New Jersey Insurance Coverage Litigation

Claims-made policies were supposed to simplify things.  In an article a few years back, insurance expert Fred Fisher noted that the idea behind such policies was to provide greater actuarial certainty for insurance companies, by ensuring that there would be no more claim activity following the end of a policy period (eliminating the “incurred but not reported” problem under occurrence-based policies).

But, of course, we humans are experts at complicating the simple.  One bedeviling issue under claims-made forms can be:  When is a “claim” actually “made”?  Specifically, when can claims be deemed “related”, so that a later claim outside the policy period is so closely tied to a prior claim inside the policy period that both are covered?  This tricky issue recently surfaced in a federal court case in Washington state involving EPLI and D&O coverage and a whistleblower claim.

Facts: Richard Klein was the CFO of a biopharma company called Omeros.  Klein claimed that Omeros unlawfully terminated him for internally reporting financial irregularities relating to a grant supervised by the National Institutes of Health.  Under a reservation of rights, Carolina Casualty defended a whistleblower lawsuit brought by Klein, and apparently spent over a million dollars in fees doing so.

During discovery in his lawsuit, Klein learned of additional facts that he felt supported a qui tam claim on behalf of the United States.  He moved to amend his complaint, asserting that Omeros had violated the federal False Claims Act.  The motion to amend was filed after Carolina Casualty’s policy period had ended.  Carolina Casualty agreed to defend Klein, again under a reservation of rights, but later filed a declaratory judgment action arguing in part that the qui tam claim was not covered.  The question was whether the qui tam claim “related back” to Klein’s original complaint, and therefore fell within the Carolina Casualty D&O policy.  That policy provided, in part, that “all claims based upon or arising out of the same Wrongful Act, or one or more series of any similar, repeated or continuous Wrongful Acts or Related Wrongful Acts, shall be considered a single claim.”

Carolina Casualty argued that the two claims were separate and distinct, in part because (A) the retaliation claim sought recovery for damage to Klein personally, while the qui tam claim sought recovery for damage to the government; and (B) the retaliation claim did not require Klein to prove that Omeros actually made false claims, while the qui tam claim did require Klein to do so.

But the Court rejected the carrier’s arguments, writing:  “This court holds that the qui tam claim and the anti-retaliation claim Mr. Klein raised in his initial complaint are based on related wrongful acts.  As the court has already noted, Mr. Klein’s initial complaint discloses his belief that Omeros made false claims.  That he chose not to pursue a qui tam claim based on that belief is immaterial, what matters is whether the qui tam claim is (in the language of the policy) ‘logically…connected’ to the anti-retaliation claim by reason of ‘any common fact, circumstance, situation, transaction, casualty, event or decision.’…Omeros’s alleged false reporting is a common event that logically connects the anti-retaliation and qui tam claims.” According to the Court, “Any common fact or event is sufficient to make two wrongful acts related.”  So, a win for the policyholder.

This ruling reminded me of two tangentially related insurance items (or concepts).

First, when determining whether the duty to defend exists, carriers aren’t supposed to depend on labels; they’re supposed to assess the substance of what’s being alleged.  As the New Jersey Supremes have written:  “Insureds expect their coverage and defense benefits to be determined by the nature of the claim against them, not by the fortuity of how the plaintiff, a third party, chooses to phrase the complaint against the insured. To allow the insurance company ‘to construct a formal fortress of the third party's pleadings and to retreat behind its walls, thereby successfully ignoring true but unpleaded facts within its knowledge that require it, under the insurance policy, to conduct the putative insured's defense’ would not be fair.”  SL Indus. v. Am. Motorists Ins. Co., 128 N.J. 188, 198-99 (1992) (citations omitted). 

Since Klein’s claims all stemmed from alleged financial improprieties engaged in by Omeros with respect to government work, wouldn’t Omeros reasonably expect the claims to be “related” for purposes of determining coverage?

Second, remember the protracted insurance fight over whether the World Trade Center attacks constituted one “occurrence” or “event,” or two?  As this 2004 article points out, the resolution of that issue depended upon the policy form being used, and also upon the jury deciding the issue.  Which leads me to the following question:  if the insurance company can’t obtain summary judgment on a coverage claim, doesn’t that mean that the policy can be reasonably interpreted in more than one way?  And if so, isn’t the policy by definition “ambiguous”?  (Ambiguities are supposed to be construed in the policyholder’s favor.)   The dictionary seems to say so.  But what does Webster know, anyway?

You can read the full Omeros decision by clicking here.  

Large first-party property damage cases often come down to a battle of accountants.  In other words, unlike Olympic beach volleyball, they’re usually not particularly thrilling to watch.  (Not that I have anything against accountants.)  But the results of the battle can have a major impact on the policyholder’s balance sheet.  How is the policyholder’s claim to be measured?  Do we use an “actual cash value” or “replacement cost” analysis?  

Shockingly, the place to start is the policy itself. 

Example:  the recent Ninth Circuit case of Sierra Pacific Power Company v. Hartford, which appears here, involved the destruction by flood of a dam over the Truckee River in California.  The replacement cost of the dam was $19,800,000.  Sierra Pacific argued that it was entitled to the full replacement cost of the dam without any depreciation.  The carriers naturally argued that Sierra Pacific was entitled to a lot less, based upon statements by Sierra Pacific’s broker as to the ACV of the dam. 

In resolving the dispute, the appeals court turned to the valuation language in the policy, which read:  “actual cash value (with proper deduction for depreciation) of the property destroyed.”  The Court wrote:  “ACV means fair market value.  FMV is most commonly determined ‘by way of market data on sales of comparable property’.  In cases where there is no relevant market, however, the FMV may be ‘determined by any method valuation that is just and equitable.’  Specifically, ‘recognized alternatives to the market data approach to valuation are reproduction or replacement costs less depreciation or obsolescence.’” 

The trial court had held that the policyholder was only entitled to $1,261,200, representing what it determined to be the ACV of the dam.  But the court had primarily based its ruling upon a letter in which Sierra Pacific’s insurance broker stated to Sierra Pacific’s claims manager, “We are only agreeing that the [actual cash value] is $1,261,200 and nothing else.”  So, there was never an actual agreement between Sierra Pacific and the carrier…only a recommendation from Sierra Pacific’s broker to Sierra Pacific.  The appeals court therefore found that the trial court had erred, writing:  “Although the district court correctly announced that it would base ACV on replacement cost of the dam less depreciation, it arrived at an amount for the dam’s ACV, $1,261,200, which is not related to the figure it found as the replacement cost ($19,800,000).  The district court relied on its view that Sierra and the insurers had agreed on the value of $1,261,200 as the ACV, but the court explicitly found that the parties did not agree on that number, or any other number, as the ACV for the dam.”  

So, the proper measure to apply under the policy was $19,800,000 (the replacement cost) less appropriate depreciation.

There were a couple of other matters of interest (to us insurance geeks, anyway) that the appeals court resolved in this case.  First was the question of whether increased costs of repair were excluded by the policy’s Building Ordinance or Law Exclusion, which stated in part:  “This policy does not insure loss or damage caused by or resulting from…any increase in the loss due to any ordinance, law or regulation, rule or ruling restricting or affecting repair, alteration, use, operation, construction or installation.”

The court held that the exclusion only excluded damage caused by the peril of building ordinances (it appeared in a section entitled “PERILS EXCLUDED”).  It did not exclude increased construction costs caused by building ordinances when the loss itself is caused by a covered peril – here, a flood.

Finally, what about $4 million spent by Sierra in preparation for rebuilding the dam (engineering studies, etc.)?  The policy contained a provision reading:  “In the event of loss or damage to property which is not repaired, rebuilt or replaced within two years from the date of loss or damage, the company shall not be liable for more than the actual cash value (with proper deduction for depreciation) of the property destroyed.” The carriers argued that, because the policy by its terms did not pay for replacement cost if the dam was not rebuilt within two years, they were not obligated to pay anything more than ACV until the dam was actually rebuilt. 

Wrong, said the appeals court:  “This provision does not state that the Insurers will not pay more than ACV until the property is actually replaced.  Rather, it merely limits the Insurers’ ultimate liability if the property is not replaced within the allotted time.”  The “preparation expenses” were recoverable if they were properly included in the ACV: “We agree that the money Sierra has already spent in preparation for rebuilding should be included in the estimate of replacement cost which is then used to determine the ACV, and we assume it was included in the estimated replacement cost ($19,800,000) the district court found reasonable.  However, if the district court intended that Sierra is entitled to recover expenses in addition to the ACV, there is no support for such a ruling.”

Notably, the trial court found that “Insurers unreasonably denied coverage ultimately available under the policy”…a finding referenced by the appeals court in its own decision.

The takeaway:  When dealing with insurance claims, there’s no substitute for reading the policy.  Carefully.    

Let’s say you own a factory building.   Construction activity on an adjacent lot causes damage to the structure.  You have the standard first-party property insurance policy providing coverage for “direct physical loss or damage,” and the policy gives the carrier the option of paying either the "cost of repair” or “loss of value.”  If the carrier elects to repair the building, must it also pay for diminution in value of the property caused by the “stigma” of having been physically damaged?  

This question was very recently answered by the Georgia Supreme Court in Royal Capital Development, LLC v. Maryland Casualty Company.  The carrier acknowledged that damage to the building was a covered loss under the policy and paid out over $1 million for the estimated costs of repair.  But the carrier refused to pay anything for the alleged diminution in value due to stigma.   

Citing to, and analogizing to, its prior authority in the context of automobile coverage, the Court unanimously held:  “An insurance policy, drafted by the insurer, promises to pay for the insured’s loss; what is lost when physical damage occurs is both utility and value; therefore, the insurer’s obligation to pay for the loss includes paying for any lost value.”

The Court also wrote that “recognition of diminution in value as an element of loss to be recovered on the same basis as other elements of loss merely reflects economic reality…the measure of damages…is intended to place an injured party, as nearly as possible, in the same position they would have been if the injury had never occurred.” 

Carriers may argue that, under the usual policy language, they have a right to pay for either (A) the costs of repair or replacement or (B) the loss in value.  In the Royal Capital case, for example, the form required Maryland Casualty to pay either “(a)…the value of lost or damaged property; [or] (b)…the cost of repairing or replacing the lost or damaged property.”  By making stigma damages an element of the costs of repair, the argument goes, the Court has muddied the distinction.   

The problem with that argument may be the actual wording of the form.  Subpart (b) of the language quoted above speaks of repairing or replacing the property.  Webster’s defines “repair” as “to restore to a sound or healthy state,” and defines “replace” in part as to “to restore to a former place or position.”  And the Georgia Court found that to accomplish either of these things required the policyholder to be placed in as good a position as it would have been in had the injury not occurred. 

Those of us who represent contractors in coverage disputes have had to wrestle a lot over the past few years with so-called “business risk” exclusions, such as the “your work” and “your product” exclusions.  Cynicism may be unhealthy, but the cynic in me says that insurance companies are twisting these exclusions far beyond their intended application, and that some judges (mostly the ones who used to work for defense firms or for insurance companies themselves) are letting them get away with it. 

The supposed purpose of a business risk exclusion is to remove from coverage any claims based upon faulty workmanship that relate to repair of the faulty workmanship itself – not unforeseen and unexpected damage to other property. Example:  I install a boiler in your house.  The boiler blows up and takes out your family room.  My liability carrier won’t pay for damage to the boiler (my work) – but it should pay for the consequential loss (repairing the family room). 

That’s pretty much what the New Jersey Supreme Court held in Weedo v. Stone-E-Brick, 81 N.J. 233, 240 (1979), writing:  “When a craftsman applies stucco to an exterior wall of a home in a faulty manner and discoloration, peeling and chipping result, the poorly-performed work will perforce have to be replaced or repaired by the tradesman or by a surety.  On the other hand, should the stucco peel and fall from the wall, and thereby cause injury to the homeowner or his neighbor standing below or to a passing automobile, an occurrence of harm arises which is the proper subject of risk-sharing as provided by the type of policy before us in this case.” 

As another example, let’s take a look at the First Circuit’s very recent decision in Oxford Aviation, Inc. v. Global Aerospace, Inc., Docket No. 11-2208 (1^st Cir. May 18, 2012).  I should point out that the decision is notable not only for what it says, but because retired U.S. Supreme Court Justice David Souter sat on the panel.

Facts:  Oxford repairs airplanes.  Airlarr owned an airplane and hired Oxford to fix it.  During the flight home from Oxford’s facility in Maine to Airlarr’s home base in Pennsylvania, one of the plane’s windows cracked.  Airlarr also contends that, following Oxford’s repairs, Airlarr was left with uncomfortable seats, leaking fuel injectors, a cracked turbocharger, and an improperly installed carpet.              

Oxford’s general liability carrier (Global Aerospace) disclaimed coverage for the resulting lawsuit, including any duty to defend, based upon the business risk exclusions. 

But the First Circuit ruled in favor of the policyholder.  As for the “your work” exclusion, the Court wrote:  “[T]he your-work exclusion by its terms does not apply to ‘property damage occurring away from premises you own or rent and arising out of your product or your work,’ and Airlarr explicitly alleged that the crack [in the window] occurred in-flight.”

As for the “your product” exclusion, the Court wrote:  “Neither the complaint nor the incorporated estimate sheet say that the side window was a product installed by Oxford; and Global has not suggested otherwise, beyond a half-hearted argument that ‘your product’ should be read broadly in the context of the whole agreement.”

The Court similarly dispatched the carrier’s arguments based upon the “products completed” exclusion and the “impaired property” exclusion.

Here’s what the First Circuit had to say about so-called “faulty workmanship” claims generally:  “For obvious reasons (e.g., to cover consequential damages claimed by third parties), the CGL policy does not have an exclusion broadly written to exclude all claims arising from faulty workmanship.  Rather, [the carrier] has crafted complex exclusions occupying several pages of text; and they have created an opportunity in some cases for a complaint to circumvent all of them.  Here, at least one scenario relating to the cracked window, occurring in flight and away from Oxford’s facilities, does fall within coverage and could plausibly avoid all cited exclusions.”   (Emphasis added.)

Therefore, opined the Court, although coverage was a “close call,” the duty to defend existed.

For those of you who might want more reference material on the business risk exclusions, the Fall 2011 edition of the ABA Tort Trial & Insurance Practice Law Journal (Volume 47, Issue 1) contains a great article entitled “Recent Developments in Insurance Coverage Litigation,” which contains a section captioned “Coverage Related to Faulty Workmanship Claims.”  The authors review a number of different recent decisions, and cite a South Carolina case, Crossman Communities of N.C., Inc. v. Harleysville Mut. Ins. Co., Op. No. 26909 (S.C. Jan. 7, 2011), withdrawn on rehearing and superseded by 717 S.E.2d 589 (S.C. 2011), in which the Court concluded that this area of the law is an “intellectual mess.” 

Hmmm.  If it’s really such an “intellectual mess,” and if the policyholder gets the benefit of the doubt on questions of policy construction…shouldn’t coverage be deemed to exist in any case not involving repair to the faulty workmanship itself?

(The Journal is available through TIPS here, although for some reason they don’t have a listing for Volume 47, Issue 1 on the ABA website yet.)

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.

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. 

I’m getting ready to participate in a panel discussion at the New Jersey Institute for Continuing Legal Education with some of my friends from both sides of the bar (policyholder and carrier).  I’ll be discussing the rules of construction in insurance policies, particularly as they relate to ambiguity, so I’m re-reading some of the more recent and significant “ambiguity” cases.  

One thing’s for certain: as construed by many courts, the term “ambiguity” is itself ambiguous.  When determining whether ambiguity exists in insurance policies, many courts seem to follow the late Justice Potter Stewart’s method of determining pornography:  “I know it when I see it.” 

To advise clients properly, and to do adequate risk assessment when involved in coverage litigation, we need a more workable definition.  Travelers’ Liability Coverage Manual from September 1983, for example, contains a succinct definition of “ambiguity”: 

“Ambiguity:  This 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.” 

In contrast to the 1983 Travelers definition, in Zacarias v. Allstate Ins. Co., 168 N.J. 590, 604 (2001) the New Jersey Supremes ruled that ambiguous policies are those that are “overly complicated, unclear, or written as a trap for the unguarded consumer.”  That’s a pretty murky test. 

One of the more interesting recent New Jersey cases involving ambiguity is  Flomerfelt v. Cardiello, 202 N.J. 423 (2010), the facts of which can be best summarized as:   “When the cat’s away, the mice will play.”  In Flomerfelt, mom and dad went away for a few days.  Their 20-year-old live-in son (Cardiello) decided to throw a party.  Instead of playing dominoes or watching old F-Troop episodes on Hulu, though, the party guests broke out the alcohol, marijuana, opiates and cocaine. 21-year-old Wendy Flomerfelt partook of the refreshments, resulting in liver and kidney damage, and permanent hearing loss.  All of the previously-mentioned substances were later found in her system at the hospital.  Flomerfelt sued Cardiello, on the theory that he negligently delayed in getting medical attention for her because he didn’t want mom and dad to know about the party.  

The homeowner’s policy in Flomerfelt excludes coverage for claims “arising out of the use…transfer or possession of controlled dangerous substances.”  The question for decision was:  What does “arising out of” mean?  The policyholder argued that the term “arising out of” was ambiguous, and that the insurance company was required to provide a defense “unless and until it could be proven that alcohol [which is not a “controlled dangerous substance”] was neither the sole nor a contributing cause.”

The carrier, on the other hand, argued that “arising out of” simply means “incident to” or “in connection with.”  Under the carrier’s interpretation, if narcotics had anything to do with the injury, no coverage existed.

The New Jersey Supreme Court agreed with the policyholder, writing:  “The insurer’s proposed construction…would expand the phrase ‘arising out of’ to mean that the injury is connected in any fashion, however remote or tangential, to the excluded act, rather than one that ‘originates in,’ ‘grows out of,’ or has a ‘substantial nexus’ to the excluded act.”

The Court further wrote:  “The insurer’s use of the phrase with no clarification of its intended meaning in circumstances arising from potentially concurrent clauses makes the phrase ambiguous, calling for an interpretation consistent with the reasonable expectations of the insured.”

In Flomerfelt, then, the Supremes seemed to use the 1983 Travelers definition of ambiguity:  namely, a term is ambiguous if it’s capable of being understood in two or more reasonably logical ways. Keep in mind that Flomerfelt was a personal lines case, and that, as a practical matter, it can be harder for business policyholders to convince courts that policy terms are ambiguous.

In my experience, there are three main reasons why companies delay in giving notice to their carriers of potentially covered claims.  First, the underlying suit is an “oddball,” such as an intellectual property claim, that the risk manager thinks isn’t covered.  Second, the company is worried that its premiums will rise.  Third, the person responsible for reporting (and following up on) claims is very busy, and the problem drifts to the bottom of the pile. 

Commercial insurance claims are complicated enough.  The last thing you want to do is give the carrier an unexpected gift, namely, another possible ground upon which to deny coverage.  Late notice qualifies as such a gift.

The recent Second Circuit decision affirming the trial court in Rockland Exposition, Inc. v. Great American Ins. Co., No. 10-4276-cv, seems to have involved some or all of the three reasons I listed above.  (The trial court decision is reported at 746 F. Supp. 2d 528, 2010 U.S. Dist. LEXIS 103267.) I should note that the Rockland case was decided under New York’s old, draconian late notice law (under which even very brief delays in giving notice can result in a forfeiture of coverage, regardless of whether the carrier was actually prejudiced).  In July 2008, N.Y. Ins. Law §3420 was amended to prohibit insurance companies from denying claims as untimely unless the policyholder’s failure to provide timely notice actually prejudiced the insurance company.  The amendment applies only to policies sold after January 17, 2009, so if you’re dealing with a delayed-manifestation claim of some type under New York law, you may still have to wrestle with the old requirements. 

Most states (including New Jersey) follow the “prejudice” rule with respect to occurrence-based policies, meaning that the insurance company has to show it was harmed by the late notice before it can be relieved of its coverage obligations.  The Reminger law firm, based in Ohio and Kentucky, has compiled a helpful chart showing which states follow the “prejudice” rule and which do not. 

And now, back to Rockland.  The case involved an underlying trademark infringement suit against the policyholder in federal court in New Jersey, relating to competing trade shows (note Reason No. 1 for not giving notice, above).  The policy required written notice of claim to the carrier “as soon as practicable.”  The policyholder delayed almost three months in giving written notice to the carrier, and the appeals court held that coverage was precluded because of the delay.  

The excuses given by the policyholder for providing late notice (each rejected by the court) were as follows: 

1. Only a month after receiving the summons and complaint, the policyholder told its broker (orally) about the suit.  Not good enough, said the trial court (affirmed by the Second Circuit): "An insurance broker is the agent of the insured, not the insurance company, and notice to an insurance broker, absent exceptional circumstances, is not notice to the insurer.”  The court added:  “Where, as here, an insurance policy requires written notice of a claim, oral notice is of no legal significance.” 

2. The policyholder argued that oral notice to an “agent” of the carrier was sufficient, because the policy contained an endorsement reading:  "Notice given by or on behalf of the insured, or written notice by or on behalf of the injured person or any other claimant, to any agent of ours in New York State, with particulars sufficient to identify the insured, shall be considered to be notice to us."  The policyholder contended that because the first clause omitted the word “written,” written notice was not required.  The trial court disagreed, writing:  “Here, it is difficult to believe that by adding  provision 2.e -- the main goal of which was obviously to allow notice to agents, as an alternative to notice to the insurer -- the Parties also intended to surreptitiously repeal two explicit provisions requiring written notice.”  Not that this would have mattered, because the court also concluded that there was no evidence that the broker (Marshall & Sterling) was an agent of the carrier.  There was, for example, no written agency agreement.

3. The policyholder argued that it delayed in giving notice because it did not realize that it had insurance coverage for intellectual property lawsuits.  The trial court again disagreed, stating:  “Where coverage is unclear, reasonable insurance-holders give notice.”   

Even if you’re in a state that requires the carrier to show prejudice, late notice is an expensive battle that you don’t want to fight.  Give notice early and often, and strictly follow the policy requirements when doing so.  If you ask your broker to give notice, make the request in writing and make sure you get a copy of the actual notice letter. 

Lots of times, businesspeople who buy insurance make (reasonable) assumptions.  For example:  “If I have employment practices liability insurance, I must be covered for claims arising out of employment practices…right?” 

Mmmmm…not so fast.  Most EPLI policies contain a hidden gap that’s wide enough to drive an eighteen-wheeler through. 

EPLI coverage came on the market a few years back when employers started to try to make claims for workplace harassment suits under Part Two of their workers’ compensation policies (the “employers’ liability” coverage).  Of course, what the claims department views as “no pay,” the marketing department views as an opportunity.  (Remember environmental impairment liability insurance?) 

Basically. EPLI is supposed to provide protection from employment law claims made by employees, former employees, or potential employees.  This includes claims of discrimination, wrongful termination of employment, and sexual harassment.  The policy provides coverage to the business, its directors and officers. 

EPLI is less standardized than other forms of coverage, which makes it scary as a matter of principle.  Sometimes it’s bundled in a business owner’s policy, or as a part of other liability insurance. 

Now, let’s consider how some employment claims actually work.   In certain circumstances (federal Title VII claims), the employee has to file a charge with the EEOC first.  The EEOC investigates the matter and tries to resolve it.  In some circumstances, though, the EEOC will file suit on behalf of the employee.  Obviously, when the EEOC files such a suit, it does so on behalf of the employee.  (The basic process can be found at the EEOC website here.) 

All of which brings us to the recent federal case of Cracker Barrel v. Cincinnati Insurance Company, a federal case from the great state of Tennessee.  (I’m writing about a Tennessee case because we have plenty of “strict constructionist” judges here in New Jersey, too.)  Between December 1999 and March 2001, ten Cracker Barrel employees filed charges with the State of Illinois and with the EEOC, alleging sexual or racial discrimination.  In 2004, the EEOC brought suit against Cracker Barrel on behalf of the charging parties (the employees).  Cracker Barrel duly filed an insurance claim under its EPLI policy.  

The policy covered “a civil, administrative or arbitration proceeding commenced by the service of a complaint or charge, which is brought by any past, present or prospective employee.” 

The carrier’s claims department and its lawyers took the position that the underlying lawsuit had been brought solely by the EEOC, which was not an employee of Cracker Barrel, and that, therefore, the EEOC lawsuit was not even arguably covered under the definition.  (Maybe I’m jaded  by 26 years of representing policyholders, but to me, that argument didn’t even get past the “red face” test.  Shows what I know.) In response, Cracker Barrel argued that the policy language meant that the underlying complaint or charge must be brought by an employee, not the proceeding; in other words, the proceeding must merely be commenced by a complaint or charge brought by an employee. 

Remarkably (given the generally accepted principle that the policyholder gets the benefit of the doubt when it comes to policy language), the Court bought the carrier’s argument.  The Court wrote:  “The EEOC Lawsuit was not ‘commenced by the service of’ a charge, according to the plain meaning of that language, even though it may have arisen because previous administrative charges brought potentially illegal activity to the EEOC’s attention…The complaint that  commenced the EEOC Lawsuit was not brought  by an employee, and, therefore, even under [Cracker Barrel’s] interpretation of the definition, the lawsuit is not a ‘claim’ under the policies.” 

The judge who wrote the opinion, Senior Judge John T. Nixon of the Middle District of Tennessee, recently awarded $1 million to an employee of Whirlpool for alleged race and sex discrimination.  I have to wonder whether he takes a dim view of management generally, and feels that management needs to be punished for discrimination, without access to insurance.  (Sometimes we forget that judges are people too, and bring their own worldview to the bench, just as jurors bring their life experience to the deliberation room.  In other words, settle whenever you can.) 

In any event, the Cracker Barrel decision seems to miss a major point: the purpose of the policy was to provide protection (in exchange for substantial premiums) against discrimination claims.  If the EEOC brings suit on behalf of an employee, it is the functional equivalent of the employee bringing suit himself.  Judge Nixon elevated form over substance.  You can almost hear the claim department twittering (small “T”).   

Takeaway:  if you have EPLI coverage, go over it with your broker to see what is and isn't covered.  If claims brought by administrative agencies are not covered, see whether you can plug that gap (and how much it would cost to do so).  More importantly, make sure your organization is engaged in good management practices, to minimize the chances of such claims ever happening.     

My first boss in this business, the late Gene Anderson, used to collect briefs filed by insurance companies in cases around the country.  Then, when a carrier attempted to take an inconsistent position in a case that he was handling, he would present the court with a brief filed by the carrier somewhere else, in which it had taken the exact opposite position.  I’m not actually sure that this technique ever had a real impact on the outcome of a case, but it used to make the carrier lawyers apoplectic, and so was definitely worth the entertainment value. 

Gene would have loved the recent tiff in Federal Insurance Company v. Ardell, a case in federal court here in New Jersey in which two carriers have been fighting over responsibility for environmental cleanup costs at an old razor blade factory.  One of the carriers – Federal – had insured the manufacturer under various pre-absolute-pollution-exclusion general liability policies.  When the manufacturer made claims for coverage under the policies, Federal and the manufacturer settled, and Federal took over responsibility for the cleanup.  Federal hired a company called Cherokee to assist with the remediation, and Cherokee bought a cost cap policy from AISLIC, naming Federal as an additional insured.  The cost cap policy had a period of June 11, 1998 through June 11, 2008, with a $2M limit and a retention of $766,015.

(A few words about “cost cap” coverage.  This sort of policy has been marketed aggressively by Chartis.  It’s basically “cost overrun” insurance.  For example, if a remedial action plan estimates that a site can be remediated for $500,000, a cost cap policy might include a deductible of $100,000, and anticipated exposure of $600,000. So, if total remediation costs exceed $600,000, insurance will make up the difference, up to the policy limits. A policy of this kind can make real estate buyers slightly less wary about taking on environmental risks.)

Federal and Cherokee sought payout under the AISLIC policy for $928,103.99 in expenses incurred as part of the environmental remediation project between June 11, 2008 and June 3, 2009.  But AISLIC argued that it was not required to pay any cleanup costs post-dating the policy’s termination date of June 11, 2008.  The relevant policy provision reads as follows: 

“[AISLIC] will indemnify the Insured for Loss which the Insured sustained for Cleanup Costs the Insured first incurs on or after the Inception Date [June 11, 1998] and before the termination date [June 11, 2008].  This Coverage applies only if the following conditions are satisfied:…2.  The Insured reports Cleanup Costs to the Company prior to the Termination Date.” 

How to get around the sticky issue of the termination date?  Federal (like any good policyholder!) argued that the AISLIC policy was ambiguous, and that AISLIC had a “continuing duty” to indemnify for costs that were “first incurred” before the termination date, even if the costs were expended and paid after that date. 

But Judge Freda Wolfson disagreed, writing:  “A plain reading of the Cost Cap Policy and its ten-year period of coverage shows that the parties agreed that the policy would cover only those expenses which Federal and Cherokee incurred within that coverage period, i.e. expended paid and reported.  It is apparent that Federal and/or Cherokee failed to complete the remediation project within the ten-year period and thus incurred various costs after the Termination  Date in order to fulfill their contractual obligations…It is not for the Court to draft a better insurance contract that would indemnify Federal and Cherokee for their expenses after the termination date.”

Observation:  It’s much harder for an insurance company to claim “ambiguity” than it is for a bona fide policyholder. 

Second observation:  Always be aware of, and comply with, policy deadlines.  Otherwise, you're in for a fight.