December 23, 2006
Caveat Advocat: Defense Lawyers as Coverage Lawyers
While insurance-coverage law has developed over the last 20 years into a rarefied specialty practice, lawyers who handle the defense of liability cases cannot punt on considering coverage issues – or they risk malpractice claims by their disgruntled clients. The New York Appellate Division recently confirmed that defense counsel may be exposed for failing to investigate the possibility of coverage – even where defense counsel has been retained by another insurance company for the benefit of the insured defendant.
In Pacific v. Wilson, Elser, Moskowitz, Edelman & Dicker, LLP (N.Y. App.Div. Dec. 19, 2006), the plaintiff – who was the defendant in a liability case – sued defense counsel for malpractice – not for dissatisfaction in how the defense case was handled but rather for failing to help in securing coverage in the event the defense mounted was unsuccessful. As the New York court framed the question:
The principal issue presented on this appeal concerns whether a law firm, retained by a primary carrier to defend its insured in a pending action, has any obligation to investigate whether the insured has excess coverage available and, if so, to file a timely notice of excess claim on the insured’s behalf.
In Pacific, the insured was covered under a policy from certain underwriters at Lloyd’s for $1 million. The underlying plaintiff sought damages in excess of $50 million, so in addition to appointing defense counsel to defend the insured against the suit, Lloyd’s advised that the insured might wish to investigate whether additional excess coverage might be available.
The Wilson, Elser firm defended the suit against the insured, but lost a summary-judgment motion establishing the insured’s liability. Two months later, before trial of the damages claim was set to commence, the firm, on behalf of the insured, tendered the defense to AIG, which denied coverage in part on the ground that it had not received prompt notice.
Several months later, the underlying plaintiff obtained a verdict against the insured for roughly $6 million, well in excess of Lloyd’s primary insurance policy limits. “In its [malpractice] complaint, the [insured] claimed that the [law firm] had been negligent in failing to advise [AIG] of the underlying action or, alternatively, that its failure to do so constituted a breach of contract.”
The appellate court (ruling on a motion to dismiss) first examined whether the retention arrangement between the law firm and the insured made clear that the firm would not have any responsibility for investigating or pursuing coverage. The court in effect presumed that when a lawyer is retained to defend a case her responsibility includes investigating the possibility of insurance coverage. Cf. Jordache Enterprises v. Brobeck, Phleger & Harrison (Cal. July 30, 1998). As the court rules:
Thus, a legal malpractice plaintiff need not, in order to assert a viable cause of action, specifically plead that the alleged malpractice fell within the agreed scope of the defendant’s representation. Rather, a legal malpractice defendant seeking dismissal . . . must ender document evidence conclusively establishing that the scope of its representation did not include matters relating to the alleged malpractice.. . .
We turn, then, to the central question presented on this appeal: Whether a law firm retained by a carrier has any duty to ascertain whether the insured it was hired to represent has available excess coverage, or to file a timely notice of excess claim on the insured’s behalf. The issue is best addressed by examining two questions. The first is whether, under ordinary circumstances, an attorney retained directly by a defendant in a personal injury action has any obligation to investigate the availability of insurance for his or her client and to see that timely notices of claim are served; the second is whether, if such an obligation exists, it also binds an attorney who is retained to defendant a personal injury action, not by the defendant directly, but by the defendant’s carrier.
The law firm argued that because it was appointed by an insurance company to represent the insured in the liability litigation it was plain that the scope of its representation was confined by the scope of the carrier’s duty to defend (which is not ordinarily thought to include insurance-recovery issues) and that there was an implicit conflict of interest when defense counsel in a tripartite relationship is asked to opine on coverage issues. The New York Appellate Decision rejected these arguments, finding that there was no legal rule that prevented a lawyer from being sued for breach of professional duty when he fails to pursue coverage in connection with a matter he is defending.
One judge dissented strongly, writing:
The insured’s contractual responsibility to notify its alleged excess insurance carrier cannot be avoided or diminished through the subterfuge of attempting to foist such obligation on an unsuspecting law firm selected by the primary carrier particularly where, as here, the law firm may have been assigned the case after the time to notify the excess carrier had expired.
Note that Wilson, Elser has not been found to have breached any duty to its former client. The issue on appeal is only whether a duty to investigate insurance coverage did not exist as a matter of law. As a matter of fact, the firm can seek to show that the scope of its representation was confined or that it was reasonable in not pursuing the excess coverage here or that the plaintiff cannot establish causation or damages.
The lessons of the Pacific case for defense lawyers include (i) do not shirk investigating whether there is coverage for the case being defended or (ii) make clear in the retention letter that defense counsel’s representation is limited to the defense of the case and expressly does not include advising on or investigating insurance coverage.
I think that the ordinary policyholder will not react negatively to a retention letter that states that the scope of counsel’s representation is limited by the paying insurer’s duty to defend and does not include advising the insured on the availability of coverage as against the defending insurer or against any other insurance company. But in the absence of an agreement making clear that defense counsel will not be advising about insurance, the lawyer may be exposed to a potential claim of breach of professional duty from the failure to pursue offsetting insurance for the client-defendant-insured. (And the law firm should look to its own E&O or professional-liability insurance for protection in the event a former client makes such a claim.)
Posted by Marc Mayerson at 6:03 PM | Comments (1) | TrackBack
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
October 26, 2005
When ERISA Suits Tagalong to D&O Claims the Fiduciary-Liability Coverage Might Not
Corporate directors and officers litigation today often involves claims asserted under the federal securities laws as well as under federal employee-benefits law (ERISA). The plaintiffs in these suits are conceptually different: securities-law plaintiffs are people who (and entities that) purchased or sold the company’s securities; ERISA plaintiffs are participants in employee-benefit plans that held or permitted the investment in company securities. Increasingly, ERISA cases are tagging along to securities cases: the directors and officers (who often are plan fiduciaries) are alleged to have failed to disclose certain facts about the company’s operations or finances to the market generally (for securities claims) or to participants in company-sponsored employee-benefit plans (for ERISA claims).
The United States Court of Appeals for the First Circuit recently had the opportunity to address coverage for a tagalong ERISA claim that was made four years after a securities-law class action was filed. In a very troubling opinion, the court ruled that no coverage was available for the ERISA class action because the gravamen of the complaint echoed the allegations in the earlier securities class action. The basis of the court’s ruling was not that the policyholder had failed to disclose the early securities-law class action, but rather that a generic prior-and-pending litigation exclusion barred coverage. Federal Ins. Co. v. Raytheon Co. (1st Cir. Oct. 21, 2005)
Prior-and-pending exclusions take one of two forms: a laser-beam exclusion that bars coverage for prior claims that are listed by name in the exclusion and a generic exclusion that bars coverage more generally if a claim subsequently made in the policy period is related to a prior claim. This was the type of exclusion at issue in Raytheon. In particular, the language provided:
The Company shall not be liable for Loss on account of any Claim made against any Insured . . . based upon, arising from, or in consequence of any demand, suit or other proceeding pending, or order, decree or judgment entered against any Insured, on or prior to [policy inception], or the same or any substantially similar fact, circumstance or situation underlying or alleged therein.This is a reasonably standard version of the generic prior-and-pending exclusion that is found in many corporate policies today.
In Raytheon, there was no dispute that at least some of the allegations in the ERISA class suit had been cut and pasted from the securities class action. The dispute centered on how much overlap must there be between the two cases for the prior-and-pending exclusion to apply.
The court focused on the pivotal language in the exclusion, which is that, for the exclusion to apply, the claim in the policy period must be “based upon . . . the same or any substantially similar fact, circumstance or situation underlying or alleged therein.” The court found that the use of the term “base” meant that “situations in which the complaint in the second action does not draw substantial support form the allegations of the first” were not within the purview of the exclusion (slip op. at 17); however, the exclusion is not limited to only those claims where the “first action provide[s] the sole support for the second.” Id. Instead, the court held:
We think that the policy thus requires the allegations in the second complaint find substantial support in the first complaint, i.e., that the allegations of the second complaint substantially overlap those of the first. [For the exclusion to apply] the second complaint [must] substantially overlap the first with respect to relevant facts.Slip op. at 17-18.
The court stated that its construction promoted the purposes of the prior-and-pending exclusion: (i) to encourage insureds to give prompt notice; (ii) to avoid stacking policy limits in successive policies; and (iii) to discourage insureds from purchasing policies knowing that claims were going to be asserted (avoiding the “adverse selection” problem). Slip op. at 18-19.
But the court’s construction does not provide an incentive for providing prompt notice – in Raytheon, there was nothing for the insured to give notice about to its ERISA liability carriers when the securities case was filed three years earlier. No ERISA claim had been made, and even if notice had been given at that time to the ERISA carriers that year, they would have had no obligations – their policies had not been triggered since no claim had been made. (Even if in the policy in effect at the time of the securities claim there was a notice-of-circumstances provision, which is an extension of coverage by which the insured at its option can lock-in coverage for post-policy period claims if it first discovers during the policy period circumstances that later may lead to claims, the insured probably would not have been able to avail itself of this protection due to the stringency of the requirements of such provisions.) Accordingly, the rationale to stimulate early notice is entirely misplaced.
The second rationale, to avoid the stacking of policy limits, is in many ways a restatement of the first – stacking results when a claim is made in year 1 and a second, related claim is made in year 2, such that the policyholder can collect under each policy for the claim made in that year. There is at a minimum a dispute in the case law whether claims-made policies permit this result in the first place, that is, whether they permit the second policy even to be triggered from the assertion of a new but related claim in year 2; many commentators and courts believe that all subsequently related claims relate back to the first claim (since most policies define claim to include a “series” of claims) such that “the” claim was “first made” in year 1. One can debate whether claims-made or claims-first-made policies really work this way as they are written, but there is certainly a large number of insurers and commentators that believe that all subsequently asserted claims relate back to the first year, such that by design there is no cumulation or stacking of policy limits. But even under this view, crucially the policyholder gets paid for the second claim under the first year’s policy. Under the First Circuit’s ruling, the policyholder does not get paid at all for the second claim.
And none of this examines whether stacking or cumulation of policy limits is something that should be avoided. There are certainly substantial arguments in terms of risk spreading and the marginal utility of (insurers’) money that support stacking policy limits; the correct analysis is to look at the obligation of each carrier separately under its contract, to recognize that it was paid a full premium for the limits it provided, and to consider the axiom that successive carriers are not third-party beneficiaries of prior coverage.
At all events, the court’s second rationale – the avoidance of stacking – is unpersuasive (or surely it is inadequately explained or justified).
The First Circuit’s third rationale is similarly unconvincing. The third justification is that it avoids “adverse selection,” that is, the propensity of those with a higher exposure to loss to seek insurance protection. Here, too, the court’s facile invocation of insurance-speak (which arguably it does incorrectly) obfuscates rather than clarifies the analysis. What must be first recognized is that by their nature claims-made policies are retrospective in the coverage they provide – in other words, they are designed to cover past events, and the insured-against contingency is whether or not a claim will be made in the particular policy year. There is no showing at all in Raytheon that the company thought an ERISA claim would be brought at all let alone in the policy year in question. More importantly, this all underscores that the way to police the so-called adverse selection problem is through underwriting. Insurers are supposed to gauge for themselves the likelihood that a policy they are considering issuing may be forced to pay out, and the underwriters have the ability to ask for information and make that assessment (or take a risk against not having adequate information). If the policyholder did not adequately respond to the underwriters’ inquiries, then the policy may be voided on nondisclosure or misrepresentation grounds. What the First Circuit’s ruling does is not to police adverse selection (bad policyholders seeking coverage) but rather encourages bad and lazy underwriting – ironically as respects policies whose very purpose is to provide retrospective coverage.
Indeed, the court does not take into account that, because they provide coverage retrospectively, claims-made policies typically include a "retro date," that is, a provision stating that the operative events leading to a claim in the policy period must take place on or after a particular date (often, the inception date of the first policy issued by the carrier to that insured). This is significant because the Raytheon court's construction sub silentio adds an additional retro-date limitation, barring coverage for past factual circumstances that are substantially similar to misconduct undergirding any prior claim made under any type of policy.
Worse, it is not unreasonable to assume on the facts that Raytheon did disclose the existence of the prior securities-law class action; it was still pending at the time of the ERISA fiduciary policy’s inception. In the circumstances, that the insurance company did not laser-beam out any subsequent claims arguably induced the policyholder to believe there would be coverage.
While the Raytheon court uses its three policy rationales to buttress its holding, it is true that they are not necessary to the court’s ruling, which is predicated on a construction of the policy language, especially the meaning of “based upon.” While we must start the analysis with the policy language, and where the language is plain it will be applied, there remains a governor on the plain-meaning rule, which is that the result must still pass a reasonableness test. There are different ways this notion is expressed: a policy will not be construed to achieve absurd results is one formulation. Here, the result in Raytheon fails any type of reasonableness review.
To illustrate, the following propositions are all supported by the facts described in the Raytheon opinion:
a. The policyholder made adequate disclosure of the securities case in the underwriting;
b. No policy is triggered until the assertion of a claim against the policyholder;
c. The constellation of plaintiffs, legal claims and theories, and remedies are different in the securities and the ERISA cases.
The Raytheon court’s ruling means that the fiduciary-liability policies never have an obligation to respond to a follow-on ERISA case that is made in any year other than the year that the securities case is brought. In other words, unquestionably had the ERISA case been filed soon after the securities case, the fiduciary-liability carriers that year would have been required to respond. But if the ERISA case is filed the next year (or thereafter), the fiduciary-liability carriers in those years will not need to respond by dint of the generic prior-and-pending exclusion.
So, where does this leave policyholders, which are increasingly facing tagalong ERISA claims to securities cases filed against their directors and officers (who often are benefit-plan fiduciaries)?
1. The Raytheon court suggests that if the policyholder wishes to preserve coverage it in effect should provoke the filing of the ERISA tagalong within the same policy year that the securities case is filed. (Similarly, plaintiffs need to be aware of the Raytheon holding and file the ERISA case promptly to assure that insurance monies may be available to fund any settlement or judgment; thus, the court's ruling stimulates the filing of claims that might otherwise not be brought at all.)2. Policyholders should resist “generic” prior-and-pending exclusions and demand that carriers laser-beam out matters that will be excluded if a related claim is asserted later. While this may result in carriers’ seeking to exclude by name the three-year-old securities claim in Raytheon, the policyholder will have the opportunity to buy back that exclusion and, if not, to know with certainty whether there will be coverage for a tagalong ERISA case.
While I believe that generally speaking the latter result is salutary, it is an unintended consequence of the First Circuit’s decision and surely is not sufficient to justify what is otherwise an untenable holding and the untoward effects it causes. Insureds face increasing risk of tagalong ERISA claims; insurers are willing to provide coverage for that risk; and in the absence of plain and compelling policy language courts should be more reluctant to take boilerplate, general exclusions and gut crucial protection that policyholders believed they paid for.
Posted by Marc Mayerson at 11:14 PM | Comments (1) | TrackBack
August 3, 2005
An Insurance Company’s Duty to Consent
In many types of insurance policies, the carrier’s obligation to perform is tied to its consenting to the incurrence of costs or the settlement of an underlying case. One assumes that an insurer cannot withhold consent willy-nilly, for that would make coverage illusory. There is a dearth of authority, however, that makes express the circumstances in which an insurer is not permitted to withhold consent – that is to say, the circumstances in which it is required to consent. The Supreme Court of Iowa recently addressed that question and made clear that insurers are obligated to consent when faced with a reasonable request.
In Belleville v. Farm Bureau Mut. Ins. Co. (July 29, 2005), the court addressed uninsured motorist coverage and a settlement of a claim against the tortfeasor. The Belleville case in part is concerned with the insured’s claim of first-party bad faith, which the court rejects in a broad decision that is highly favorable for insurance companies. But for present purposes, that aspect of the decision is notable because the court distinguishes the relationship of the insurer and its policyholder in the UIM context from the ordinary first-party context in holding that with respect to UIM coverage the relationship between the two “is arms-length” and thus the insurer is freed from its ordinary obligations to consider the interests of the insured to be paramount, to construe the facts and coverage in the light most favorable to the insured, and to comport with other dictates associated with the carrier’s obligation of good faith and fair dealing. (p. 11-12).
Having concluded that the insurance company does not need to extend itself to accommodate the interests of the insured, the court nevertheless imposed on insurance companies a duty to consent (where coverage is tied to consent) where the request is reasonable. In other words, in an arms’ length relationship, the Iowa court recognized that, where a reasonable request is made, it would be unreasonable to withhold consent, and therefore the insurer has a duty to consent. Thus, an insurer has a duty to consent “unless it has a reasonable basis for refusing to do so.” (p. 17)
The court’s holding applies with greater force outside of the UIM context, where insurance companies are required to consider the interests of their insureds and reasonably construe the facts and policy language in their favor. Accordingly, the Iowa decision is helpful not only concerning consent-to-settlement clauses in UIM and in liability coverage generally, but also in directors’ and officers’ policies, errors and omissions policies, and other coverages where, for example, defense costs are recoverable only if they are incurred with the insurance company’s consent.
The Belleville decision also is pertinent in considering carrier claims of prejudice from breach of a duty by the policyholder, since so long as the policyholder acted reasonably the carrier cannot claim that it was prejudiced, since it would have had a duty to consent to the reasonable course of conduct anyway. See generally Coastal Iron Works v. Petty Ray Geophysical, 783 F.2d 577, 585 (5th Cir. 1986); Pickering v. Am. Employers Ins. Co., 292 A.2d 584, 591 (R.I. 1971).
Posted by Marc Mayerson at 10:06 PM | Comments (2) | TrackBack
July 14, 2005
Late Reporting in Claims-Made Policies: Getting to the Root of the Issue
The California Court of Appeal issued an innovative decision that fills in important gaps in the analysis of issues concerning providing notice under “claims made and reported” liability insurance policies. The case, Root v. American Equity Specialty Ins. Co., available at http://caselaw.lp.findlaw.com/data2/californiastatecases/g033818.pdf (Cal. Ct. App. June 28, 2005), involved an insured who faced falling between two stools: not having coverage under consecutive liability policies because the claim was made during one policy period and its report was made in the second. The Fourth Appellate District (Division Three) emphasized that its holding was narrow: it was not invalidating claims-made-and-reported policies but rather was implying an equitable grace period to report a claim under an expired policy.
Root is different from the litigation in the 1980s where policyholders swung for the fences and ultimately struck out: policyholders had early success, especially in New Jersey and California, arguing that claims-made-and-reported policies were in their nature against public policy. (This had been the result in France which effectively invalidated claims-made policies in 1990 until legislation reversed the decision a couple of years ago.) These early cases – which in California were wiped from the books by the California Supreme Court through its practice of “depublication” (see Rule 976(b)) – generally held that the disjunction between policyholders’ expectations of coverage and the forfeiture of coverage stemming from “late” notice (different from the no-loss-of-coverage-from-late-notice-unless-the-carrier-has-been-prejudiced rule) was so extreme as to warrant invalidating the reporting requirement (virtually) altogether.
As was obvious at the time, these decisions lacked sound analytical footing legally and failed to come to grips with the fundamental reality that the policy says what it says – coverage is triggered if a claim is made and is reported during the policy period. (Policies that are simply “claims made” are different inasmuch as the policyholder covenants to provide notice but the notice provision is not part of the insuring agreement itself.) Moreover, insurers did a good job in convincing courts – without evidence – that claims-made policies were inherently cheaper than are occurrence policies (but compare Tip's Package Store, Inc.,. v. Commercial Insurance Managers, Inc., 86 S.W.3d 543 (Tenn. Ct. App. 2002) (occurrence policy implicitly cheaper than claims-made on facts presented)), and the courts ultimately adopted a "you get what you pay for” stance, holding that the notice-prejudice rule does not apply to claims-made policies and thus that notice provisions in such policies are strictly enforced.
It is against this historical backdrop that Root becomes particularly important, because the Root court was well aware of this history and the California Supreme Court’s penchant for de-publishing decisions mitigating the notice provisions of claims-made policies, and the Root court strove in its lengthy opinion to lay out an analytical framework that was consonant with fundament principles of California practice and with the reasonable expectations of both sides of the insurance transaction. The key to the court’s decision was its embrace – following the argument of Professor Bob Works in particular and the Restatement 2d Contracts § 229 – of the principle that non-occurrence of a condition, which would otherwise suspend or excuse the counter-party’s contractual performance, should be excused where a disproportionate forfeiture otherwise will result.
The facts in Root involved a suit’s being filed with three days to go in the policy period, the suit not being served until the last day of the policy, the policyholder’s having been called by a reporter the day suit was filed asking about a possible malpractice action, and the insured’s prompt provision of notice once he had actual knowledge of the suit against him.
The policy at issue was a claims-made-and-reported policy but which did not contain any “extended reporting period” (that is, a contractually established grace period to report claims that were made during the initial policy term based on conduct occurring before the expiration of the policy), and the insured never was given the opportunity to purchase an extended reporting period. As the court described the facts, “the late report was made a de minimis time after the expiration of the policy and [ ] the insured had not been given the opportunity to be protected under an extended claim reporting endorsement.” (Slip op. at 14.)
The court then framed the question before it: “The central issue in this case, then, is whether the policy period reporting requirement is a condition precedent of coverage that may be equitably excused when it works a forfeiture.” (Slip op. at 17)
The court’s framing of the issue required that it determine whether the notice provision was a condition or something else. (Generally, contract law presumes that provisions are covenants and not conditions, in order to avoid forfeitures.)
The Root court found some diverging signals between whether the notice provision was a true condition precedent or was something else, in part because the notice obligations appears more than once in the policy. The court nicely captures its own thinking, saying “[s]uperfluity does not vitiate, and in fact there are occasions when it defines.” (Slip op. at 19), which it also characterized as the policy’s “contain[ing] the seeds of its own cognitive dissonance on the problem of whether the policy period reporting requirement is a element of coverage or a condition.” (Slip op. at 20.)
To try to understand what the policy drafters were seeking to accomplish the court sought to understand the fundamental commercial context for the introduction of – and hence the drafting of – claims made policies. As the court explained this: “The key is the pricing of premiums. The core idea behind the move to claims made insurance policies was to close the gap between the time when insurer prices a risk and the time when the insurer may incur an obligation to pay on that work.” (Slip op. at 20 (citing Prof. Works)).
The time gap between the collection of the policyholder’s performance – its payment of the premiums it promised – and the carrier’s being required to perform services or pay money following a casualty is what makes the pricing of policies and operation of insurance companies a tricky business. (See generally Richard Stewart and Barbara Stewart, The Loss of the Certainty Effect, 4 Risk Management & Ins. Rev. 29 (2002), and Insurance Scrawl, Economics of Property-Casualty Insurance Business). “Insurers like all businesses in a free market, have the fundamental problem of making decisions now that depend on future events, and their survival depends on guessing right often enough to be profitable. . . . Professional malpractice insurance underwriting is [] likewise particularly vulnerable to gaps between the time of pricing and the time obligation.” (Slip op. at 21). According to the court, this changes the nature of the transaction in a claims-made-and-reported policy: “With pure ‘claims made policies, that risk is shifted to the insured, who pays present dollars for protection against claims that will themselves be paid in those same dollars, that is, without regard to inflation and at a time relatively close to the insurer’s pricing decision.” (slip op. at 22)
While the court’s discussion of the economic rationales of claims-made policies gives some context to its ratio decidendi – though court pronouncements of the nature of insurance markets are in my judgment invariably simplistic and, frankly, inaccurate – what is more interesting and important to the decision is the court’s identification of the consequences of the reporting requirement in claims-made-and-reported policies and its impact on the contractual risks assumed by the parties inter sese.
The court found that the insured’s obligation to report claims affects the carrier’s ability to monitor potential payouts under the policy. (The court then leaps the chasm to speculate about the economic impact of this in hypothesizing, again without evidence and surely subject to challenge empirically and theoretically, that the insurer’s gaining administrative closure by learning of the existence of claims more promptly yields a benefit that “is passed on to the insured in the form of lower premiums.” Slip. Op. at 22.) The court recognizes that how much a particular claim will cost is unknown at the moment of its report, but knowing of the existence of the claims sooner is better than its opposite. (Slip op. at 22-23).
The court also found salient that the reporting requirement can be understood as a simple election provision, that is, a contractual hook to ensure that if the insured elects not to exercise its rights to coverage that that election is irrevocable (or what the court characterizes as a “naked forfeiture clause”, slip op. at 23). Considered either as an information-forcing provision or as an election clause, the court found that the reporting requirement thus operates as a true condition to coverage. As the court explains, “[t]he addition of a reporting requirement therefore doesn’t go to risk of a claim against the insured (i.e., what sort of claim might fall within the ambit of the costs the insurer promises to cover), but to the logically independent risk that the insured simply will not report the claim in time.” (Slip op. at 23)
Having found the reporting requirement to be a condition, the court then confronts the consequence of that characterization, for the failure of a condition can result in a forfeiture of contractual rights (or more strictly, the failure of a condition results in the other party’s contractual obligations not becoming mature). The Root court next considered the notice/prejudice rule, where the notice “condition” has been mitigated by requiring the carrier to prove that it was prejudiced from late notice before it could avail itself of the protection the notice condition provided; the court found that that approach was too blunt an instrument, especially in the context of a claims-made-and-reported policies, since a prejudice rule would effectively transmute such policies into simple “claims made” policies, which are different. “Application of the rule thus fundamentally rewrites the claims made and reported contract into a pure claims made contract.” (Slip op. at 24)
Instead, the court applied the well established, if little known, rule providing for the equitable excuse of the failure of a condition, finding this rule to be “more flexible, nuanced, and does no violence to the claims made and reported nature of the policy.” (Id.) Applying the rule to the case before it the court reasoned:
[I]n the present case, the fact that the insurer did not give the insured the opportunity to buy an extended reporting endorsement which would . . . have given him an extra 60 days to report any claims may be of significance. Had Root been given that opportunity, for example, equity might not require excuse of the condition, because its excuse would, in effect, be to give Root the benefit of something he had the opportunity to buy and passed up. The same might be said if Root had had sufficient time to conduct an investigation as to whether a claim had indeed been made against him, or had delayed reporting the claim beyond the day on which he received confirmation of the claim. But given this record the facts are sufficient to support the equitable excuse of the reporting condition. . . . In the [California Supreme Court’s] phrase, given these facts it would be ‘most inequitable’ to enforce the condition precedent of a report during the policy period.
(slip op. at 25, footnote omitted).
The Root court’s holding is narrow on the facts and the court cautions that its ruling should not be extended unduly. As is often the case, in these types of forfeiture cases, one wonders why the carrier pressed the issue as it did, when the facts are so compelling and the harm to the insurer non-existent. A modicum of good claims judgment would have avoided litigation and avoided what is for insurers a bad decision that opens the space for new arguments on claims-made-and-reported policies and, the court acknowledges, fewer summary-judgment rulings for carriers on late reporting (at least in reasonably compelling circumstances).
Root is important not just in terms of its impact on claims-made-and-reported policies but more generally in its embrace of the doctrine of equitable excuse of conditions precedent. The Root decision also supports the idea that one needs to analyze closely whether something that is labeled a condition is truly a condition – as opposed to a covenant (as I’ve elsewhere pointed out, ) and even if a provision is a condition whether noncompliance should be excused to avoid a disproportionately harsh result, as Restatement 2d of Contracts § 229 supports. See generally Bob Works, Excusing Nonoccurrence of Insurance Policy Conditions in Order to Avoid Disproportionate Forfeiture: Claims-Made Formats as a Test Case, 5 Conn. Ins. L.J. 505 (1999).
Posted by Marc Mayerson at 1:45 PM | Comments (3) | TrackBack
April 9, 2005
Better by Fax? Perfecting Coverage under Notice-of-Circumstances Provisions of Claims-Made Policies
Many claims-made liability-insurance policies have an important extension of coverage that enables a policyholder to lock in coverage in one year – the year that a bad situation is discovered that later may produce claims– even though claims against the insured arising from the situation are not made until after the policy period. Under “notice of circumstances” provisions, an insured can provide written notice of such a circumstance to its claims-made carrier and later-asserted claims will be deemed to have been made during the policy period in which "notice of circumstances" was given.
Insureds may want to provide notice of circumstances because it guards against the risk that a later claims-made insurer will laser-beam out eventual claims from that situation by imposing an exclusion; the later insurer may ask in its underwriting materials for the insured to identify situations that may lead to claims during the policy year – and then exclude them. Accordingly, if the insured identifies a situation that may lead to claims it may not have coverage for claims that indeed come to fruition. (If the insured fails to disclose the existence of such a situation, the insurer may later seek to rescind the policy or assert nondisclosure as a defense to performance.)
Notice-of-circumstances provisions typically require that the insured provide this notice during the policy period, which brings us to a recent decision by the New Hampshire Supreme Court. http://www.courts.state.nh.us/supreme/opinions/2005/cmc013.htm In this case, the insured consciously sought to invoke the protections of its notice-of-circumstances provision by providing written notice to the carrier. The carrier did not dispute that the content of the notice was appropriate (which is often the point of dispute) or that the relevant claims were not from the circumstances identified (another common point of dispute). Instead, the carrier refused to perform because the insured has prepared its notice on the last day of the policy period and sent it by overnight mail. The insurance company thus did not receive the notice until the day after the policy period – though the notice was prepared and sent during the policy period – and therefore, according to the insurance company, the insured had failed to comply with the notice-of-circumstances policy provision.
The case in part turns on the meaning of the word “give” as in to “give” notice to the insurance company. Once we are debating things at that level, however, we’ve already departed from practicality (or, as some have characterized, the world of the "law merchant"). The insured plainly sought to invoke the protection of the notice-of-circumstances provision, and the insurer conceded it had suffered no prejudice from what might have been a 10 hour delay in receiving notice. Yet, the New Hampshire Supreme Court denied coverage, ruling that “give” means to receive and thus the notice-of-circumstances provision had not been complied with.
Only a lawyer could have conjured this case. Presumably, if the insured had faxed the letter to the carrier, the court would have found the notice adequate. (The mailing-rule wasn’t discussed, but that rule generally goes only to proving that someone received a letter deposited in the mail, not when he or she received it.)
A somewhat related issue was decided by the 11th Circuit in an interesting case called Cast Steel v. Admiral Insurance, http://caselaw.lp.findlaw.com/data2/circs/11th/0216511p.pdf. Cast Steel involved an extended reporting period under a claims-made policy. (Actually, the policies were “claims made and reported,” which require that both the claim and the report of the claim be made in the policy period.) The policyholder had purchased consecutive claims-made-and-reported policies, and the claim was made in one policy but reported in the next one. Facially, neither policy is triggered, since both claim and report need to occur during the policy period. Had the insured not renewed the first policy, however, it automatically would have had a grace period to report claims under the first policy, a grace period that would have picked up the few hours of the “late” report. In other words, by paying an additional premium and renewing, the insured was potentially worse off than if it had not renewed at all. As the Eleventh Circuit put it, “[t]he district court’s opinion presents a somewhat alarming scenario.” (p.7)
The Eleventh Circuit concluded that the result advocated by the carrier made no sense and found that the first policy was triggered (ruling that the policy language was ambiguous). Another ground for the court’s decision that would have been available is the doctrine of disproportionate forfeiture, see Bob Works, Excusing Nonoccurrence of Insurance Policy Conditions in Order to Avoid Disproportionate Forfeiture: Claims-Made Formats as a Test Case, 5 Conn. Ins. L.J. 505 (1999). The Cast Steel case wasn’t discussed in the New Hampshire opinion but perhaps its consideration might have encouraged that court to reach a different result.
Posted by Marc Mayerson at 3:49 PM | Comments (1) | TrackBack