the parties no doubt spent a million dollars exhuming various corporate transactions – all to the end that the court concluded that none of these really mattered so long as the insurers could be assured that nobody else would sue the insurance companies for the same obligations being claimed by the entity before the court.

Earlier this year, in rebuffing the effort of an insurer to deny coverage based on the assignment of the chose in action, the Pennsylvania Supreme Court likewise allowed the transfer of the right to collect. As that court explained:

The assignment changed only the identity of the party who was entitled to recover under the Gulf policy, in the event an excess verdict was obtained. [B]ecause [the insurer’s] risk was not increased following the assignment, [and] since the assignment was subject ‘to such claims, demands, or defenses as the insurer would have been entitled to make against the original insured,’ [citation omitted] the Superior Court correctly determined that the assignment was valid.

Egger v. Gulf Ins. Co. (Pa. Aug. 23, 2006). Indeed, several months ago, the California Supreme Court went so far as to hold that not only the insured’s coverage benefits but also first-party insurance bad-faith damages could be recovered by an assignee. Essex Ins. Co. v. Five Star Dye House Inc. (Cal. July 6, 2006).

In sharp contrast, the Oregon Supreme Court recently allowed an insurer off the hook because of an assignment of the chose in action. Holloway v. Republic Indem. Co. of Am. (Ore. Nov. 16, 2006) . As the Oregon court framed the question presented: “The central issue in this insurance contract case is whether an anti-assignment clause providing that ‘[y]our rights or duties under this policy may not be transferred without our written consent[]’ is ambiguous and thus should be construed against its drafter.” In Holloway, the court ruled that the policy’s anti-assignment provision was clear, thus eschewing any difference between pre-loss assignments (changing the named insured) with post-loss assignments (transferring the chose in action) and held that a post-loss assignment of the right to collect under the policy vitiated coverage.

Some courts, as in Holloway, look at the question in terms of whether the terms of the anti-assignment provision applies – but most courts as did the Pennsylvania Supreme Court in Egger find that the terms of that provision do not apply or are ambiguous in their application to the assignment of the right to collect and thus must be construed against the drafter. The court in Holloway put on blinders and failed to examine whether there was any real consequence to the insurer from changing who was asserting the insured’s rights (the original insured or someone else suing in the name of the insured or suing for the benefits owed the insured); instead, the Holloway court (like Glidden) viewed the anti-assignment clause as being applicable and absolute.

But even if one were to accept that analysis at face value, Holloway plainly goes wrong in not asking what is the consequence of the violation of the anti-assignment provision. In other words, it is never enough to say that the terms of a contract were violated – before the non-breaching party’s performance is excused, the breach must be one that is either material to the contract as a whole or whose satisfaction is a (valid) condition precedent to performance. Holloway simply stops after finding that the assignment at issue was subject to the policy provision – and the court does not address whether its violation constitutes a material breach of the contract as a whole.

This is another way of backing into the argument that assignments of the chose in action – as distinct from an assignment of the policy itself, i.e., changing the named insured – is not material in the ordinary case. The only real difference is to whom the insurance company is supposed to write its check. As in Egger, the insurance company is free to argue that the nature of the damages are uncovered or that the conduct leading to the claim is uncovered – but that is different from saying that because someone other than the original insured is knocking on the carrier’s door with the original-insured’s hat in hand the insurer somehow escapes paying.

Even though had the original insured pursued the identical claim for damages the insurance company would be required to pay, the courts in Holloway and Glidden allow insurers to distract them from the merits, expose managers to claims of waste from making good on the legal obligation of the tortfeasor-insured – sometimes decades later and many corporate-predecessors removed, permit insurers to keep the premiums for risks they were paid to assume and which came to pass, or allow tort victims who pursue collection against the tortfeasor’s insurer to go uncompensated, all because the court concludes the twain did not meet between the liability and the insurance. In contrast, the rule in Egger and cases like it ensures that the contracting parties achieve the benefits (or detriments) of the original bargain in the event the risk the insured sought to transfer-- and for which the insurer collected premium -- comes to fruition.

Posted by Marc Mayerson at 6:02 PM | Comments (2) | TrackBack

‘Round and ‘Round the Tort Liability Goes – When It Stops, Whither the Insurance Chose?

The assignment changed only the identity of the party who was entitled to recover under the Gulf policy, in the event an excess verdict was obtained. [B]ecause [the insurer’s] risk was not increased following the assignment, [and] since the assignment was subject ‘to such claims, demands, or defenses as the insurer would have been entitled to make against the original insured,’ [citation omitted] the Superior Court correctly determined that the assignment was valid.

Posted by Marc Mayerson at 6:02 PM | Comments (2) | TrackBack

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 (5) | TrackBack

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

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.

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 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.

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.)

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.

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

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.

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

August 22, 2006

Conflict of Laws and Insurance Disputes: Choice of Law or Choice of Outcomes?

Most insurance policies are silent as to which state’s substantive law governs their terms. As a result, insurance-coverage lawyers often find ourselves deep into the world of choice of law and conflict of laws, a subject most of us sidestepped in our law-school education. Conflicts issues are (largely) untethered from the merits yet can be outcome determinative, so it is crucial to understand and focus on choice-of-law principles in complex insurance disputes, which can yield the application of different state laws within a single case to issues of contract formation, performance, and bad faith.

There are two paradigmatic approaches to choice of law, but nuances in every state affect the analysis. What one can call the First Restatement or lex loci contractus approach looks to some formal act involved in the making of a contract and holds that the location of that act tells one which state’s law governs. Now more than 75 years old, several states still follow its teachings.

Then there is the Second Restatement approach, promulgated thirty years ago, which is plainly the dominant intellectual framework for choice of law in the US. This looks to the state with the “most significant relationship” between the issue to be resolved and the states affected. See Restatement 2d §§ 6, 188, 193. The Second Restatement analysis proceeds issue by issue, that is, one state’s law can apply to one issue in a case and another state’s law to a different one. (This is a principle called depeçage.)

In the absence of a contractual choice-of-law clause (which in any event is considered merely to be evidence of the proper choice of law and not determinative in and of itself), one can predict the governing substantive law only if one starts with a particular forum in mind. The choice of forum is not directly a selection of the forum’s law; instead, it is a selection of the forum’s rules for choice of law (there being no difference between suing in state or federal court on this issue, Klaxon Co. v. Stentor Electric Mfg. Co., 313 US 487 (1941)).

The choice-of-law question is not what law governs this contract for all purposes but rather what law should govern a particular issue for which there is a difference were one state’s or another’s law to apply. One law can govern a single contract issue or a discrete claims-handling issue, all depending on the interests of the state involved. Typically, the law of the forum applies unless and until a party demonstrates that another state’s law should apply to a particular issue. E.g., Trostel & Sons Co. v. Employers Ins. of Wausau, 576 N.W.2d 88 (Wis. Ct. App. 1998). (Note also that some states have enacted choice-of-law statutes that will supersede the common-law choice-of-law analysis, so long as their application passes muster under constitutional principles. See generally Sangamo Weston Inc. v. National Surety Corp., 414 S.E.2d 127 (S.C. 1992). )

The court’s selection of a given state’s law can be change the result, which introduces great instability in the relationship between insureds and carriers given that a race to the courthouse may lead to one result (coverage) or the other (none). To be concrete, in one matter I handled for the Michigan subsidiary of an Illinois corporate parent, we considered suing in South Carolina (where one of the carrier defendants was located), which would have resulted in the application of Georgia law (where the broker was located) and which we thought would be relatively favorable; instead, we sued in Illinois and argued successfully for the application of Illinois law to the contract (which we obviously perceived to be a bit more favorable than Georgia law). See generally Babcock & Wilcox Co. v. Arkwright-Boston Manufacturing Mutual Ins. Co., 867 F. Supp. 573 (N.D. Ohio 1992); Gabe's Construction Co. v. United Capitol Insurance Co., 539 N.W.2d 144 (Iowa 1995) (additional-insured issues); Auto Europe, LLC v. Connecticut Indemnity Co., 321 F.3d 60 (1st Cir. 2003) (location of subsidiary in forum an important contact even where parent negotiated policy). In that case, we were seeking insurance recovery for a nationwide product-liability problem, involving possible death cases and a nationwide, multi-industry product recall and replacement program involving the Consumer Products Safety Commission (CPSC). That on the same facts it was possible to apply any of Georgia, Illinois, or Michigan law underscores the malleability of the issue as well as the importance of considering carefully choice-of-law in deciding how to manage insurance recovery. See Piper Aircraft Co. v. Reyno, 454 U.S. 235, 250 (1981) (“Ordinarily, these plaintiffs will select that forum whose choice-of-law rules are most advantageous.”).

Additional complexity is introduced when one considers insurance bad-faith issues or similar remedial measures that may exist both at common law and as a matter of statute in individual states. The question in part concerns due process: does the state legislature have the power to regulate the conduct at issue? The question may also involve choice of law: does the state’s law apply to the transaction at issue? Ever since the US Supreme Court decision of Allstate Ins. Co. v. Hague, 4498 U.S. 302 (1981), which was a 4-1-3 decision (with 1 recusal), the analysis has been collapsed into the choice-of-law inquiry alone, eschewing examining the power of a state to regulate conduct. As the Third Circuit has explained:

[T]he relevant issue is the constitutionality of a choice of substantive law (not constitutional limitations on the permissible scope of a state’s substantive law). In our case we must ask whether New York’s substantive law would constitutionally apply to the facts we review, not whether New York could permissibly choose to apply its law (the choice of which substantive law to apply being an issued reserved to Pennsylvania law).

Budget Rent-a-Car System, Inc. v. Chappell, 407 F.3d 166, 176 (3d Cir. 2005).

Through the 1940s and 1950s, there was a series of US Supreme Court cases that approached these issues by looking at Due Process, Equal Protection, and Full Faith and Credit. Some of these cases have fallen into disfavor under Hague but others were cited in Hague and thus have continued vitality. E.g., Watson v. Employers Liability Corp., 348 U.S. 66 (1954). I have argued in a case that Watson dictates that the forum (Virginia) state’s statute on bad faith applies to benefit the (former) Virginia subsidiary of a D.C. company that purchased insurance from a New York company and that suffered a fidelity loss through the operation of a (sub)subsidiary in New Hampshire. On its face, the statute applied to admitted insurers doing business in the state (as was true in my case), and we posited that the legislature meant to protect Virginia citizens from the misdeeds of foreign, but admitted, insurers. While we could run that argument under choice-of-law principles, e.g., Babcock & Wilcox, 867 F. Supp. 573, to me it makes more sense to approach the matter as one of the scope of legislative authority, which is what Watson speaks to.

The Supreme Court’s decision in Watson is not a choice-of-law case but rather concerns the constitutionality of applying a state insurance statute. Watson involved Louisiana’s direct-action statute, which conflicted with a provision in the insurance policy requiring that no action could proceed against the insurer until the underlying tort claim was resolved. Given that the dominant approach to selecting which law to apply involves consideration of which state “‘would have the strongest interest in seeing its laws applied to the particular case,’” United Western Grocers, Inc. v. Twin City Fire Ins. Co., slip op. at 9550 (9th Cir. Aug. 14, 2006) (citation omitted), Watson remains relevant in assessing state interest.

At issue there was a bodily injury claim stemming from the use in Louisiana of a home hair-care product manufactured by an Illinois subsidiary of a Massachusetts company where the insurance policy was negotiated and issued in Massachusetts and delivered in Massachusetts and Illinois. “The basic issue raised . . . . is whether the Federal Constitution forbids Louisiana to apply its own law and compels it to apply the law of Massachusetts or Illinois.” 348 U.S. at 69. The plaintiff was a tort victim with no privity of contract seeking to force the insurer to provide coverage to the defendant-tortfeasor, the Illinois company.

The Supreme Court ruled that Louisiana had an interest in applying its law because the tort victims, while strangers to the contract, were Louisiana residents who obtained medical care in Louisiana and drew upon other Louisiana private and public services in connection with their injuries. “Where, as here, a contract affects the people of several states, each may have interest that leave it free to enforce its own contract policies . . . . [M]ore states than one may seize hold of local activities which are part of multistate transactions and may regulate to protect interests of its own people, even though other phases of the same transactions might justify regulatory legislation in other states.” 348 U.S. at 73, 72.

As Watson anticipates, coverage disputes can involve the application or potential application of the law of more than one state within a given case. Two recent federal district court decisions addressed choice of law in the context of both coverage questions and alleged bad-faith conduct. A comparison between them highlights the vagaries of judicial outcomes in this area. (Choice-of-law decisions are invariably fact bound, so it is always difficult to conclude that rulings are inconsistent.) In one case, an out-of-state statute was held not to be available for bad-faith conduct by claims handlers occurring in that jurisdiction; in the other, while the bad-faith acts took place in a different state – the jurisdiction whose law plainly governed the coverage questions – the court nonetheless applied the law of bad faith where the effects of that conduct were felt and thus afforded a more vigorous remedy to the policyholder who had moved to a different jurisdiction after the policy period.

In Cecilia Schwaber Trust Two v. Hartford Accident & Indem. Co., 2006 WL 1888691 (D. Md. June 26, 2006), the policyholder sought coverage as construed under Maryland law with regard to a property located in Baltimore but sought to impose bad-faith liability on the insurer based on the location of the insurer’s claims handlers (Pennsylvania). The federal district court held that Maryland had an affirmative policy against allowing first-party bad faith claims (that is, claims for unreasonable denials of coverage), which the policyholder sought to side-step by arguing that the location of the wrong at issue – bad-faith claim denial – occurred in Pennsylvania, whose law should apply under principles of lex loci delicti. The court ruled, however, that although Pennsylvania’s bad-faith scheme is implemented pursuant to a statute the question was controlled by what law properly governed the contract/coverage claim. Id. at *3.

Moreover, the court observed:

Plaintiffs are Maryland residents pursuing a claim for damage to a Maryland property under an insurance contract they admit is governed by Maryland law. Maryland has consistently refused to permit tort claims based on bad faith conduct by insurers . . . . I am confident that Maryland would not choose to import tort claims from other states in a case such as this, particularly when those tort claims are not intended to protect Maryland residents..

Id. The court sought to buttress its conclusion by arguing that the mirror-image result would likewise be absurd: that is, if a Pennsylvania policyholder with Pennsylvania property suffered bad faith at the hands of a Maryland-based claims handler, then the Pennsylvania citizen would have no bad-faith remedy. Id. at n.3.

But the problem of analytical symmetry posited by the Schwaber court does not exist: there is nothing inconsistent for choice-of-law purposes in applying Pennsylvania law on claims-handling conduct to claims handers dealing with Marylanders and applying Pennsylvania law also to claims handlers dealing with Pennsylvanians, so long as the claims handlers in each instance are located and licensed in Pennsylvania. Pennsylvania can well have an interest in ensuring that all insurance operations conducted in its state conform to its standards. (New York for example has always sought to require licensed insurers to conform to the standards of New York wherever they may operate.)

A useful contrast to the Maryland case is another federal court decision decided one week before, Love v. Blue Cross and Blue Shield of Georgia, Inc., 2006 U.S. Dist. LEXIS 42275 (D. Wis. June 20, 2006). In Love, the insured purchased a health-insurance policy in Georgia and was a permanent resident there. Later, the insured moved to Wisconsin, and the dispute concerned the handling of certain bills submitted for treatments received in Wisconsin.

The question presented was whether a Georgia statute applied, which limited bad-faith remedies, or whether Wisconsin common law did. The insured applied for coverage in Georgia, lived in Georgia, and Georgia law applied to construe the policy. The court stated that applying the law of wherever the insured roamed would lead to “confusion, not predictability, in the law.” Id. at *7. Consequently, the court concluded that “predictability of results is fostered when a state’s substantive law applies to a policy issued in that state by a state corporation to a resident of that state, especially when, as here, the policy in question explicitly states that Georgia law should apply.” Id.

Nevertheless, the court concluded that Wisconsin had a strong interest in protecting Wisconsin residents regarding services provided in Wisconsin, even from an out-of-state insurer that issued a policy under out-of-state law to someone who then lived outside the state. Id. at *11-12. This was true even though “a policy issued in Georgia to Georgia residents might well cost less because of the damage caps the [Georgia] state legislature has put in place” and “the processing of the claims occurred in Georgia.” Id. at *9, *12. As the court concluded, “Wisconsin has indicated its belief that bad faith is a tort for which a wide array of damages [should be] available, and it has a strong interest in ensuring that its residents receive full compensation for such torts.” Id. at *19.

That an insurance contract was issued and delivered in Massachusetts did not preclude the application of Louisiana law in Watson, where Louisiana had a more direct and concrete interest in the particular dispute before the court. A Maryland policyholder suffering bad faith at the hands of Pennsylvania claims handlers perhaps should have the same remedies that a resident of Pennsylvania would have in the same circumstances, Schwaber notwithstanding. The former Georgia policyholder in Love was found to have the same remedies available as Wisconsin residents because the impact of the insurer’s alleged post-policy bad-faith conduct occurred there, even though performance otherwise would be gauged under Georgia law.

The choice-of-law issue, albeit seemingly divorced from the merits, can determine who wins or loses a coverage case. See Fluke Corp. v. Hartford Acc. & Indem. Co., 7 P.3d 825 (Wash. App. 2000), aff’d, 34 P.3d 809 (Wash. 2001) (finding insurance coverage for punitive damages following choice-of-law analysis). Given the current regime of state-by-state regulation of the insurance industry and the absence of choice-of-law provisions in policies, fighting over which law to apply (and to which issues) is one more crucial battle in complex insurance disputes.

Posted by Marc Mayerson at 5:39 PM | Comments (3) | TrackBack

Conflict of Laws and Insurance Disputes: Choice of Law or Choice of Outcomes?

[T]he relevant issue is the constitutionality of a choice of substantive law (not constitutional limitations on the permissible scope of a state’s substantive law). In our case we must ask whether New York’s substantive law would constitutionally apply to the facts we review, not whether New York could permissibly choose to apply its law (the choice of which substantive law to apply being an issued reserved to Pennsylvania law).

Budget Rent-a-Car System, Inc. v. Chappell, 407 F.3d 166, 176 (3d Cir. 2005).

Moreover, the court observed:

Plaintiffs are Maryland residents pursuing a claim for damage to a Maryland property under an insurance contract they admit is governed by Maryland law. Maryland has consistently refused to permit tort claims based on bad faith conduct by insurers . . . . I am confident that Maryland would not choose to import tort claims from other states in a case such as this, particularly when those tort claims are not intended to protect Maryland residents..

Posted by Marc Mayerson at 5:39 PM | Comments (3) | TrackBack

July 10, 2006

Additional Insured?: Defense Assured

Companies that work with each other share insurance through adding the other company as an “additional insured” in connection with their work together. Sometimes it is not clear that the claim falls within the scope of additional-insured coverage. The New York Appellate Division recently confronted whether an insurer had a duty to defend in those circumstances, answering the question that it does. BP A.C. Corp. v. One Beacon Ins. Group, 2006 NY Slip Op. 05297 (N.Y. App. Div., 1st Dept. July 6, 2006).

What happens if we don’t know if the entity is “truly” an additional insured until the underlying liability case is resolved? In the New York case, an HVAC contractor was an additional insured “only with respect to liability arising out of your ongoing operations performed” and “ends when your operations for that insured are completed.”

The New York court found that the purpose of being an additional insured, with the concomitant right of defense, would be defeated if the insurer did not provide a defense until the underlying action was over. The majority reviewed prior cases, which basically cleave between those policies that require proof of a fact establishing additional-insured status as a condition precedent and those where no such pre-condition is made clear. The court found that, so long as the allegations of the complaint reasonably can be construed as indicating the facts establishing additional-insured status, the insurer has a duty to defend.

The dissent is right that, if the accident at issue took place after the operations are completed, then there is no coverage (and from the perspective of heaven there never was coverage). But that fact will be determined during the trial of the liability case. The dissent reasons that this dispute of fact precludes summary judgment, and thus that the parties need to await the outcome of the liability case before determining additional-insured status. The dissent does not flesh out the analysis whether the insurer would be collaterally estopped by the finding in the liability case (and under traditional collateral-estoppel principles it’s not clear that it would be bound), but it obviously would make no sense to allow the insurer to relitigate the question and obtain a different result. And the dissent does not address how the question should be resolved if the liability case is settled rather than tried.

The majority, in contrast, finds a presumptive, ongoing duty to defend, but recognizes that indemnity coverage might not apply depending on the way the facts are developed in the underlying case. Given (i) the vigilance of courts in construing defense coverage, (ii) that awaiting the trial of the underlying case before determining whether there was a duty to defend defeats the purpose of the duty to defend, and (iii) the impracticality of not knowing whether coverage is potentially involved (which will impede settlement, among other things), the majority opinion on balance is better taken.

The dissent is also right that an essential element of the insured’s prima facie case for coverage is that it is a covered entity, but it does seem sufficient, in the absence of other undisputed evidence, to allow the insured to rest on the allegations on this point. One way to harmonize the result with existing case law is to apply the ordinary principle that contract provisions are presumed not to be contractual conditions precedent. As a result, in the absence of clear and unambiguous language mandating that proof of a particular fact is a prerequisite to coverage, allegations permitting proof of that fact combined with a dispute of fact proves additional insured status (for purposes of the duty to defend).

The insurer will have the right to terminate its defense prospectively and not to pay for the judgment depending on the facts as found against the insured (which if adverse to the insured would be subject to offensive non-mutual collateral estoppel), but the duty to defend will not terminate retroactively. In other words, the insurer will not have a right to recover from the putative additional insured the defense costs it incurred even though in truth the conduct was not covered by the particular policy.

This is no different from any other circumstance where the duty to indemnify does not apply to the judgment eventually awarded. If a policy applies only to injury during the policy period and injury in that period is disproved at trial of the liability case, the insurer then will not have a duty to indemnify, but the defense obligation is not lost retroactively. While one can come up with some distinctions between named-insured status and other coverage facts, ultimately it does not seem that there is any real distinction of substance. Accordingly, unless the contract makes clear that insured status is a condition precedent or provides an express right of reimbursement for defense costs incurred on behalf of putative insureds, the majority holding seems right: the insurer has an obligation to defend.

Posted by Marc Mayerson at 4:53 PM | Comments (3) | TrackBack

Additional Insured?: Defense Assured

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June 13, 2006

Running Out of Time: Statute of Limitations for Liability Insurance Policies

Liability-insurance policies were introduced in 1881, yet there is no great certainty in most states as to when the statute of limitations commences for bringing suit on an insurance policy for performance. Somewhat complicating matters – and simplifying it too – is the availability of declaratory relief, a remedy designed in part to pull insurance disputes into court. So to understand the application of statute of limitations in this context, one must draw distinctions among several concepts: (i) anticipatory repudiation of contract, which is considered a present breach of contract; (ii) anticipatory relief of seeking a declaration of rights before breach of contract; (iii) continuing breach of the duty to defend by an insurer; and (iv) breach of the duty to indemnify. The Alaska Supreme Court recently confronted these issues and elected to follow the California Supreme Court's approach to the questions presented.

Declaratory judgments are meant as a vehicle for obtaining a ruling from a court, typically in advance of a breach of contract. E.g., Cal. Civ. § 1060 (“The declaration may be had before there has been any breach of the obligation in respect to which said declaration is sought.”). They are not meant ony for policyholders: an insurance company may seek a negative declaration from a court that there is no obligation to defend or indemnify; in the absence of a declaratory-relief remedy a carrier could not sue at common law for non-breach of contract. Declaratory relief – a form of equitable remedy (and not a separate cause of action) – does not require a breach of contract at the time of bringing suit; it is properly directed in futuro, that is, before the time for contractual performance is due. The power of a court to entertain a declaratory judgment is constrained by the advisory-opinion doctrine; in other words, one can bring a declaratory judgment so long as the dispute is sufficiently mature that a court ruling would be helpful, concrete and not advisory. See Marc Mayerson, Executability of Article III Judgments and the Limits of Congressional Discretion, 35 DePaul L. Rev. 51, 58-61, 63-64 n.71 (1985). If a case is nonjusticiable, then it is axiomatic that a statute of limitations cannot have started.

Just because a case is justiciable is not sufficient, however, to initiate the statute of limitation, which protects interests of repose and guards against staleness of evidence (among other things). There is some confusion, however, as to whether if one can bring a suit whether one must bring a suit.

If a breach-of-contract claim exists, the right way to plead the matter is one for damages or other relief appropriate to the contract claim. In other words, it is not necessary or really proper to plead an declaratory count for a declaration of duty (on an existing set of facts) and then a count for damages; such a claim is more properly styled as a breach-of-contract claim based on an existing set of facts; if the set of facts that would ripen a contractual duty has not yet occurred, then a declaratory-relief action would be proper.

Declaratory relief may lie regarding any issue of contractual interpretation, though a court maintains a residuum of discretion not to hear an action that otherwise is proper. Wilton v. Seven Falls Co.., __ U.S. __ (1995). In fact, declaratory relief actions were largely designed to facilitate the resolution of insurance disputes. Edwin Borchard, Declaratory Judgments and Insurance Litigation, 34 Ill. L. Rev. 245-270 (1939); Edwin M. Borchard, Declaratory Judgments (2d ed. 1941).

In the context of liability insurance, when a claim has been made against an insured, an insurer will then have a present obligation to respond. If the insurer does not assume the defense, for example, the duty to defend may have been breached. If it is anticipated that the claim will continue to be prosecuted against the insured, then the insurer will have future obligations to the insured, i.e., a declaratory relief action as to the insurer’s obligations in the future will be proper.

An insurer, like any other contractual party, can renounce its obligations even before the time for performance has occurred. This is an anticipatory repudiation, which is considered a present breach of contract at the time of repudiation. Hall v. Allstate Ins. Co., 880 F.2d 394, 397 (11th Cir. 1989); Snow v. Western Savings & Loan Ass'n, 730 P.2d 204 (Ariz. 1986). The nonbreaching party is as of that moment vested with the option to bring its breach of contract claim and obtain whatever damages it can show, subject to the rules for mitigation and proof of damages. (In the meantime, the insured may be freed of its obligations to provide further notice, provide proofs of loss, and the like.) However, through a repudiation, the breaching party cannot accelerate the running of the statute of limitations; the law allows the nonbreaching party the option to bring an immediate action for breach of contract or to await the time for contractual performance and bring an action at that time. See Lane v. Nationwide Mut. Ins. Co., 582 A.2d 501, 505 (Md. 1990). The nonbreaching party is vested with that option to allow the repudiator the opportunity to have a change of heart and to perform its obligations. Cf. Mobley v. New York Life Ins. Co., 295 U.S. 632 (1935).

This in part is the context for a recent decision of the Alaska Supreme Court, which addressed the question when the statute of limitations commences. Brannon v. Continental Cas. Co. (Alaska June 9, 2006). The court first ruled that “[a] cause of action for denial of coverage under an insurance policy accrues when coverage is disclaimed and the insured is notified.” Id. at 7 (footnotes omitted). While a breach-of-contract action may lie at that moment, the question is whether the insured necessarily must commence a lawsuit or risk forfeiting its claim for coverage. Usually, courts find that an insured is not required to bring an action for breach of the duty to defend until the claim against it is over. See Moffat v. Metropolitan Cas. Ins. Co., 238 F. Supp. 165, 175 (M.D. Pa. 1964). This avoids insureds being doubly burdened from the carrier’s nonperformance – fighting the defense case on its own and being required to sue its insurer simultaneously.

The Alaska court, following the California Supreme Court, held that, while the cause of action for breach of contract accrues upon the carrier’s refusal to perform, the limitations period is tolled while the underlying action is pending. Id. at 10. The Alaska court recognized that its holding was consistent with the majority result, which sometimes finds that due to the continuing nature of the breach by the insurer the insured’s damages are not finalized until the underlying action is concluded, and thus the statute of limitations does not commence. Under either approach, equitable tolling or simply ruling that the insured’s damages must be complete before the statute of limitations commences, the court found that “any prejudice [from awaiting until the underlying action was completed] should not be held against the insured” because “the insurance company has the ability and motivation to gather evidence.” Id. at 11. The court further recognized the unfairness of “requir[ing] the insured to file a lawsuit against the insurance company while simultaneously defending himself in the underlying lawsuit.” Id. at 12 (fn. omitted).

Regardless of the particular rationale, most courts that have carefully analyzed the question hold as the Alaska Supreme Court did that the insured must be permitted to await the conclusion of the underlying action before being at risk of losing its rights to insurance recovery. Yet to ensure that the value of the insurer's timely help is not lost, the insured has the option to bring an action seeking a declaration of the insurer’s obligation to defend on an ongoing basis and potentially for specific performance of the duty to defend. See Marc Mayerson, Insurance Recovery of Litigation Costs, 30 Tort & Ins. L. J. 997 (1995).

Posted by Marc Mayerson at 3:36 PM | Comments (0) | TrackBack

Running Out of Time: Statute of Limitations for Liability Insurance Policies

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April 5, 2006

What You See Is Not What You Get: Renewal Policies

One aspect of insurance practice that I like is the seemingly unlimited number of nooks and crannies in insurance law. But like a tree falling in the forest, the existence of one pro-policyholder rule or another in a given state has little impact on human behavior -- or trial outcomes -- unless that rule is called upon. One such rule is the "renewal rule."

When a policyholder renews an insurance policy with its carrier, the insurer must provide prior notice to the insured if it intends to reduce coverage under the newly issued policy. In one of my cases, a corporate client had purchased a primary-layer CGL policy from one insurer in 1969, renewed it in 1970, and then renewed it again. The sudden-and-accidental pollution exclusion was introduced in early 1970 (see Mayerson, Affording Coverage for Gradual Property Damage Under Standard Liability Insurance Policies: A History, 8 Coverage 3 (Sept./Oct. 1998)), so for the final policy the insurer issued its then-standard CGL form and stapled to it the pollution exclusion. The question presented was whether the pollution exclusion in this last policy -- which had been provided to the policyholder, a large multinational chemical company -- was to be given effect.

For a first policy with an insured, the insurer does not have the same duty to point out a limitation on the coverage. Generally speaking, insureds are charged with knowledge of the content of their insurance policies, even if it is undisputed that the insured never actually read the policy at the time it was issued. See generally Western World Ins. Co. v. Stack Oil. Co., 922 F.2d 118, 122 (2d Cir. 1990); Metzger v. Aetna Ins. Co.,, 125 N.E. 814, 816 (N.Y. 1920). (By the way, did you read the insurance policy issued to you before completing the purchase?) But this general rule that insureds are charged with knowledge of the terms of their policies does not overcome the application of the more particular rule regarding renewal of insurance policies. If this were not so, then the well-established notice-of-reduction rule would be without effect. See Davis v. USAA, 273 Cal. Rptr .224, 227 (1990); Magness Constr. Co. v. Ohio Farmers Ins. Co., 261 A.2d 537, 539 (Del. Super. 1969); Walton v. Sterling Fire Ins. Co., 197 N.Y.S.2d 277, 280 (N.Y. App. 1960) ("Implicit in such renewal is that the terms of the existing policy are to be contained in he absence of a contrary intention.").

The renewal rule is not a matter of reformation, see 91 ALR 2d 546, 549 & n.10, or fraud in the factum, and is not subject to a contractual limitations period. The insured may defend against the effort to enforce a coverage-reduction in a renewal policy without pleading and proving the elements of reformation; instead, the (purported) coverage reduction is of no effect. The insurer must prove that in renewal it gave notice before the policy took effect of the desired coverage restriction (and it is not enough for the insurer to send along a notice enclosed with a copy of the renewal -- the insured must be given the opportunity ex ante to object to its inclusion, negotiate its elimination, or take its business elsewhere).

Insureds are under no obligation to disabuse the carrier of a belief that its limitation or exclusion was effective. There is no authority of which I am aware that holds that, when a carrier attempts to reduce coverage in a renewal policy without notice, the insured can be prevented from objecting to enforcement of the unauthorized reduction. Otherwise, an insured would be required to be forever vigilant, guarding against the risk that its carrier might slip an unannounced new exclusion into the renewed policy.

In the case I handled mentioned above, we were litigating the question more than two decades later (the 20-year-old policy nevertheless having been triggered), and no peep was ever made by the insured or its broker at the time. No matter, though. Neither contemporaneous objection nor (detrimental) reliance by the insured is an element of this legal doctrine. In my case, because in the renewal process the insurer did not provide specific advance notice of the reduction in coverage the court had little trouble in concluding that the exclusion -- physically a part of the policy -- was of no legal effect.

Given the state of the law, the outcome we obtained was hardly surprising (to me at least, I'm not so sure about how the insurer thought about it). A more difficult question was presented in a Sixth Circuit case decided in 2003 where a follow-form excess insurer sought to rely on a coverage restriction that was included in the underlying policy, which in turn was a renewal. See Amway Distributors Benefits Ass'n v. Northfield Ins. Co. (6th Cir. 2003). By way of definition, a following-form insurer issues a couple-page policy that principally adopts the terms of the underlying wording and incorporates it as its own. Coca-Cola Bottling Co. v. Columbia Cas. Ins. Co., 11 CA 4th 1176,1182-83, 14 Cal. Rptr. 2d 643, 647 (1992) ("Following form policies 'are typically written on the same terms and conditions as the coverage provided by the underlying primary coverage. They are generally short, consisting of one or two pages, with an endorsement or provision that incorporates by reference the underlying policy coverages, except for the premium, the liability limits, and the obligation to investigate, defend, or pay costs of defense'."); Monsanto Co. v. American Centennial Ins. Co., 1991 WL 35714 (Del. Super. Ct. Feb. 20, 1991); Ford Motor Co. v. Northbrook Ins. Co., 838 F.2d 828 (9th Cir. 1988); following-form carriers may add additional terms and coverage restrictions per other endorsements in the policies they issue. See Home Ins. Co. v. American Home Products, 902 F.2d 1111, 1113 (2d Cir. 1990).

In Amway, here's how the court framed the dispute:

The real question, then, is whether an excess carrier . . . is bound as a matter of law by the underlying carrier's failure to comply with the renewal rule. We believe that the answer is "yes," because the "follow form" linkage between an excess insurer and the primary insurer should logically apply to procedural as well as substantive obligations to their common insured. In effect, an excess insurer who lives by the sword must die by the sword.

Id. The majority rejected the insurer's implicit argument that the insured's position was really the invention of its lawyers and that the coverage -- which would otherwise be barred for the particular claims being fought over -- were not all that important to the insured at the time it bought the policy. Seeming to the relish being confronted with this unusual insurance-law rule, the court states:

This type of extra-contractual argument, if successful, would require those purchasing insurance to affirmatively validate the importance of each and every coverage purchased. We find no authority supporting such an obligation. Furthermore, we suspect that any such obligation would turn the world of insurance upside down, since one has to be either super-diligent or a masochist to read an insurance policy with a fine-toothed comb.

Id. Furthermore, the Sixth Circuit rejected the argument that the presence of a broker as an intermediary on behalf of the insured negates application of the renewal rule. See id. (Kennedy, J., dissenting) ("Where brokers are involved in negotiating the terms of the policy, the rationale for a 'renewal rule' such as Michigan's is diminished, since there would be less need to protect unknowing insureds from the passive misrepresentations of their insurers."). The rejection of the insurer's argument that the renewal rule does not apply if a broker is involved means that just because the insured and its agents are "sophisticated" or possess "bargaining power" does not negative application of the rule, nor is it relevant that the brokers may know (as in the case I handled) that the new exclusionary language was "in the air" as it were, being discussed in trade publications, speeches, industry-form-drafting-organization [now, ISO] press releases, and other vectors of inculcation.

Both the majority and the dissent agreed further that, if an excess insurer was to be bound by the misdeeds of the primary that failed to provide notice of the reduction in coverage, the excess insurer would have recourse against the primary. As the court explained,

This triangular relationship between the primary insurer, the excess insurer, and the insured presents the classic problem of which one of the two relatively "innocent" parties must suffer when the "wrongdoer" causes a loss. IN the present situation, we believe that . . . the excess insurer ] was in a much better position than the insureds to analyze unannounced changes in the underlying policy that it had agreed to follow. As between [the excess insurer] and the insureds, therefore, [the excess insurer] should be bound to provide the greater coverage and be the one to seek indemnity back against the [primary].

This assumption -- which serves as what I tend to call an existential escape valve for the court -- may not be so straightforward; the question whether a primary insurer owes any legal duties directly to excess insurers and the theory under which such a claim is pursued is highly controverted, with much of the judicial commentary falling into obiter dicta rather than ratio decidendi. The nature of the duty and its limits may not be so clear. E.g., Continental Casualty Co. v. Reserve Ins. Co., 307 Minn. 5,10 239 N.W. 2d 862,865 (1976); Certain Underwriters at Lloyd's v. The Fidelity and Casualty Ins. Co. of N.Y., 4 F.3d 541, 547 (7th Cir. 1993). One can imagine such an action being pursued as an equitable contribution or indemnity claim by the excess insurer, but I have not puzzled through how that outcome would be resolved in a well-presented case by both sides. (In turn, the tagged excess or primary might make an claim under its insurance company professional-liability or errors-and-omissions (E&O) coverage or its reinsurance under, in particular, a follow-the-fortunes clause (and then be greeted with negligent underwriting claims as in Bonner v. Cox., known as the Aon 77 case).)

The focus here, of course, from the perspective of the policyholder lawyer, is the renewal doctrine, or the rule that in renewal policies that coverage restrictions are not effective if the insured had no prior notice from the insurer itself of their inclusion. In the case I handled, a chemical company presented with a standard-form CGL policy in 1970 that had a pollution exclusion included. That exclusion was "accepted" by the broker and the insured without objection -- no one ever pointed out any error or confusion about the terms of the coverage. Yet, two different courts looked at the same facts (why two courts is a different story) and each concluded independently that the renewal rule unquestionably applied, and so a primary policy with defense (in additional to limits) coverage was found to apply to several major environmental-liability, site clean-up, natural-resources damages, and toxic-tort administrative and court proceedings, liabilities the carrier would have skated out of (it claimed) if this particular exclusion applied. What we saw -- what both sides saw -- in the file as the actual, bona fide copy of the policy was indeed what we ended up with -- sans an outcome-determinative exclusion.

While the notice-of-reduction-in-a-renewal-policy rule is a favorable one that policyholders should press when presenting or litigating claims against their insurance company, it cannot do so unless the policyholder's counsel is aware of this particular rule; if not, then the insured's lawyer better be an insured lawyer.

Tags: Insurance, Blawg, Renewal Policy, Reduction in Renewal Policy, New Exclusions, Insurance Litigation, Insurance Coverage, Policyholder Lawyer

Posted by Marc Mayerson at 12:11 AM | Comments (3) | TrackBack

What You See Is Not What You Get: Renewal Policies

In Amway, here's how the court framed the dispute:

The real question, then, is whether an excess carrier . . . is bound as a matter of law by the underlying carrier's failure to comply with the renewal rule. We believe that the answer is "yes," because the "follow form" linkage between an excess insurer and the primary insurer should logically apply to procedural as well as substantive obligations to their common insured. In effect, an excess insurer who lives by the sword must die by the sword.

This type of extra-contractual argument, if successful, would require those purchasing insurance to affirmatively validate the importance of each and every coverage purchased. We find no authority supporting such an obligation. Furthermore, we suspect that any such obligation would turn the world of insurance upside down, since one has to be either super-diligent or a masochist to read an insurance policy with a fine-toothed comb.

This triangular relationship between the primary insurer, the excess insurer, and the insured presents the classic problem of which one of the two relatively "innocent" parties must suffer when the "wrongdoer" causes a loss. IN the present situation, we believe that . . . the excess insurer ] was in a much better position than the insureds to analyze unannounced changes in the underlying policy that it had agreed to follow. As between [the excess insurer] and the insureds, therefore, [the excess insurer] should be bound to provide the greater coverage and be the one to seek indemnity back against the [primary].

Tags: Insurance, Blawg, Renewal Policy, Reduction in Renewal Policy, New Exclusions, Insurance Litigation, Insurance Coverage, Policyholder Lawyer

Posted by Marc Mayerson at 12:11 AM | Comments (7) | TrackBack

March 29, 2006

Blast Fax -- Policyholders Continue to Obtain Defense Coverage

The ongoing fights over coverage for junk faxes continue, with the trend favoring policyholders, most recently in the form of a US Court of Appeals for the Tenth Circuit decision, Park University Enterprises, Inc. v. American Cas. Co. (10th Cir. March 27, 2006).

A year ago at this time, policyholders began to feel more confident following an Eighth Circuit opinion that refused to follow negative decisions from the Seventh and Fourth Circuits; since then, the trend has continued to swing toward policyholders, at least insofar as they seek defense coverage to class actions alleging violations of the Telephone Consumer Protection Act (TCPA), 47 U.S.C. 227.

Most recently, the Tenth Circuit found that there was coverage under both the property-damage and the advertising-injury coverage. With respect to property damage, the court focused in part on what I term "prong 2" property damage, that is, loss of use of tangible property that has not been physically injured. Here, the court considered the loss of use of the fax machine during transmission to be the loss-of-use property damage. The court implicitly considered the waste of paper and ink to be "prong 1" property damage, that is, physical injury to tangible property. See Park University, slip op. at 8.

The Park University court rejected the argument that the property damage was expected or intended from the standpoint of the insured or was so unfortuitous as not to be covered. Instead, the court focused on the denial of liability of the insured in the TCPA action wherein it alleged (subject to Fed. R. Civ. P. 11) that it believed it had permission to send the offending fax. Id. at 14 n.3. "Hence, from its standpoint, any resulting use of [the recipient's] fax machine, paper, and toner could not have resulted in injury because Park University thought the fax was welcome." Id. at 11.

As to advertising-injury coverage, the Tenth Circuit rejected the argument that coverage was limited only to injury to "seclusion," the theory espoused by the Seventh Circuit (per Judge Easterbrook), concluding that the policy, "defined by a reasonable person in the position of the insured, provides coverage for TCPA violations." Slip op. at 17. Ultimately, the Park University court found that accepting the advertising-injury coverage arguments of the insurer would be to "construe the language of the contract from the vantage of an insurer or an attorney, rather than the insured." Slip op. at 20.

Accordingly, "[t]he transmission of an allegedly unsolicited fax can constitute a [covered] publishing act, while receiving the same can result in a[ covered] invasion of privacy." Slip op. at 22. Furthermore, the nature of insurers' responses to these claims likely will vest in the policyholder the right to select the counsel it wishes to defend it against the TCPA liaiblities.

Note that the increased success of policyholders in obtaining defense and indemnity coverage for these cases pressures insurers not to offer this type of coverage at all, a development I have previously described.

Posted by Marc Mayerson at 11:57 AM | Comments (0) | TrackBack

Blast Fax -- Policyholders Continue to Obtain Defense Coverage

Posted by Marc Mayerson at 11:57 AM | Comments (0) | TrackBack

March 12, 2006

Aloha to Unasserted Coverage Defenses: Waiver, Estoppel, and Mend the Hold in Insurance Cases

Sometimes when an insurance company does not have an obligation to perform, it can be required to pay anyway. There are typically three doctrinal hooks that force insurers to provide coverage in circumstances where the terms of the contract strictly speaking does not require them to do so: waiver, estoppel, and “mend the hold.”

While commonly conflated, the doctrines are different, and there’s no good reason for lawyers for either insurers or policyholders to wrap their arguments in the wrong garb. As the Hawai'i Supreme Court recently reiterated:

In the context of insurance law, . . . the terms “waiver” and “estoppel” have often been used without careful distinction, and thereby abused and confused. . . . The fact that these doctrines are closely akin and often may coexist does not mean they are identical in connotation.

Enoka v. AIG Hawai'i Ins. Co., Inc. (Haw. Feb. 23, 2006), slip op. at 32 (citations omitted). In the Enoka case, the Hawai‘i Supreme Court was forced to “attempt to extricate” the two arguments, which were used “interchangeably throughout [the] opening brief, ” and in doing so the Hawai‘i Supreme Court helpfully collected cases nationwide on both waiver and estoppel in the insurance context. In addition to waiver and estoppel, insurance cases also may involve the less commonly invoked “mend the hold” doctrine, which like the others is a principle whose effect is to preclude an insurer from interposing an otherwise valid ground for avoidance.

By way of background, it is important to recognize that insurers have duties to investigate claims submitted by insureds, may only reasonably assert the grounds they interpose for refusing to perform, and must assist their insureds in perfecting claims against them. Let’s assume that an insurer has done all this and thereafter asserts two valid grounds for refusing to perform, each of which is sufficient to bar coverage. In such circumstances, the insurer quite obviously has no obligation to pay and has breached no duty to the insured.

Let’s say that instead, the insurer asserts two grounds for refusing to pay, but only one is valid. It is still possible (at least in some jurisdictions, including Hawai'i) for the insurer to be liable for first-party bad faith – or flipping the matter around, a valid ground for denial of coverage is not a license to commit bad faith. E.g., Enoka. But in those circumstances, the insurer will not be liable for breach of contract.

But where the situation is reversed, that is, where the invalid ground is asserted, and the valid ground is not, questions of waiver, estoppel, and mend-the-hold arise. Really, the question is whether we should allow the insurer belatedly to assert the valid ground for denial. (The use of the word “belatedly” in the previous sentence is not a question-beg but rather is a matter of definition: these issues do not arise if the assertion of the valid coverage defense is timely.)

There is nothing wrong with an insurer’s electing not to press one defense or another. Moreover, one does not wish to encourage insurers to change tack after they learn that a claim may be expensive (and covered) and seek to refuse to perform on a ground they initially thought to be a trifle. Precluding insurers from resuscitating defenses thus forecloses opportunistic behavior.

Similarly, the law does not wish to induce in insureds a false sense of security, that is, even if the insurer asserts an invalid ground, one can suppose the insured would have understood the ground not to be valid, and therefore have assumed there will be coverage (once the misunderstanding is cleared up and since the insured does not know the insurer will (later) rely on the unasserted, valid ground). Allowing insurers then to raise seriatim defense after defense undermines the objective of security that the insurance is meant in part to provide.

Further, where an insurer interposes only the invalid ground, we do not want to create a situation where an insured acts in a manner different from how it would have acted had the insurer articulated the valid ground for denying coverage; in other words, if an insured changes its position in a fashion based on the nonassertion of the coverage defense, the insurer should not later be permitted to revive the coverage defense that it could have asserted earlier.

A countervailing consideration is that absent unusual circumstances a policyholder that incurred a loss never comprehended within the insurance contract should not be able to manufacture coverage merely from an insurer’s misstep.

These are all principles that animate how insurance law deals with the situation of the untimely assertion of a valid coverage defense by insurers, many of which are explored by the Hawai'i Supreme Court in Enoka.

The Enoka court first addressed whether the insurer in that case “waived” its coverage defense. Sometimes the case law in this regard is confused in drawing a distinction between express and implied waivers: it is not the “waiver” that is express or implied; rather, it is the insurer’s conduct that may be said to waive a defense expressly or by implication. Either way there is a waiver, and the only question is how that waiver is proved at trial. (The idea is similar to the “difference” between an express and implied contract – there is no difference, the only distinction is one of proof.) So it is with “waiver,” and the question is whether the insurer mouthed or wrote the words that it was waiving a particular defense or whether though silent the carrier’s conduct indicates its waiver.

There is no doubt that insurers are free to waive their valid coverage defenses or to make a payment to an insured for a loss that was never covered by the insuring agreement to begin with. (Insurers may give such succor deliberately to foster positive business relationships with the particular insured or may make payment for other reasons, such as obtaining the favor of politicians or insurance regulators.)

Waiver can be evidenced by conduct inconsistent with the assertion of the coverage defense, and courts are more willing to find such waivers when the defense concerns “technical” or “forfeiture” grounds, such as timely notice or proof of loss; courts are less likely to find a waiver if that which is being claimed to have been waived goes to the non-existence of coverage in the first place (i.e., that a loss was not covered by the insuring agreement, without regard to exclusions, etc.).

Accordingly, a demand by an insurer for more information after a deadline for submitting claims whose expiration is readily apparent will be deemed to be a waiver of that deadline. Enoka, slip op. at 37. (One can also conceive of this as an estoppel claim based on the insured’s going to the effort to respond to this request, but its aptness is questionable given that the expiration of the deadline should be as apparent to the policyholder as it is to the insurer which leads to questions of the reasonableness of the insured’s reliance on the insurer’s request for more information, etc. etc.)

But where the carrier’s defense relates to a “coverage issue”, waiver will be less likely to be found from conduct alone. The notion largely goes to the burden of proof on each party’s prima facie case: the insurer bears the burden of showing exclusions and limitations on coverage and as with any affirmative defense it can be waived (in this context classed as a “technical” defense); this is different, however, from an insurer’s “waiving” its objection to the policyholder’s failure to sustain its prima facie case for coverage (classed as a “coverage” issue).

The other common fount for argument that an insurer cannot revive a defense to performance is estoppel, which prevents an insurer from switching positions in its dealings with the particular insured. (One should also be aware of the notion of “judicial estoppel,” which prevents litigants from taking inconsistent positions from case to case where the party had prevailed on a prior ground, Iowa v. Duncan (Iowa Feb. 17, 2006); Whiteacre Partnership v. Biosignia Inc. (N.C. Feb. 6, 2004) (containing a lengthy discussion of estoppel and judicial estoppel).)

Many if not most courts say that estoppel may not be used to “broaden the coverage” granted to begin with, Enoka slip op. at 39. Nevertheless, estoppel can apply to broaden coverage in three circumstances according to the Enoka court:

1. Where the insurer or its agent made a misrepresentation at policy inception that, if corrected at that time, would have enabled the insured to protect itself by buying back an exclusion or purchasing a different policy form;
2. Where the insurer undertook and controlled the insured’s defense in a liability matter without mentioning the coverage issue (and thus prevented the insured from protecting its interest in the conduct of the defense or in settling the matter, a topic on which I have previously commented .
3. Where the insurer has acted in bad faith or relatedly where allowing the change of position would be manifestly unjust.

“Estoppel” requires detrimental, reasonable reliance by the “innocent” party and injury that would result from allowing the change in position. In the first exception, the principle applied is meant to prevent “sharp practices” and is more a pure invocation of equity. (There is also the related idea of estoppel in pais, which applies more broadly in that the party claiming the benefit of the estoppel need not be the same as the person to whom the representation was made (i.e., there is no “mutuality” limitation), as in Free v. Sluss, 87 Cal.App.2d Supp. 933 (1948) and Morton Int'l Inc. v. General Accident Ins., 134 N.J. 1, 629 A.2d 831 (1993) (unnecessarily called “regulatory estoppel” when estoppel in pais is sufficient).) It is also related to a rule of contract construction whereby an promisor will be held to a meaning of a contract in the sense it knew the promisse had understood it at the time of contract formation.

The third situation again is more a broad principle of equity such that where the conduct involved is sufficiently unreasonable, equity will prevent a party from changing its position in order to prevent manifest injustice – i.e., detrimental, reasonable reliance is not needed. (Injury is implicit, otherwise there would be no fight over the issue: de minimis non curat lex.) This type of circumstance may fall also under “quasi estoppel” principles but mutuality is required for quasi-estoppel to apply. See Whiteacre.

Waiver and estoppel are not confined to contracts or insurance contracts, but there is one additional doctrine that is derived from contract law whose operation is similar, which is the “mend the hold” principle. The most important recent articulation of this rule is the opinion for the Seventh Circuit authored by Judge Posner in Harbor Ins. Co. v. Continental Bank Corp., 922 F.2d 357, 362 (7th Cir. 1990). And while notions of estoppel and waiver are sprinkled into analyzes of the rule, the core notion, as stated by the US Supreme Court well more than a century ago, is that:

Where a party gives a reason for his conduct and decision touching any thing involved in a controversy, he cannot, after litigation has begun, change his ground, and put his conduct upon another and a different consideration. He is not permitted thus to mend his hold.

Railway Co. v. McCarthy, 96 US 258, 267-68 (1877). The phrasing “mend the hold” hearkens to wrestling.

The mend-the-hold idea is grounded in contract law (substantive law) rather than being a mere implementation of a procedural rule requiring the articulation of claims or defenses (or elections of remedies). It effectuates ex ante decisionmaking and conduct (which undergirds all contract law), whether that prospective private ordering takes place at the time of contract formation or at the time of contract performance (or non-performance). As the Kansas Supreme Court held, “[s]ince the defendant here, before litigation was commenced, gave only as its reason for nonperformance a ground which was inadequate, it could not, after suit was filed, ‘mend its hold’ and rely upon other and different defenses. It was limited in the trial to the single defense it asserted at the time of breach.” Heidner v. Hewitt Chevrolet Co., 199 P.2d 481, 484 (Kan. 1948); see also Coporacion de Mercadeo Agricola v. Mellon Bank Int’l, 608 F.2d 43, 348 (2d Cir. 1979); Western Grocer Co. v. New York Oversea Co., 28 F.2d 518, 520-21 (N.D. Cal. 1928).

Mend-the-hold should have particular force in insurance cases, as the Seventh Circuit found in Continental Bank, but courts sometime dilute its effect by importing (in error) some of the limits to estoppel more generally, Design Data Corp. v. Maryland Cas. Co., 503 N.W.2d 552, 560 (Neb. 1993). But it is in the insurance context and real-estate-brokerage contexts that the doctrine has most typically been applied. See Sitkoff, “Mend the Hold” and Erie, 65 U. Chi. L. Rev. 1059 (1998). It also prevents insurers from insulating against the application of waiver or estoppel by putting in general language in disclaimer/denial letters or reservation-of-rights letters whereby they purport to reserve generally other grounds that have not been articulated, a practice that if validated by the courts undermines the whole purpose of requiring insurers to investigate claims and state their coverage positions.

Insurers are supposed to be the masters of the contracts they sell, and all three of these doctrines create incentives for insurers to do their job right the first time. (They also give insurers incentives to over-articulate defenses to coverage, an incentive that (one hopes) may yield self-correction in the marketplace due to consumer revolt from being greeted with interminable denial-of-coverage letters and regulatory displeasure from such market conduct.) On balance, forcing the prompt articulation of coverage defenses, a corollary of the rule that insurers have the duty to investigate claims, is a good thing, and courts should not hesitate in the individual case to apply waiver, estoppel, or mend the hold, even though an “undeserving” insured obtains coverage from the carrier’s mistake. In the long run everyone – insurers too – benefits from a system that requires insurers, which are responsible for the terms of coverage, sell peace of mind and promptness of performance in the time of need, and have trained forces of claims handlers (paid for by policyholders through the collection of premiums), to both put up and shut up.

Posted by Marc Mayerson at 5:17 PM | Comments (2) | TrackBack

Aloha to Unasserted Coverage Defenses: Waiver, Estoppel, and Mend the Hold in Insurance Cases

In the context of insurance law, . . . the terms “waiver” and “estoppel” have often been used without careful distinction, and thereby abused and confused. . . . The fact that these doctrines are closely akin and often may coexist does not mean they are identical in connotation.

1. Where the insurer or its agent made a misrepresentation at policy inception that, if corrected at that time, would have enabled the insured to protect itself by buying back an exclusion or purchasing a different policy form;
2. Where the insurer undertook and controlled the insured’s defense in a liability matter without mentioning the coverage issue (and thus prevented the insured from protecting its interest in the conduct of the defense or in settling the matter, a topic on which I have previously commented .
3. Where the insurer has acted in bad faith or relatedly where allowing the change of position would be manifestly unjust.

Where a party gives a reason for his conduct and decision touching any thing involved in a controversy, he cannot, after litigation has begun, change his ground, and put his conduct upon another and a different consideration. He is not permitted thus to mend his hold.

Posted by Marc Mayerson at 5:17 PM | Comments (2) | TrackBack

February 19, 2006

The Risks of the Seas and of Federal Courts Seizing -- or Being Seised of -- Jurisdiction

Insurance contracts typically are creatures of state law. As a result, unlike other kinds of complex litigation, insurance-coverage disputes often are litigated in state, not federal, court. There are exceptions to this where there is diversity jurisdiction, though in complex, multiparty coverage cases it is often unusual for there to be complete diversity between and among all the parties.

Insurance disputes can end up in federal court under admiralty jurisdiction, which provides a jurisdictional hook to get into federal court where the insurance is maritime in character – or what is sometimes referred to as “salty.” There are traditional forms of maritime insurance that are subject to federal jurisdiction, such as hull, protection and indemnity, and cargo. Other forms of coverage may have a relationship to maritime risks, and parties may fight over getting into federal court and having federal admiralty law apply.

Where policies are not expressly maritime – or are combination policies with some maritime and traditional non-maritime coverage parts – there is a fair amount of uncertainty as to whether a case should be in federal court. The Second Circuit confronted these issues in Folksamerica Reinsurance Co. v. Clean Water of New York Inc. (2d Cir. June 30, 2005), a case that may well have impact on whether disputes associated with hurricane Katrina will be subject to federal-court jurisdiction, even though the particular facts concerned a bodily injury claim brought by a worker cleaning a vessel.

Clean Water was one of several entities covered under the policy at issue, which contained both a “Shiprepairers Legal Liability” section and a Comprehensive General Liability section. This package policy had combined limits for both sections, and a single premium for the policy as a whole. It was the insurer that argued for admiralty jurisdiction, arguing that it had a stronger basis for a misrepresentation defense under the standards of federal admiralty law.

The Second Circuit’s opinion is a lengthy tour of the issues concerning the standards for divining which types of contracts are sufficiently salty as to qualify for admiralty jurisdiction. The court characterized the question before it as a seemingly “simple inquiry: Is the Policy a maritime contract giving rise to admiralty jurisdiction?” Slip op. at 5. The federal courts possess a unique lawmaking authority under Article III for admiralty matters, with the essential idea being that it is important to have a uniform law for maritime matters even in the absence of Congressional action. This power stems from the need to “protect maritime commerce,” (p. 6). In the case before it, the dispute concerned “an insurance claim based on a ship-maintenance-related injury sustained by a ship oil-tank cleaner aboard an ocean-going vessel in navigable waters.” (p. 8)

Nevertheless, the coverage had little to do with maritime issues: the question concerned ordinary CGL coverage. While a portion of the package policy unquestionably was maritime in character, the coverage under which the dispute arose was the general-liability section, and on this basis the district court found the policy to be divisible and that the nonmaritime aspects predominated (and thus there was no jurisdiction).

The Second Circuit reviewed recent Supreme Court jurisprudence that it believed undermined aspects the prior Second Circuit precedent. In general, “admiralty jurisdiction will exist over an insurance contract where the primary or principal objective of the contract is the establishment of ‘policies of marine insurance,’” (p. 12) but positing the issue this way obviously is circular.

Courts typically have looked at whether the maritime aspects predominate or whether they are incidental. The Second Circuit here found there was “nothing intrinsically ‘shore side’ about a CGL policy.” (p. 15). Instead, the keys are the terms of the insurance and the nature of the business insured, with the label or form of the policy not being determinative. (p. 16-17)

In the case at hand, the policy excluded typical or traditional maritime risks, though the court found ultimately an overlap in the coverage provided for premises/operations, products, completed-operations, pollution, and incidental-contract coverage. While concluding that the contracts coverage was not maritime, the Second Circuit found that the other portions were in the circumstances maritime in nature.

In Clean Water, the insured’s repair and maintenance operations on seagoing vessels implicated marine issues, and the insured’s replacement of parts on the ship in its maintenance activities similarly were maritime. As the court stated, “[t]he risk of injuries from, and damage to, a ship after defective or faulty repair or maintenance is a ‘maritime risk’ that includes the risk of ‘the loss of the ship or goods.’” (p. 22) While this coverage overlapped with P&I coverage, that confirmed rather than confuted admiralty jurisdiction.

In finding that disputes under the policy to be subject to admiralty jurisdiction, the court summarized:

In the circumstances of this case – a contract with two sections, one of which provides fully marine insurance [the shiprepairers legal liability], and the other specifically modified to cover maritime risks – we conclude that the Policy is marine in nature . . . [and that] the primary objective of the policy is to establish marine insurance. (p. 29)

The Second Circuit conceded that part of the policy unquestionably was nonmarine and that the policy did not fall within the traditional categories of marine insurance, yet it found there was a sufficient nexus to the risks of the sea as to merit the exercise of admiralty jurisdiction. The court’s lengthy opinion is not altogether satisfactory in guiding litigants on the question of how much of the policy needs to be maritime in nature and the required nexus between the dispute at issue and the maritime portions of the coverage for federal-court lawmaking to govern and for the federal court to be seised of jurisdiction under 28 USC § 1333(1).

Posted by Marc Mayerson at 3:34 PM | Comments (0) | TrackBack

The Risks of the Seas and of Federal Courts Seizing -- or Being Seised of -- Jurisdiction

In finding that disputes under the policy to be subject to admiralty jurisdiction, the court summarized:

In the circumstances of this case – a contract with two sections, one of which provides fully marine insurance [the shiprepairers legal liability], and the other specifically modified to cover maritime risks – we conclude that the Policy is marine in nature . . . [and that] the primary objective of the policy is to establish marine insurance. (p. 29)

Posted by Marc Mayerson at 3:34 PM | Comments (0) | 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

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

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.

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

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January 16, 2006

Gelding the Pollution Exclusion: Welding Exposure Claims Not Barred

For the past several years, the plaintiffs’ tort bar has sought to make workplace-exposure claims by welders the proverbial “next asbestos.” These cases typically allege a Parkinson’s Disease-like syndrome (“Parkinsonism”) or other neurological impairments (all generally referred to as “manganism”) allegedly stemming from the welder’s exposure to manganese while working. Whether this is a mass-tort with legs is certainly not clear, and the defense has had successes (even in what are considered to be plaintiff-friendly jurisdictions). Naturally, this litigation has produced insurance cases too, and the Maryland Court of Appeals (its highest court) recently ruled that an absolute pollution exclusion did not apply to bar coverage. Clendenin Bros. v. United States Fire Ins. Co. (Md. Jan. 6, 2006).

The Clendenin decision is significant in part because it disagrees with a prior Fourth Circuit decision, National Electrical Manufacturers Association (NEMA) v. Gulf Underwriters Insurance Company, 162 F.3d 821 (4th Cir. 1998). The NEMA case found that a pollution exclusion applied to the bodily injury claimed in the welding-rod litigation. The Maryland high court disagreed. (The Fourth Circuit is a bit of a recidivist in this regard, inaccurately predicating that state law would rule for insurance companies only to have the state later expressly go the other way. Compare Mraz v. Canadian Universal Insurance Company, 804 F.2d 1325 (4th Cir. 1986) (holding that Maryland law mandated a “manifestation” trigger of coverage) with Harford County v. Harford Mutual Insurance Co., 610 A.2d 286 (Md. 1992) and compare Maryland Casualty Co. v. Armco Co., Inc., 822 F.2d 1348, 1352-54 (4th Cir. 1987) (predicting that Maryland would refuse to recognize CERCLA response costs as “damages” under CGL policies) with Bausch & Lomb, Inc. v. Utica Mut. Ins. Co., 625 A.2d 1021, 1032-33 (Md. 1993).)

The Maryland court recognized that the substance at issue had a useful purpose and only allegedly was harmful where a person was exposed to undue levels. As the court ruled: “Therefore, reading this definitional provision as a whole, we conclude that to qualify as a pollutant under the contractual definition the substance must be understood to be an irritant or contaminant.” (Slip op. at 13) The court distinguished prior authority (where the insured had conceded that carbon monoxide was a contaminant) on the basis that the manganese might or might not be considered a pollutant depending on the circumstances. (Id. at 14) This should strongly counsel to policyholders that they need (in good faith) to dispute in the liability case, and certainly in the coverage case, that the substance to which the plaintiff was exposed is malum in se.

The court further embraced the standard creation-story of the absolute pollution exclusion to confirm that its linguistic, contextual construction allowing for coverage was not inconsistent with the policy intent. (Slip op. 18-20; slip op at 21 (“We conclude also that the current construction of the total pollution exclusion clause drafted by Insurer was not intended to bar coverage where Insureds ' alleged liability may be caused by non-environmental, localized workplace fumes.”).

And the court confirmed that this type of product-liability risk – though it takes the form of contamination of exposed persons – is reasonably thought to be comprehended by the product-liability insurance provided by CGL policies. As the Maryland high court explained: “Welding fumes emitted during the normal course of business appear to be the type of harm intended to be included under coverage for routine commercial hazards.” (Slip op. at 19). Indeed, the court expressed its overall rationale more broadly and powerfully: “The specific language used in the total pollution exclusion clause, when read in its entirety, supports the conclusion that noxious workplace fumes were not intended to be excluded.” (Slip op. at 20)

Well aware of the continuing litigation over application of the absolute pollution exclusion to workplace- and product-exposure claims, the court recognized: “We expect that, our decision notwithstanding, interpretation of the scope of pollution exclusion clauses likely will continue to be ardently litigated throughout state and federal courts.” (Slip op at 21).

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Gelding the Pollution Exclusion: Welding Exposure Claims Not Barred

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January 8, 2006

Disavowals of Liability Do Not Disembowel Coverage: Liability Settlements and Insurance Coverage

Liability insurance policies apply where the insured is liable for bodily injury, property damage, or wrongful acts (depending on the policy). What happens, however, when the policyholder denies that any injury or wrongdoing took place? Does that mean that insurance is not applicable?

Perhaps the most pointed illustration concerns Dow Corning, which denied that its breast implants caused injury but entered into a major settlement. In its coverage case, its insurers turned around and argued that, because the policies apply to “injury” and because Dow Corning denied there was “injury,” the insurers had no obligation (or technically that their policies had not been triggered). The court made short work of this argument:

[I]f an underlying plaintiff alleges that she suffered injuries caused by a Dow Corning breast implant . . . [and] Dow Corning settles claims on the basis of those allegations, defendants must indemnify Dow Corning based on those allegations. This conclusion is not based on a theory of res judicata or collateral estoppel, or law of the case. Rather, it is based on a plain reading of the policy language.

Dow Corning Corp. v. Continental Cas. Co., 1999 WL 33435067 at *5 (Mich. App. Oct. 12, 1999). As the court aptly put it, “the question in this insurance dispute is not ‘what really happened?’ Instead, the question is, . . . ‘what did Dow Corning fear a judge or jury might believe happened?’”. Id. at *5 n.8.

Insurers may not take the policyholder’s denial of wrongdoing and injury and offer it as a fact or some form of estoppel. See generally United Servs. Auto. Ass’n. v. Morris, 154 Ariz. 113, 120, 741 P.2d 246, 253 (1987) (finding that to establish coverage “the indemnitee need not establish that he would have lost the case; he need only establish that given the circumstances affecting liability, defense and coverage, the settlement was reasonable.”). Settlement agreements usually contain a clause stating that the defendant does not admit liability, but such disavowals of liability are not germane to proving whether coverage should apply. Instead, what governs in these circumstances effectively are the allegations – or more accurately the risk of adverse factfinding. See St. Paul Fire & Marine Ins. Co. v. American Int’l Specialty Lines Ins. Co., 365 F.3d 263, 274 (4th Cir. 2004) (“AISLIC contends that the lack of any judicial determination that Merritt’s injuries resulted only from ordinary negligence prevents any classification of the settlement liability for indemnification purposes. But AISLIC cites no authority for this proposition, and our independent review indicates that the weight of authorities would allow an indemnification claim to rely on a settled liability. Moreover, courts have relied on the type of fault asserted in the claims against the indemnitee in order to determine whether the relevant acts or omissions fall within the scope of restrictive language of fault contained in the indemnification agreement.”); American Motorists Ins. Co. v. General Host Corp., 946 F.2d 1482, 1489 (10th Cir. 1991) (determining duty to indemnify based on allegations in underlying complaint where no evidence settlement encompassed claims beyond those alleged in complaint); Northland Cas. Co. v. HBE Corp., 160 F. Supp. 2d 1348, 1360 (M.D. Fla. 2001) (“the duty to indemnify is measured by the facts as they unfold at trial or are inherent in the settlement agreement”); McNally & Nimergood v. Neumann-Kiewit Constructors, Inc., 648 N.W.2d 564, 578 (Iowa 2002) (crediting allegations in denying indemnity where settlement of claim was limited to such allegations, holding “an indemnitee cannot transform the underlying claim by the injured party into a different lawsuit by making [different] allegations”); Hyatt Corp. v. Occidental Fire & Cas. Co., 801 S.W.2d 382, 388 (Mo. App. 1991) ("In negotiating a settlement an insured need only be able to: 'take into consideration the likelihood of success or failure, the cost, uncertainty, delay, and inconvenience of trial as compared with the advantages of settlement.'") (quoting Berke Moore Co. v. Lumbermens Mut. Cas. Co., 185 N.E.2d 637, 639 (Mass. 1962));United States Gypsum Co., v. Admiral Ins. Co., 643 N.E.2d 1226, 1244 (Ill. App. 1994) (“[I]n order to recover a settlement, the insured need not establish actual liability to the party with whom it has settled so long as a potential liability on the facts known to the [insured is] shown to exist”) (internal quotations omitted); Luria Bros. & Co. Alliance Assur. Co., 780 F.2d 1082, 1091 (2d Cir. 1986); Uniroyal Inc. v. Home Ins. Co., 707 F. Supp. 1368, 1378-79 (E.D.N.Y. 1988) (“A reasonable settlement binds the insurer to indemnify . . . [and] a settlement is reasonable when it reflects the probability of loss and the probable size of that loss”); Nordstrom, Inc. v. Chubb & Son, Inc., 820 F. Supp. 530, 535 (W.D. Wash. 1992), aff'd, 54 F.3d 1424 (9th Cir. 1995).

A policyholder’s denial of liability prior to settlement has no legal significance and does not amount to a found “fact” or admission. It does not eviscerate the duty to defend nunc pro tunc. The assumed verity of the allegations form the basis from which one infers what were the facts concerning the settled claim. As the Tenth Circuit held, “where a reluctant insurer fails to participate in an insured’s settlement discussions, and the insured becomes party to a global settlement agreement, the insured may be indemnified [by its insurance] for any amount of the total settlement package for which it can establish a reasonable anticipation of liability.” Vitkus v. Beatrice Co., 127 F.3d 936, 945 (10th Cir. 1997). It would be more than passing strange to permit insurers to wrongly deny coverage, which frees the insured to settle without the insurer’s consent or participation (Samson v. Transamerica Ins. Co., 30 Cal.3d 220 (1981)), and then allow the insurer to force the policyholder to take the plaintiff’s case and prove it against itself as a condition for pursuing coverage. This result applies as well with respect to insurers that have yet to wrongly deny coverage. As the Tenth Circuit elaborated:

[There are] two important policy considerations in adopting a legal standard that requires courts to examine only the potential exposure of the settling party, rather than the actual liability of that party. First, if actual liability were the applicable standard, settling defendants would be in the ‘hopelessly untenable position of having to refute liability in the underlying action until the moment of settlement, and then turn about face to prove liability in the insurance action.’ [citation omitted] Second, requiring an insured to prove the case brought against it in order to receive insurance coverage would dissuade the insured from settling the underlying litigation. Faced with the choice of vigorously defending the underlying tort action or settling it without the hope of insurance coverage, the insured would choose the former. [citation omitted]

Vitkus, 127 F.3d at 945.

This rule works in favor of insurance companies, too, when they pay a claim and then seek subrogation; insurers are not required to prove that the payment made actually was covered by the insurance policy but only that it had a “reasonable basis for believing that it was obligated to provide coverage.” Id. at 943.

Policyholders thus are free to defend the cases against them, and then if they decide it is reasonable to settle the case, they may seek to prove their coverage cases later under a standard of proof that liberally construes the factual allegations in a manner that favors coverage. While this approach sometimes is criticized as collapsing the duty to indemnify standard, which typically is based on the actual facts, cf., Servidone Construction Corp. v. Security Ins. Co., 477 N.E.2d 441, 445 (N.Y. 1985), any other rule would work an absurd result. (This favorable factual presumption applies also to general verdicts, Hogan v. Midland Nat’l Ins. Co., 476 P.2d 825, 833 (Cal. 1970), and to default judgments, State v. Nat’l Auto Ins. Co., 290 A.2d 675 (Del. Ch. 1972); Nixon v. Liberty Mut. Ins. Co., 120 S.E.2d 430 (N.C. 1961).) Where the insured reasonably settles a matter, the factual matters that are actually or implicitly at issue are construed to be within coverage. To the extent their coverage defenses otherwise have been preserved, insurers remain free to assert that policy terms bar coverage to the facts as construed favorably to the insured, but they are not free to require the litigation of the facts where litigation was reasonably avoided in the liability action due to the insured’s settlement of the claim against it.

Note: A version of this commentary was published in Insurance Coverage Law Bulletin (March 2006) at 5 and is available also via Law.Com

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Disavowals of Liability Do Not Disembowel Coverage: Liability Settlements and Insurance Coverage

[I]f an underlying plaintiff alleges that she suffered injuries caused by a Dow Corning breast implant . . . [and] Dow Corning settles claims on the basis of those allegations, defendants must indemnify Dow Corning based on those allegations. This conclusion is not based on a theory of res judicata or collateral estoppel, or law of the case. Rather, it is based on a plain reading of the policy language.

[There are] two important policy considerations in adopting a legal standard that requires courts to examine only the potential exposure of the settling party, rather than the actual liability of that party. First, if actual liability were the applicable standard, settling defendants would be in the ‘hopelessly untenable position of having to refute liability in the underlying action until the moment of settlement, and then turn about face to prove liability in the insurance action.’ [citation omitted] Second, requiring an insured to prove the case brought against it in order to receive insurance coverage would dissuade the insured from settling the underlying litigation. Faced with the choice of vigorously defending the underlying tort action or settling it without the hope of insurance coverage, the insured would choose the former. [citation omitted]

Vitkus, 127 F.3d at 945.

Note: A version of this commentary was published in Insurance Coverage Law Bulletin (March 2006) at 5 and is available also via Law.Com

Posted by Marc Mayerson at 4:35 PM | Comments (1) | TrackBack

January 4, 2006

Defense Coverage Under Excess Insurance Policy Forms

Defense-cost expense in major litigation – either one-shot cases or related, serial cases – can accumulate to rather substantial amounts, so naturally policyholders look to their liability-insurance policies for coverage. While most defense-cost coverage disputes concern primary-layer policies, excess insurers, too, may have obligations to perform. As discussed below, a recent Indiana appellate decision addressed coverage for defense costs under a primary-layer policy written on an excess policy form and held that the coverage was restricted to after-the-fact payment as an incident to covered indemnity amounts.

Defense costs will be sought under excess-type policies when the primary coverage is exhausted or where the insured maintains a self-insured retention with an “excess” policy sitting above the retention. (Calling a policy above an SIR an “excess” policy is a bit of a misnomer, since it is excess to no-insurance but such policies are written commonly on excess-type forms with the obligation to perform characterized in terms of “ultimate net loss,” the common wording in excess policies. Cf. Nabisco, Inc. v. Transport Indemnity Co., 143 Cal.App.3d 831 (1983)).

The typical issues for defense coverage under excess policies are:

1. Is there an obligation to pay defense costs at all (once the underlying is exhausted)? See Aetna Cas. & Sur. Corp. v. Certain Underwriters at Lloyd’s, 129 Cal. Rptr. 47 (Cal. App. 1976); State Farm Mut. Auto Ins. Co. v. Foundation Reserve Ins. Co., 431 P.2d 737 (N.M. 1967); Maryland Cas. Co. v. Marquette Cas. Co., 143 So. 2d 249, (La. App. 1962).

2. Is the obligation to pay defense costs only an incident to paying covered indemnity claims (such that there is no coverage if the insured wins the liability case or to the extent that defense costs relate to potentially covered claims rather than to actually covered ones)?

3. Relatedly, does the obligation to pay defense costs arise at the outset of the liability case or only after the insured has lost the liability case (meaning both that the insured fronts the costs of the defense and that the defense costs are covered not based on the allegations of the complaint but only based on the facts as proved at trial)?

4. Where the insurer does not have an obligation to defend but has a right to associate in the defense or to consent to the incurrence of defense costs, does the insurer have the unfettered power to refuse to contribute to defense costs for a covered claim?

5. Where an insurer does not have an obligation to assume control of the defense, may it still have an obligation to reimburse the costs of defense as they are incurred? Gon v. First State Ins. Co., 871 F.2d 863 (9th Cir. 1989).

6. Where an excess policy does not expressly set forth a defense obligation but “follows form” to an underlying policy with a defense obligation, does the following-form carrier presumptively have an obligation to contribute to the defense costs? Monsanto Co. v. American Centennial Ins. Co., 1991 WL 35714 (Del. Super. Ct. Feb. 20, 1991); Ford Motor Co. v. Northbrook Ins. Co., 838 F.2d 828 (9th Cir. 1988).

7. Are defense costs paid by the excess carrier in addition to policy limits or within its policy limits (sometimes referred to as “defense inclusive” policies)? Alternatively, if policy limits are expressed in terms of “ultimate net loss” and defense costs are carved out of ultimate net loss, does that mean that costs are not payable at all or are they still payable but outside of policy limits? Affiliated FM Ins. Co. v. Owens-Corning Fiberglas Corp., 16 F.3d 684 (6th Cir. 1994); North River Ins. Co. v. Cigna Re Co., 52 F.3d 1194 (3d Cir. 1995); Home Ins. Co. v. American Home Prods. Corp., 902 F.2d 1111 (2d Cir. 1990); Continental Cas. Co. v. Pittsburgh Corning Corp., 917 F.2d 297 (7th Cir. 1990); Planet Ins. Co. v. Mead Reinsurance Corp., 789 F.2d 668 (9th Cir. 1986).

[The above-cited cases touch on some of these issues both pro and con (depending on one’s perspective). Lawyers for both policyholders and insurers should be mindful that some cited cases are inter-insurer disputes where the policyholder perspective – and supporting facts – were not presented, e.g., Crown Center Redevelopment Corp. v. Occidental Fire, 716 S.W.2d 348 (Mo. App. 1986) (and compare this holding to my note, An Insurance Company’s Duty to Consent , or are reinsurance disputes where the factual record may not have been developed or where there is a deferential standard of review of an arbitration decision, e.g., North River, 52 F.3d at 1208-1217.]

The Indiana Court of Appeals recently addressed some of these matters, Cinergy Corp. v. St. Paul Surplus Lines Ins. Co.., (Ind. App. Dec. 13, 2005). The court described the question presented as “Whether a policyholder of a first-layer liability insurance policy is entitled to payment of defense costs as they are incurred when the insurance policy does not contain a duty to defend clause or express language authorizing a delay in payment of those costs until determination of whether the underlying claims are covered.” The policy at issue provided that the insurer was obligated “to indemnify” sums the insured becomes liable to pay “as Ultimate Net Loss by reason of the liability imposed upon the Insured by law or liability assumed by the Insured under Contract.” The case did not go off on the language that the insurer was to “indemnify . . . by reason of the liability imposed” but instead turned on the ultimate-net-loss provision.

“Ultimate Net Loss” was defined as “the total of the following sums . . . to which this Policy applies: (1) all sums which the Insured shall become legally obligated to pay as damages . . . and (2) all expenses incurred by the Insured in the . . . defenses of any claim or suit seeking such damages.”

The court ultimately seized on the use of the term “total” in the ultimate-net-loss provision, reasoning that one cannot know the “total” ultimate net loss until both the defense costs and the damages were determined. Slip op. at 11 (“The pivotal requirement in the payment of the defense costs lies in the definition of ultimate net loss as a total of incurred defense costs and damages which h the insured becomes legally obligated to pay.”) From this, the court found it plain and unambiguous that there was no obligation to pay defense costs until covered damages were awarded. The court further stated that until the policyholder was found liable, one cannot know that a covered occurrence or wrongful act took place, and thus (?) ultimate net loss does not “even exist,” slip op. at 10. Because the carrier’s obligation is to indemnify ultimate net loss, there was no duty to pay for defense costs before the insured was found liable for a covered act.

Probably the court’s strongest rationale is that, unless one waits until the underlying liability case is over, it is possible that the carrier will pay defense costs for a matter found ultimately to be outside of coverage (even if that prejudice might be mitigated by the insurer’s obtaining reimbursement of the amounts expended. See In re Kenai Corp., 136 B.R. 59 (S.D.N.Y. 1992)). (And the split of authority regarding whether insurers may recover defense costs from their own insureds – or trend away from permitting such claims – serves to strengthen the equities favoring insurers.) Note that directors’ and officers’ insurance policies may disclaim an obligation to defend but provide for the advancement of defense costs subject to reimbursement, which often makes those cases of little use in this context.

The Cinergy court’s holding principally is predicated on the use of the term “total” in the ultimate net loss definition and the language “to which this policy applies” (in that definition). While this language may support the court’s conclusion, other language does not: in the ultimate-net-loss provision, the coverage for defense costs is defined as expenses incurred in the defense of “any claim or suit seeking such damages.” In this context, the word “seeking” is key. A suit “seeking” such damages is judged ex ante – that is, is judged by what the complaint alleges. If the carrier intended for defense to be reimbursed only where a covered indemnity claim was adjudged, the defense language should say something like “all expenses incurred by the Insured in the defense of any claim or suit where such damages are awarded” or “have been awarded”. These formulations, especially the latter, would make clear that a truly retrospective approach was intended.

At a minimum, the policy language should be found to be unclear on this point, and while the carrier’s argument that it might have to pay for potentially uncovered claims has some force, the overwhelming practice for “first layer” insurers is to pay for defense costs on a allegations basis. Further, the court’s construction creates a gap in coverage for cases where the insured wins the liability case (since no “wrongful act” or “occurrence” took place), a gap in coverage that surely would be unexpected by any reasonable policyholder. In this light, the insurer should have utilized language making it clear that defense costs are reimbursed only as an incident to covered indemnity claim. Indeed, I think that the insurer should make express its negative intention not to pay defense costs unless and only if the policyholder loses a suit for a covered wrongful act.

Part of the difficulty in this entire area is the dearth of case law and the superficiality of much of the analysis in the cases. The keys to successfully litigating these issues for policyholder counsel are: (i) focus on the policy language; (ii) think about what happens if the policyholder wins the liability case; (iii) considering the overwhelmingly common practice of carriers’ funding the defense, argue that the burden of dispelling the expectation of coverage is on the carrier to negate defense coverage; and (iv) recognize that while the incurrence of defense costs can be a catastrophic exposure to the policyholder it can also be so for the carrier, meaning that the policyholder must sensitively respond to the equitable force of the insurer’s arguments and not simply rely on “punish the drafter” arguments or what the Nabisco court characterized as “‘mom and pop’ grocery store argument[s]” (unless one has to). Of course, sometimes the excess policy really will have no or quite limited obligations to pay defense costs, which the client needs to recognize is a consequence of the coverage it purchased (and possibly the insufficient advice provided by its broker – opening a different vista for recovering the unpaid defense costs).

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Defense Coverage Under Excess Insurance Policy Forms

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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.

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Triggering Asbestos Coverage: Creating Gaps

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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.

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E Pluribus Plures: More on Number of Occurrences

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.

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November 6, 2005

Insurance for Goods in Transit

Companies that make things need to get those things to their customers, and they face the risk of loss while the goods are in transit to the customer. Via contract, one can shift or retain the risk of loss during transit, such as having title pass to the customer once the item leaves the company’s facility or to wait until the customer accepts the item at its location. In addition to shifting to one party or the other the risk of loss via the sale contract, the company can obtain insurance to protect itself against loss. Recent cases have addressed both liability coverage – insurance against the risk of loss to goods for which title has passed to the buyer – and first-party coverage – insurance against loss in transit while title remains vested in the seller.

In a recent case, Rad Source Technology Inc. v. Colony National Insurance Co. (Fla. App. Nov. 2, 2005), a manufacturer of blood irradiation machines shipped one to a customer, a university medical facility. During transit, the machine was damaged, and the customer sued. The manufacturer turned to its liability insurer and asked for a defense, which was refused. The Florida Court of Appeals, however, held that the insurer had a duty to defend the suit. One basis for the carrier’s coverage denial was the injury-to-products (or “own products”) exclusion. That exclusion bars coverage for property damage to “your product” arising out of it (or any part of the product). As the court found, the exclusion is meant to bar coverage for “situations wherein the product itself is defective.” Slip op. at 4. The court found the exclusion inapplicable because there was no allegation that the product itself was the source of whatever damage occurred. Because the allegations were not confined to a claim that an endogenous risk led to the damage, one could reasonably construe the complaint to allege exogenous risk, which is covered.

The carrier also denied coverage on the ground that the contractual-liability exclusion applied. This exclusion bars coverage in the event that the insured assumes via contract liabilities that it would not otherwise have at tort (in other words, it applies to circumstances where the policyholder for consideration becomes an insurer for someone else). Here, the manufacturer had agreed to assume the risk of loss until the product was delivered to Atlanta (“F.O.B.”), and the facts of the case showed that that product was damaged after it had reached Atlanta. As a result, the seller had not assumed the risk of the loss at issue via its sales agreement, and therefore the contractual liability exclusion did not apply. Thus, the court concluded there was a duty to defend.

The Rad Source Technology case addressed liability insurance coverage; as noted, manufacturers may insure against the risk of loss while they retain title in their products during transit under first-party coverage. The case for insurance recovery is straightforward where the goods are destroyed; but sometimes goods can be affected by conditions during shipment that affects their value such that the insured will claim loss.

In a recent case, American Home Assur. Co. v. Merck & Co., Inc., __ F. Supp. 2d __, 2005 WL 22206797 (S.D.N.Y. Sept. 12, 2005), a pharmaceutical manufacturer claimed losses in three unrelated circumstances arising from its decision to destroy products that were either damaged or exposed to inappropriate shipping conditions during transit.

The policyholder, Merck, engages in a highly regulated business, and it faces a high risk of legal-liability claims. For any pharmaceutical manufacturer, the risk of third-party liability and claims for punitive damages is severe if it is lackadaisical about knowledge that components of product have been contaminated, damaged, or inappropriately stored. Given the legal environment in which it operates, Merck must be sensitive also to managing its risk of regulatory violation stemming from any alleged lack in care in the stewardship of its products. Accordingly, in purchasing its first-party property policy, Merck sought to retain control of the decision of what to do when there was a risk that its products were damaged or degraded during shipping.

The clause at issue in particular

(i) assigned to Merck a right of possession for any damaged goods and to retain control over them,
(ii) made Merck the “sole judge” as to whether the goods were “fit for use”,
(iii) vested in Merck the power to dispose of the goods as it saw fit (subject to the insurer’s right of salvage).

Goods were deemed to have suffered a loss that triggered the coverage

(i) if the product in fact was condemned by government authority, or
(ii) if Merck concluded that a reasonable construction of the applicable law would require that the goods no longer be considered fit for sale, or
(iii) if the only means to determine whether the goods were unfit is through destructive testing.

Moreover, the policy included a “sue and labor” clause, that is, a clause that affords the insured the opportunity to obtain reimbursement for the costs it incurs in avoiding further loss to covered property.

The losses involved three unrelated situations, but each had in common that Merck had shipped a component of a pharmaceutical product and during shipment some untoward event occurred that led Merck to conclude that part or all of the shipment no longer could be used. For one of the claims, a temperature indicator showed that for part of its journey the product had been exposed to temperatures below what had been prescribed. Concerned that the product (vaccine) had been frozen, Merck concluded that the product in the truck could not be used or resold. (This conclusion was based on its interpretation of 21 C.F.R. 211.208.) The insurance company, however, disputed that any of the vaccine had been frozen in fact, that the regulation applied to vaccine, or that the regulation prohibited testing and rehabilitation of vaccine even if a portion was not usable.

Another of the claims concerned the shipment in the same truck of a poison with pharmaceutical product; Merck concluded that FDA regulation prohibited such transport, and it ordered destruction of the entire shipment even though there was no evidence of actual contamination of its product. Again, the insurer challenged the reasonableness of Merck’s conclusion and conduct.

The final claim involved product that was shipped in fiberboard drums. Four drums that were shipped by airplane were thought to be damaged; for two drums, the plastic liner containing the active pharmaceutical ingredients (“APIs”) was breached, but for the other two drums, which were themselves damaged, there was no evidence of any injury inside of the drum (e.g., the plastic liner was intact). Merck did not test the material in any of the four drums and instead destroyed all four on the grounds they had been subjected to improper storage conditions within the meaning of 21 CFR 211.208. The insurer questioned Merck’s actions here, too.

The court refused to grant summary judgment, in part criticizing Merck for its failure to involve its insurer, particularly in determining whether there might be salvage value to the affected product. The court did not seem comfortable with the idea that the insurer was subsidizing Merck’s (reasonable) decision to be conservative in handling its product by destroying it whenever there was objective evidence calling into question the product’s integrity during shipment. Because the interest of the insurance company was implicated, the court seems to imply that Merck needed to be attentive to the interest of this constituency too. While Merck plainly was vested with considerable discretion, the court seemed to question whether Merck was acting as a “prudent uninsured” throughout the process or whether it destroyed the material prophylactic ally in part in the belief that its insurance would cover the loss.

When it purchased the coverage, Merck had sought initially to amend the policy form to afford it broader latitude than its rights and responsibilities under the policy language ultimately agreed. Accordingly, while it was entirely sensible to place Merck in charge of the product and of ensuring its own compliance with FDA regulation, the provision gave the insurer some interest in the disposition of damaged product for which it was expected to pay. The lesson here is that managing the relationship with the insurer needs to be accounted for in the insured’s business processes of handling situations like these. The risk-management department must ensure not only that coverage is purchased but also that the company’s business practices conform so that the right to insurance recovery is safeguarded – and the risk of litigation with one's insurer is reduced.

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Insurance for Goods in Transit

The clause at issue in particular

Goods were deemed to have suffered a loss that triggered the coverage

Another of the claims concerned the shipment in the same truck of a poison with pharmaceutical product; Merck concluded that FDA regulation prohibited such transport, and it ordered