New Jersey Insurance Coverage Litigation

Here’s an interesting situation that recently came up.  A general contractor (Aristone) got sued in a construction defect case involving continuous water damage to a building over several policy periods, involving several insurance companies.  One of Aristone’s carriers – OneBeacon – stepped up to provide a defense.  Another – Pennsylvania Manufacturers – took a “no pay” position, but agreed to go to binding arbitration with Aristone on the coverage dispute.  Aristone won the arbitration against Pennsylvania as to coverage, and Pennsylvania then agreed to settle the insurance claim with Aristone for $150,000.  In exchange for the payment, Aristone executed a general release in Pennsylvania’s favor, encompassing “[a]ll claims that have been brought against [Pennsylvania] or could have been brought against [Pennsylvania] in  [the coverage] action brought by Aristone.”  The release stated that it applied to Aristone and “[a]nyone who succeeds to [Aristone’s] rights and responsibilities.”  

Later, OneBeacon filed suit against Pennsylvania, seeking reimbursement for Pennsylvania’s supposed allocated share of defense costs ($105,773.50, according to OneBeacon).  Interestingly, the attorney who brought the coverage suit against Pennsylvania was the lawyer who had been previously appointed by OneBeacon to defend Aristone in the underlying suit (and who had negotiated the release with Pennsylvania on Aristone’s behalf).  In response to OneBeacon’s suit, Pennsylvania naturally argued that OneBeacon’s claim was barred by Pennsylvania’s earlier settlement with Aristone.  

The New Jersey Appellate Division, citing California authority, disagreed, writing:  “Where two or more insurers independently provide primary insurance on the same risk for which they are both liable for any loss to the same insured, the insurance carrier who pays the loss or defends the lawsuit against the insured is entitled to equitable contribution from the other insurer or insurers…As a corollary to this principle, we hold that one insurer’s settlement with the insured is not a bar to a separate action against that other insurer or insurers for equitable contribution or indemnity.”     

As to the effectiveness of the release, the Court wrote: “Because OneBeacon had an independent, rather than a derivative, right to contribution, Aristone’s release of its rights, like the settlement itself, did not, by itself, extinguish OneBeacon’s right to seek contribution.” (Emphasis added.)  But the Court went on to hold that this specific release, by its terms, was ambiguous as to whether the parties actually intended to bar a future claim by OneBeacon against Pennsylvania for contribution. After criticizing the lawyers who drafted the release and who seem to have intentionally left it ambiguous, the Court ruled that the interpretation of the release would be an issue for trial.

The policyholder, Aristone, seems to have made out all right in this case – it got a full defense as well as a $150,000 payment against the claim.  (It’s not clear whether the $150,000 was for a total policy buyback, which would raise its own set of separate issues, but that’s a subject for another post).  But it seems that OneBeacon may have found itself in trouble here because of its failure to clarify the coverage picture up front as required by the New Jersey Supremes in Owens-Illinois v. United Ins. Co., 138 N.J. 437, 479 (1994).  There, the Court specifically stated:  “Insurers whose policies are triggered by an injury during a policy period must respond to any claims presented to them and, if they deny full coverage, must initiate proceedings to determine the portion allocable for defense and indemnity costs.”

Put another way, in a recent article in Claims Magazine, Ken Brownlee wrote:  “When the auditor is reviewing a claim in litigation for declaratory relief, he or she should look for evidence that the adjuster sat down and reviewed the policy with the insured, seeking advance agreement that the coverage did not apply or applied to only part of the claim.  If that is missing, the file was not well adjusted.”    

I can easily imagine situations where, because of ambiguity as to who was covering what, Aristone would not have made out as well.  What if, for example, OneBeacon had argued that it was entitled to attach the $150,000 settlement payment from Pennsylvania on equitable grounds, to contribute to the defense costs?  (That may have been difficult to do here, because OneBeacon’s own appointed defense lawyer negotiated the release on Aristone’s behalf, but just suppose.)  That’s why the idea of intentionally leaving settlement documents ambiguous makes me very nervous.  I don’t know what specific provisions were in the release relating to contribution, but I’d have wanted some sort of protective language or indemnity agreement to deal with the possibility that someone would later want to attach the settlement funds paid to the policyholder.

One last item of interest:  Insurance companies frequently disclaim coverage for construction defect claims based upon the so-called “business risk” exclusions (such as the “your work” exclusion).  Here, it seems that OneBeacon did not do so.   

The full citation for the Aristone case is Potomac Ins. Co. of Illinois v. Penn. Mfrs. Ins. Co., Docket No. A-3164-09T2 (N.J. App. Div. Apr. 13, 2012), and the full decision is here.

Here’s a fairly common circumstance in large commercial liability claims.  A policyholder settles with the carrier in Layer 1 for less than its limits, leaving a gap between Layer 1 and the next layer up.  Does the carrier in Layer 2 then have an obligation to contribute to settlement with the underlying plaintiff?  

Example:  I recently had a circumstance in which Carrier A and Carrier B each had a $7.5M quota share of a $15M excess layer.  The client settled with each carrier for $5M (total $10M).  The settlement amount of $10M with these two carriers left a $5M gap before reaching the next layer of coverage, occupied by Carrier C.  Carrier C argued that its coverage wasn’t triggered, and that it had no obligation to contribute to settlement with the underlying plaintiff, because the limits beneath its coverage hadn’t been properly exhausted.  

Carrier C’s exhaustion language read:  “The Insurer shall pay the Insured…for Loss by reason of exhaustion by payments of all applicable underlying limits by either the Underlying Insurers…or the Insured.”  (Emphasis added.)  

Under this policy language, it seems pretty clear that if the policyholder covers the gap in Layer 1, then the coverage in Layer 2 is triggered. But it’s also possible that a policyholder might not even be required to cover the gap in order to get to Layer 2.  .  (In the matter I’m talking about, the issue is currently being negotiated.  Hopefully the carrier will see the light.)  

The venerable one-page decision in Zeig v. Massachusetts Bonding, 23 F.2d 665 (2d Cir. 1928) is still good law on this issue.  The Zeig Court wrote:  “[The excess carrier] had no rational interest in whether the insured collected the full amount of the primary policies, so long as it was only called upon to pay such portion of the loss as was in excess of the limits of those policies. To require an absolute collection of the primary insurance to its full limit would in many, if not most, cases involve delay, promote litigation, and prevent an adjustment of disputes which is both convenient and commendable.”  (So, under Zeig, it wouldn’t even be necessary for the policyholder to pay the $5M gap.) 

In JP Morgan v, Indian Harbor, 2011 NY Slip Op. 51055 (N.Y. Sup. Ct. N.Y. County May 31, 2011), which was decided under Illinois law, the Court distinguished Zeig and held that there was no exhaustion unless and until the underlying carrier actually paid the full extent of its policy limits – but in that case, the policy required the underlying excess insurers to have "admitted liability" and "paid the full amount of their respective liability" before the next layer’s liability attached. 

Another recent decision, Maximus v. Twin City, No. 1:11cv1231 (LMB/TRJ), slip op. (E.D. Va. March 12, 2012), includes a very good discussion of case law on this issue.  The Court wrote:  “The Axis Policy's exhaustion provision is ambiguous in that it does not clearly require all underlying insurance carriers themselves to pay the full amounts of their policy limits in order to trigger the Axis Policy's coverage and does not clearly provide that settling for less than the policy limit, even if the insured fills the gap, fails to satisfy the exhaustion requirement.” (Emphasis added.)

As you can see from the decisions cited above, there is no standardized policy language on this issue.  But if you’re in settlement discussions that may trigger several layers of coverage, it’s critical to review the exhaustion language of all excess policies before concluding the settlement.  Otherwise, you may leave a large self-insured gap, with no ability to trigger the upper layers.

Here’s a fairly frequent scenario in the insurance world.  The carrier takes a “no- pay” position on a liability claim.  The policyholder settles the case and then seeks reimbursement from the carrier in a coverage suit.  What exactly does the policyholder have to prove in order to get paid?  

In Fireman’s Fund v. Security Ins. Co., 72 N.J. 63, 71 (1976), the New Jersey Supremes long ago set forth the general rule, writing:  “Where an insurer wrongfully refuses coverage and a defense to its insured, so that the insured is obliged to defend himself in an action later held to be covered by the policy, the insurer is liable for the amount of the judgment obtained against the insured or of the settlement made by him…The only qualifications to this rule are that the amount paid in settlement be reasonable, and that the payment be made in good faith.” 

A couple of weeks ago, this issue again came up, this time before the Appellate Division in GAF v. Allstate, 2012 N.J. Super. LEXIS 35.  A class of homeowners filed a class action lawsuit against GAF, alleging that GAF’s roofing shingles were defective because they began to deteriorate “only a few years after installation.”  National Union denied coverage for the suit, in part based on an “own product” exclusion, and GAF eventually settled the case on its own for $63 million.

In the subsequent coverage suit, GAF argued that the underlying claimants had alleged that there had been damage to items other than GAF’s shingles (GAF’s own product), such as other parts of the homeowners’ roofs.  GAF contended that that was enough to trigger coverage for the settlement, without GAF having to prove that, in fact, items other than the GAF shingles had been damaged.

Following 12 years of expensive litigation and a 23-day jury trial, the jury came back with a no-cause against GAF, now affirmed by the Appellate Division.

The Appellate Division wrote: “It is incumbent upon the insured to articulate to a reasonable degree of certainty what portion of its overall damages constitute a covered loss. This can be accomplished either by direct evidence of payment for third-party damages or by competent testimony demonstrating that third-party losses were a reasonably likely consequence of damages to the insured's product.”  It’s somewhat difficult to understand where this ruling leaves policyholders in complex coverage litigation involving multiple underlying claimants, such as in a class-action setting.  Assume, for example, that GAF had put up an expert to say that “third-party losses were a reasonably likely consequence of disintegration of the shingles.”  The carrier would likely have argued (A) that this testimony was impermissibly speculative and (B) that GAF had to prove third-party damage with respect to each individual class member.  In other words, the carrier will almost certainly attempt to make the bar in such a coverage dispute unreachable, and we really don’t know how a trial court will respond. 

The unreachable and ever-moving bar seems to be contrary to the New Jersey Supreme Court’s public-policy based ruling in Owens-Illinois v. United Ins. Co., 138 N.J. 437 (1994).  There, the Court stated that in complex coverage litigation, a “rough measure” was all that was needed to establish coverage, writing:         “Because the defendants refused to involve themselves in the defense of the claims as presented, they should be bound by the facts set forth in the plaintiff's own records with respect to the dates of exposure and with respect to the amounts of settlements and defense costs. Those losses for indemnity and defense costs should be allocated promptly among the companies in accordance with [a] mathematical model developed, subject to policy limits and exclusions. We stress that there can be no relitigation of those settled claims…Available data should enable the master to grasp the generality of the underlying claims and the exposures involved.”  (Emphasis added.)

We almost certainly have not heard the end of this issue.  The one seemingly certain thing is that policyholders can’t enforce coverage for underlying settlements simply because the underlying claimants alleged covered damage.  At the very least, in the class action product-liability property damage context, the Court will likely require an expert to review a statistically significant portion of the underlying claims and opine that, in the words of the GAF court, “third-party losses were a reasonably likely consequence of damages to the insured's product.”   (Isn’t insurance law fun?)

Spring is a time of rebirth and hope, especially for baseball fans.  No matter how badly your team played last year, when March rolls around, you’re tied for first!  That is, unless (like me) you’re a fan of the woeful New York Mets.  After just a few weeks of spring training, their third baseman already has a rib injury; their first baseman (who missed most of last year after spraining his ankle by tripping over his own feet) has come down with some sort of weird desert fever; and one of their key relief pitchers is out for at least six weeks with a torn meniscus.  Oh, I almost forgot, their All-Star shortstop now plays for someone else.  

Can it get any worse?  When it comes to the Mets, yes, of course it can! There’s the little matter of Bernie Madoff.  Mets ownership has now been ordered to return $83 million to Madoff’s victims. 

Leaving the Mets and my baseball misery to one side, the Madoff situation in general has given rise to some interesting insurance coverage questions.  Recently, in Jacobson Family Investments v. National Union, a New York state court judge rejected efforts by carriers to lump named insureds together for the purpose of showing that on the whole, they were “net winners” in the Madoff fraud and therefore not entitled to insurance recovery for their losses from the Ponzi scheme.  The case involved a fidelity-type bond or policy, in part covering damages caused by “outside investment advisors.”  

The plaintiff-policyholders were investment vehicles set up by the heirs to the founders of industrial equipment supplier MSC Industrial Direct Co. Inc. and affiliated with Jacobson Family Investments, Inc.  The carriers argued that, because the investment vehicles were all listed in the policy under the heading “Complete Named Insured,” they were in essence one policyholder, and their net wins and losses had to be aggregated.  Because the aggregate amount of all of the policyholders’ net account balances with Madoff actually made them a “net” equity winner (together, they had withdrawn $5.9 million more than they invested with Madoff), the argument was that there was no compensable loss for insurance purposes.  

Based upon the clear terms of the policy, the judge wasn’t buying it.  The Court stated that the named insured rider “does not provide that [the] entities’ net wins and losses should be aggregated…it is [simply] an informational declaration of all the entities and individuals who may draw from the bond.”  

The carriers also tried to rely upon the “Single Loss” provision of the policy, which states:  “Subject to the Aggregate Limit of Liability, the Underwriter’s liability for each Single Loss shall not exceed the applicable Single Loss Limit of Liability…If a Single Loss is covered under more than one Insuring Agreement or Coverage, the maximum payable shall not exceed the largest applicable Single Loss Limit of Liability.”  “Single Loss” was defined as “all covered loss” resulting from a fraud.  Therefore, the carriers again argued, all of the policyholders’ wins and losses had to be aggregated to determine whether there was a compensable “Single Loss.”  

Again, the Court wasn’t buying.  First, the Court held that the purpose of the “Single Loss” provision was simply “to limit [the primary carrier’s] liability, under the Bond, for separate acts of malfeasance,” not to require aggregation of wins and losses.  Second, the Court held that a “Single Loss” was defined as “all covered losses, not all covered net losses.”  The Court stated:  “Courts should be extremely reluctant to interpret an agreement as impliedly stating something which the parties have neglected to specifically include.”  

Finally, the carriers cited a “Joint Insured Provision” in an effort to support the argument that all of the named insureds’ wins and loses had to be aggregated together.  The “Joint Insured Provision” states, in part:  “If two or more Insureds are covered under this bond, the first named Insured shall act for all Insureds.  Payment by the Underwriter to the first named Insured of loss sustained by any Insured shall fully release the Underwriter on the account of such loss…The liability of the Underwriter for loss or losses sustained by all Insureds shall not exceed the amount for which the underwriter would have been liable had all such loss or losses been sustained by one Insured.”  

The Court shot that argument down as well, writing:  “It is clear from the cited language that the main purpose of this Provision was to create an organized procedure to make claims under the Bond.  There are over 160 entities or individuals covered under this Bond…and if each entity had a claim…the insurance company would be processing significant amounts of paperwork.  Assigning one of the Insureds the power to act for others covered under the Bond resolves this issue.”  

This decision shows that, even in cases involving so-called “sophisticated” policyholders, some Courts will still apply strict rules of construction against carriers.  Interestingly, at no point did the Court say that the policy was ambiguous.  Rather, the Court essentially said that the carriers were attempting to engraft terms upon the policy that did not actually exist.  This is known in our business as “post-loss underwriting.”  

The excellent policyholder attorney Robin Cohen and her great team at Kasowitz Benson handled this case for the policyholders. 

In ethics or metaphysics, the “law of unintended consequences” states that, for any willed action, there are consequences that occur which are not intended.  The concept has long existed, but was named and popularized in the 20^th century by American sociologist Robert K. Merton.

Merton would have been fascinated by laws that were intended to protect policyholders (like ERISA) that often have the opposite effect.

Consider bad faith law in New Jersey.  One of the important cases regarding the insurance company’s duty of good faith and fair dealing is Pickett v. Lloyd’s, 131 N.J. 457 (1993).  In Pickett, the New Jersey Supreme Court crystallized the issue as follows:

“An insurance company may be held liable to a policyholder for bad faith in the context of paying benefits under a policy. The scope of that duty is not to be equated with simple negligence.  In the case of denial of benefits, bad faith is established by showing that no debatable reasons existed for denial of the benefits.  In the case of processing delay, bad faith is established by showing that no valid reasons existed to delay processing the claim and the insurance company knew or recklessly disregarded the fact that no valid reasons supported the delay.”

Bad faith liability exposes the insurance company to extracontractual damages, such as (under Pickett) “consequential economic losses that are fairly within the contemplation of the insurance company.”  Extracontractual damages can also include punitive damages.  Insurance company bean counters can’t set proper reserves on a claim when the possibility of extracontractual damages exists.  Insurance companies therefore hate bad faith liability the way Ohio State hates Michigan.

Leave it to insurance companies to find the gap in the armor, though.  In Pickett, the Court unfortunately commented:  “Perhaps [the] rule is easiest to understand in the context of the denial of benefits on the basis of noncoverage, such as for experimental surgery under a medical-insurance policy.  Under the ‘fairly debatable’ standard,  a claimant who could not have established as a matter of law a right to summary judgment on the substantive claim would not be entitled to assert a claim for the insurer’s bad-faith refusal to pay the claim.”

Note that, in its comment, the Pickett court gave the example of experimental surgery, which would generally not be covered.  Insurance companies and their lawyers, however, have twisted this passage to mean that if they deny coverage under any policy on any basis, and if the policyholder later is unable to obtain summary judgment against the carrier in a coverage lawsuit, there’s no bad faith liability.  And, a number of carrier-friendly judges have bought into that rationale.  The cynic in me thinks that some of these judges may want to make coverage cases settle by removing the policyholder’s biggest hammer.  In business coverage cases, also, I suspect that some judges figure that all’s fair as long as no one’s dying.  

Now, New Jersey state senator Nicholas Scutari, a plaintiff’s personal injury lawyer by trade, has attempted to plug some of the holes in the state’s bad faith law through a new bill, S-766.  The bill would create a private right of action against an insurer “arising from the insurer’s breach of its duty of good faith and fair dealing, which breach shall include the insurer’s failure to attempt in good faith to effectuate a prompt, fair and equitable settlement of a claim in which liability has become reasonably clear.”  To recover damages, the claimant must “prove that the insurer acted unreasonably in the investigation, evaluation, processing, payment or settlement of the claimant’s claim for coverage under the policy or without a reasonable basis for denying coverage.”

While perhaps a laudable effort, the Scutari bill falls many miles short in a number of major respects.  First, a private right of action for bad faith already exists, as shown under Pickett.  I think the bill meant to create a private right of action under the Unfair Claims Settlement Practices Act, codified in New Jersey at N.J.S.A. 17:29B-4(9), which some states permit, but New Jersey does not.  Second, what does it mean that liability must be “reasonably clear”?  Are we back to the standard enunciated by the Pickett-twisters,  that is to say, no liability exists unless the policyholder can prevail on summary judgment on the coverage issues? Third, what does it mean that the carrier acted “unreasonably”?  Carriers will argue that as long as they deny coverage on a basis that gets past the red-face test, no matter how tenuous, they’re in the clear – and if past performance is a predictor of future events, many judges are apt to agree.  Fourth, under the bill, claims of bad faith are to be determined solely by a judge, not a jury.  At the risk of going out on a limb here, jurors are much more likely than judges to be attuned to the real-world problems caused by carrier recalcitrance, and the threat of a jury verdict is much more likely to serve as a deterrent to insurance company bad behavior. 

Finally, the bill allows a wronged policyholder to recover damages in excess of policy limits, such as punitive damages, prejudgment interest, reasonable attorneys’ fees, and reasonable litigation expenses. But all of the damages enunciated by bill are already allowed under Pickett, with one notable exception.  Due to a quirk in the New Jersey Court Rules [R. 4:42-9(a)(6)], attorneys’ fees are only recoverable by a successful claimant in a liability coverage case.  The Rules do not permit a policyholder in a first-party case to recover fees (and they should). 

If I were King for a Day, I would scuttle S-766.  (My guess is that it will be dead on arrival anyway.)  It doesn’t add anything that really helps policyholders, and in fact, takes some valuable rights away.