September 22, 2005
Stay What? Coverage Claims May Proceed Against Insolvent Insurers
When insurance companies become insolvent, they are eligible for reorganization or liquidation pursuant to special state-law “bankruptcy” proceedings. As with federal bankruptcies, the debtor typically seeks a stay of litigation against it, ostensibly for the purpose of permitting the bankruptcy court to centrally manage the valuation of claims and distribution of assets.
In insurance bankruptcies, it is common for the liquidation or rehabilitation court to issue an order stating that all actions against the insurer are stayed. When an action is pending outside that forum, complex issues of federalism and statutory constructions seemingly are presented; when the action against the insurer is pending in federal court, the questions are doubly complex – or so they seemed before a lucid opinion by the United States Court of Appeals for the Ninth Circuit, which recently cut through all the questions presented and held the issues were quite simple after all.
In Hawthorne Savings FSB v. Reliance Ins. Co., (9th Cir. Aug. 24, 2005) (amended Jan. 13, 2006), which as the court notes involves a matter remotely connected to the criminal prosecution of Mr. Orenthal James Simpson, the policyholder brought a coverage action against Reliance, which (after some corporate transactions and bad underwriting) became insolvent. The matter was in federal court on diversity-of-citizenship grounds (it having been removed by Reliance) with California state law providing the substantive rule of decision.
Under 11 USC 109(b)(2)-(3), Congress disavows any significant federal interest in the bankruptcy of insurance companies, a view consistent with the (current) tenor of federal involvement in the insurance industry, which (generally) defers to state regulation of the activities of insurance companies as they relate to that business as such.
Under the McCarran-Ferguson Act, 15 USC 1011, generally state law reigns triumphant over federal law in insurance-regulatory matters, and the odd scenario is sometimes presented where the parties argue about “reverse preemption,” that is, they argue that state law displaces federal law. E.g., Love v. Money Tree (Ga. June 6, 2005).
In Hawthorne, the insurer argued that federal diversity jurisdiction (28 USC 1332) was displaced by the Pennsylvania state insurance regulatory regime, thus divesting the federal district court of subject-matter jurisdiction. The Ninth Circuit, following Fourth Circuit authority, held that, while Pennsylvania properly maintained exclusive jurisdiction over the liquidation of the insurer and its assets, federal jurisdiction on the breach-of-contract claim and its merits was retained. Slip op. at 11355. Indeed, the court point out the reductio ad absurdum conclusion of the insurer’s argument that no federal court sitting in diversity would have jurisdiction over any insurance dispute and easily rejected that contention. Id. (citing prior authorities). The court furthermore finely argued that the diversity-jurisdiction statute did not “invalidate, impair, or supersede” the state’s liquidation effort. Accordingly, the court held that the federal diversity jurisdiction statute, 28 USC 1332, was not reverse preempted by the McCarran-Ferguson Act.
Reliance next argued that, even if there were federal-court jurisdiction, the court should abstain from its exercise on the ground that federal involvement would be inconsistent with a comprehensive state regulatory proceeding. After reviewing prior authorities, the Ninth Circuit rejected the argument for abstention under the principles of Burford v. Sun Oil Co., 319 U.S. 315 (1943) (and Quackenbush v. Allstate Ins. Co., 517 U.S. 706 (1996)) or under Colorado River Water Conservation Dist. v. US, 424 US. 800, 813 (1976). The Ninth Circuit reasoned that the decision in a single case of breach of contract posed no threat to the development of state policy or regulation overall. This was true even though the breach of contract action, if successful, would affect assets under the control of the supervisory court.
Reliance further argued that the court was required to give full faith and credit to the stay order. The Ninth Circuit easily disposed of the issue, arguing that the question of full faith and credit was dependent on the enforceability of judgments in general, and that the policyholder was neither a party nor in privity with a party in the rehabilitation proper – accordingly, the terms of the order did not apply to it. Moreover, the state court lacked power directly to enjoin the federal court from proceeding. And the Ninth Circuit likewise did not find that generalized notions of comity required any different result.
The court thus held there was no basis why a federal court in particular was required to abide by the stay order. The Ninth Circuit next considered, however, whether a state court sitting in California would abide by the stay order.
This question turned in part on construing the Uniform Insurers Liquidation Act (UILA), which requires that the enacting states abide by the insolvency and rehabilitation processes of another enacting state. Within the terms of the UILA, deference is required for a “reciprocal state,” and because the Pennsylvania scheme differed somewhat from the uniform act (as passed by California), the Ninth Circuit was required to evaluate the substance of the Pennsylvania regime. In concluding that the Pennsylvania scheme was close enough to the UILA, the Ninth Circuit then was faced with the question of the interpretation of the California-version of the UILA and whether it required that the Pennsylvania court’s stay be respected.
The Ninth Circuit concluded, however, that the UILA required deference only to the rehabilitation proceeding as such and did not apply to in personam actions, such as a claim for breach of contract. As the court concluded, “reciprocity does not apply to the determination of in personam legal rights, as opposed to the enforcement of any resulting judgment against the estate of an insolvent company in state court proceedings.” Slip op. at 11375. In particular, the UILA makes this distinction clear by specifying that an action in the non-rehabilitation state could not be maintained if it was “in the nature of an attachment, garnishment, or execution.” Cal. Ins. Code 1064.9. Accordingly, the Ninth Circuit concluded that either a California state court or a federal court sitting in diversity was free to reach the merits of the breach-of-contract action against Reliance, even if that court could not issue execution.
While possessing a judgment for coverage without a right or power of execution might be a pyrrhic victory in other circumstances, that wasn’t the case for the policyholder in Hawthorne. Once it appeared that Reliance was heading towards insolvency, the policyholder compelled Reliance to post a bond, pursuant to state law requiring that nonadmitted insurers post bonds as a condition to filing an answer. (The Ninth Circuit’s opinion did not address whether this statute applies in a federal-court action sitting in diversity, but long-established authority holds that pre-answer security statutes do apply in federal court. E.g., Akron Co. v. Fidelity Gen. Ins. Co., 250 F. Supp. 201 (N.D. Ohio 1964).) Accordingly, the policyholder’s trial victory was upheld and the judgment ordered to be satisfied from the bond.
A version of this article was published in 22 Tolley's Insolvency Law & Practice 22 (London 2006).
Posted by Marc Mayerson at 11:31 AM | Comments (2) | TrackBack
September 16, 2005
Tragedy and Failure
Insurers dealing with Katrina losses are caught between a rock and a hard place -- more accurately, between flood and wind-driven rain. Generally, under typical homeowners policies, flood-caused loss is excluded but wind-driven rain and other windstorm-caused loss is covered. The Mississippi attorney general, under pressure from leading members of the plaintiffs' mass-tort bar, has brought suit seeking to force insurers to pay claims, notwithstanding the terms of the insurance policies.
There is historical precedent for insurers' paying claims following mass disaster in derogation of policy terms. The story is told famously of Cuthbert Heath, an underwriter at Lloyd's of London, who following the San Francisco earthquake cabled his US attorneys saying: "Pay all our policyholders in full irrespective of ther terms of their policies." And there seems to be little doubt that this decision of C.E. Heath helped establish the positive reputation (deserved or not) Lloyd's enjoyed in the US for many, many years.
But there is a key difference between Heath's cable and the complaint filed by the State of Mississippi: Heath's commitment of capital was voluntary. The Mississippi action seeks to void insurers' policy defenses and extract the insurers' money involuntarily.
The state will argue that its action is not a taking of the insurers' capital because the policy terms are void ab initio. But what the state's argument highlights is the failure of its insurance-regulatory scheme. Mississippi should not have permitted insurance policies to be issued in the state with flood exclusions if such exclusions are so violative of public policy. Besides arguing on the merits that the exclusions are proper, insurers will argue that voiding them constitutes a taking of property (meaning that the taxpayers will then fund the losses).
If for some reason the insurers are compelled to make these payments, the insurers may well be stuck with the costs and unable to pass the costs onto their reinsurers. So the comment by a plaintiffs' bar attorney, Mr. Richard Scruggs, is misplaced: "The Philadelphia lawyers wrote these things to protect the insurance companies and most of the risk have been spun off in worldwide reinsurance markets. What I want is for some Swiss gentlemen to be very nervous about rebuilding the Gulf Coast." (Regulators of Katrina-Torn States Grapple With Wind vs. Flood Assessments, BestWire (Sept. 12, 2005)).
The European reinsurers probably have little to fear -- other than the threatened insolvency of their customers (i.e., the insurers). This is because if the insurers follow the precedent of C.E. Heath the reinsurers will deny reinsurance recovery on the ground that the payments were voluntary or ex gratia -- that is, were made to enhance goodwill and the like but were not compelled by the terms of the ceded coverage. (The directors and officers of the insurers that make such voluntary payments no doubt will be sued by their shareholders for mismanagement and corporate waste.) Alternatively, the reinsurers will argue that the expropriation of capital by Mississippi and perhaps others is not reinsured, notwithstanding "follow the fortunes" clauses. See Commercial Union Assur. Co. v. NRG Victory Reinsurance Ltd., 1996 Folio No. 1350 (English App. March 16, 1998).
At all events, the Mississippi lawsuit is an extreme example of regulation by litigation and only underscores a massive failure of the Mississippi insurance regulators and the Mississippi state legislature to ensure that their citizens are protected financially through insurance mechanisms, were that their intent. (Of course, not all Mississippi citizens purchase homeowners, renters or other first-party property insurance -- it is not a mandatory coverage like auto often is.) No doubt the Katrina losses substanially will be socialized in some manner: whether it be done through the tax system and thus publicly or the insurance system and thus privately. But changing the rules on an after-the-fact basis and attempting to paint the insurers as the bad guys simply is not fair.
To be sure, the losses suffered by the citizens of the affected communities are mindboggling. And while tapping -- or taking -- insurers' capital may be expedient, that doesn't make it right. Although responding to Katrina poses a challenge to America, one hopes that Americans' values were not blown or washed away at the same time.
Posted by Marc Mayerson at 9:42 AM | Comments (8) | TrackBack
August 11, 2005
Walks and Quacks like a Duck: The Reach of Insurance Regulation to a Seller’s Provision of Insurance-Like Benefits – Of Warranties, Requirements Contracts, & Other Benefits
State regulation of insurance applies if the transaction in question is found to be “insurance.” If something is “insurance,” the entity providing it generally must be a licensed insurance company. If not licensed, then the entity exposes itself to fines and potential criminal liability, in addition to the invalidation of the “insurance” it provided. Many manufacturing, service, and retail companies can find it in their interest to package an insurance-like benefit along with the sale of its product or provision of its service. What are the legal risks to the company from providing this type of benefit to its customers and how can the benefit be structured to minimize the risk yet achieve business objectives?
An hoary case in this area concerned a bicycle store that guaranteed to replace bike tires for a period, no questions asked (i.e., regardless of the cause of loss). The bicycle-tire guarantee provided a remedy broader than a simple warranty against defect; innumerable events exogenous to product failure could trigger the bike shop’s obligation to perform (to replace the tire). The Ohio Supreme Court found the transaction to constitute “insurance”, such that it had to be provided by a licensed insurance company or not at all. As the Court explained:
If the contracts of indemnity involved here are not violative of the insurance laws, then every company may, in consideration of the purchase price paid therefor, furnish its product and also undertake to insure it against all hazards for a specified period. Even if such a contract is an incident in the sale of merchandise and its use therein does not constitute the business of insurance, it is in effect a contract ‘substantially amounting to insurance’ within [the statute].
Ohio ex rel Duffy v. Western Auto Supply Co., 16 N.E.2d 256, 259, 119 A.L.R. 1236, 1240 (Ohio 1938). See also Ollendorff Watch Co. v. Pink, 17 N.E.2d 676, 677 (N.Y. 1938) (a watch replacement policy included with the sale of a watch was insurance).
We see similar transactions where, for example, for a fixed annual fee a company will provide maintenance to a fleet of trucks. See Transportation Guarantee Co. v. Jellins, 174 P.2d 625 (Cal. 1946). Or take the example of a supplier of medicines to a dispensary, where the supplier agrees to provide all pharmaceuticals required annually in exchange for a capitated price (i.e., a fixed dollar fee per participant). Compare Group Life & Health Ins. Co. v. Royal Drug Co., Inc., 440 U.S. 205 (1979). These transactions transfer the risk of greater demand by third parties, price spikes, and other risks outside the parties’ controls, but also involve incentives to provide the service or to produce the medications at lower costs to actualize the profit in the known revenue stream. Usually, to mitigate their exposure, the sellers concurrently maintain several programs, so as to decrease the likelihood that one site would prove to be particularly prone to loss or claims. (Sometimes, sellers will purchase an insurance product -- or what may be characterized as a reinsurance product depending on how the antecedent transaction is characterized -- to fund their obligations. E.g., Ollendorff Watch, 17 N.E. 2d 676.) For a price these transactions both transfer and distribute risk, key badges of insurance transactions. Are these types of transactions “insurance”? Should they be considered to be insurance and unlawful unless approved by the insurance commissioner?
A recent New York trial court decision confronted these issues in connection with a heating fuel oil company’s provision, for a fee, to its fuel-oil customers of clean-up services for spills up to $100,000, an amount well in excess of the value of the fuel oil provided or any service performed. In Petro, Inc. v. Serio, 2005 WL 1792866 (N.Y. Sup. July 29, 2005), the insurance commissioner sued for an injunction barring continuation of the program.
The Petro case is different from the bicycle-tire or watch-replacement cases above in that the New York legislature had passed a statute expressly exempting at least some such fuel-oil clean-up programs from insurance regulation. (The rationale includes that this is an important consumer benefit that protects the environment and thus should be encouraged.) New York law defines an insurance contract (which may be offered only by regulated insurance entities (with some exceptions not pertinent here)) as a contract that confers pecuniary benefit “dependent upon the happening of a fortuitous event.” N.Y. Ins. Law 1101.
The New York insurance department focused on the fact that the clean-up agreement would respond to losses on a much broader basis than merely those consequent to a defect in the fuel-oil system or some poor service that was performed. Particularly to the extent that the clean-up program would respond to losses having no relationship to the product or service that the fuel-oil company provided, the New York insurance department argued, the transaction constituted “insurance.” Compare Anstine v. Lake Darling Ranch, 233 N.W. 2d 723, 728 (Minn. 1975) (“[A] contract which requires the indemnitor to indemnify an indemnittee for losses with which the indemnitor had no connection and over which it had no control would be a contract of insurance.”), overruled on other grounds, 281 N.W.2d 838, 842 n.4 (Minn. 1979).
The court recognized that where a seller provided for the maintenance or repair of products made by others such an arrangement was more akin to insurance than it was to a warranty. 2005 WL 1792866 at *8. Yet, the court recognized that sometimes, where the other product was so closely tied to the seller’s product that its failure impugns the quality of the seller’s product, the relationship is sufficiently close as to fall outside the insurance box. Id. at *9. This is particularly true where the seller exercises some degree of substantial control over the circumstances that might give rise to covered loss.
While conceding in effect that the spill clean-up arrangement at issue does provide “insurance” where unrelated or exogenous events occur – such as third-party negligence, vandalism, or an animal’s intervention – the Petro court found these to be incidental to the arrangement rather than characteristic of it, especially because the fuel oil company made the showing that of the 1750 claims it had handled to date not a single one resulted from some catastrophic event or act of God. See id.
The court further recognized the limitations in the program for losses from the customer’s negligence or recklessness and from war and revolutions, all of which were reasonable efforts to limit the indemnification provided to those circumstances where the fuel-oil company’s product or service were substantially related. As a result, the court found the transaction to be more like a warranty, and thus outside the scope of regulated insurance contracts.
While the Petro case involved several parts of the New York Code that specifically exempted certain programs offered by fuel-oil companies from the reach of insurance regulation (and given this the NY Department's decision to prosecute is somewhat surprising), the reasoning of the court applies more broadly to companies that wish to offer some form of protection to their customers along with the sale of product or services. Petro is helpful in that it allows considerable fuzziness at the edges of transferring risks that are not associated with the product or service. In other words, the New York department was undoubtedly correct that many aspects of the risk transferred were exogenous to the relationship and thus insurance-like; the Petro court, however, resisted the invitation to focus on theory and the abstract, particularly where the company made a factual showing (having sold these instruments for a while) that the insurance aspects were incidental.
For companies interested in providing similar benefits, Petro suggests that this type of program can be offered where some reasonable effort is made to tie the obligation to indemnify to those risks of loss over which the seller has some substantial control – particularly, the quality of its product or its services. To the extent these programs pick up liabilities outside of these, the more insurance-like the transaction becomes.
Another way to approach this issue from a company’s perspective is to focus on the fact that in all cases that I’m aware of the transaction found to be insurance constituted an extra benefit conferred on the customer. In other words, the customer still possessed whatever remedies it had under the law for product defects or the like, but in addition possessed a contractual right to some pecuniary benefit, replacing the bike tire or watch, for example. (Tangentially, an extension of a manufacturer's warranty has withstood challenge as not being insurance, GAF Corp. v. County School Board of Washington County, 629 F.2d 981 (4th Cir. 1980), and under the view I'm suggesting can be conceived of as a waiver of the statute of limitations for claims that would otherwise be subject to tort or contract remedies.)
In structuring a non-"insurance" program, a different approach would be to limit the customer’s legal remedies and channel all claims to the benefit sought to be conferred. If in Petro for example a customer could not sue the fuel oil company for negligence resulting in an oil spill but instead was limited to its $100,000 clean-up right, that type of election of remedies provision should not be found to constitute insurance. Instead, it represents a reasonable, ex ante compromise of potential legal uncertainty that if its terms are disclosed clearly and is substantively fair is likely to withstand challenge. At a minimum, such arrangements should withstand challenge from insurance regulators; the question becomes then whether they withstand challenge from the customer who has a claim for greater than the contract-limited amount.
Posted by Marc Mayerson at 11:16 PM | Comments (0) | TrackBack
July 6, 2005
Mess in Texas -- Insurer Reimbursement of Settlement Payments
While in May 2005 the Texas Supreme Court had unanimously held -- but with splintered rationales -- that an insurer may recover from its own insured monies advanced by the insurer to settle an uncovered liability claim, the Texas court rang in the 2006 new year by granting rehearing in the case. The case, Excess Underwriter’s at Lloyd’s, London v. Frank’s Casing Crew & Rental Tools, Inc., (Tex. May 27, 2005), rehearing granted, 2006 Tex. LEXIS 1 (reversed on 1 February 2008), picks up the cudgels on this issue from the California Supreme Court’s opinion in Blue Ridge Ins. Co. v. Jacobsen, 22 P.3d 313 (Cal. 2001) and seemingly abandons the prior decision in Texas Ass’n of Counties County Gov’t Risk Mgmt. Pool v. Matagorda County, 52 S.W.3d 128 (Tex. 2000), which had cast substantial doubt on the viability of an insurer-recoupment claim, at the time seeming to bring Texas in line with Massachusetts on this issue. See Med. Malpractice Joint Underwriting Ass’n of Massachusetts v. Goldberg, 680 N.E.2d 1121 (Mass. 1997). Frank’s Casing also parts company with the recent holding of the Illinois Supreme Court in General Agents Insurance Company Of America, Inc. v. Midwest Sporting Goods Company, 828 N.E.2d 1092 (Ill. March 24, 2005), which had rejected a carrier claim to recoupment of defense costs, though on a basis that would bar recoupment of settlement or indemnity payments, too.
In Frank’s Casing, the insured was involved in a serious case, resulting in a $7.5 million settlement. The insurers had previously offered to pay roughly two-thirds of this amount without a right of recoupment against the insured; the insured rejected this proposal, and the insurers paid the full sum and sought recovery from the insured of the entire amount.
Earlier, the insured had written to the carriers stating that the proposed settlement was reasonable in the circumstances (holding aside coverage issues) in an effort to set up the carriers for a third-party bad-faith claim, that is, a claim that the insurers unreasonably failed to settle within policy limits (which in Texas is known as a “Stowers” claim). The policy contained standard boilerplate language saying the insurer couldn’t be sued until a final judgment was entered against the insured or unless a tripartite deal was reached among the claimant, the insured, and the insurer, which the Texas Supreme Court’s lead opinion characterized as vesting in the insured a right to consent to settlements.
The majority opinion in Frank’s Casing announces the rule that an insurer has a right to be reimbursed by its insured if: (i) it timely asserted a reservation of rights; (ii) it notified the insured it intends to seek reimbursement of settlement amounts; (iii) it pays to settle claims that are not covered; and (iv) the insured confirms that the settlement offer is a reasonable one that should be accepted. Slip op. at 8.
The majority reasoned that if the insured confirms that the settlement offer is reasonable – in the context of sending a letter to the carrier setting it up for an excess-of-policy-limits excess-verdict third-party bad-faith claim – it may not contend that settling with only its own money was inappropriate (even though had a settlement not been reached the carrier would have been required to pay for the continued defense of the case). As the majority reasons, “[i]f the offer is one that a reasonable insurer should accept, it is one that a reasonable insured should accept if there is no coverage.” (Slip op. at 10) In a strange twist, the court reasons that by settling with the plaintiff the insurer effectively only is continuing to prosecute the plaintiff’s claim against the policyholder, so the policyholder should [sic?] be in a position of indifference. (Id.) (Of course, the court does not mention that in the tort case the insurer pays for the defense but does not in the coverage case.)
In reaching its holding, the majority evinces great concern that the insurer otherwise would be forced into an uncomfortable position:
1. “It could refuse to settle and face a bad faith claim if it is later determined there was coverage.”
2. “Or it could settle the third-party claim with no right of recourse against the insured if it is determined there was no coverage, which effective creates coverage where there was none.”
Slip op. at 11. The majority does not consider that insurers will not lose the bad-faith case if the failure to settle was reasonable, and no doubt the insured’s not agreeing to fair terms of the settlement would be powerful evidence that the insurers’ failure to settle was not unreasonable or in bad faith. Moreover, the Texas court never considers that insurers are in a position to protect themselves against this risk by, as it had explained in Matgorda County, “drafting policies to specifically provide for reimbursement or by accounting for the possibility that they may occasionally pay uncovered claims in their rate structure.” 52 S.W.3d at 136. Were there an express policy provision on this point, then policyholders could elect not to purchase insurance from carriers that demand reimbursement provisions, and at all events insurance commissioners could scrutinize the terms of any such reimbursement provisions to ensure fundamental fairness.
The Texas majority deems an essential element of a reimbursement claim to be that the carrier reserve its rights to deny coverage, but then does not complete its implicit legal analysis of saying that the insured agreed to a new reimbursement contract with the carrier by accepting the defense on those terms. (As noted below, one of the concurring justices points outs this analytic hole in the majority’s analysis.) Instead, the majority hides behind the judicial fiction of “quasi contract” and finds that “an agreement to reimburse an insurer is implied in law.” Slip op. at 13. Thus, whether or not an insured agrees to a side deal with its carrier by which the insured agrees to reimburse the carrier in exchange for the carrier’s agreement to fund a settlement, the insurer will have a right to reimbursement if it says so before writing the check and the insured makes some acknowledgment that settlement is (in general) a good idea.
Many aspects of the majority opinion come under sharp attack by the concurring justices, and indeed each part of the intellectual edifice created by the majority more or less is decimated by the concurring justices who search for a better rationale for the result.
For example, Justice Hecht’s concurrence asks rhetorically, “Why an insured should assume an obligation to reimburse an insurer’s settlement of a non-covered claim when the insured has the right to consent to settlement and does so, but not when he consents though he has no right to do so, is baffling.” (Hecht, concurring, slip op at 5). Justice Hecht would simply overrule Matagorda County and find that a carrier can always obtain reimbursement for reasonable settlements. (Id.) As he elaborates, “no one suggests that an insurer may unilaterally settle a claim for an unreasonable amount, or in circumstances that actually (rather than hypothetically) prejudice the insured, and then force reimbursement from the insured.” (Id. at 6.) On the other hand, the exposure of the carrier to “severe consequences” and “stiff statutory liabilities” from unreasonably failing to settle a claim powers the insurer’s right to obtain reimbursement where there is no coverage and the settlement is reasonable. (Id. at 3, 7).
Justice O’Neill in her concurring opinion first objected to the majority’s weighing so heavily the insured’s effort to Stower-ize the insurers; as she points out, an insurer only has an obligation to settle if there is coverage. Accordingly, if by hypothesis there is no coverage, then the effort to set up a bad-faith claim is irrelevant as far as strict contractual obligations. See Slip op. at 3 (O’Neill, J., concurring). Justice O’Neill furthermore found salient that the insured had a contractual right to consent to settle; in the absence of such a right, Justice O’Neill implies that a reimbursement right would exist if the carrier offered the insured the ability to continue with the defense (though the concurrence does not address whether the insured must fund that defense alone or whether it may take the amount of money the carrier would have otherwise devoted to settlement and then continue with the defense, with no further recourse against the carrier). Justice O’Neill finds on the facts an agreement by the insured to reimburse because it consented to the settlement and it was clear the insurers would not have settled without that consent. But Justice O’Neill does not find an implied in fact agreement by the insured; instead, like the majority, she finds an implied in law obligation to reimburse. Id. at 5.
Justice Wainright adopts a different tack in his concurring opinion. Like Justice O’Neill he finds Stowers not to be relevant to the contract question presented; instead, he looks to whether a new contract was created in connection with the settlement of the underlying case – in other words, he looks to an implied in fact, separate agreement to reimburse. Justice O’Neill is not concerned as such with the idea that one side or the other obtained advantage through the settlement:
Did Frank’s Casing obtain a windfall – i.e., payment by its insurer of millions of dollars to settle claims against it for which there was no coverage? Or did Excess Underwriters voluntarily pay a settlement to obtain the benefits of saving itself potentially millions of dollars from the expected verdict and millions more from a possible bad faith verdict in a subsequent lawsuit? Two sophisticated entities carefully exercised their rights and obligations in light of their potential exposure.
Slip op. at 6 (Wainright, J., concurring). And he concludes that “[a]bsent the parties entering into a [new] legally enforceable agreement, I do not believe that the equities of the parties’ respective circumstances alone supports allowing a right to recoup the settlement payment.” Id. at 7. On the facts, Justice Wainright finds that “Frank’s Casing, by its acquiescence in the settlement, bound itself under principles of contract law to the condition that Excess Underwriters would be able to seek reimbursement. . . . Frank’s Casing has never disputed that Excess Underwriters’ settlement offer was conditioned on a right to seek reimbursement” Id. at 7, 9.
Justice Wainright further reasoned that:
[T]he weight and potential severity of a Stowers or bad faith insurance verdict can[not] serve as a basis to alter the agreement of the parties [in the insurance policy]. Insurance is a consensual arrangement not subject to change by the threat of a lawsuit. . . . In summary, I would hold that absent a provision in the insurance policy providing for the insured to reimburse the insurer for paying to settle a claim that is later held not to be covered, there is no right to reimbursement of the settlement payment. However, an insurer should be allowed the opportunity to prove a right to recoupment of a reasonable settlement under contract law, including under the theories of implied-in-fact contracts and quasi-contracts, if the insurer gives notice of its intention to recoup the payment in a timely reservation of rights letter or makes reimbursement a term or condition of a subsequent agreement.
Id. at 13. Justice Wainright defends his approach as “straightforward and predictable.” Id. at 14.
Illinois confronted similar issues in finding that insurers could not obtain reimbursement of defense costs through the expedience of “reserving” a right to reimbursement and the insured’s acceptance of the defense. As the General Agents court reasoned:
As a matter of public policy, we cannot condone an arrangement where an insurer can unilaterally modify its contract, through a reservation of rights, to allow for reimbursement of defense costs in the event a court later finds that the insurer owes no duty to defend. We recognize that courts have found an implied agreement where the insured accepts the insurer's payment of defense costs despite the insurer's reservation of a right to reimbursement of defense costs. However, . . . recognizing such an implied agreement effectively places the insured in the position of making a Hobson's choice between accepting the insurer's additional conditions on its defense or losing its right to a defense from the insurer.
828 N.E.2d at 1102. Rather, the better approach is to require insurers to make provision in their insurance policies for the not-infrequent circumstance of settling uncovered claims. The Massachusetts Supreme Court, in addressing the identical issue presented in Frank’s Casing, in part relied on the absence of such a contractual provision in rejecting the right of reimbursement – and cited a nearly 60+ years’ old case where such language was used. Goldberg, 680 N.E.2d at 1128, citing Service Mut. Liab. Ins. Co. v. Aronofsky, 308 Mass. 249, 251, 31 N.E.2d 837 (1941).
At least in Texas, one can expect insurers now routinely to state in the reservation-of-rights letter that they reserve the right to reimbursement; given there is no downside for the carrier in doing this, insureds should expect to be greeted with reimbursement language whenever a claim is submitted if there is any possibility of no coverage, in whole or in part. See generally Northern County Mut. Ins. Co. v. Davalos, 140 S.W.3d 685 (Tex. 2004) (discussing need for independent counsel for insureds). Rather than to deal with these issues at the point of claim, however, insurers should be required to (i) adopt policy language subject to insurance commissioner approval or (ii) enter into separate, valid (interest-free) “loan” arrangements with their insureds at the point of claim where they advance funds subject to reimbursement. This would make clear to all involved what the rules of the road will be. But a splintering of decisions and rationales as displayed by the Texas Supreme Court in Frank’s Casing – resulting in four separate opinions totaling 47 pages – hardly contributes to legal certainty, especially in an area of contract law where parties are searching for certainty, risk transfer, and peace of mind.
Note: A version of this commentary was published in 4 Insurance Coverage Law Bulletin 1 (October 2005) and in the ABA's Insurance Coverage Litigation Committee newsletter (Fall 2006) at 1.
Posted by Marc Mayerson at 4:59 PM | Comments (4) | 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 6:12 PM | Comments (1) | TrackBack
June 9, 2005
Recoupment of Defense Costs
The question whether an insurance company that defends its policyholder may recoup the defense-cost payments it made continues to be litigated with divergent results. Most recently, the Illinois Supreme Court and Montana Supreme Court reached opposite conclusions in opinions issued a few weeks apart. See General Agents Insurance Company Of America, Inc. v. Midwest Sporting Goods Company, http://www.state.il.us/court/Opinions/SupremeCourt/2005/ March/Opinions/Html/98814.htm (Ill. March 24, 2005); Travelers Cas. & Sur. Co. v. RIBI Immunochem Research Inc., http://www.lawlibrary.state.mt.us/dscgi/ds.py/Get/File-39479/04-228.pdf (Mont. March 1, 2005).
Primary-layer liability insurance policies typically contain a promise by the insurer to defend the insured against suits alleging injury and damages covered by the duty to indemnify. In most states, where a suit expressly or implicitly alleges a set of facts that, if proven, would eventuate in a judgment covered by the duty to indemnify, the insurer has a duty to defend. The duty to defend applies to potentially covered indemnity claims; it applies at the outset of the case; it arises immediately and continues until such time as the insurer establishes that there no longer is any possibility that a covered indemnity claim may result in the case. See Marc S. Mayerson, Insurance Recovery of Litigation Costs, 30 Tort & Ins. L. J. 997 (1995), available at http://www.spriggs.com/news/pdfs/ACF54A7.pdf.
An insurer that defends should alert its insured of the possibility that the judgment in the case against the insured might not be covered by the policy’s duty to indemnify, whether that is because an exclusion bars coverage completely or in part or because the damages that might be awarded may exceed the limits of the insurance policy. An insurer that fails to apprise the insured of this possibility risks being found to have waived its ability (or to be estopped) to assert bases to refuse to indemnify that reasonably were known to the insurer. This is the origin of reservation-of-rights letters where insurers identify those grounds that may bar coverage. See D.E.M. v. Allickson, 555 N.W.2d 596 (N.D. 1996).
An insurer that defends an insured may terminate the defense where there no longer is any prospect that the case may result in a covered judgment. See Insurance Recovery at 1000. Where the insurer has so “confined the claim,” its duty to defend will terminate prospectively; that is, it may cease performing its defense obligation (subject to its withdrawal not prejudicing the insured, but that is a special case), but its contract will be interpreted to have required it to perform up until that time.
But what happens where there never was a possibility that the duty to indemnify might arise but the insurer defended anyway? The recoupment cases deal with the situation that with respect to the entirety of the action or an allocable portion of it the insurer should never have had to defend in the first place.
This question arises in part because of the “discovery theory” of the common law, that is, that a court discovers the preexisting, if undeclared law; for example, a ruling that a policy provision means that a certain class of cases is not covered means that those cases were never covered, not just that they are not covered once the relevant state’s supreme court says so. If one is considering a type of suit, such as a nontraditional environmental liability claim that a court finds to be barred by the absolute pollution exclusion, the insurer never had any obligation to defend or indemnify.
Even if the carrier thinks the case should not be covered in such circumstances, until there is a court ruling declaring no coverage it risks (i) being held liable for breach of contract and prejudgment interest and (ii) being found to have acted in bad faith (though if its construction were reasonable, even if wrong, it won’t be found to have failed to perform in bad faith, see Marc S. Mayerson, “First Party” Insurance Bad Faith: Mooring Procedure to Substance, 38 Tort Trial & Ins. Prac. J. 861 (2003), available at http://www.spriggs.com/news/pdfs/MSM-31.pdf)). Moreover, where the carrier refuses to defend and that determination was wrong, it may also be found liable for third-party bad faith if it fails to settle a case that is covered and its unreasonable failure to settle proximately causes a verdict in excess of policy limits.
Accordingly, insurers may elect to defend initially and concurrently litigate their defense obligations or wait until the underlying case is over and then try to sort things out in a coverage case. (In some states, like Illinois, the carrier really does not have the luxury of waiting until the underlying case is over because it may be found to have waived its right to deny coverage by not bringing an early declaratory-judgment action.) The insurer will advance a claim that, though it defended, it never had an obligation to do, so it should be able to get its money back from the insured.
Insurance policies do not contain provisions explaining that where an insurer agrees to pay for the defense of a matter that does not potentially implicate indemnity coverage the policyholder will be required to reimburse the carrier. Instead, carriers seek to force such reimbursement, or to recoup their payments, through the help of the courts.
Because the insurance policy itself does not explain what happens when a defense payment is made pendente lite, the insurer must go outside the policy and rely either on (i) a new and separate contract with the policyholder or (ii) principles of equity.
Typically, the separate “contract” insurers cite is the reservation-of-rights letter sent in response to the policyholder’s notice of claim; this letter will identify the grounds that potentially apply to bar coverage, but nevertheless states the insurer will provide the defense, subject to its “right” of reimbursement. This now- boilerplate language is interpreted by some courts as establishing a new agreement whereby following the reservation-of-rights letter the policyholder’s acceptance of the defense is an acceptance of the reimbursement term. Some courts have found such agreement by the policyholder simply from the policyholder’s allowing the carrier to defend, and indeed some courts have found such an agreement even where the policyholder has objected to the insurer’s reservation of a reimbursement right but allowed the insurer to defend. This is what the Montana Supreme Court held, at least where the policyholder did not expressly object at the time to the claim for reimbursement. See RIBI, slip op. at 20 (“Ribi implicitly accepted Traveler’s defense under a reservation of rights when it posed no objections.”).
For a contractual relationship otherwise governed heavily by state regulation, it is surprising indeed that courts find an new contract created by the insurer’s stating in a lengthy letter that it “reserves” its right to reimbursement, especially in the absence of a writing confirming the policyholder’s promise to repay. Of course, where a court finds an “implied” agreement one understands that it is really imposing an agreement – the best evidence of which is the fact that the policyholder is litigating the reimbursement issue. (Obviously, if the policyholder thought it had agreed to reimburse the carrier there would be no litigation on this point.) But the court’s imposing this arrangement on policyholders does not have a sound analytical foundation: the court is seeking to protect carriers and avoid “unjust” enrichment of the policyholder – though carriers could easily protect themselves by writing provisions into their policies allowing for reimbursement rather than relying on courts to impose such an implied reimbursement agreement by a post-policy letter.
The Illinois Supreme Court refused to find such an implied agreement to reimburse: “As a matter of public policy, we cannot condone an arrangement where an insurer can unilaterally modify its contract, through a reservation of rights, to allow for reimbursement of defense costs in the event a court later finds that the insurer owes no duty to defend.”
The absence of a satisfactory contract law basis for a recoupment claim leads to the argument that at equity the carrier should be able to recoup its money on the grounds that it would be inequitable to allow the policyholder to keep the benefit conferred by the carrier that was never owed in the first place. But if the carrier never had an obligation, assuming the carrier was not seeking to waste corporate assets, one can presume that the carrier undertook the defense to protect its own interests – notably, the avoidance of a bad-faith claim cast against the backdrop of legal uncertainty of its coverage obligations or helping to ensure that the underlying claim is defended appropriately. As the Illinois court held: “We agree that when an insurer tenders a defense or pays defense costs pursuant to a reservation of rights, the insurer is protecting itself at least as much as it is protecting its insured. Thus, we cannot say that an insured is unjustly enriched when its insurer tenders a defense in order to protect its own interests, even if it is later determined that the insurer did not owe a defense.”
Once it is clear that the carrier has a dog in the fight – that it is acting to protect its own interests – then the calculus at equity changes considerably, because equity typically will not intervene if one pays money in the teeth of a legal dispute or is seeking to protect one’s own interest (even if the payment is disproportionate). Moreover, that the carrier is facing a potential bad-faith claim if it were to deny coverage incorrectly is not sufficient to render its payment involuntary (since voluntary payments are not recoverable via equity). See Genesis Ins. Co. v. Wausau Ins. Co., 343 F.3d 733 (5th Cir. 2003).
The way to balance the insurer’s interest in not paying for uncovered claims, the policyholder’s interest in obtaining a complete defense, and both side’s interests in having insurance promptly perform is to require insurers to write into their contracts a right to reimbursement. In this way, policyholders can elect to purchase a policy with a reimbursement provision or not and state insurance commissioners can determine whether or not to approve such policies. The question in these cases is whether action at the point of claim can create a reimbursement right. The Illinois Supreme Court, following other courts, such as the Third Circuit and the Wyoming Supreme court said no: “Certainly, if an insurer wishes to retain its right to seek reimbursement of defense costs in the event it later is determined that the underlying claim is not covered by the policy, the insurer is free to include such a term in its insurance contract.” Montana allows an insurer to stand silent at the point of sale but to unilaterally reserve a right to reimbursement at the time the policyholder needs to turn to its coverage or potential coverage. Were the Illinois approach followed, insurance regulators could monitor reimbursement provisions, and policyholders could elect to purchase policies from carriers that do not include such provisions. For now, however, as with so many other issues, the question of reimbursement of defense costs will continue to be fodder for litigation.
Posted by Marc Mayerson at 4:16 PM | Comments (0) | TrackBack
February 9, 2005
Issues in Terrorism Insurance
One of the best insurance publications I’ve read is a paper on terrorism insurance that was published by MunichRe shortly after 9/11. http://www.munichre.com/publications/302-03092_en.pdf It still pays reading today in that it addresses the issues surrounding terrorism lucidly.
Posted by Marc Mayerson at 3:52 PM | Comments (0)