Since the economy tanked, we’ve seen a number of cases in our office (particularly in the area of construction defects) where a defendant (such as a subcontractor) has become insolvent, and we’ve been called upon to pursue a direct action against that defendant’s insurance company.  Surprisingly, insurance companies don’t really care for this. So, the question becomes, when is such a “direct action” permissible?

Generally, in New Jersey, you first have to obtain a judgment for a sum certain against the defendant, and try to collect on that judgment without success. Recently, a variation of this situation came up in an Appellate Division case, Ferguson v. Travelers Indemnity Company, which presents an interesting scenario because an insurance company was essentially the claimant. You can read the decision by clicking here

The facts in Ferguson are a bit convoluted, but basically, an insurance company called Clarendon allegedly got some bad advice from an outside insurance program manager and managing general agent called Raydon.  Raydon had unwisely encouraged Clarendon to get involved in a reinsurance program known as “LMX” that was a poor risk. The program caused Clarendon to suffer significant losses. In a later corporate transaction, Clarendon’s shareholders were assigned Clarendon’s rights against third parties (including Raydon).

So, the shareholders sued Raydon in Bermuda for professional negligence. Since Raydon had gone bust, the suit was uncontested. The shareholders obtained a judgment against Raydon for $92 million, and then went after Raydon’s errors and omissions carrier, Travelers. You’re not going to believe this, but Travelers wasn’t enthralled by the prospect of writing a $92 million check. Coverage litigation followed here in New Jersey, and the Trial Court dismissed the case,  holding that the shareholders didn’t have standing to bring a direct suit against Travelers, because no statutory or contractual basis existed for doing so.

But the Appellate Division has now disagreed.

The Appeals Court first analyzed the term “direct action,” noting that the tern “has sometimes been utilized to describe to situations that are analytically distinct. The first is where a third party either skips an action against the insured outright and sues the insurer alone, or seeks to join the insurer in an action against the insured. The other scenario is, as here, a case where the third party has sued and obtained judgment against the insured, and thereafter initiates a second lawsuit to collect an unpaid judgment against the insurer. We think the latter could more appropriately be labeled a ‘post-judgment action’ or ‘derivative action.’”

The Appeals Court then held:  “An injured plaintiff, having obtained a judgment against an insured tortfeasor which remains unsatisfied due to insolvency, ‘stands in the shoes’ of the insured with respect to the insurance policy and thus acquires standing to pursue an action against the insurer.”

The Appeals Court disagreed with the Trial Court’s reliance on New Jersey’s so-called “direct action statute,” N.J.S.A. 17:28-2, which basically requires insurance companies to cover the tort liabilities of belly-up policyholders.  Travelers had argued that the statute authorizes “direct actions” solely for particular types of personal injury and property damage lawsuits. But the Appeals Court held that the statute only meant that when certain types of policies are triggered, the carrier is not free to prohibit contractually a lawsuit by an injured third-party for an unsatisfied damages judgment.

The Court concluded that “Plaintiffs have alleged a valid cause of action to recover damages from defendants under the applicable insurance policies as judgment creditors of Raydon and N.J.S.A. 17:28-2 does not act as a bar to plaintiffs’ lawsuit.”

The upshot of all this is, whenever you’re dealing with an unpaid debt, think about the possibility of tapping the deadbeat’s insurance coverage.