New Jersey Insurance Coverage Litigation

I’m reading a wonderful book right now called “Young Men and Fire,” by Norman Maclean.  The book is about a horrific forest fire that took place in Montana in 1949.  Amazing how small sparks can result in a conflagration beyond all belief.   Those of us involved in the litigation game are familiar with that problem.  How about an $11 million claim by a client against a law firm resulting from a discovery violation, spawning several lawsuits and a major insurance battle? That was the situation recently faced by the Third Circuit in Post v. St. Paul Travelers, which has been approved for publication.  The case has some interesting things to say about how far the duty to defend extends, and about the essential elements of a bad faith claim.   

The facts:  Post and another attorney at the firm of Post & Schell, P.C. got themselves into hot water for improperly redacting information from documents produced by their client Mercy Hospital in a medical malpractice suit.  Unfortunately for Post, the misconduct came up during testimony at trial.  Mercy immediately fired Post, but became extremely concerned that the jury believed there had been a “cover-up,” which could lead to uninsured punitive exposure.  So, Mercy settled with the plaintiffs for $11 million – its full liability limit.

Mercy then retained counsel to bring a malpractice suit against Post.  The malpractice lawyer asked Post to advise his carrier (Travelers) of the claim, but did not immediately file suit. 

The plaintiffs in the underlying case commenced a sanctions proceeding against Post and his firm for the redactions.  Here’s where this gets interesting, from an insurance perspective.  Post filed a claim for coverage for the sanctions proceeding under his E&O policy on the ground that, although styled as a sanctions proceeding, the complaint was basically a claim for legal malpractice, and facts developed in the sanctions proceeding could be used against him in a malpractice suit.  (Note:  The underlying plaintiff, not Post’s client, filed the sanctions petition.) 

Travelers denied coverage based upon an exclusion for “civil or criminal fines, forfeitures, penalties or sanctions.”  Travelers also denied coverage on the ground that a covered “claim” is defined in the policy as a “demand that seeks damages,” and sanctions are not “damages.” 

Then, the plot thickened.  Mercy (or perhaps its carrier, perhaps sensing a potentially quick way to recover some insurance money) intervened in the sanctions proceeding, arguing that it had an “important interest” in the proceeding because the misconduct of its former counsel was at issue.   Mercy requested whatever relief was “just and equitable” from Post, including “costs, attorneys’ fees and expenses.”  Mercy’s Chief Executive Officer confirmed at deposition that Mercy sought money damages in the sanctions proceeding, including the amount of the settlement and compensation for negative publicity.

At this point, Travelers “saw the light” and offered to contribute to Post’s defense costs in the sanctions proceeding, subject to various qualifications.  Post agreed to Travelers’ terms, and submitted legal invoices for over $400,000, which included $250,000 in fees incurred in the sanctions proceeding before Mercy had intervened.  Travelers, bless its heart, generously offered to pay $36,000 of the $400,000.  Post was not happy.  Later, Mercy offered to mediate its malpractice claim with Post, and Travelers again generously agreed to contribute $3000 toward the mediation.  Post was even unhappier.

Meanwhile, Post sued the underlying plaintiffs’ lawyer (Quinn) for defamation and tortious interference, thinking that, faced with such a suit, Quinn might withdraw the sanctions petition, preventing Mercy from getting “free discovery” to be used in the yet-to-filed malpractice suit.  The “best-defense-is-a-good-offense” tactic worked, and the underlying plaintiffs withdrew their claim.  Mercy then sued Post for malpractice, and Post filed a separate suit against Mercy (not a counterclaim), presumably for fees.  Ultimately, Mercy and Post dismissed their claims against each other, with no money exchanging hands.

In the inevitable coverage litigation between Post and Travelers over defense costs incurred in the various litigations, here were the main issues and how they were resolved:

1. Did Travelers have to pay defense costs associated with the sanctions proceeding (in addition to the malpractice suit)?  Answer:  Yes, but only after Mercy (Post’s client) joined the proceeding and sought damages from Post.  The Court wrote:  “No amount of participation by Mercy in the sanctions proceedings would be sufficient prior to the filing of a ‘suit’ – which means under the Policy ‘a civil proceeding that seeks damages’ – a prerequisite to Travelers’ liability…that prerequisite was satisfied [when] Mercy filed its answer to the sanctions petition and sought damages against Post.”  Once that condition was met, however, the sanctions proceeding and the malpractice claim were inextricably intertwined, so the defense of one necessitated the defense of the other.   

2.  Did Travelers have to pay the costs of Post’s separate suit against Mercy, which was interposed as part of his overall defense strategy?  Answer:  No, although had Post asserted a counterclaim instead of a separate suit, Travelers would have been compelled to cover the costs of prosecuting the counterclaim, because “the pursuit of the counterclaims [would have been] inextricably intertwined with the defense.”  The Court wrote:  “However, Post did not simply assert counterclaims in the same proceeding; rather, he filed a separate civil action in a different venue…to hold that Post’s separate action was covered by the Policy simply because it related to Mercy’s suit would condone, and perhaps even encourage, the multiplicity of litigation.”

3.  Did Travelers commit bad faith by denying coverage based upon the “sanctions exclusion” when it knew that actual damages were sought? Answer:  No, because according to the Court, there was no “dishonest purpose.”  Specifically, the Court wrote:  “Travelers did not frivolously decline to provide a defense to Post; rather, after an investigation and retention of outside counsel, Travelers reasonably concluded that the sanctions exclusion in the Policy applied to Post’s claim and denied coverage.  Even if Travelers’ claims-handling was not ideal, there is no evidence in the record…to indicate that Travelers’ purported handling of Post’s claim was motivated by dishonest purpose or ill will.”  (Emphasis added.)

One observation on the bad faith issue. “Dishonest purpose or ill will” is a pretty murky standard.  Exactly how would a policyholder go about proving that?  Not every case involves a statement from a claims person saying:  “Even though we should, we’re not paying, and, by the way, I hate you.”  Maybe judges should avoid formulating standards that are difficult if not impossible to apply in the real world.  If the insurance company takes a coverage position that is not legitimately debatable and is not reasonably supported by documents in the claim file, that’s bad faith…which most people in the insurance industry understand.

You can read the full decision by clicking here.   

Here’s an interesting question recently confronted by the Ninth Circuit:  Is it bad faith for an insurance company to refuse to initiate settlement discussions in a third-party context when liability has become reasonably clear?  The carrier (Deerbrook, an Allstate company) took the position that bad faith could not exist unless the carrier failed to respond to a settlement demand.  (If you do coverage work, then you know that this is part of the dance.  In large-loss third-party cases, the carrier rarely will volunteer an offer.  The claims rep usually wants a demand on the table first.  Probably this is to set a “celling” on the negotiations.)  

The facts of the Ninth Circuit case were simple:  a car accident in which four people were injured.  The policy had a liability limit of $100,000 for each individual claim, with an aggregate maximum of $300,000 for any one accident.  The lawyer for the underlying plaintiffs submitted a global demand of $300,000.  The claims rep refused to negotiate, saying that there was insufficient information regarding the injuries sustained by three of the four plaintiffs.  Plaintiffs’ counsel then suggested that they try settle the claim of one of the plaintiffs (Yan Fang Du) separately, but did not make a specific demand.  The claims rep refused, stating that Deerbrook had to pay its $300,000 limit and settle all claims.  Later, the carrier offered to pay in its $100,000 “per person” limit with respect to Du.  Du’s counsel rejected the offer as “too little too late.”

The jury came back with over $4 million on Du’s claim.  Deerbrook paid in its $100,000 limit with respect to Du.  The underlying defendant then assigned his bad faith claim to Du in exchange for a covenant not to execute.  Coverage litigation followed, in which the “policyholder” argued that the case would have settled within policy limits had the carrier initiated earlier negotiations. 

To me, the question of whether a carrier has an affirmative duty to initiate settlement discussions is resolved by a simple review of the Unfair Claims Settlement Practices Act, which is codified in New Jersey at N.J.S.A. §17:29B-4(9).  (While the Act does not create a private right of action in New Jersey, the New Jersey Supreme Court has held that it “declare[s] state policy.”  Pickett v. Lloyd’s, 131 N.J. 457, 468 (1993)).  Like New Jersey’s version of the Act, California’s (where the accident took place) identifies as an “unfair claims settlement practice” “’[n]ot attempting in good faith to effectuate prompt, fair and reasonable settlements of claims in which liability has become reasonably clear.”  (In California, this provision appears at Insurance Code section 790.03(h)(5).)

The Ninth Circuit cited the California provision and wrote:  “[T]he conflict of interest that animates the duty to settle exists whenever there is a significant risk of a judgment in excess of policy limits and there is a reasonable opportunity to settle within those limits; this conflict obtains regardless of whether a settlement demand is made by the injured party.  If, as the general duty of good faith requires, the insurer ‘conduct[ed] itself as though it alone were liable for the entire amount of the judgment,’ a rational party should attempt to settle if there is a ‘substantial likelihood in excess of those limits,’ and there is a reasonable likelihood to settle within those limits.”  (Citations omitted.)

But take heart, you carrier types out there.  Under the specific facts of this case, the Court held that Deerbrook did not breach its duty of good faith and fair dealing.  Despite repeated requests, Deerbrook was not given sufficient information to evaluate the claimant’s injuries, and “could not base a settlement offer solely on the representations of plaintiff and plaintiff’s lawyer.”  Therefore, the carrier could not be liable for bad faith in refusing to settle earlier.      

One other interesting thing about this case.  Citing the California Supreme Court in Johansen v. Cal. State Auto. Ass’n Inter-Ins. Bureau, 123 Cal. Rptr. 288, 292-93 (1975), as well as other authority, the Court stated that “a good faith belief in noncoverage does not insulate an insurer from liability for failure to settle a claim.”  So, at least in California, unless the carrier has actually obtained a declaratory judgment of noncoverage, it remains exposed. 

Awhile back on this blog, we were discussing developments in insurance bad faith law, and I hypothesized that Courts were generally more apt to find bad faith in cases involving a carrier’s delay of benefits, rather than outright denial.  But what if the outright denial contains a bald-faced lie, or a deliberate omission?  In that case, the complexion of the matter may change substantially. 

Along these lines, Bob Chesler at Lowenstein Sandler, one of the preeminent policyholder-side coverage lawyers in the country, recently sent around a copy of an interesting unreported federal court decision in Dawn Restaurant Inc. v. Penn Millers Insurance Co.

The case involves a warped roof at a restaurant.  The carrier hired an engineer (Sharick)  to inspect the premises and determine the cause of the warping. Sharick concluded that the damage could not be positively attributed to a single cause.  He cited a variety of factors contributing to the damage, including excessive humidity in the attic, the long-term load on the rooftop, HVAC equipment, and repeated instances of normal rainfall and snowfall during the life of the building. 

The carrier denied the claim, citing all of the factors noted by Sharick….except for precipitation.  That’s because, unlike the other factors, damage by precipitation would have resulted in a covered loss under the Business Owners Coverage section of the policy.

After the carrier’s denial, Dawn Restaurant sued the carrier for breach of contract.  Later, having obtained a copy of Sharick’s report, Dawn moved to amend its complaint to include a count for bad faith based upon the carrier’s selective recitation of causes of loss in the denial letter.  The carrier opposed the amendment, in part because (according to the carrier) such amendment would be “futile.” The carrier argued that the omission of “precipitation” as a cause was at most negligence, as opposed to bad faith.

The Court, however, found that the restaurant had more than enough ammo to proceed with a bad faith claim, writing:

“In the proposed amended complaint Plaintiff alleges that Defendant intentionally withheld selected reasoning of its expert so that the insurance policy would not trigger…Both parties agree that certain forms of rainfall damage do trigger clauses in the insurance policy that would cover the cost of repairs…Accepting all of the facts in the Proposed Amended Complaint as true, the Court is able to draw a reasonable inference that Defendant is liable for the misconduct alleged.”

Of course, this all leads to the ultimate question:  Should a policyholder include a bad faith claim in its complaint against a carrier, when the policyholder believes that the carrier has behaved unfairly?  Well…in my view, not always.  Bad faith claims often degenerate into expensive and time-consuming sideshows, and punitive damages against a carrier are relatively rare.  (Why are there expensive and time-consuming sideshows?  Could it be that insurance defense lawyers, who are getting lowballed on fees by their carrier clients, convince the carriers that it’s absolutely necessary to leave no stone unturned?  Nah, that couldn’t be it.)  If you have substantial consequential  damages, though – such as increased costs due to the carrier’s delay or denial – then a bad faith claim may well be worth thinking about.  You may be able to recover the additional damages in addition to the principal amount of the claim.

Got into a discussion recently with some of my policyholder counsel friends. They were lamenting the death of bad faith law in New Jersey.  When a carrier unreasonably denies or delays paying a claim, the key case is supposed to be Pickett v. Lloyd's, 131 N.J. 457 (1993), which was written by the late Justice Daniel O’Hern, a true gentleman and scholar.  Pickett holds that carriers that fail to pay valid claims will be subject to extracontractual damages.  The problem is that many New Jersey judges (and all insurance company counsel) read Pickett so restrictively that unless you can win a summary judgment motion on the coverage issues (which is usually pretty difficult), there’s no bad faith.   This means that as long as the carrier performs a perfunctory “investigation,” it’s generally off the hook. 

But not always, and especially not in cases involving wrongful delay instead of outright denial.  (Pickett itself was a case of wrongful delay.)  Recently, down in Burlington County, Merrimack Insurance Company got stung for a $624,000 verdict, all of which was beyond the policy limits, in a case involving damage to a 108-year-old, 210-foot stone retaining wall.  (Merrimack paid in its policy limits before trial.) The facts were as follows:

Policyholder Bello’s home, which included two rental units, was damaged in a windstorm.  The storm knocked down part of the wall, which served as a barrier between the property and the Delaware River.  Merrimack initially rejected the wall-damage claim.  Months later, Merrimack’s appeals panel reversed the denial of coverage and paid Bello the policy limit of $100,750.  The problem is that, while Merrimack was “evaluating” the claim, the wall suffered further deterioration.  Bello argued that his true loss exceeded the policy limits.  He contended that Merrimack had acted in bad faith because its claim representatives knew early on that the claim should have been covered, and the payment delay allowed additional damage.  Merrimack, meanwhile, argued that the wall had been compromised before the storm due to lack of maintenance. 

Now, here’s the exact New Jersey bad faith standard as set forth in Pickett at page 481:  “[A]n 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.  In either case (denial or delay), liability may be imposed  for consequential economic damages that are fairly within the contemplation of the insurance company.” 

The Bello trial took ten days.  Bello’s counsel showed how, during the lengthy claims process, deterioration in the wall caused the repair cost to go from $85,000 to $625,000, of which $425,000 was for replacement and $200,000 was to correct erosion. Meanwhile, the insurance company presented evidence from a lawyer-expert on how it had not committed bad faith in its claim-handling.  So, what the jury saw was a local resident whose property had been destroyed, pitted against the gray flannel suits from the insurance company.  Not good for Merrimack. 

The jury took two hours to come back with a 6-0 verdict against the carrier.  The trial court also awarded attorneys' fees and costs, in excess of $230,000, as additional extra-contractual damages.  The carrier has appealed.

The Bello matter shows that, in the appropriate case – especially one involving delay rather than denial – bad faith lives in the Garden State.

Joel Garber of Voorhees, N.J. handled the case for the policyholder. 

I'm just back from Orlando where I had the opportunity to speak at an ABA conference on business interruption insurance.  During the talk, I referred to a case I often cite, Rawlings v. Apodaca, 151 Ariz. 149, 726 P.2d 565, 1986 Ariz. LEXIS 253 (1986).  For me, the key quote from the case is:

"In delineating the benefits which flow from an insurance contract relationship we must recognize that in buying insurance an insured usually does not seek to realize a commercial advantage but, instead, seeks protection and security from economic catastrophe...Thus, the insurance contract and the relationship it creates contain more than the company's bare promise to pay certain claims when forced to do so; implicit in the contract and the relationship is the insurer's obligation to play fairly with its insured."

That quote crystallizes the insurance relationship, doesn't it?  When the policyholder overreaches and tries to realize a commercial advantage through insurance, the policyholder gets into trouble.  Conversely, when the carrier forgets the purpose of insurance and starts viewing the claims department as a profit center, the insurance company gets into trouble.

Needless to say, it can be very dangerous for insurance companies to "roll the dice."  Over at the Michigan Auto Lawyers Blog, Steve Gursten tells the story of an adjuster who showed up 40 minutes late for a mediation, and then wouldn't go north of $1 million in a catastrophic truck accident case involving serious personal injury.  The carrier rep obstinately told Gursten that no jury would "ever return a verdict of more than a million dollars for pain and suffering."  Well, the guy was at least partly correct - the jury didn't come back with a million.  They came back with $3.5 million.  Ouch.   

A couple of lessons about negotiation here.  First, always treat your opponent with respect.  Showing up 40 minutes late for a meeting is really not a good idea.  To paraphrase a former law partner of mine, never give the other side something to put on their locker room bulletin board. And second, instead of making an obnoxious statement like "no jury will ever return a verdict of more than a million dollars," always resort to objective fact.  As in, "we've looked at the case carefully, and based on similar cases, we think this one should be valued at about a million."  Show your opponent some verdicts from similar cases and say something like:  "We want to do the right thing here.   Have a look at these and tell us how your case is different and why you think we're wrong."  Will this strategy always work?  No.  Sometimes your opponent will be unreasonable and you'll have to take your chances with a judge or jury.  But you'll know that you approached the situation intelligently and gave yourself the best chance to succeed.     

Recently, one of my friends in the insurance defense bar told me that he'd been given a very strict standing order by his insurance company client.  In any case involving a potential conflict-of-laws situation, he was prohibited from EVER arguing for the application of New Jersey law. 

This attitude stems from cases like the New Jersey Supreme Court's landmark environmental insurance coverage decision in Morton Int’l, Inc. v. General Accident Ins. Co., 134 N.J. 1 (1993).  There, the Court held that the so-called "sudden and accidental" pollution exclusion would not be construed as written, because insurance industry representatives had lied to New Jersey insurance regulators about its purpose and intent.  (As a result, the exclusion causes a forfeiture of coverage only where the policyholder intentionally discharges a known pollutant.) 

But from the policyholder side, the carriers' fear of New Jersey befuddles me.  New Jersey law is, in actuality, pretty lousy for policyholders on a lot of issues.  One of those issues is bad faith. 

Which brings us to the Appellate Division's July 28, 2010 decision in Wood v. New Jersey Manufacturers' Ins. Co.  The facts are pretty simple.   A mail carrier (Wood) gets mauled by a loose dog, and says she injured her back and neck in the process of trying to escape the beast's clutches.  She sues the dog's owner (Critelli), his grandmother who owned the premises (Caruso), and the housing complex association.  NJM insured Critelli and Caruso with a $500,000 limit. 

By the time of trial, Wood had a worker's compensation lien of $280,281 and NJM's own lawyer warned the carrier that another scheduled surgery would "certainly place the non-compromisable workers' compensation lien well into the $400,000.00 [range] and the value of the case will exceed your insured's policy." On top of that, Wood had lost-wage claims, which her expert pegged at $561,590.  NJM's adjuster concurred that a dismal result was likely.  In nonbinding arbitration through the state court ADR program, the arbitrator issued an award of $600,000. 

Despite all of this, NJM refused to settle for more than $300,000, even when plaintiff demanded only $450,000 before the case was sent to the jury. 

You can guess what happened next.  The jury brought back a staggering $2,422,000 verdict. The 51 percent allocated to Crittelli amounted to $1,235,220, and, with interest, resulted in a $1,408,320 judgment against him. 

Is this fact pattern enough to find bad faith on the part of the carrier and require it to cover the entire verdict?  No, says the Appellate Division, which reversed the trial court's summary judgment for the policyholder on that very issue, and ruled that a searching inquiry was needed into the actual mindset of the carrier in refusing to settle.  Such an  inquiry would require a full-blown separate trial.    

The Wood court held that the summary judgment record did not support a finding of bad faith under the landmark case of Rova Farms Resort, Inc. v. Investors Ins. Co., 65 N.J. 474, 483-84, 323 A.2d 495 (1974).  Rova Farms requires "a consideration of all the factors bearing upon the advisability of a settlement for the protection of the insured. While the view of the carrier or its attorney as to liability is one important factor, a good faith evaluation requires more. It includes consideration of the anticipated range of a verdict, should it be adverse; the strengths and weaknesses of all of the evidence to be presented on either side so far as known; the history of the particular geographic area in cases of similar nature; and the relative appearance, persuasiveness, and likely appeal of the claimant, the insured and the witnesses at trial." 

So, under the Wood court's interpretation of Rova Farms, forget about proving bad faith by an objective standard.  If you're a policyholder, you'd better find the smoking gun. 

Mike Marone of McElroy Deutsch represents NJM.  Mike's an excellent lawyer and I've known him for many years.  He's quoted in the press as saying that the ruling is a good one for his client, the insurance industry and the public, and that to allow automatic liability for extracontractual verdicts would hamper insurance companies' ability to negotiate and would cause insurance costs to skyrocket. 

I disagree with Mike.  When carriers start talking about "skyrocketing insurance costs hurting the public," they generally mean that the insurance industry's profit margin might be a little less this year if carriers are held accountable for their actions.  Ignoring the advice of your appointed defense counsel and your own adjuster, and rolling the dice with your policyholder's money, should objectively equal bad faith.  The fact that there was no dissenting opinion in Wood is disturbing.