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 30, 2005
Grab Your Umbrella -- and Magnifying Glass
For the past two decades, policyholders and insurers have been fighting over whether the cost of cleaning up hazardous-waste sites is covered under general-liability policies by arguing over the nature of that liability. The argument has tended to center on the meaning of the word "damages" and the insuring agreement's promise to afford indemnification for the sums payable "as damages."
Departing somewhat from the standard version of these arguments, the California Supreme Court ruled in 2001 that covered "damages" were limited to amounts awarded by a court. Now, the court has reaffirmed that holding, County of San Diego v. Ace Property & Casualty Ins. Co. (Cal. Aug. 29, 2005), but in a companion case held that an umbrella policy that afforded coverage for "expenses" in addition to "damages" unambiguously applied to clean-up costs incurred in an administrative proceeding. Powerine Oil Co. v. Superior Court (Cal. Aug. 29, 2005). The court purports to be implementing the "mutual intent" of the parties, with the result that one insured has coverage due to the inclusion of the word "expenses" and the other one does not.
It is true that the purpose of umbrella policies is to provide broader coverage than the underlying coverage and to drop down or step down and fill in any gap created by a loss that is not covered by the underlying insurance. We generally conceive of this gap- filling function as ensuring that the policyholder does not fall between two stools, when for example neither an auto policy nor a homeowners' policy applies to some strange loss involving an automobile. Nothing in the language of umbrella policies limits their coverage to these types of gaps, and the California Supreme Court apparently had no trouble at all concluding that indemnification for expenses naturally includes clean-up costs in state administrative actions, even though the underlying coverage -- which indemnifies "only" for "damages" -- does not apply. As the Powerine court explained, "We therefore conclude that under a literal reading of Central National's excess/umbrella policies, the indemnification obligation is expressly extended beyond court-ordered money 'damages' to include expenses incurred in responding to government agency orders administratively imposed outside the context of a government lawsuit to cleanup and abate environmental pollution." (Slip op. at 23)
But this was not the result for the County of San Diego, because though its policies used the term "expenses" in the "ultimate net loss" provision (thus making clear the policy indemnifies for "expenses" and indicating how the policy limits were to apply), the word "expenses" was located in the wrong place as far as the Calfornia court was concerned. As the court explained [sic] in italicized language no less: "In contrast, the defintion of 'ultimate net loss' here is neither incorporated into, referenced, nor a part of the central insuring clause of the [] policy." (Slip op. at 14, original italics omitted). Accordingly, the court holds:
We conclude that costs and expenses associated with responding to administrative orders to clean up and abate soil or groundwater contamination outside the context of a government-initiated lawsuit seeking such remedial relief, and property buy-out settlements negotiated with third party claimants outside the context of a court suit, do not fall within the literal and unambiguous coverage terms of the [] policy's insuring agreement.
Slip op. at 16 (emphasis in original). Three of the six current California Supreme Court justices, however, indicated their disagreement with the merits of the holding of the opinion for the court.
The three dissenting justices no doubt are right (in my judgment) that it is, shall we say, quirky to have the case law end up where it is as of yesterday. In some ways, a more rational result would have been to deny coverage to Powerine, too, at least to accomplish some degree of aesthetic consistency (and lest there be any misunderstanding I think the original ruling by the court in the earlier case limiting coverage to amounts awarded in court, was plainly wrong). Now, at least in California, we need to scrutinize policies not just for the word "expenses" but also for its coordinates within the policy.
There is an important, broader implication of this duet of opinions: policyholders need to be vigilant in notifying umbrella carriers (and presumably the following-form tower) whenever some form of unconventional relief, i.e., other than pure compensatory damages, is sought against it, whether it be in a court proceeding or in an administrative proceeding. Accordingly, a claim for medical-monitoring, which some insurers have challenged as "non-damages", should be noticed to the umbrella carriers to guard against the risk that those amounts might be considered to be "expenses" rather than "damages" (no matter how unreasonable that result might be). Similarly, whenever a policyholder is interested in settling with a claimant prior to litigation, the policyholder should notify the umbrella carriers, for any such payment might (under current California authority) be found not to be covered "damages" either.
Of course, this all will create new burdens on umbrella carriers, who typically rely on the primary insurer for everyday claims handling. But according to the California Surpeme Court nowadays, we simply must assume the umbrella carrier had the contractual intent to cover claims settled before court proceedings start and forms of monetary relief other than traditional compensatory damages.
Posted by Marc Mayerson at 02:49 PM | Comments (0) | TrackBack
August 03, 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 (0) | 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 01:45 PM | Comments (2) | TrackBack
June 27, 2005
Notice this Case
New York has been one of the last jurisdictions to hold onto the view that a policyholder’s promise to provide notice to its insurer of occurrence, claim or suit must be performed punctiliously at the risk of complete forfeiture of coverage. Following a relaxing of this rule when insurers themselves are the policyholder – that is, when they are in their capacity as cedents seeking reinsurance recovery – and given the lack of analytic foundation for New York’s formalism (addressed further below), many thought that New York would eventually adopt some form of what is usually called the “notice/prejudice” rule (probably akin to that in neighboring Connecticut, cited infra).
The New York Court of Appeal dispelled any such notion in Argo Corp. v. Greater New York Mut. Ins. Co., (April 5, 2005), available at http://www.nycourts.gov/courts/appeals/decisions/apr05/42opn05.pdf . Argo holds that an insurer in New York is not required to show “prejudice” from the policyholder’s providing notice “late” in order to be excused from coverage; on pain of a complete forfeiture of coverage, it is the policyholder’s burden to show that it reasonably complied with the obligation to provide notice.
While Argo confirms that whatever exceptions to the no-prejudice rule exist do not swallow the rule, the case that really reveals (in an ‘inside baseball’ way) the New York Court of Appeals’ perspective is the subsequent memorandum decision in Great Canal Realty Corp. v. Seneca Ins. Co., (June 16, 2005), available at http://www.courts.state.ny.us/ctapps/decisions/jun05/ssm13mem05.pdf. The reversal in Great Canal is more significant because there the Appellate Division had held that the “notice/prejudice” rule did reflect the law of New York. And that the high court decision is a mere memorandum indicates the high court’s ire.
The First Department Appellate Division opinion in Great Canal, available at http://www.courts.state.ny.us/reporter/3dseries/2004/2004_09419.htm, was notable not just because of its holding but also because of its analytical power. In a clever bit of legal craftsmanship, the Appellate Division had postured the no-prejudice rule (correctly) as an exception to the contract-law rule that an immaterial breach of contract does not excuse the other side’s performance (though it may entitle the non-breaching party to damages or set off). The Appellate Division ruled that: “Ultimately, we see no reason to extend the ‘no-prejudice’ exception to allow insurers to disclaim coverage on the basis of late notice of claim where ‘lateness’ is an arbitrary temporal standard applied to a lapse between occurrence and notice, and where contractual rights favor just one party, the insurer.”
While the Appellate Division addressed the idea of disproportionate forfeiture, compare Aetna Cas. & Sur. Co. v. Murphy, 538 A.2d 219 (Conn. 1988) (relying significantly, as did the First Department, on the “celebrated case of Jacob & Youngs, Inc. v. Kent, 230 N.Y. 239 (1921)”), the Appellate Division court could have buttressed its analysis by considering whether the notice provision is a true condition precedent or is a covenant, that is, an independent promise of performance. There is a maxim of contract construction that provisions should be construed as covenants and not as conditions, precisely to avoid forfeiture from technical breaches. Maryland’s high court correctly recognized this point in Sherwood Brands, Inc. v. Hartford Accident and Indemnity Co., 698 A.2d 1078 (1997) available at http://www.courts.state.md.us/opinions/coa/1997/104a96.pdf; see also Stephen Klein, Insurance Recovery of Pre-Notice Defense Costs, 34 Tort & Ins. L.J. 1103 (1999). This is a key insight, because it makes clear that a breach of the notice covenant does not (usually) equate to a material breach of contract by the policyholder (in the light of its other covenants and performance already rendered).
The idea that notice is a covenant, not a condition, (that is, that notice is a promise of contractural performance by the policyholder) also provides a more satisfactory framework for understanding the notice/prejudice rule. Those courts adopting a requirement of showing prejudice before nonperformance by the carrier is justified have been telling us that notice is not a condition. Were notice a “condition,” then, as the New York court held in Argo, prejudice wouldn’t matter – a condition is a condition. Because of this prospect of forfeiture, however, contract law adopts the maxim that provisions should be construed as covenants and not as conditions. But since the courts say (other than in NY) that prejudice does matter, then it follows that notice is not a condition. (Just because it is found in the “conditions’ section of the policy is not dispositive; there are other provisions there identifying aspects of the policy relationship that cannot plausibly be construed a conditions precedent to coverage.)
The covenant idea furthermore helps ground arguments about what types of things get ‘counted’ as prejudice to insurers under a notice/prejudice rule. When we then argue about whether a carrier has been prejudiced, we have a normative guidepost, for we are evaluating what happened in the light of the parties’ contractual relationship and whether whatever noncompliance is alleged so goes to the heart of the parties’ mutual contract as to constitute a material breach of the entire relationship – which then would excuse the non-breaching party’s obligations to perform at all. (The covenant framework also provides the way to analyze the question of the recoverability of pre-notice defense costs, see Klein, Insurance Recovery of Pre-Notice Defense Costs, 34 Tort & Ins. L.J. 1103.)
But the New York Court of Appeals does not address the covenant versus condition point, the idea of material versus immaterial breach, or of disproportionate forfeiture (see Restatement (2d) Contracts § 229). The Appellate Division’s now-reversed opinion in Great Canal addressed the concept of disproportionate forfeiture, a doctrine that New York led the way in adopting in Judge Cardozo’s opinion in Jacobs & Young. Yet the Court of Appeals does not even address its own prior (landmark and famous) precedent in smacking down the Appellate Division in its terse memorandum decision.
The most charitable construction of Argo and Great Canal is that the Court of Appeals did not want to disturb its own prior (if ill considered) precedent. (Protocol counsels that I refrain from invoking Emerson here.) This means that it is now up to the New York legislature to adopt remedial legislation. Or the Insurance Commissioner could act to prohibit an unfair policy term (as construed by the Court of Appeals). One would think it would be politically popular to allow policyholders (voters) to obtain the benefit of the coverage they paid for when they fail to give notice immediately to their carriers and the carrier has suffered no prejudice from the late notice. “No harm, no foul” seems like a good position politically, even if it is not a winning one in the New York court system (unless you’re a carrier).
Of course, the best position to be in for policyholders is not to need to argue about conditions versus covenants, material versus immaterial breach, prejudice, or disproportionate forfeiture: as with voting in Chicago policyholders should give notice early and often. See Marc Mayerson, Perfecting and Pursuing Liability Insurance Coverage: A Primer for Policyholders on Complying with Notice Obligations, 32 Tort & Ins. L. J. 1003 (1997), available at http://www.spriggs.com/news/pdfs/MSM-6.pdf.
Posted by Marc Mayerson at 06:12 PM | Comments (1) | TrackBack
April 09, 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 03:49 PM | Comments (1) | TrackBack