Insurance Scrawl: Notice / Cooperation Archives

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

January 16, 2008

The Covenant to Provide Notice: Materiality or Prejudice Needed To Refuse Payment

Sometimes courts get it right, both analytically and in the result. This was true in the landmark decision of the Texas Supreme Court in PAJ, Inc. v. Hanover Insurance Co. (Texas Jan. 11, 2008). In this case, the Texas court holds that “an insured’s failure to timely notify its insurer of a claim or suit does not defeat coverage if the insurer was not prejudiced by the delay.” While I agree with the holding, what may be more significant is the court’s adoption of the right analytical approach, specifically, considering the notice provision as covenant whose breach discharges the insurance company’s performance only where that breach constitutes a material breach of the contract.

The Texas Supreme Court sought to fashion a rule that avoided “draconian consequences for even de minimis deviations from the duties the policy places on insureds” (which is how it characterized the position of the dissent). Both the majority and the dissent embraced the principle that contractual provisions should be construed as covenants rather than conditions, owing to the fact that a breach of condition works a forfeiture. This principle applies even if a provision is in the “conditions” section of the policy. In PAJ, which I wrote about previously, the dispute between the majority and dissent centered on whether the particular provision should be considered to be a true condition or not.

Certainly, an unexcused breach of the obligation to provide timely notice is not sympathetic, and insurers have legitimate interests in knowing of the existence of claims against their insureds, in investigating claims while the evidence is fresh, and taking steps to safeguard their insureds’ interests and their own. The question in PAJ and other notice cases is whether it is best to set up a system that results in automatic forfeiture in all cases where notice is late or other “conditions” are violated. The Texas Supreme Court ruled that a “no harm, no foul” or “little harm, minor penalty” approach was fair to both sides. Accordingly, a policyholder that violates an obligation under the policy in general will be considered to have violated a covenant, not a condition. This was the holding also in the recent California appellate case of Belz v. Clarendon Am. Ins. Co. (Cal. App. Dec. 28, 2007), which while ostensibly focused on the question whether the particular clause at issue was a "no voluntary payments" or (merely) a "cooperation" clause adopts the equivalent framework considering material (prejudicial) versus immaterial breaches of policyholder duties.

Classifying a policy provision as a covenant does not mean that the insurer’s legitimate interests cannot be recognized. An immaterial breach of contract allows the non-breaching party a right to damages or set off; however, the non-breaching party is not allowed to suspend its promised performance completely. Put differently, to the extent the insurer can show that a policyholder’s breach of covenant in fact worked a harm to it in some way, the insurer is free to seek to prove the extent of that harm. If that harm is “immaterial” – that is, does not vitiate the entirety of the contract – then the insurer is able to set off its obligations (subject to the usual rules of proving damages). If the harm is material, then the insurer’s obligation to perform may be excused entirely. See generally Belz , slip op. at 15 ("'To establish actual prejudice, the insurer must show a substantial likelihood that, with timely notice, and notwithstanding [any] denial of coverage or reservation of rights, it would have settled the claim for less or taken steps that would have reduced or eliminated the insured’s liability.'") (citation omitted).

But it does not make sense to allow an insurer to keep the policyholder’s premium and refuse to perform when the policyholder’s late notice works no harm. Most policyholders do not have multiple claims under a single policy, and a strict forfeiture rule would create the situation that in the sole instance where the policyholder might achieve value from its insurance investment the insurer is excused from performing even though it has not in fact been harmed from late notice (all the while keeping the policyholder’s premium).

The confusion in the law has stemmed in part from the nomenclature adopted by courts in this area, where they have sought to protect insureds that or who gave “late” notice by requiring the insurer to show “prejudice” (or the policyholder to prove the absence of prejudice). But it makes no sense from a contract-law vantage point to characterize a provision as a condition but only to enforce it if the other party has been prejudiced from its nonperformance. The casual reference by courts to notice provisions as “conditions” and the adoption of the “notice/prejudice” rule itself has created confusion in the law.

The right approach is to presume that all contractual provisions setting forth policyholder duties are covenants, whose breach if immaterial entitles the innocent party to set off or if material entitles the innocent party to refuse performance. As the dissent in PAJ recognizes, “’[m]agic words are not controlling; labeling something a ‘condition precedent’ does not make it so.”

The right question is whether the specific language and the particular obligation is one whose performance should be completed before the other party’s obligation matures or is required at all. If an insurance company wishes to make notice a true condition precedent, it should make the contract provision absolutely clear that noncompliance will work a forfeiture. We see the equivalent of this in claims-made-and-reported policies which require that reporting of the claim (i.e., providing notice) occur during the policy period in order for the insuring agreement to be satisfied. As a leading English judge wrote in a key notice ruling there, “If insurers consider that they want or need such protection, they can and should try to express it in their insurance contracts and see if insureds and the broking market will accept it.” Friends Provident Life & Pensions Ltd. v. Sirius Int’l Ins., [2005] EWCA Civ. 601 (per Lord Mance).

PAJ was a split decision, 5 to 4, with strong majority and dissenting opinions. From the perspective of insurance law, it is a very positive development that the Texas justices all accepted the framework of determining whether notice was a condition or a covenant and if so the consequences of breach. Adopting the right framework not only produces correct results, as in PAJ, but also clarifies for insurers and insurance regulators how to approach revising the policy language to make clear – if intended – that punctilious compliance is requisite on pain of forfeiture. Were this made pellucid, then insurance regulators could step in to protect consumers or the marketplace could respond by pricing such policies commensurate with the traps they lay. Most important, insurers should say what is expected and what they require and make clear to purchasers the consequences of noncompliance (in plain, unambiguous language, and labeling something a "condition precedent" certainly fails on that score).

Regardless whether a particular jurisdiction is a “notice/prejudice” state, see Prince Georges Cty. v. Local Gov't Ins. Trust (Md. 2004) at n.9 (classifying 38 states as "notice/prejudice" and discussing most others), policyholders in all circumstances should seek to involve their insurers as soon as practicable, and they timeously should consider whether claims against them potentially implicate coverage. As always, rather than arguing about conditions versus covenants and material versus immaterial breach, policyholders are advised to abide by the rule that notice is like voting in Chicago – do it early and often.

Posted by Marc Mayerson at 2:09 PM | Comments (0) | TrackBack

January 21, 2007

Cone of Silence or Echo Chamber: A Policyholder’s Privileged Communications and its Insurers

An insurance company that receives a claim from one of its policyholders inevitably wears both a white hat and a black one. The insurer is there to help its insured deal with the claim – it may dispatch claims handlers or service providers to help the policyholder in its time of need; the insurer, however, also is the insured’s adversary in the sense that it must determine whether it has any obligation to pay the insured. To the latter extent, the insured and the insurer have directly adverse interests. (The law of first-party insurance bad faith is predicated on the recognition in part of this fundamental adversity of interests between the insurer and its insured, especially at the precise moment when the insured is calling upon the insurer for performance.)

The insurer’s wearing two hats poses the opportunity for mischief when those roles get confused or blurred. Take the example of a defense lawyer hired by an insurance company to defend the insured: the defense attorney plainly has an attorney-client relationship with the insured, the touchstone of which is confidentiality. Assume that the defense lawyer is told a fact by the insured that supports the insurer’s denying coverage: the insured confesses to being drunk while driving, the insured acknowledges that it knew of a latent problem before it purchased the policy, or the insured knew of the potential claim against it for a long time but had simply hoped it would go away and so did not notify the insurer sooner. The insurance company might wish to learn of this fact because it might permit it to terminate its defense obligation and avoid paying anything on the claim. In these circumstances, may the defense counsel tell the insurance company about this admission from the insured?

Ratting out the insured in this fashion would be found to be a breach of the lawyer’s duties to his or her client (the policyholder). What happens if the insurance company acts on this information to deny coverage? Has the insurer breached any duty?

Different courts have approached this question somewhat differently, but no court (to my knowledge) is comfortable with the insurer acting on this information. The Arizona Supreme Court has held that the insurer has committed an act of bad faith if it denies coverage based on defense counsel’s breach of the policyholder’s confidence. In Parsons v. Continental National American Group, 660 P.2d 94 (Ariz. 1976), the court held:

When an attorney who is an insurance company’s agent uses the confidential relationship between an attorney and a client to gather information so as to deny the insured coverage . . . . we hold that such conduct constitutes waiver of any policy defense, and is so contrary to public policy that the insurance company is estopped as a matter of law from disclaiming liability.

550 P.2d at 99. Other courts have adopted an exclusionary-rule approach, barring the insurer from using the information or any fruit from the poisonous tree in service of a denial of coverage Employers Cas. Co. v. Tilley, 496 S.W.2d 552, 560-61 (Tex. 1973); Snodgrass v. Baize, 405 N.E.2d 48, 54 (Ind. App. 1980). These cases recognize that mixing the insurer’s two roles – mixing up its white and black hats – is at a minimum inappropriate and potentially abusive. This double betrayal – of confidence and using the confidence as a weapon against the insured – calls for some remedy.

But let’s vary the situation somewhat, from an insurer that has provided defense counsel to an insurer that has not provided counsel when the insured believes it should have done so. In those circumstances, the insured will defend the liability case against it and separately pursue coverage against the insurer in a coverage case. Routinely, we see insurers seeking discovery of underlying defense counsel’s files. Often, this is seemingly an effort to obtain evidence that will embarrass the insured and sway the jury – for example, a memo from defense counsel to the insured evaluating the liability case and stating something like “the [insured] company’s conduct flagrantly disregarded standards for appropriate conduct and safety and this led directly to the injury.” In a coverage case, the insurer would like to proffer this kind of document against the insured to argue that the insured expected/intended the injury and thus coverage should not be provided. (Moreover, carrier counsel wants to argue at closing that “even the insured’s defense counsel agrees that the insured flagrantly disregarded safety standards, etc. etc.”) Discovery of this kind of document also makes carrier counsel’s job easier because the defense lawyer has investigated and synthesized the facts leading to the liability claim.

Insurers have argued that they are entitled to the discovery of this information in the coverage case on the ground that it fits within the scope of discovery and that, although the documents constitute privileged communications, no privilege is properly assertable as against them. The rationale insurers offer is that they share a common interest with the insured in these privileged communications.

A tiny number of jurisdictions have accepted this argument, and the vast majority of cases have rejected it. In Illinois for example, where the argument has been accepted, insurance companies have an unfettered right of access to defense counsel’s files. Waste Management Inc. v. International Surplus Lines Ins. Co., 579 N.E.2d 332 (Ill. 1991). The Illinois Supreme Court reasoned that, even though the insurer was alleged to have breached its contract with the policyholder, the insurers nonetheless shared a “common interest” with the insured in defeating the underlying plaintiff’s claim against it. Because the insurers “shared” in the privilege, relevant materials could not be withheld on this ground. (In other words, like Big Brother, in Illinois one’s insurers are always looking over defense counsel’s shoulder, even where the insurer has breached its contract to perform.)

Thus, even though there is direct adversity of interests between the insurers and the policyholder at the time that the insurers are seeking discovery of defense counsel-s files, the Illinois courts hold that at the time of document creation (as opposed to disclosure) the insurer’s are privy to the thoughts of defense counsel.

Policyholders find this argument preposterous; the insurer may be in breach of contract and unquestionably is seeking bullets to fire at the insured. Ruling that insurers are on the same side as the policyholder and therefore get access to defense counsel’s files confuses the two different roles of insurers – in service of a coverage denial insurers plainly have adverse interests with the insured, and when the insurer has failed to perform they have failed to come to the insured’s aid and rescue (the role that forms the premise for the Illinois courts’ ruling that insurers have a common interest with the insured). As the Fifth Circuit observed in a related context:

We know of no case in which the insured’s duty of assistance and cooperation has been used to force a putative insured to divulge to the insurer every jot and tittle of information which may aid the insurer in defeating his claim for coverage but which in no way hinders the insurer’s ability to provide the insured with a proper defense.

Martin v. Travelers Indemnity Co., 450 F.2d 542, 553 (5th Cir. 1971).

Most courts have rejected the Illinois approach, on a variety of rationales. See Remington Arms. Co. v. Liberty Mut. Ins. Co., 142 F.R.D. 408, 418 (D. Del. 1992). One is that, properly understood, the common interest “privilege” is no privilege at all but rather is a shorthand way of considering whether the disclosure of otherwise privileged communications effects a waiver of the privilege. See United States v. McPartlin, 485 F.2d 1321, 3336 (7th Cir. 1979). As a result, whether there is a common interest depends on the circumstances at the time of disclosure. In these circumstances, while the coverage war is en flagrante there will typically not be a common interest. Put differently, the insured’s privilege still exists and may properly be interposed as a basis for refusing to produce otherwise relevant documents and materials. In Re Envtl. Ins. Declaratory Judgment Actions, 612 A.2d 1338, 1341-43 (N.J. Super. App. Div. 1992). An insurer cannot force a waiver by the fact that a coverage suit is pending. (Relatedly, courts uniformly hold that the mere fact that the insured has been required to file a suit against its insurer does not waive privilege or put all privileged communications “at issue” (which is simply another variant of waiver principles). See FDIC v. US, 527 F. Supp. 942, 950-51 (S.D.W.Va. 1981) (advice-of-counsel defense places communications at issue and subject to discovery); Long Island Lighting Co. v. Allianz Underwriters Ins. Co., 749 N.Y.S.2d 488, 496 (App. Div. 2002); Home Ins. Co. v. Advance Mach. Co., 443 So. 2d 165, 168 (Fla. 1st Dist. App. 1983); Rockwell Int’l Corp. v. Superior Court, 26 Cal. App. 4th 1255, 1268 (1994).)

Nor is the insured’s duty of cooperation with its insurers construed as a waiver of privilege. Metropolitan Life Ins. Co. v. Aetna Cas. & Sur. Co., 730 A.2d 51, 63-64 (Ct. 1999); Martin, 450 F.2d at 553. See also Gulf Ins. Co. v. Transatlantic Reinsurance Co., 788 N.Y.S.2d 44 (1st Dep’t 2004).

So, insurers cannot compel insureds to provide them with privileged (or work product) information. This is true both informally and in the context of coverage litigation. Nevertheless, insureds and their insurers may wish to exchange defense counsel’s evaluation of a case, for example. Can an insured provide its carrier with privileged communications without fear that it has effected a broad waiver with respect to the tort claimants? Does a policyholder need fear that its carrier will use that communication against it to deny coverage?

Policyholders may wish to share defense-counsel’s analysis with its insurers to facilitate the insurers decision to pay to settle a case. I have found it reasonably common in the directors’ and officers’ liability insurance, fiduciary-liability insurance, and errors and omissions insurance contexts that policyholders and their insurers do share privileged communications, reflecting the reality that in many cases the insurers will pay for settlement of the underlying claim against the insured. On the other hand, in the product-liability and mass-tort context, such sharing of information is seemingly more rare.

If an insured elects to share privileged information, is there a risk of finding of waiver? While I am reluctant to provide a definitive conclusion one way or the other, no doubt there is a risk that a court may find waiver.

The starting point for any analysis of this problem is that, in most jurisdictions, there is no insured-insurer privilege. Linde v. Resolution Trust Corp., 5 F.3d 1508, 1514-15 (D.C. Cir. 1993) (“we now firmly reject any sweeping general notion that there is an attorney-client privileged in insured-carrier communications”). As the Linde court ruled:

An insured may communicate with its carrier for a variety of reasons, many of which have little to do with the pursuit of legal representation or the procurement of legal advice. Certainly, where the insured communicates with the carrier for the express purpose of seeking legal advice with respect to a concrete claim, or for the purpose of aiding an insurer-provided attorney in preparing a specific legal case, the law would exalt form over substance if it were to deny application of the attorney-client privilege. However, a statement betraying neither interest in, nor pursuit of, legal counsel bears only the most attenuated nexus to the attorney-client relationship and thus does not come within the ambit of the privilege. . . . . [I]f what is sought is not legal advice, but insurance, no privilege can or should exist.

Linde, 5 F.3d at 1515. See also Aiena v. Olsen, 194 F.R.D. 134, 136 (S.D.N.Y. 2000). As the Alaska Supreme Court explained, “communications between insured and insurer are not in the same class as communications between client and attorney, because the insurer may use its information for purposes inimical to the interests of the insured.” Langdon v. Champion, 752 P.2d 999, 1002-03 (Alaska 1988). Thus, some courts have found that otherwise privileged communications lose their protection from sharing them with an insurer. See Go Medical Indus. Pty., Ltd. V. C.R. Bard, Inc., 1998 WL 1632525 (D. Conn. Aug. 18, 1998); Hartford Fire Ins. Co. v. Guide Corp., 206 F.R.D. 249, 250-51 (S.D. Ind. 2001).

Even if both the carrier and its policyholder would benefit from a defense victory over a tort plaintiff, that may not be sufficient to establish a “common interest” to maintain privilege. See Shamis v. Ambassador Factors Corp., 34 F. Supp. 2d 879, 893 (S.D.N.Y. 1999) (holding that the fact that two entities would benefit from a judgment in favor of the plaintiff, that is not sufficient to find that they share an identical legal interest). What constitutes a common interest has been defined in the following manner:

A community of interests exists among different persons or separate corporations where they have an identical legal interest . . . . The key consideration is that the nature of the interest be identical, not similar, and be legal, not solely commercial. The fact that there may be an overlap of a commercial and legal interest for a third party does not negate the effect of the legal interest in establishing a community of interest.

North River Ins. Co. v. Columbia Cas. Co., 1995 WL 5792, at *3 (S.D.N.Y. Jan. 5, 1995) (citation omitted). The court continued, “What is important is not whether the parties theoretically share similar interests but rather whether they demonstrate actual cooperation toward a common goal.” Id. at *4. Stated further, the same court held in International Insurance Co. v. Newport Mining Corp., 800 F. Supp. 1195 (S.D.N.Y. 1992):

The “common interest,” logically viewed, and New York law supports, which makes the privilege inapplicable, is where an attorney actually represents both the insured and the carrier – joint representation – and accordingly both clients are working together with a single attorney toward a common goal.

Id. at 1196 The International Insurance court found that, while the insurance carrier and its insured shared the same desire for a successful defense of a legal claim against the insured, this was insufficient to find a common legal interest. Id. The International Insurance case involved a defendant-insured seeking to withhold from a plaintiff-carrier materials that were privileged. When the plaintiff-insurer argued that the common-interest exception should apply and the privileged materials (which were otherwise relevant) therefore should be produced, the court disagreed. The court stated:

I conclude that while the insurer had the same ‘desire’ as its insured to have a successful defense of [the actions that necessitated the case at bar], for if coverage was later determined to exist, it would be responsible for any obligation of its insured remaining, this in my view is an insufficient ‘common interest’ to warrant invasion of the attorney-client relationship with the privilege . . .

By extension, and this is the key point, if the insured provided these types of materials to its insurers, then it is providing the communications to an entity that does not share a common interest; therefore, privilege (or immunity) may not be preserved vis a vis (other) third parties. Kansas City Fire & Marine Insurance Corp., 351 N.Y.S.2d 767, 768 (App. Div. 1974).

In Go Medical Industries Pty, Ltd. v. C.R. Bard, Inc., 1998 WL 1632525, a patent-infringement action, the defendant sought production of the plaintiff’s communications with its insurance carrier, which included certain opinions of its lawyer that had been provided to the carrier. The plaintiff alleged the common-interest extension of the attorney-client privilege shielded these documents from discovery. The court in Go Medical disagreed, finding that the plaintiff and its insurance carrier did not share common legal interests:

Go Medical’s [the plaintiff] purpose in providing these documents to CIC [its insurance carrier] was to try to obtain coverage from CIC for expenses Go Medical would incur in litigation to stop the alleged infringement of its patent. However, whereas Go Medical’s interest is in protecting its patent, CIC has no interest in the [] patent. CIC’s interest in Go Medical’s infringement claim is limited to CIC’s coverage of Go Medical’s litigation expenses. An insurer’s contractual obligation to pay its insured’s litigation expenses does not, by itself, create a common interest between the insurer and the insured that is sufficient to warrant application of the common interest rule of the attorney client privilege.

Id. at *3.

So, can communications with an insurer be conducted in a manner that does not result in a waiver? Certainly, if the insurer acknowledges coverage and takes over control of the defense, unquestionably in that circumstance the insurer is functioning as the insured’s lawyer and is entitled to no less protection. When the insurer has not yet provided full-throated acknowledgement of coverage, the insured and the insurer need to lay a foundation to show that, in the particular circumstance, the exchange of privileged information should not be deemed to be a waiver. To accomplish this, the parties are advised to make clear that there is a purpose related to the settlement or defense of the underlying case that justifies sharing the information – that is, the justifies extending the cone of silence over lawyer-client communications of the policyholder to include the carrier. (The carrier’s merely sharing the hope that the policyholder may win the liability case is not likely to be sufficient basis for proving sufficient commonality of interest. E.g., Shamis, 34 F. Supp. 2d at 893.)

So the issue for all counsel involved – policyholder, carrier, tort plaintiffs, government investigators – is whether a foundation has been established that satisfies a showing that in the particular circumstance disclosure of privileged/work product material is consistent with preserving the confidentiality protections we otherwise protect them with. See Cutchin v. State of Maryland, 143 Md. App. 81 (2002); Metroflight Inc. v. Argonaut Ins. Co., 403 F. Supp. 1195 (N.D. Tex. 1975); Reavis v. Metro Property & Liability Ins. Co., 117 F.R.D. 160 (S.D. Cal. 1987); Bellman v. District Court, 531 P.2d 632 (Colo. 1975); Grand Union Co. v. Patrick, 246 So.2d 474 (Fla. Dist. Ct. App. 1971); People v. Ryan, 197 N.E.2d 15 (Ill. 1964). Some courts have ruled that statements to an insurance adjuster are protected by the work-product doctrine, and thus the plaintiff who later sues the insured making the statement cannot obtain its discovery. In re Fontenot, 13 S.W.3d 111 (Tex. App. 2000); Heidebrink v. Moriwaki, 706 P.2d 213 (Wash. 1985). Some courts have employed seemingly more stringent proof requirements to show that privilege should be preserved. In Re Bevill, Bresler & Schulman Asset Mgmt Corp., 805 F.2d 120, 126 (3d Cir. 1986); Government of Virgin Islands v. Joseph, 685 F.2d 857, 862 (3d Cir. 1982); Sheet Metal Workers Int’l Ass’n v. Sweeney, 29 F.3d 120 (4th Cir. 1994); Ft. Howard Paper Co. v. Affiliated FM Ins. Co., 64 F.R.D. 694 (E.D. Wisc. 1974); Travelers Ins. Cos. v. Superior Court, 143 Cal. App. 3d 436 (1983).

The key lesson is that, if one desires to preserve the privilege (or immunity) that would otherwise attach to a statement shared with an insurance company, the circumstances surrounding sharing the statement should indicate that it is being provided to assist the insurer in the defense or in evaluating the settlement of the claim. E.g., Exxon Corp. v. St. Paul Fire & Marine Ins., 903 F. Supp. 1007, 1010 (E.D. La. 1995). In other words, to the extent that one can show that the insurer’s role is in protecting the interest of the insured, then the communication is more likely to remain protected. If the role of the insurance company is more ambiguous – that is, if it is unclear which hat the insurer is wearing and whether the statement might be used against the insured in service of a denial of coverage – then the risk of a court finding waiver is increased. See Hedebrink, 706 Pl.2d at 220 (Goodloe, J., dissenting) (“The use of the statement for a purpose adverse to the interest of the insured is certainly inconsistent with the claim of privilege upon his behalf.”); see also Vermont Gas Systems, Inc. v. United States Fid. & Guar. Co., 151 F.R.D. 268, 277 (D. Vt. 1993); cf. Great American Surplus Lincs, Inc. v. Ace Oil Co., 120 F.R.D. 533 (E.D. Cal. 1988) (preserving insurer’s privilege re information shared with reinsurer). Ideally, the policyholder and the insurer will enter into an agreement that pledges the insurer will maintain the communication in confidence, is receiving the communication for the purpose of evaluating the defense of the claim or settlement of the claim, and will not use the communication as a basis to deny coverage to the insured (subject to the insurer’s being able to use the documents in defense of a failure-to-settle bad-faith claim and allowing the insurer to seek the identical discovery in a coverage case against the insured, though without being able to argue that sharing the information effected a waiver). Such an approach differentiates the insurer's white hat and black hat and allows the policyholder's privileged information to be kept under the insurer's hat.

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Cone of Silence or Echo Chamber: A Policyholder’s Privileged Communications and its Insurers

When an attorney who is an insurance company’s agent uses the confidential relationship between an attorney and a client to gather information so as to deny the insured coverage . . . . we hold that such conduct constitutes waiver of any policy defense, and is so contrary to public policy that the insurance company is estopped as a matter of law from disclaiming liability.

We know of no case in which the insured’s duty of assistance and cooperation has been used to force a putative insured to divulge to the insurer every jot and tittle of information which may aid the insurer in defeating his claim for coverage but which in no way hinders the insurer’s ability to provide the insured with a proper defense.

An insured may communicate with its carrier for a variety of reasons, many of which have little to do with the pursuit of legal representation or the procurement of legal advice. Certainly, where the insured communicates with the carrier for the express purpose of seeking legal advice with respect to a concrete claim, or for the purpose of aiding an insurer-provided attorney in preparing a specific legal case, the law would exalt form over substance if it were to deny application of the attorney-client privilege. However, a statement betraying neither interest in, nor pursuit of, legal counsel bears only the most attenuated nexus to the attorney-client relationship and thus does not come within the ambit of the privilege. . . . . [I]f what is sought is not legal advice, but insurance, no privilege can or should exist.

A community of interests exists among different persons or separate corporations where they have an identical legal interest . . . . The key consideration is that the nature of the interest be identical, not similar, and be legal, not solely commercial. The fact that there may be an overlap of a commercial and legal interest for a third party does not negate the effect of the legal interest in establishing a community of interest.

The “common interest,” logically viewed, and New York law supports, which makes the privilege inapplicable, is where an attorney actually represents both the insured and the carrier – joint representation – and accordingly both clients are working together with a single attorney toward a common goal.

I conclude that while the insurer had the same ‘desire’ as its insured to have a successful defense of [the actions that necessitated the case at bar], for if coverage was later determined to exist, it would be responsible for any obligation of its insured remaining, this in my view is an insufficient ‘common interest’ to warrant invasion of the attorney-client relationship with the privilege . . .

Go Medical’s [the plaintiff] purpose in providing these documents to CIC [its insurance carrier] was to try to obtain coverage from CIC for expenses Go Medical would incur in litigation to stop the alleged infringement of its patent. However, whereas Go Medical’s interest is in protecting its patent, CIC has no interest in the [] patent. CIC’s interest in Go Medical’s infringement claim is limited to CIC’s coverage of Go Medical’s litigation expenses. An insurer’s contractual obligation to pay its insured’s litigation expenses does not, by itself, create a common interest between the insurer and the insured that is sufficient to warrant application of the common interest rule of the attorney client privilege.

Id. at *3.

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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.

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‘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.

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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).

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

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May 27, 2006

Late Notice by Liability Insurance Policyholders as Excuse Not to Pay – of Notice, Covenants, Conditions, Material Breaches, Innominate terms, and American versus English Law

Courts continue to struggle with claims where the policyholder may not have provided notice as soon as one might have liked, and the coverage litigation typically centers on whether the dispositive argument is “no harm, no foul” -- that is, policyholders will argue that coverage is not lost unless the insurer has been prejudiced in some fashion from the allegedly “late” notice. The Illinois Supreme Court and a Texas appellate court both have confronted this question recently, and these are largely consistent with recent holdings from New York’s highest court finding that the notice provision must be enforced as written – no ifs, ands or buts.

I dare say that policyholders – and most insurer-side representatives – are astonished by this seeming trend vitiating coverage where insurers have suffered no harm from noncompliance. The clear “modern” trend has been to move away from a forfeiture approach to one that requires a showing of harm to the insurer before coverage will be lost – and most properly then only to the extent of the harm. (Different courts have assigned the burden of proof differently, but the undisputed trend has been towards liberality.) Usually, this trend is called the “notice-prejudice” rule, the idea being that unless the insurer has been prejudiced from the late notice coverage is not forfeited.

Policyholders promise to notify their insurers of loss, or circumstances that may lead to loss, and insurers will deny coverage if they believe that obligation has been breached. Accordingly, the first question is whether notice is “late” at all or whether the policyholder’s performance of its obligation to provide notice has complied with the policy terms. Most courts supply a reasonableness of time requirement, taking into account the purpose of the policy and the function of the notice policy therein. E.g.,