Enforcing insurance coverage for “intentional” torts

I have in my office a copy of a Travelers claims manual from the 1980s. In discussing the duty to defend, the manual says, in part: “Ambiguity…means that the words are capable of being understood in two or more reasonably logical ways. Ambiguity should be resolved in favor of the insured. Prompt decisions must be made and effectively communicated to the insured. Defense obligations are broader than the obligation to pay. More and more jurisdictions require the insurer to look beyond the allegations in a lawsuit to determine if the loss is covered. Underlying these principles is the requirement to meet the duty of good faith to the insured. The most positive way to do that is to look for coverage in our policies, and not to look for ways to deny coverage.”  (Emphasis mine.)

Sounds like a policyholder brief!  Respectfully, though, there are some areas in which claims personnel do seem to look for ways to deny coverage. One of these areas is Coverage B of the standard commercial general liability policy, which covers “advertising injury” and “personal injury.” That includes protection against claims for torts such as defamation and invasion of privacy.  The problem is that the covered offenses often include an element of intent on behalf of the policyholder; and claims personnel are taught that any injury expected or intended by the policyholder is never covered.

This thorny issue recently came up in a case in the Second Circuit, National Fire Ins. Co. of Hartford v. E. Mishan & Sons, Inc.  The case involves class action lawsuits alleging that the policyholder (Emson), which imports promotional products and other merchandise, engaged in a scheme to deceive customers into incurring recurring credit card charges.  The policy contained the standard coverage for “personal and advertising injury,” defined in part to include “the oral or written publication, in any manner, of material that violates a person’s right of privacy.” But the policy also excluded coverage for personal and advertising injuries resulting from “knowing violations” of another’s rights. The policyholder contended that the claims involved allegations of violation of the right to privacy. But the insurance company contended that the “knowing violations” exclusion provided it with a way out.  (The insurance policy giveth, the insurance policy taketh away…)

The Court disagreed with the carrier, though, because the possibility existed that Emson’s violation of privacy could have been negligent, not intentional.  Specifically, the Court wrote: “We cannot conclude with certainty that the policy does not provide coverage, because the conduct triggering the knowing violation policy exclusion is not an element of each cause of action. Therefore, Emson could be liable to plaintiffs even absent evidence that it knowingly violated its customers’ right to privacy. Furthermore, while the underlying plaintiffs alleged generally that Emson acted knowingly and intentionally, the actual conduct described does not rule out the possibility that Emson acted without intent to harm.”   (Emphasis mine.)

The Court noted that the duty to defend exists “until it is determined with certainty that the policy does not provide coverage.” Given that test, the Court held that it was improper for the insurance company to deny the claim.

(Side note of the “toot my own horn” variety:  In holding that coverage existed, the Court relied extensively on CGS Industries, Inc. v. Charter Oak Fire Ins. Co., 720 F3d 71 (2d Cir. 2013). The CGS Court rejected application of the “knowing violation” exclusion in a Lanham Act coverage case, because even under the Lanham Act, the policyholder may have inadvertently, as opposed to intentionally, infringed. I served as local counsel on that case for David Gauntlett of Gauntlett & Associates in Irvine, California.)

A couple of observations about this decision.  First, because the case was decided under New York law, the Court held that the carrier had “a duty to defend the entire action brought under any of the Policies, including the uncovered claims.” Under New Jersey law, conversely, if there is a reasonable way to allocate defense costs between covered and uncovered claims, the insurance company is only obligated to provide a defense as to the covered claims. This is why choice of law can be so critical in insurance coverage actions (and also why you should review proposed policy forms carefully for choice-of-law provisions before binding coverage.). Second, if you’re on the policyholder side, and an exclusion is used to remove coverage that has been specifically granted, think about the concept of “illusory coverage” as a way to support your claim.  See  Russell v. Princeton Laboratories, Inc., 50 N.J. 30, 38, 231 A.2d 800 (1967) (holding that contracts should not be interpreted in a way that gives the promisor – in our context, the carrier –  the ability to make its promise “illusory,” or worthless).

A potential business insurance coverage trap: the Professional Services Exclusion

When my daughter was little, we loved putting jigsaw puzzles together. We would dump the pieces on the floor and spend hours trying to figure out how they fit. Sometimes there would be a “gap” in the puzzle, and we’d eventually get frustrated and assume that we were missing a piece. But somehow, the missing piece would almost always show up. In many ways, that’s how insurance exclusions work. They often create a (frustrating) “gap” that’s intended to be filled by other types of insurance. The so-called professional services exclusion is an excellent example of that phenomenon.

In insurance-speak, many businesses have two separate components: (A) the commercial, and (B) the professional.  “Professional services” exclusions ostensibly serve the purpose of limiting a general liability carrier’s exposure in an area in which the policyholder is supposed to buy separate errors and omissions coverage. Many courts have found that losses falling within the insuring provision of an errors and omissions policy are excluded by the typical professional services exclusion in a commercial general liability policy.

But here’s the foundational question:  What are “professional services”?  It’s not always so clear, but generally “professional services” are acts that require the actor to draw upon his or her professional training or expertise.  As an example of wrestling with this question, in Guaranty Nat. Ins. Co. v. North River Ins. Co., a patient died after jumping out a hospital window.  After an earlier incident in which a psychiatric patient had escaped through a window, the hospital had inserted screws in the window sashes to prevent the windows from being opened more than a few inches.  But they didn’t work. The carrier tried to disclaim coverage for liability resulting from the patient’s death, arguing that the “professional services” exclusion applied, because the decision on how best to secure the windows involved professional, medical judgment. The Court disagreed, writing: “The decision to protect…patients through screws in the window sashes rather than through fixed, protective screens over the windows was an administrative, business decision and was not a professional, medical decision.”  (Emphasis mine.)

(You can read the Guaranty National case by clicking here.)

The Third Circuit recently dealt with an interesting twist on the “professional services” question. PNC Financial Services Group paid $102 million to resolve several class action lawsuits.  The suits involved an automated, fee-based overdraft program that processed debit card transactions, and charged PNC’s customers overdraft fees. PNC allegedly manipulated the order in which transactions were processed, by processing them from largest to smallest instead of chronologically, supposedly to gouge customers on the fees. The suits also contended that PNC failed to disclose to customers that they could opt out of this policy and avoid overdrafts and fees altogether.

PNC had a $25 million self-insured retention, above which sat a $25 million professional liability policy sold by Houston Casualty Company. Axis sold a $25 million excess policy, over the Houston coverage.

The policies defined “damages” to mean “a judgment, award, surcharge or settlement… and any award of pre-and post-judgment interest, attorneys’ fees and costs.” But the policies excluded “fees, commissions or charges for Professional Services paid or payable to an Insured” from the definition of “damages.”

“Professional Services” were defined to mean “services performed… for the benefit of, or on behalf of a Customer or potential Customer of the Insured for a fee, commission, or other consideration…”

The Court held that PNC’s practice of charging overdraft fees constituted “professional services,” and were therefore excluded from the definition of “damages” under the policy. Approximately $30 million of the settlement related to the underlying plaintiffs’ attorneys’ fees and costs, and the Court held that those weren’t covered either.

The Court wrote: “We conclude that the approximately $30 million awarded to class counsel as attorneys’ fees and costs do not constitute an award of attorneys’ fees and costs that PNC was legally obligated to pay. Rather, PNC was legally obligated to pay $102 million to reimburse class members for charged overdraft fees, from which the class plaintiffs – not PNC – paid their attorneys approximately $30 million for their services. Accordingly, the entire $102 million in settlement payments constitute a refund of fees or charges for Professional Services that class members paid to PNC…and as such, are excluded from coverage pursuant to the Professional Services Charge Exception.”

A couple of takeaways from this case.

First, I wasn’t personally involved with the case and therefore I’m sure I’m missing something, but I don’t understand the assumption that a program for charging bank fees necessarily constitutes “professional services,” in light of the case law on that issue. It seems more like a ministerial function, more akin to the decision to use screws on the windows that we saw in the Guaranty National case.  From the policyholder’s perspective, the first question always has to be, are these really “professional services” – that is to say, services that require some level of professional judgment – at all?

Second, from a coverage perspective, always be careful how you describe payments in settlement documents. Here, the policyholder may have left $30 million on the table because, the Court said, the fees were simply part of a larger settlement payment intended to compensate the underlying plaintiffs for improper overdraft fees. It’s possible that a more insurance-savvy approach to categorizing the fee payment in the documents could have supported coverage. (And again, armchair hindsight is always 20/20.)

(You can read the PNC decision by clicking here.)

Is “occurrence” an ambiguous term?

There’s a famous (apocryphal?) story about Cato the Elder, one of the leaders of ancient Rome.  Cato was obsessed with destroying Carthage (now Tunis), the Roman Empire’s rival. He would end every speech (and apparently most conversations) with “Carthago delenda est” – Carthage must be destroyed.  The story goes that when Demosthenes (a prominent Greek orator) would speak, the people would say, “What a pretty speech!”  But when Cato would speak, the people would say, “On to Carthage.”

One of my mentors in this business was kind of like Cato.  His favorite – and frequent – saying was: “Occurrence is ambiguous.”  And he managed to convince a lot of courts that he was right.

The insurance industry incorporated the term “occurrence” into its standard-form comprehensive general liability policies in 1966. You would think that, after 50 years of battles, we would now know what the term means.  But new cases continue to come down the pike showing that we still don’t.  And the answer to whether an “occurrence” has taken place is critical. In many liability policies, an “occurrence” is the triggering event; no “occurrence,” no coverage. Construction of the term is also important because if there’s more than one “occurrence,” then more than one limit of liability can apply.

So let’s take a look at a couple of recent decisions. Hollis v. Lexington Insurance (out of the Eastern District of Virginia) involved a fireworks display gone awry. A 3-inch mortar shell landed in the crowd of spectators, detonating inches from the underlying plaintiff Kathryn Hollis and her two sons. Kathryn and her infant son M.H. suffered terrible burns and brain injuries.  Her other son Alexander was less seriously injured (and later recovered $45,000). A jury ultimately awarded Kathryn a verdict of $4,750,000 after finding that the fireworks company and its president were negligent. She and her husband then filed another lawsuit, this one on behalf of M.H. The court stayed the M.H. case, pending a determination of whether insurance coverage existed and to what extent.

The relevant insurance policy contained a familiar definition of occurrence: “[A]n accident, including continuous or repeated exposure to substantially the same harmful conditions.” The policy covered up to $1 million per occurrence and $2 million in the aggregate.  Excess coverage also existed, in the amount of $4 million per occurrence and in the aggregate.

The plaintiffs argued that there were 19 occurrences in the case (!), corresponding with the number of duties that the defendants allegedly breached, which included negligently selecting and purchasing the fireworks; violating laws and regulations in importing the fireworks; failing to test the fireworks; failing to make sure that the crowd was at a safe distance; and so on. The insurance company, naturally, wanted there to be only one occurrence, if there was any coverage at all.

I’m a policyholder guy, but even I admit that the “19 occurrences” argument was a tough one to win.  We’ve all seen plaintiff’s lawyers who draft complaints as though they were issue-spotting on a law school exam.  (And even if the policyholder did win, there were only $6 million in aggregate limits, which may have been impacted by the prior judgments.)  Making each alleged breach of duty a separate “occurrence” seems somewhat arbitrary, at least under the facts of this case.  And, in agreeing with the insurance company on the number of occurrences issue, the Court wrote: “The allegations of negligence in this case are all associated with the exact same injuries, which occurred contemporaneously due to the explosion of the fireworks shell. Without any allegation of distinct injuries attributable to the 19 allegedly wrongful acts, the insureds’ negligence forms only a single cause. Therefore…the Underlying Complaint alleges only a single occurrence.”  (Emphasis mine.)

The Court’s decision is silent on the question of whether Kathryn’s prior $4,750,000 verdict (or Alexander’s $45,000 verdict) was covered by insurance, and to what extent. An obvious question is:  If all three plaintiffs had brought suit in the same case, would only one “per occurrence” limit apply to them collectively?  This is why, when examining your company’s coverage package, you want to be sure how the “per occurrence,” “per claim” (if any), and aggregate limits work.  If the worst happens, you could be left with a lot less insurance then you thought you had.

Now let’s look at a second recent case, Lee v. Universal Underwriters, from the 11th Circuit.   A Ford dealer negligently repaired the brakes on a 2000 Ford Expedition.  Years later, the driver (Lee) tried to stop while approaching ongoing traffic, but the brakes failed. Lee drove onto the grass shoulder to try to slow down, and the SUV flipped, killing him and injuring his passenger, Brenner.  Lee’s widow and Brenner both sued the dealer, Terry Holmes Ford.

The policy defined “occurrence” as “an accident, including continuous or repeated exposure to conditions, which results in…INJURY…during the Coverage Part period neither expected nor intended from the standpoint of a reasonably prudent person.”

The dealer’s insurance carrier, Universal, denied coverage because the “occurrence” date, which Universal deemed to be the accident date of December 11, 2008, supposedly fell outside the policy period.

After Universal declined coverage, the dealer settled by admitting liability for all counts alleged in the lawsuits. The dealer then assigned to Lee’s widow and Brenner the rights to recover under any applicable insurance policies. With liability established, the case went to arbitration for an assessment of damages. The arbitrator awarded $4.2 million for Lee’s death and $1.2 million for Brenner’s injury. Lee’s widow and Brenner then sued Universal directly to recover.

Universal again argued that there was no coverage because the “occurrence” hadn’t happened during the policy period, but the Court disagreed, writing: “The policy’s plain text is ambiguous about what type of ‘occurrence’ triggers coverage. The policy does not clearly state that it applies only to injuries that occur within the policy period, nor does it state specifically what type of ‘accident’ during the policy period might trigger coverage. The policy also identifies an ‘injury’ as a distinct concept from an ‘occurrence’ or ‘accident’ for coverage purposes, suggesting that the ‘occurrence’ trigger for coverage is not the same as the time of injury…The policy could reasonably be interpreted as requiring either that the accident – here, the negligent repair – occur during the policy period, or that the injury resulting from the accident – here, the car crash – occur during the policy period.”

Since the policy was ambiguous, the Court construed the against the carrier as drafter.

Takeaways from the policyholder’s perspective:  Whether an “occurrence” has happened is often a matter of heated debate.   (In fact, in the context of long-tail claims, such as asbestos claims, the New Jersey Supreme Court, finding standard-form insurance policy language unequal to the task, has created a legal fiction that a separate “occurrence” happens in each policy year of the triggered time period.  Owens-Illinois v. United Ins. Co., 138 N.J. 437, 478 (1994)).   If you can offer a reasonable theory for how your set of facts fits into the “occurrence” definition, and how many “occurrences” took place, you can often win.  Part of the reason that the policyholder lost in Hollis is that the Court likely felt that the idea of 19 occurrences was arbitrary and unreasonable.

You can find a complete copy of the Hollis decision by clicking here, and a complete copy of the Lee decision by clicking here.

Enforcing insurance coverage for “intentional” business torts

The other day, I was talking with a lawyer who represented a plaintiff in litigation relating to a failed business transaction. He was lamenting the fact that, if he were to take judgment against the defendants, there wouldn’t be insurance to help satisfy the claim, since, according to him, “no insurance company is ever going to pay for breach of contract.” This called to mind a fundamental tenet of my first boss in this business, who used to say: “If you go into a case thinking there’s no coverage, I guarantee you won’t find any.” I think this may be especially so when dealing with Coverage B of a standard general liability policy (which relates to “personal injury” and “advertising injury”). You really have to compare, very carefully, all of the allegations in the underlying complaint to the specific terms of coverage, and not rely on the labels created by the underlying plaintiffs’ attorney or your insurance company or broker.

This issue recently came up in the New Jersey Appellate Division, in a case involving the alleged breach of a non-compete and confidentiality agreement by an insurance broker.  (The case is Borden-Perlman Insurance Agency v. Utica Mutual Insurance Company, and you can download a complete copy of the decision by clicking here.)

Facts: Trombetta worked for Orchestrate, a company that, among other things, serves as a managing general underwriter, placing coverage in the “sports medicine industry.”  He had signed a three-year non-compete and confidentiality agreement with Orchestrate.  He left Orchestrate and went to work for Borden-Perlman, an insurance brokerage, and one month later, he apparently used Orchestrate’s confidential information to go after Orchestrate’s clients. That understandably made Orchestrate unhappy, so Orchestrate brought suit for, among other things, tortious interference and defamation. According to Orchestrate, Trombetta improperly had told Orchestrate’s clients that Orchestrate didn’t process insurance claims in a timely manner; didn’t provide promised discounts to its clients; and was generally guilty of sloppy paperwork.

Business torts like defamation always present a problem for those of us who do coverage work, because they contain an element of deliberate intent, and judges and insurance claims representatives are sometimes unable to process the concept of insurance coverage for alleged intentional acts that cause intended results.

Here, though, the Utica policy defined “personal injury” to include slander and libel (as is typical in Coverage B of a general liability policy). While the policy excluded coverage for “deliberate…[or] knowing conduct,” the policy also stated that Utica would defend such allegations, but would not “have any liability for any judgment for dishonest, fraudulent, malicious, or criminal conduct.” (Emphasis mine.)

In holding that Utica had breached its duty to defend, the Court wrote: “We have determined that the defamation, tortious interference, and negligent misrepresentation allegations may potentially arise out of negligent misleading and false statements made during the course of rendering services to various clients. The policy recognizes that insureds may be sued for defamation, and in such suits, insureds may generally be accused of engaging in dishonest, fraudulent, or malicious conduct [which] may be excluded under the policy as a covered loss, [but] the clear language of the policy requires Utica to defend Borden-Perlman for covered losses, such as defamation and tortious interference, which allegedly were caused by the defamation.”  (Emphasis again mine.)

An aside:  Sometimes in coverage claims, the policyholder’s failure or success will turn on which state’s law applies.  Here, the New Jersey Court rendered its decision under Texas law, because the policy was a multistate liability policy, covering disclosed risks in New Jersey, Texas, and Pennsylvania; Borden-Perlman’s underlying liability arose in Texas; and there was no choice-of law provision in the policy. (To me, the carrier’s failure to include a choice-of-law provision always creates a latent ambiguity that should be construed in the policyholder’s favor.  But that’s just me.) Why was this significant? Because under Texas law, the carrier had to defend the entire case, not only the covered claims.  In New Jersey, conversely, some case law holds that the carrier has a duty to reimburse the policyholder only for covered claims, as long as defense costs can be reasonably apportioned between covered and non-covered claims. (Even in New Jersey, though, when the defense costs can’t be reasonably apportioned, the carrier must assume the cost of defense of both covered and non-covered claims.)

The takeaway:  When dealing with insurance claims, always remember the Felix Unger Rule, which you can review by clicking here.

Beware the Strict Interpretation of Notice Provisions in Claims-Made Policies

A few years back, a major financial institution retained us to review its insurance coverage program. After checking the main items I usually look for, I asked the Risk Manager whether the heads of the organization’s various business units knew the basics of the notice provisions in the company’s major coverages. I could see her eyes glazing over. Why would anyone care about that, and why in the world was I adding make-work to the already-overburdened Risk Manager’s to do list?

The answer is pretty simple: You can have the best coverage in the world, and you can still be in trouble when a major claim rolls in, because you blew the notice provisions under the policy. This danger is even more acute in large and diffuse (“sophisticated”) organizations, because your people in the field may have no idea what types of things are and aren’t covered under your program, and when and how to send information to the Risk Management Department. They may think insurance is only for slip and fall incidents and fender benders; and of course, a complex business coverage program goes way beyond that.

We once represented a defense contractor, for example.  The contractor had designed and manufactured certain machinery to be installed in a military application, and the work was done at a facility in another state, far distant from corporate headquarters (and the risk management department). When the contractor performed a final inspection on the equipment before sending it to the military, the equipment inexplicably started to discharge lead (prohibited in this type of application).  Frenetic activity resulted, including numerous interviews of employees, and destructive testing of the equipment. No one, however, focused on filing an insurance claim with the contractor’s property carrier, until an insurance broker raised the issue while conducting an annual review, a year and a half later. We became involved very late in the process, and, after filing suit, we were able to achieve a decent settlement – but the settlement would’ve been a lot better if we weren’t facing a serious late notice issue.  Such are the perils of unclear lines of communication.

With that background, consider the New Jersey Supreme Court’s recent decision in Templo Fuente de Vida Corp. v. National Union, which you can read here.  The case involved the notice provisions under a claims-made D&O policy.

Templo hired Morris Mortgage Inc. (MMI) to help obtain funding for the purchase of certain property, for the relocation of a church and daycare center. MMI identified a possible funding source (Merl), but the anticipated lender failed to come through on the final closing date (ouch).  Templo sued Merl (the recalcitrant lender), which later became known as First Independent.

National Union had sold First Independent a D&O and Private Company Liability Policy with a $1 million limit.  The Policy potentially covered the Templo claim. More than six months after being served with the first amended complaint in the underlying suit, and only after retaining counsel and filing an answer, First Independent provided notice of the claim to National Union. National Union denied coverage, arguing in part that notice of the claim had not been given to National Union “as soon as practicable,” as the policy specifically required.  There was no dispute, however, that First Independent gave notice within the policy period.

First Independent settled the underlying litigation. The settling defendants’ liability exceeded $3 million, and they committed to pay plaintiffs a portion of that liability by a fixed date. To cover part of the settlement amount, First Independent assigned to Templo (the underlying plaintiff) its rights and interests under the National Union policy.

In its declaratory judgment suit against National Union, Templo argued in part that notice had been given during the policy period, and that National Union had suffered no prejudice as a result of the timing of notice. The New Jersey Supreme Court rejected this argument, holding that the existence of prejudice was only relevant to late notice issues arising under “occurrence”-based policies, and not under claims-made coverage.

The Court wrote: “Plaintiffs do not assert that the notice provision in question was ambiguous. During oral argument plaintiffs conceded that First Independent did not notify National Union of the claims ‘as soon as practicable,’ and plaintiffs did not provide the trial court with any evidence to justify First Independent’s reporting delay…We hold only that on this record the unexplained six-month delay did not satisfy the policy’s notice requirement.…We need not and do not draw any ‘bright line’ on these facts for timely compliance with an ‘as soon as practicable’ notice provision.”

Then, picking up on the old saw often relied upon by insurance companies, the Court noted that First Independent – which had 14 full-time employees, two part-time employees, and a Human Resources Department – had been represented by an insurance broker in its negotiations with National Union, and was a “sophisticated insured” and therefore not entitled to the benefit of the doubt on notice.  This confirms that there are two different worlds: “Judge World” and the “Real World.” In “Judge World,” “sophisticated policyholders” get less insurance then ordinary consumers, based upon the same policy language. Also in “Judge World,” insurance brokers apparently routinely negotiate the terms of standard form notice provisions contained in commercial insurance policies.

Although most of us operate in the “Real World,” we sometimes can’t avoid being dragged into “Judge World.” I therefore go back to the beginning of this post. Make sure your business unit managers (or your clients’ business unit managers) know the basics of the notice procedures under your major coverages.  And be careful about taking assignments of insurance claims to satisfy debt. You may think that the claim is worth substantially more than it actually is.

By the way, here’s a pretty good article on proper risk management controls.

Recent Developments in Business Interruption Claims

Arnold Palmer once described golf as “deceptively simple and endlessly complicated.”  That’s a good description for insurance also.  (Fortunate for me, since I get paid to figure it out.)  Given the rules of construction, ambiguities (even latent ambiguities) in insurance policies are supposed to be construed against the carrier. I’ve therefore always wondered why the insurance industry doesn’t do much more to minimize the “endless complications.”  On the other hand, trying to get a judge to find that policy language is ambiguous, especially in the commercial context, can be like trying to get a camel through the eye of a needle (to go all Biblical on you), so maybe the insurance industry knows what it’s doing.

The basic concept of business interruption insurance is pretty easy to understand.  A covered cause of loss of happens (like, say, a fire) and your company loses money because of a resulting slowdown or suspension of operations. Business interruption coverage (also known as “business income coverage”) applies to loss suffered during the time required to repair or replace the damaged property and get back up and running. The coverage may also be extended to apply to loss suffered after completion of repairs, for a specified number of days. There are two ISO business income coverage forms: the business income and extra expense coverage form (CP 00 30) and the business income coverage form without extra expense (CP 00 32).

Sounds “deceptively simple,” eh?  But let’s take a look at two recent decisions.

DirecTV v. Factory Mutual involved the question of what happens when a supplier suffers a catastrophe, causing the policyholder to lose income. Factory Mutual sold DirecTV business interruption coverage containing a “contingent time element” provision. This type of coverage extends insurance beyond the policyholder’s own property to the location “of a direct supplier, contract manufacturer or contract service provider.”

DirecTV, of course, is a satellite television company. Its satellite dishes pick up signals from satellites and submit those signals to a DirecTV receiver, known as a setup box or “STB”, which transmits the signals to the subscriber’s television.

DirecTV contracted with four companies to manufacture and supply its STBs. The manufacturers bought the component parts and incorporated them into the finished STBs, and then sold the STBs to DirecTV. The STBs included, as a component part, hard drives manufactured by two companies, one of which was Western Digital. In October 2011, a monsoon in Thailand damaged Western Digital’s hard drive manufacturing facilities. DirecTV argued that the damage to the Western Digital facilities reduced the supply of hard drives available for incorporation into DirecTV’s STBs. The resulting price increase in Western Digital hard drives, as well as the expense of obtaining substitute hard drives, caused DirecTV approximately $22 million in losses and extra expenses.  DirecTV submitted a business interruption claim to Factory Mutual, requesting reimbursement of the $22 million.

Factory Mutual denied the claim, arguing that Western Digital was not a “direct supplier, contract manufacturer or contract service provider” to DirecTV. And, unfortunately for DirecTV, the Court wholeheartedly agreed, writing: “Absent any evidence that the parties intended ‘direct supplier’ to have any technical, or industry-specific meaning, there is no reason to look beyond the ordinary meaning of the term. And without recourse to electronics supply industry jargon, any definition of ‘direct supplier’ to mean ‘customer-controlled component supplier’ would not be reasonable…The ordinary meaning of ‘direct supplier’ does not apply to a situation where DirecTV never received anything from Western Digital.”

This case points out the need for risk managers and insurance brokers to understand the policyholder’s business fully. Had the supply chain been analyzed, perhaps the policy could have been amended by endorsement to include indirect suppliers, or at least certain indirect suppliers.

Another recent decision concerning business interruption coverage stemmed from Superstorm Sandy, known to lawyers in the New York metro area as “the gift that keeps on giving.”  Almah LLC v. Lexington involved an office building in Lower Manhattan that got torn apart pretty badly by the storm. Lexington paid over $26 million on the claim, including $1,342,392 for wind damage. The policyholder argued that it was entitled to a further payment of $15.8 million for non-physical damage and losses, including the cost of removing debris and contaminated property; the cost of hiring professionals to inspect the property; rental loss for the time when the building was not habitable; rental loss and rent abatements caused by the lack of voice, data, or video services; and the demolition and rebuilding of portions of the building to comply with municipal ordinances. Lexington, on the other hand, argued that it already had paid in its entire flood limit of $25 million, and that no further payment was required.

So, the question was whether the claims for consequential loss (including business interruption) fell within the flood sublimit and were therefore properly rejected. The Court wrote: “The flood sublimit applies to many of Plaintiff’s claims arising from the Superstorm Sandy flood. The plain language of the Policy provides that the $25 million coverage for flood in an ‘area of 100-Year Flooding, as defined by the Federal Emergency Management’ (i.e., the Property) is for total loss or damage including any insured Time Element loss. Therefore, any claim by Plaintiffs that arises out of [time element] falls within the $25 million limit of liability for flood. Making this distinction may not be as easy as Lexington contends. Plaintiffs’ other claims must be addressed on an item-by-item basis.”

In other words, the Court rendered a decision that essentially said nothing, after (I’m sure) an enormous amount of money was spent on lawyers by both sides. The Court basically said, if a particular time element loss is attributable to the flood, then the flood sublimit applies.  It’s not clear from the decision whether a good argument could be made that the building was uninhabitable due to wind damage alone. In a number of instances following Sandy, too many lawyers and insurance adjusters jumped to the conclusion that the storm was a “flood event,” without carefully analyzing the facts applicable to each specific insured property.

Deceptively simple, but endlessly complicated.

Insurance insolvency and allocation-of-loss

A few years back, we wrote about the New Jersey Supreme Court’s decision in Farmers Mutual Ins. Co. v. New Jersey Property-Liability Guarantee Assn.  In Farmers, the Court held that, in the context of long-tail claims, any damages or defense costs allocated to insolvent policies could not be assigned to the policyholder.

When dealing with disputed claims in the long-tail area (and aren’t they all still disputed?), I always get a chuckle at the late (and great) Justice O’Hern’s pronouncement in the seminal New Jersey Supreme Court case on allocating loss among insurance policies in long-tail claims, Owens-Illinois v. United Ins. Co., 138 N.J. 437 (1994): “We can…narrow the range of disputes and provide procedures better to resolve the disputes that remain. If we can accomplish that much, we can better channel the available resources into remediation of environmental harms.”

Justice O’Hern was the consummate gentleman, and we could use more judges like him, but his hope that the disputes in allocation cases could be “narrowed” and resolved consensually hasn’t quite come true.  There are still too many unanswered questions.  Last week (as I write this), the Appellate Division issued an unreported decision in which it held that costs allocated to insolvent policies could be allocated to the policyholder, under certain circumstances.  The case is Ward Sand and Materials Co. v. Transamerica.

Ward Sand involved a garden-variety long-tail environmental case.  The policyholder operated a landfill at which it accepted Pennsauken Township’s municipal waste. In 1978 it sold the property to the Township. Later, the Township and the Pennsauken Solid Waste Management Authority, having entered into an Administrative Consent Order with NJDEP relating to remediation, sued numerous parties, including Ward, for contribution under the Spill Act. Ward notified its primary and excess carriers. Unfortunately, Ward had hit the jackpot when it came to carriers with shaky finances. Five of its carriers – Reliance, Home, Mission National, Integrity, and Western Employers – had become insolvent. Important factor in the Court’s decision: all of the carriers had gone belly up before December 2004.

The Court noted that the Farmers decision had been based upon the PLIGA Act, N.J.S.A. 17:30A-1, et seq., which established and governs the New Jersey Property-Liability Insurance Guaranty Association.  PLIGA provides protection to policyholders in the event of carrier insolvency, generally up to $300,000 “per claimant.”  The Act requires exhaustion of all solvent triggered coverage before PLIGA has to contribute anything, though.  In December 2004, the Legislature amended the PLIGA Act to provide that “in any case in which continuous indivisible injury or property damage occurs over a period of years… exhaustion shall be deemed to have occurred only after a credit for the maximum limits under all other coverages, primary and excess…issued in all other years has been applied.”  Ward Sand argued, quite reasonably, that given the protective purposes of the PLIGA Act, and the public policy relating to the 2004 Amendment, the policyholder should not have to bear any losses assigned to insolvent policies in long-tail claims.

But the Ward Sand Court held that, unless the triggered carrier’s insolvency happened after December 2004 (when the Act was amended), the policyholder gets tagged with any allocation to the insolvent carrier’s policy (to the extent that PLIGA doesn’t pay).  That’s because the Amendment specifically stated that it applied “to covered claims resulting from insolvencies occurring on or after [December 22, 2004].”   The Court also engaged in a bit of “moral equivalency,” writing: “We are not insensitive to the unfairness that results when a responsible business has purchased insurance to cover its business risks and the insurer becomes insolvent. Yet, insolvent insurers might argue it is equally unfair to require them to pay claims on risks they have not insured.”

That last bit is where, from the policyholder perspective, the analysis breaks down. First, the analysis assumes that we’re dealing with an “equal” playing field between carriers and policyholders. In reality, that’s seldom the case. Most insurance is sold on preprinted forms that are subject to only limited negotiation, and the insurance companies have access to gigabytes of data to help them rate their risks.  Many older policies were sold during a period of time when “pick-and-choose” was still the law in New Jersey, meaning that a policyholder was free to decide which triggered policies should apply to a loss (leaving the chosen carrier a right over against other triggered carriers). Presumably, each carrier, when setting its rates, took into consideration the possibility that it could be primarily responsible for a long-tail claim. Second, the legislature established PLIGA to resolve the very “unfairness” noted by the Court. Why should the policyholder get “whacked” as the result of the Court’s interpretation of a statute designed to help policyholders? Third, the suggestion that policyholders seek to require carriers “to pay claims on risks they have not insured” is a straw man. If a carrier is in the triggered coverage period, it has, by definition, insured the risk.

The Court also left a key question unanswered:  What if a carrier with, say, a $1 million limit goes bankrupt, and PLIGA contributes only the $300,000 statutory limit?  Does the “gap” get assessed to the policyholder for purposes of an Owens-Illinois allocation?  Given the statutory scheme and purpose of the PLIGA Act, shouldn’t the limit be deemed “collapsed” to $300,000 for purposes of the allocation? The Court only noted, without analysis, that the trial court had decided the issue against the policyholder. Too bad, since we could use some appellate-level clarity on that question.

One last important point about this decision. I wonder whether brokers will face increased liability for recommending carriers that later go bankrupt. If you’re a broker and you’re recommending that coverage be placed with a carrier that isn’t top-rated by Best, you probably want to make sure that you’ve disclosed the publicly known relevant facts about the insurance company’s financial picture to the client, in writing, before the coverage gets placed.

Can an insurance company depreciate labor costs in determining actual cash value?

Years ago, there was a comedy ensemble variously called “The Dead End Kids,” “The East Side Kids,” and, finally, “The Bowery Boys.”  (They were made famous in the 1938 Cagney/Bogart film, “Angels With Dirty Faces.”)  The protagonist of the group was a character named “Slip” Mahoney, played by the actor Leo Gorcey. Slip would routinely butcher the English language, by saying things like, “Here’s a token of my depreciation.”

Depreciation often isn’t a “token” in property insurance claims, though. It can result in substantial reductions from the amount of a claim. Insurance companies can be fairly aggressive in calculating depreciation, and, in a recent case in Arkansas, an interesting question came up: Can the insurance company depreciate not only the value of the property, but also the value of the labor involved in restoring the property?

The case, Shelter Mut Ins. Co. v. Goodner, involved damage to a mobile home, and while the case didn’t involve big money in the scheme of things, it involved an important issue. The carrier estimated the total restoration cost to be about $10,000, but deducted $3397.24 for depreciation. The deduction for depreciation included depreciation of both materials and labor. The carrier’s in-house counsel, in an affidavit submitted to the Court, explained: “The same amount of depreciation (expressed as a percentage of its full repair or replacement cost) is applied to both the labor and materials required to repair or replace that damaged component.” In other words, there was no separate formula for labor depreciation.

The Arkansas Supreme Court, quoting prior authority, refused to allow the carrier to depreciate labor costs, writing as follows: “Labor…is not logically depreciable. Does labor lose value due to wear and tear? Does labor lose value over time? What is the typical depreciable life of labor? Is there a statistical table that delineates how labor loses value over time? I think the logical answers are no, no, it is not depreciable, and no. The very idea of depreciating the value of labor is illogical.”

In ruling against the carrier, the Court also emphasized the need to fulfill the basic purpose of insurance: “It is important to keep in mind that indemnity is the basis and foundation of all insurance law. The objective of indemnity is to put the insured in as good a condition, as far as practicable, as he would have been in if the loss had not occurred, that is to reimburse the insured for the loss sustained, no more, no less. To properly indemnify [the policyholder], [the carrier] should pay him the actual cash value of the [damaged property], depreciated for wear and tear, plus the cost of [its] installation.… Allowing the insurer to depreciate the cost of labor would leave the insured with a significant out-of-pocket loss, a result that is inconsistent with the principle of indemnity.”

In short, even though the policy specifically stated that labor would be depreciated in calculating actual cash value, the Court held that depreciating labor violated public policy, and would not be allowed.

One of the justices on the panel filed a sharp dissent, on the ground that policyholders and insurance companies are free to contract as they see fit, and that policies should therefore be enforced as written.  (This, of course, is a fiction.  Most insurance policies are preprinted forms containing an impenetrable thicket of insurance jargon, and few policyholders – individual or corporate – are in a position to analyze the language and to anticipate every coverage situation that may arise.)   The dissenting justice wrote in part:  “This is not an area of paramount public concern where the court should offend traditions of separation of powers and create public policy.  The majority rewards [the policyholders] by giving them the benefits of an insurance policy that they declined to purchase…[The parties] were free to contract as to policy terms…Today there is a vast marketplace of insurance providers and policies.  Some providers and some policies provide greater restrictions and exclusions than others.”

Here are some takeaways from this case.   First, just because the carrier prints a number on a piece of paper doesn’t mean you have to accept it. I’m not necessarily advocating filing coverage litigation (which is expensive and energy-draining), but I am advocating questioning all calculations and assumptions with objective data. (Note the Court’s pointed questions:  what objective data exists justifying the depreciation of labor costs?)  Second, replacement cost coverage is better for you and your company than actual cash value coverage, because ACV coverage takes into account depreciation, while replacement cost coverage does not.  So always try to get replacement cost coverage.  And finally, this case illustrates why litigation is always a last resort.  You have two written opinions in the same case in which two different judges looked at the same fact pattern and policy language and reached diametrically opposed conclusions. Lesson:  Whenever you go to court, you’re gambling.

(By the way, it’s a bit difficult for me to understand why the carrier would have spent the time and resources to appeal a $10,000 case. The cost of the appeal surely dwarfed the amount claimed. I guess the carrier’s representatives felt that in a smaller case, they’d be dealing with less experienced counsel, and might be able to create good law for themselves.  Oops.)

You can read the full decision here.

Beware the differences between indemnity agreements and insurance policies

I used to know a guy who worked for a major, nationally known public adjustment company.  In years where there were no major hurricanes or tornado incidents, he would literally walk around looking like he had the weight of the world on his shoulders. He never overtly wished death or destruction on anyone (as far as I can remember), but hey, a guy has to eat, right?  I thought of him when I read a recent coverage decision from the Fifth Circuit arising from the Deepwater Horizon disaster in 2010.  The explosion and resulting oil spill into the Gulf generated tons of work for lawyers, and maybe some of them were thinking: “We don’t want tragedies to happen, but somebody has to do the legal work when they do, and it might as well be me.”  Ghoulish, perhaps, but it’s the life we’ve chosen.

This particular coverage litigation involved Cameron International Corporation, which had manufactured the “blowout preventer” used on Deepwater Horizon.  Cameron had an extensive insurance program, which included Liberty International Underwriters.  Liberty had sold Cameron a $50 million liability policy, excess of $100 million, as part of a $500 million tower of coverage.

In addition to the insurance program, a web of indemnification agreements existed.  Basically, BP contracted with a company called Transocean to drill the well, and Cameron manufactured and sold the blowout preventer connecting the rig to the well.  Under the various contracts, BP agreed to indemnify Transocean, which in turn agreed to indemnify Cameron.

After the terrible accident, thousands of lawsuits were filed against BP, Transocean, Cameron, and others.  The indemnity agreements might as well have been on the Deepwater Horizon when the blast happened, because BP refused to indemnify Transocean, and Transocean refused to indemnify Cameron.

After a major legal bloodletting, BP and Cameron started to discuss settlement, and they developed a framework as follows:  BP would indemnify Cameron in exchange for $250 million, but only if Cameron’s carriers agreed to waive subrogation rights, and only if Cameron agreed to drop its indemnification claim against Transocean. (If the settlement agreement went through, BP didn’t want Transocean to step into Cameron’s shoes and try to reclaim the $250 million that BP just got paid.)

As magicians and comedians will tell you, there’s always one guy in the room who tries to mess up your show.  Cameron’s carriers all agreed to the arrangement…except for Liberty, which also refused to contribute its $50 million in limits.  Not wanting to lose the deal, Cameron went ahead and settled anyway, contributing out of its own pocket the $50 million that would have been paid by Liberty, and then going after Liberty in Court.

Liberty defended against the claim by arguing, among other things, that its “other insurance” clause meant that its payment obligations had never been triggered.  The clause provided that “if other insurance applies to a ‘loss’ that is also covered by this policy, this policy will apply excess of such other insurance.”  The policy defined “other insurance” to include “any type of self-insurance, indemnification or other mechanism by which an Insured arranges for funding of legal liabilities.”  (Emphasis added.)

Bottom line:  Liberty argued that, because of the “other insurance” clause, all indemnification agreements had to be exhausted before Liberty had to pay anything.  Given the amount of money involved, Liberty’s position isn’t surprising.  I have a case right now in which a carrier is arguing that indemnification agreements have to be included in an allocation-of-coverage analysis for multiple long-tail asbestos claims.  (Hey, who needs precedent?)

Cameron countered by contending that the “other insurance” clause only governed situations where such other insurance actually and presently applies.  After all, relevant case law holds that the purpose of an “other insurance” clause is to “avoid an insured’s temptation or fraud of over-insuring…property or inflicting self-injury” – certainly not the situation here.

Liberty lost. The Court ruled that “Cameron’s interpretation is reasonable and Liberty’s is not.”  According to the Court: “Liberty’s policy is excess only if other insurance ‘applies,’ present tense.  Liberty’s interpretation requires the court to read the word ‘potentially’ into the contract.  Moreover, the clause provides that Liberty’s policy being excess of other insurance is conditional on other insurance applying. Liberty reads this to mean that the policy is excess of other insurance until Cameron affirmatively shows that no other insurance exists. That reading would transform the Other Insurance Clause from a protection against double-insuring into a clause that makes Liberty’s policy a policy of last resort.”

Liberty also unsuccessfully argued that, under Cameron’s interpretation of the “other insurance” clause, Cameron had no incentive to enforce its indemnification agreements (presumably resulting in unfair prejudice to Liberty).  The Court made quick work of that contention, writing: “That…ignores Liberty’s subrogation rights. If Cameron refuses to seek indemnification, Liberty can pay the policy and then itself sue Transocean for indemnification.”

So what can we learn from this mess? I think there are three main lessons.  First, Cameron was smart to get the deal done instead of allowing it to blow up because of Liberty’s recalcitrance.  If you have the funds to cap your liability, never let the insurance tail wag the dog.  Second, when things start to get real, the truth is that you may not be able to count on insurance or indemnity agreements.  Commercial insurance policies are often an impenetrable thicket of conditions and exclusions, and if a carrier thinks it has an escape route, it’s generally going to go that way if the claim is big enough.  So effective risk management means managing risks before they blossom into liabilities.  Third, it’s critically important to have your insurance professional review your supposed safety net – including indemnification agreements, insurance policies, and “other insurance” clauses – before a problem happens.  You can’t predict everything, but you may be able to identify gaps that need to be plugged.

You can read the full Deepwater Horizon decision by clicking here.

Insurance Coverage for Premises Liability

I admit it, I admit it –  I’m addicted to the TV show “Bar Rescue.” (When my daughter was about 12 years old, and my wife was out shopping for the day, we once binge-watched about six hours straight, which probably could get me into trouble with the child welfare authorities.)   The idea of the show is pretty simple. The host (Jon Tapper) is a consultant in the proper and profitable operation of bars and taverns. He finds establishments that aren’t being run particularly well, and helps fix them through tough love. It’s a very interesting show for people who run their own businesses, because we can see many mistakes that all business owners make (and hopefully avoid them). (And it’s also convinced me that I would never own a bar or restaurant.  Too much trouble and stress.  Running a law firm is difficult enough.)

One thing that all businesses (not just bars) have to worry about is premises liability. We recently handled the insurance coverage aspects of a very tragic case in which a waitress was shot by an ex-boyfriend in the parking lot of her restaurant-employer. The insurance coverage questions were complex, and involved the interplay of general liability, workers compensation and EPLI coverage. And another New Jersey trial court has just dealt with similar issues in a written decision. The case is Webster v. Palladium Associates, LLC (Superior Court of New Jersey, Law Division, Essex County).

In the Webster case, during a concert at a nightclub, a customer was shot and killed, and another was injured, by an unknown assailant. The plaintiffs (including the estate of the man who was killed) brought suit alleging that the owner of the property, and the tenant who ran the nightclub, were negligent in failing to provide adequate security.  Two insurance policies were involved. First, the general liability policy for the property owner (48 Branford). Second, the general liability policy for the tenant (Palladium). The carriers for both entities disclaimed coverage based upon “assault and battery” exclusions. The decision shows pretty clearly how minor variations in policy language can lead to very different results.

USLI sold the general liability coverage to Palladium.  The “assault and battery” exclusion in the USLI policy applied to, among other things, “assault” or “battery” arising out of “hiring, placement, employment, training, supervision or retention of a person for whom any insured is or ever was legally responsible.”

The Court had no problem finding that USLI’s exclusion negated coverage “because the operative facts of the complaints constitute an assault and battery [and] the plain language of USLI’s policy excludes coverage for the claims brought against the Third-Party Plaintiffs.”

Executive Risk sold the general liability coverage to the landlord, 48 Branford. Unlike the USLI exclusion, Executive Risk’s “assault and battery” exclusion did not expressly exclude claims for “hiring, placement, employment, training, supervision or retention of a person for whom any insured is or ever was legally responsible.” The Court therefore found that the exclusion was ambiguous and inapplicable, writing: “There is no clear indication to the average reader that claims of negligent hiring, supervision, retention or inadequate crowd control would be excluded under the assault and battery exclusion.…The court finds that allegations of negligence in the complaint allege a risk that is covered under the policy, giving rise to a duty to defend.” (Emphasis added.)

I know that rulings like this one drive my friends in the insurance industry (to the extent I have any friends in the insurance industry) nuts. And yes, in deference to them, it’s possible that the judge simply didn’t want to leave the injured parties with no recourse. But it’s important to remember that policyholders are supposed to get the benefit of the doubt. If there’s more than one version of a particular type of exclusion, and the wording in one version is “looser” than the wording in other versions, it’s not that hard for a Court to find that ambiguity exists.

But an ounce of prevention is worth a pound of cure.  It’s important to assess your major risks and consider them in connection with the policy form before a claim happens.

You can read the full Webster decision here.