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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

I agree with the III that the Bloomberg story is too facile, and it is inappropriate to leap from the observation that an insurer paying less than what the policyholder wanted ineluctably means that the insurer is paying less than what the policyholder deserved. I recently suffered a major homeowners' loss when a (crazed) intruder broke into my home and caused huge amounts of damage; our insurer was fantastic in dispatching someone to board up a broken door, arrange for a contractor to do repair work, and reimburse us for other loss (including paying the vendor of our choice on some home electronics). So I know first hand that insurers can ride to the rescue, treat their customers with "good hands," and live up to their advertising slogans. On the other hand, I bring suits against insurers on behalf of clients when I think amounts are owed and unpaid, and I am kept busy by wrongful denials by insurers inflicted against my corporate clients (both large and small). At a time when respected news outlets like Bloomberg (and CNN and PBS) feel comfortable producing pieces that seem well suited to the Fight Bad Faith Insurance Companies website, the insurance industry should look deep into its practices and understand the perceptions of consumers and businesses to ensure that insurers' historic mission of helping their insureds, being "there" in the time of need, is embraced and, more importantly, put into practice every day in paying claims.

Arguing that the term "flood" was ambiguous when considered in the context of third-party negligence that released water, the policyholders contended that the various flood exclusions should not apply, i.e., a man-made flood does not a "flood" make. The issue has considerable importance given that a decision in the policyholders' favor would have rendered nugatory the flood exclusion in the bulk of New Orleans' losses. (Put differently, should the costs of the loss be transferred to insurers via private market mechanisms or should they be transferred to the government through public mechanisms (the flood insurance program or the tax system), or should they not be transferred at all and thus the victims should bear the losses?)

The court followed a Colorado case in finding that a "large-scale inundation of water [is] a 'flood.'" See Kane v. Royal Ins. Co., 768 P.2d 678, 681 (Colo. 1989). See slip op. at 33-35. The Fifth Circuit distinguished cases involving inundations from a water-main break as being something different in kind from the failure of a levee.

Finally, the court did not enter into the "efficient" or "concurrent" cause debate that has been central in the Mississippi litigation where questions have been presented whether a particular loss there was from wind, water, wind-driven rain, or some combination thereof, with one or more of those causes being covered and others, not. In this instance, the only cause of loss was water from the failure of the levees, which the court held was excluded by the flood exclusion.

No doubt that any collection such as BlawgWorld will omit many fine commentators, but I take as the project's point more to show off the range and diversity of this newer forum for discussion writ large and to encourage lawyers -- who strike all of us legal bloggers as ideal readers and competitors -- to take advantage of the considerable benefits these vectors of communication present. I certainly spend at least 30 minutes a day cruising through various blog entries in the US, UK, and Canada, as well as news sources that utilize an RSS feed, to keep up on the most current developments and to stimulate my own thinking. I find this work is more effective at keeping up to date on legal developments than just about any other mode of communication, and the manner in which people write in BlawgWorld makes ingesting that information easy.

You are cordially invited to find materials in which you have an interest -- and if the right stuff does not already exist out there then, by gum, you've got the tools via blogging to start your own printing press too and get into and shape the conversation, the practice of law, public policy, and court decisions, too.

In effect, the court found that the liability involved was not as a result of any past or existing property damage, but rather was based only on complying with legal requirements to conduct its operations safely. (Alternatively, the court could be said to have found that there was no property damage yet for which the insured was being held liable.) Accordingly, “the costs of installing government mandated equipment intended to reduce future emissions of pollutants and to prevent resulting future environmental harm” does not constitute covered sums for which the insured is liable because of property damage. Slip op. at 16.

The “remedial” versus “prophylactic” distinction in the environmental context is often elusive (and for that reason alone courts should be chary of denying coverage for bona fide liability). While it is true that insurance policies are not funding mechanisms for the costs of operating in compliance with the law, where property damage has occurred and an element of the damages on account thereof include measures to prevent the recurrence of damage, then the costs of those future-oriented remedies should be (and generally are) covered. When one is dealing with water contamination or air contamination, for example, it may be that the remedy includes measures to reduce the concentrations of the deleterious substance released by the insured; by limiting additional releases of that substance, the water system, for example, is able to dilute the contaminants through ordinary recharges of the system and reduce the concentration below the level of “damage.” In this way, stopping the on-going contribution of the deleterious substance can be thought of as a remedy for past damage (because this type of preventive remedy allows the damage to be mitigated). Were one to freeze-frame the issue, however, and look only at the remedy (and not the reason for the remedy), it might be argued that the measure is “prophylactic,’ that is, is meant to prevent the future release of contaminants.

For purposes of analyzing the availability of insurance-coverage, however, the question is why is the insured responsible for containing future releases. Where there has already been damage for existing releases of contaminants, “stop[ping] that ongoing release is not mere prophylaxis.” Watts Industries, Inc. v. Zurich American Ins. Co., 121 Cal. App. 4th 1029 (2004)
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In legal proceedings where the insured faces liability for “damages,” primary CGL insurers will have a duty to defend. Where there is no possibility, however, that the action against the insured can eventuate in a judgment covered by the insurer’s duty to indemnify, then the insurer will not have an obligation to defend. Because in Cinergy the Indiana Supreme Court held that the costs at issue were purely prophylactic and not “damages because of property damage,” the court ruled that the insurers had no duty to defend (though rejecting the rationale of the court below that there was a duty to pay defense costs only as an incident to the obligation to indemnify and thus only after the underlying action was concluded). Cinergy, slip op. at 16.

Even if the insured faces bona fide damages, the duty to defend applies to “suits,” and naturally insurers and insureds have joined issue on whether various types of proceedings constitute “suits” to which the duty to defend extends. Most courts have recognized that enforcement proceedings that can eventuate in a “damages” award are in the nature of a “suit” against the insured, but some courts have equated the term “suit” with “lawsuit” and held that only actions in a court of law – as opposed to an administrative proceeding – can constitute a “suit.” That said, even these jurisdictions may allow a claim for the cost of defense of a non-traditional or non-court proceeding where “suit” is defined more broadly to encompass other forms of liability-seeking actions or where the insurer’s obligation to pay includes obligations to reimburse “expenses” incurred in the defense, without those expenses being tethered only to court-proceedings. The recent decision of the California Court of Appeal in Ameron Int’l v. Insurance Co. of State of PA (Cal. App. May 15, 2007) analyzes a number of different formulations of insuring obligations, cast against the backdrop of decisions holding that the undefined term “suit” is limited only to actions in a court of law. Ameron is a useful reminder to policyholder and insurer lawyers that we need to parse the language of the contract carefully in determining the obligations to provide coverage vel non.

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

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

Some disputes involve whether the appraisal provision has been waived by one side’s dilatoriness in invoking it, J. Wise Smith & Assoc. v. Nationwide Mut. Ins. Co., 925 F. Supp. 528 (W.D. Tenn. 1995), or whether the policyholder invoked appraisal too soon, which was the conclusion of the North Carolina Court of Appeal recently in Hailey v. Auto-Owners Ins. Co. (N.C. App. Feb. 20, 2007). In Hailey, although the policyholder disagreed with the insurer’s valuation and although the insurance company rebuffed commencing an appraisal proceeding – fighting the matter at both the trial court and later on appeal for more than two years – the court held that the policyholder “prematurely invoked appraisal,” since the disagreement between the policyholder and the insurer was only “unilateral” [sic?]. Slip op. at 13. As the court stated, “[w]e hold that the unsupported opinion of the insured that the insurer’s payment was insufficient does not rise to the level of a disagreement necessary to invoke appraisal,” id. at 13-14, even though the carrier offered no more money, issued a blanket denial of coverage for part of the claim, and repudiated any further steps toward appointment of an appraiser! (A more sensible result might have altered the insured's right to obtain prejudgment interest, or its calculation, from the insurer on the ground that the insured failed to fully perfect its right to pursue appraisal. e.g., Airies Ins. Co. v. Hercas Corp., 781 So.2d 429 (Fla. Dist. App. 2001).)

Another type of dispute concerning appraisers centers on whether the appraiser or the umpire met the requirements of the qualifications clause in the policy or was otherwise an inappropriate appraiser (or umpire) for the dispute. It was this last type of dispute – over the appraiser himself – that confronted the Florida Court of Appeals in Citizens Property Ins. Corp. v. M.A. & F.H. Properties, Ltd (Fla. App. Feb. 21, 2007). In this case, after the insurance company tendered an amount approximating one-third of what the policyholder thought it was owed, the policyholder demanded an appraisal. The homeowner-selected appraiser, Mr. Pellet, determined the amount of loss to be nearly $800,000 (three times the amount offered by the carrier). An umpire was appointed, who sided with the homeowner-selected appraiser.

The insurer sought to vacate the award on the ground that Mr. Pellet was inappropriate to serve as an appraiser, for though he had conducted some 1800 appraisals and written articles in the field, the insurer contended that he was unduly biased against it. No doubt he was biased:

1. Pellet was compensated in the case based on the amount of money the policyholder collected from the insurer.

2. Pellet seems to have developed a bit of a personal animus against the insurer-selected appraiser and, as will be seen, with the insurer. Pellet sent a letter to the other appraiser reading in part:

“This letter is to inform you that you are expressly prohibited from telephonic contact with my office. ALL COMMUNICTAIONS SHALL BE REDUCED to writing . . . . All matters involving appraisal assignments will result in Court ordered umpire. I have zero intentions of discussing any negotiations, settlement, scope or unit costs with you EVER! . . . . Is there any part of this you are unclear about?”

3. Moreover, Pellet had his own personal lawsuit against the insurance company pending before the appraisal at issue, in which he was represented by the same attorney who represented the homeowner in the present case.

Finding that Pellet has “unquestionable personal bias” against the insurer, the Court of Appeal however rejected the challenge to his suitability to serve. The insurance policy’s qualifications clause (that is, the clause that identifies the characteristics of a suitable appraiser) required the appraiser to be “competent.” Compare Auto-Owners Ins. Co. v. Allied Adjusters & Appraisers, Inc., 605 N.W.2d 685 (Mich. App. 1999). (Indeed, other than following the terms of the appraisal clause, the insured is free to select someone who otherwise competent in the matter to serve as the party-appointed appraiser, even a lawyer. Glen Falls Ins. Co. v. Garner, 155 So. 533 (Ala. 1934).) The Florida Court found that Pellet had prior experience and expertise, and that “competence is not synonymous with neutrality or independence.”

Note that one difference between the Florida and North Carolina cases decided one day apart is that in Florida it was the appraiser who said that he would never negotiate with the insurer and instead would automatically seek appointment of an umpire, whereas in the North Carolina case it was the policyholder who sought to initiate appraisal without negotiating preliminarily with the carrier (even though the carrier had issued a blanket denial for at least part of the claim). Notwithstanding that neither law nor equity requires the insured perform idle acts, Cal. Civ. Code § 3532, prudence might dictate that the policyholder go a bit through the motions to satisfy the court that it has given the insurer a last clear chance to make good on its obligations to pay before the policyholder seeks appointment of appraisers.

* * * *

See generally Jonathan Wilkofsky, The Law and Procedure of Insurance Appraisal (Ditmas Park Legal Pub. 2003); Janet Brown and Michael Scroder, Appraisal, Federal of Defense & Corporate Counsel Q.303 (2003).

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

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

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

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

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

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

The California appellate court rejected this proposition, reasoning:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Id. at *3.

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

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

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