Claims-Made Coverage and "Related Wrongful Acts"

Posted by Gene Killian on April 04, 2013

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.  

The Penn State scandal and the duty to defend

Posted by Gene Killian on March 14, 2013

I greatly respect judges.  And, I feel sympathy for judges. They have a very difficult job. We hand them enormous caseloads for relatively low pay (most of them could make a lot more money in private practice) and then expect them to become conversant in every legal subject imaginable, from water rights to alimony.  By way of comparison, I’ve been studying the ins and outs of insurance law for almost 30 years and I still haven’t mastered them (and probably never will).

Sometimes, though, judicial inexperience with the arcane aspects of law can lead to unintended and potentially serious consequences.  I think that this may have been the case with the recent decision in Federal Ins. Co. v. Sandusky.

By now, we’re all familiar with the sordid and shocking story behind the Penn State scandal.  A famous and highly regarded football coach at a major university runs a charity for underprivileged kids, named “The Second Mile.”  He uses the charity as a means of making contact with young boys, and then sexually abuses them.  He’s convicted and sentenced to 30 to 60 years in prison. 

The Sandusky affair has an insurance component.  Sandusky (the pedophile coach) filed claims under The Second Mile’s D&O and EPLI coverages for the civil and criminal charges brought against him.  The D&O coverage provided the familiar protection against “’loss’ which an insured person becomes legally obligated to pay for a wrongful act committed, attempted or allegedly committed by an insured person.”  The D&O coverage was limited to “wrongful acts” committed by those acting in an “insured capacity.”  The EPLI coverage required Federal to pay “loss on account of any third party claim,” including claims for “conduct of a sexual nature.”  Similar to the D&O requirement, for there to be coverage, the wrongdoing must have been committed “by an insured person in his or her capacity as such.”

The court denied both defense and indemnity to Sandusky, writing as follows:  “It is clear that Defendant Sandusky was not acting in his capacity as an employee or executive of The Second Mile in sexually abusing and molesting the victims named in the civil and criminal cases brought against him.”   (One thing I’ve learned over the years:  when a lawyer or judge uses the words “clear” or “clearly,” the situation is usually anything but.) The court analogized to cases dealing with the scope of employment for purposes of determining governmental immunity, writing:  “Conduct of an employee is within the scope of employment if it is of a kind and nature that the employee is employed to perform; it occurs substantially within the authorized time and space limits; it is actuated, at least in part, by a purpose to serve the employer; and if force is intentionally used by the employee against another, it is not unexpected by the employer.”

Since sexual abuse is not conduct “of a kind and nature” that The Second Mile hired Sandusky to perform, the reasoning goes, no coverage.  Implied:  Besides, Sandusky is a monster who should rot in hell.  (I happen to agree with that last part.)

Let’s divorce emotion from this for a moment and think it through.  When, if ever, would sexual harassment be conduct “of a kind and nature” that the employee is hired to perform?  Never, of course.  So what happens, for example, if a manager is falsely accused of sexually harassing a subordinate, and has to incur tens of thousands of dollars defending himself or herself in court?  Under the Sandusky court’s flawed logic, there apparently would be no defense coverage for such a suit, because sexual harassment is not within the manager’s job description.  But if that’s true, then EPLI insurance (and D&O insurance, when applied to particularly egregious acts) is just a ripoff.

What’s frustrating about this case is that the court could have based its decision based on other grounds raised by Federal, and not muddied the “scope of employment” issue.  Federal had argued that Sandusky was collaterally estopped from claiming coverage, because he had been adjudicated guilty of sexual abuse, and it was against the public policy of Pennsylvania to insure sexual abuse.  Had the court gone that route, the defense obligation would have been preserved for appropriate cases (until actual excluded bad acts are actually proven), and indemnity would have been precluded for those policyholders adjudicated guilty of intentional and egregious wrongdoing.  Presumably, that is the scenario envisioned by the carriers when rating these kinds of policies.

This type of shortsightedness is what led to the Burd v. Sussex [56 N.J. 383 (1970)] line of cases in New Jersey.  In Burd, the policyholder kneecapped someone with a shotgun, was convicted of atrocious assault and battery, and then sought coverage under his homeowner’s policy for the ensuing civil suit.  The court wrote: “[T]he carrier should not be permitted to assume the defense if it intends to dispute its obligation to pay a plaintiff's judgment, unless of course the insured expressly agrees to that reservation.”  (Emphasis added.)  If the policyholder does not agree to the reservation, then the duty to defend is converted to a duty to reimburse if and when coverage is proven.  And, that’s fine.  That does not destroy the defense obligation.  

But the Burd ruling – which is meant to protect policyholders from carrier conflicts - has been transformed by some carriers into a position that no immediate defense is required whenever there are allegations of intentional harm, regardless of whether the policyholder agrees to a reservation.

Worse, Burd has now been bastardized into the following dicta by the New Jersey Supreme Court:  “In an effort to fashion a practical remedy, and aware of the implications that arise because of the insurer's divided loyalties, the [Burd] Court concluded that the insurer had two options. That is, the insurer could assume the defense if the insured agreed, with a reservation of its right to dispute coverage, or it could refuse to defend and dispute its obligations thereafter, so as to ‘translate its obligation into one to reimburse the insured if it is later adjudged that the claim was one within the policy covenant to pay.’”    Flomerfelt v. Cardiello,  202 N.J. 432,  997 A.2d 991, 999 (2010).

Where, I ask you, does Burd say that the carrier, and not the policyholder, has the “options”?  Answer:  Nowhere.   And if the carrier has the “options” of (A) defending under a reservation of rights, or (B) not defending at all, which “option” do you think the carrier will select? 

I hope that, in the future, courts will take into consideration the purpose of the duty to defend (protection against litigation, even and perhaps especially when bad acts have been alleged) and the fact that carriers charge premiums accordingly.  For now, with full respect to all of the judges involved in these decisions, all I can say is that bad facts make bad law.

You can read the full Sandusky decision by clicking here.

Other insurance clauses and the duty to defend

Posted by Gene Killian on April 27, 2011

New York's highest court just handed down an interesting decision in Fieldston Property Owners Ass'n v. Hermitage Ins. Co.  The case involved an underlying suit for "injurious falsehood," and the question of who was obligated to provide a defense - the CGL carrier, the D&O carrier, or both?  The CGL policy stated that its coverage was primary "unless any of the [policyholder's] other coverage is also primary," in which case it would share costs.  The D&O policy included a provision stating that if the policyholder had "any other valid polic[ies]" that applied, then the D&O policy would serve as excess only, covering the policyholder beyond what the other primary policies supplied.  The Court held that the D&O policy language trumped the CGL coverage, and that the CGL carrier had the sole duty to defend under the "plain language" of the policies.

David Siegel, who writes the New York State Law Digest, had something funny to say about all this:  "Why wasn't the commercial policy phrased in like terms?  We've seen similar insurance collisions in the Digest over the years, prompting us to visualize what the drafting section of an insurance company looks like.  (What comes to mind is a windowless room with an elderly man at a small table, dipping a quill into an inkwell.)"