New Jersey Insurance Coverage Litigation

There’s a funny (perhaps unintentionally so) website called The Robing Room, on which lawyers rate judges in various categories.  The site is funny mostly because, from reading the reviews, you can generally predict who won and who lost a case before that particular judge.  Take, for example, Judge Joseph F. Bianco of the Eastern District of New York.  One lawyer-reviewer of Judge Bianco writes:  “The judge was extremely fair and reasonable in all pretrial discussions and extremely courteous in oral arguments. He asked questions and let you know what he thought without being abusive or ill-tempered.  His decision was thorough and well thought out.”  (Winner.)  But another lawyer-reviewer writes:  “An extremely uncooperative Judge who thinks he is above the law of the Constitution of the United States of America.”  (Loser.) 

I’m not sure what to do with such conflicting views, but here’s a completely nonpolitical (and not always accurate) comment of my own about researching the background of judges: insurance companies tend to do better with conservatives.  From looking at Judge Bianco’s background, I see that he is a Bush appointee, that he’s a former prosecutor, that most of his career has been spent in government service (including as Chief of the Fraud Section of the Justice Department’s Criminal Division), and that he did a stint at a major law firm (Debevoise & Plimpton, LLP) that represents insurance companies.  Since judges are people too, and their background can be predictive of their worldview, all of this spells trouble to me when dealing with a coverage case that involves alleged bad acts by the policyholder.  As Bernard Baruch supposedly said, if all you have is a hammer, everything looks like a nail.  (Disclaimer:  I don’t know Judge Bianco, and I’ve never appeared before him.  For all I know, my initial impressions are totally wrongheaded.)  

So, how would we expect Judge Bianco to handle a recent coverage case involving a policyholder alleged to have participated in a major fraud?  Let’s see. 

The  policyholder (Silverman Neu) is an accounting firm.  Two of Silverman’s clients were credit counseling companies that held themselves out to the public as not-for-profit organizations.  The credit counseling companies apparently didn’t live up to their advertising, and their owners funneled consumer funds to various for-profit companies to enrich themselves.  Silverman got hauled into a resulting class action suit brought by consumers, because the firm had audited the companies and prepared tax documents verifying their (false) nonprofit status.  The class plaintiffs alleged that Silverman “knew or should have gained knowledge of” the fact that the credit counseling companies were not legitimate nonprofits.  (Emphasis mine.)  Note:  “Should have known” is a negligence standard, not an allegation of intentional wrongful acts.

Silverman’s E&O carrier, Admiral Insurance, denied coverage for the suit, in part based upon a “Wrongful Acts” exclusion.  The exclusion removed coverage for “any liability based in whole or in part on any knowingly wrongful, dishonest, fraudulent, criminal or malicious act committed by or at the direction of any ‘Insured’ in the course of providing ‘professional services.’”

The problem for Admiral, of course, was that pesky negligence allegation.  Under the familiar eight-corners rule, if there’s any possibility of coverage, the carrier is supposed to step up and provide a defense.  Based on the allegations contained in the complaint, was there a possibility that Silverman wasn’t an active participant in the fraud, but instead negligently overlooked the clues, or was duped by its own clients?

Here’s what Judge Bianco did with that possibility:  “Silverman/CNS asks the Court to put the cart (here, the exclusionary provision) before the horse (the coverage provision). That is, if a claim reasonably falls within a policy’s coverage provision, Silverman/CNS suggests that an insurer read no further:  It is bound.  Continuing the logical implications of Silverman/CNS’s argument a step further, if an insurer examines other provisions of an insurance policy that address the existence and/or scope of coverage, these are not outcome determinative; the only issue is whether the claims fall under the policy’s coverage provision in the first place.  Any restrictions or limitations on coverage – even if they potentially or actually affect coverage – do not change an insurer’s obligations.  The Court disagrees with that argument.” 

No disrespect intended to Judge Bianco, but his logic here is based upon a fairly obvious straw man.  The issue is not whether the insuring agreement negates the policy exclusions.  The issue is that, unless and until the possibility of (the specifically alleged) negligence is eliminated, there is a possibility of a negligence finding, and the carrier is obligated to provide a defense.  That’s hornbook law, which the Court cited earlier in the opinion:  “The duty to defend on the insurer’s part remains steadfast, unless the insurer can establish, as a matter of law, that there is no possible legal or factual basis on which the insurer might eventually be obligated to indemnify [the insured] under any provision contained in the policy.’” (Citation omitted; emphasis mine.)

When bad acts are alleged, judges (maybe especially those with a background in the prosecutor’s office) often have a difficult time enforcing insurance policies.  The reluctance is understandable, and we saw it in an earlier post on this blog about the horrific Sandusky-Penn State situation.  But the concept of liability insurance is actually quite simple.  It’s lawsuit insurance, and perhaps it’s most needed when bad acts are alleged and financial devastation is threatened.  If there’s any possibility, however slight, that the finder of fact could come back with a verdict within the coverage, then the duty to defend exists.  A court’s view of the how the underlying case should come out may be interesting, but it’s also irrelevant, as is the “potential” application of policy exclusions. 

You can read the full decision here.

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.

One of the issues that frequently comes up in complicated third-party cases is:  How far outside the underlying complaint does the carrier have to go to determine whether coverage exists?  New Jersey is not an “eight corners” state (in which all the court considers is the four corners of the policy and the four corners of the complaint). The New Jersey Supreme Court has specifically held: “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 Industries, Inc. v. American Motorists Insurance Co., 128 N.J. 188, 197 (1992) (citations omitted).  

Along these lines, some time ago, I wrote about the New Jersey Appellate Division’s decision in Adams-Stiefel Funeral Home v. Zurich American, which involved issues of coverage for companies that were essentially “innocent bystanders” in an illegal plot to harvest body parts from corpses.  In a companion case, the New Jersey Supremes have now affirmed the Appellate Division’s ruling of no coverage.  The case facts are a little unique (and ghoulish), but the decision raises some important questions about the scope of the duty to defend.  The Supreme Court decision is here.  

Memorial Properties and Mt. Hebron are the owner and manager (respectively) of a cemetery known as Liberty Grove Memorial Gardens.  They were implicated in a scheme in which a New Jersey dentist and a New Jersey “master embalmer” worked in conjunction with funeral homes and crematories to obtain access to human remains, and to sell body parts.  Memorial and Mount Hebron denied any involvement in the plot, and consistently maintained that, when they received bodies from funeral directors for cremation, the remains were already in sealed containers that were not opened by Memorial and Mt. Hebron prior to cremation. They also argued that the documentation accompanying the remains appeared proper.    

The families of the decedents alleged that, following the deaths of their relatives on various dates in 2003, 2004 and 2005, two persons not connected with Memorial Properties or Mt. Hebron extracted tissue, bones and organs from the remains without authorization, sometimes replacing harvested bone with polyvinyl chloride (PVC) piping so that the bodies would appear intact. The families contended that these persons falsified decedents' medical and funeral records to conceal the illegal tampering with the remains.  The families allege that they were unaware of the “harvesting” until law enforcement authorities told them about it in 2006.  They claimed, among other things (and understandably), damages relating to emotional distress.

Two insurance companies – Assurance and Maryland Casualty - denied coverage for the families’ claims. The policies involved are specially tailored to the funeral home industry, but they basically contain “occurrence”-based coverage.

The Assurance policy provided coverage for the year 2003 for claims arising from damage to human remains and bodily injury, including mental anguish.  Assurance took a “no pay” position, on the ground that the occurrences were outside of the policy period, since the families only learned of the harvesting scheme in 2006. 

In upholding the Assurance denial, the Supreme Court wrote in part:         “The decedent's surviving spouse seeks damages for ‘severe pain and suffering, severe emotional distress and harm, [and] financial or economic loss,’ including lost wages. Her alleged damages derive from her distress upon learning of the unauthorized harvesting of her husband's tissue, bones and organs, and not from a purported cause of action based on property damage to her decedent's remains. Accordingly, in the New Jersey case in which the harvesting took place in 2003, the ‘occurrence’ was the plaintiff-spouse's alleged emotional distress upon discovery of the harvesting scheme in a 2006 conversation with law enforcement, and her claim falls outside of the policy period set forth in the Assurance policy.”

In other words, the Supremes divorced damage to the body (the “property”) from the emotional damage suffered by the plaintiffs.  Since the plaintiffs’ emotional damage only took place after 2003 (hence outside the policy period), no coverage.  Burt how does this square with the principles of SL Industries?  Since the cause of action was in fact based upon damage to the decedent’s body (without that, there would have been no “emotional distress”), wouldn’t a reasonable policyholder expect coverage for this claim?

The other carrier, Maryland Casualty, denied coverage based upon an exclusion removing coverage for claims based upon such activities conducted "by any insured or anyone for whom the insured is legally responsible" including "disarticulation" of body parts from a deceased body, "distribution, sale, loaning, donating or giving away" parts of a deceased body, and “any criminal act.”  Based upon this exclusion, the Supremes wrote in part that the underlying plaintiffs had alleged “an active role by Memorial and Mt. Hebron in the harvesting scheme” which fell “squarely within the parameters of the exclusionary clause.”  

The problem with the ruling in favor of Maryland Casualty is that the policyholders presented evidence that they had not participated in the scheme, and that the bodies had been delivered to them in sealed containers with appropriate certifications.  The Supremes simply resolved that issue against the policyholder without apparently conducting the outside-the-eight-corners analysis required by SL Industries…which is disappointing, to say the least. 

Good stuff over at Amy Stewart's blog on the issue of who gets to pick counsel - the policyholder or the carrier.  Naturally, this depends on the policy language...unless the carrier reserves its rights, in which case the interests of the policyholder and carrier may be in conflict.  The flip-side, of course, is if the carrier lets the policyholder select counsel, it's going to be subject to the carrier's often bargain-basement rates.  

Every now and then, a business owner asks me to review his company’s coverage program to make sure that adequate protection exists.  I always say the same thing. “You’re looking at this all wrong.  Buying insurance isn’t about buying protection.  Buying insurance is about buying a right to sue an insurance company.  Once you accept that, the world becomes much clearer.”

That’s because insurance is such a word game.  One word out of place – one comma out of place – and poof, the insurance company says “no soup for you.” 

With that in mind, let’s revisit the case of Abouzaid v. Mansard Gardens, which I first wrote about earlier this year.  The facts are horrific.  Three kids are in an apartment kitchen. The pilot light on the stove ignites some paint thinner that earlier had been applied to the floor by the landlord’s worker.  The kids’ mothers see them engulfed in a fireball and badly burned.

In count three of their ensuing complaint against the landlord, the plaintiffs alleged that the kids’ parents were “forced to endure emotional distress and suffering resulting from watching . . . their sons becoming engulfed by flames."

The landlord’s carrier denied coverage for count three (naturally), arguing that its policy provided coverage only for “bodily injury,” which under New Jersey insurance law does not include emotional distress without physical manifestations. 

Later, apparently realizing the error of their ways insurance-wise, plaintiffs’ counsel amended count three to state that the adult plaintiffs "had to incur the cost of medical treatment for the physical impact caused by their emotional distress and suffering."

The Appellate Division held that there was no duty to defend count three in the original complaint, but that there WAS a duty to defend once the complaint was amended to allege “physical impact.”

The New Jersey Supreme Court, apparently beset by a bout of common sense, has now reversed and held that the duty to defend existed from the beginning.  After a lengthy recap of New Jersey law regarding the duty to defend (which as some of you know, contains some frightening pitfalls for the uninitiated), Justice Long wrote:  “Although [the third] count was silent regarding the existence of physical manifestations, it did not exclude the possibility that such manifestations would be proved during the course of the litigation.  Accordingly, it was indefinite whether the claim was within the scope of coverage.  In those circumstances, a potential for plaintiffs to prove a covered claim existed and doubts regarding the duty to defend should have been ‘resolved in favor of the insured.’” (Emphasis mine.) 

This is a good decision, consistent with well-settled principles of insurance policy interpretation, and I’m hoping that all courts in New Jersey will now, finally, understand how liability insurance works.  If there’s any possibility of coverage, however remote, the duty to defend exists.

Counsel for the policyholder in the Abouzaid case were Alan Bernstein and David Klein from Brach Eichler.  Nice work, fellas. 

I’m currently preparing to try another coverage case.  This one involves the question of whether an insurance company, having denied a defense outright, can later second-guess the amount of defense costs and settlement paid by the policyholder out of its own pocket. 

In preparing the case, I came across an interesting opinion written by the sometimes-controversial Judge Richard Posner of the Seventh Circuit, Charter Oak Insurance Company v. Color Converting Industries Company, 45 F.3d 1170 (7^th Cir. 1995).  (The case coincidentally involves the same insurance company as in my case.  I won’t bore you with the details, but the issues are slightly different.)   Whatever you may think of Judge Posner, the guy can write.  Here’s how he concisely defines the competing interests of the policyholder and the carrier when it comes to settlement with the underlying plaintiff:

“The principal contractual duty that an insurer's delay in coming to terms with the insured's tort victim can violate is the implied duty…to manage the defense of the liability claim in such a fashion as will minimize the risk to the insured of an excess judgment. Because insurance policies have limits, a liability insurance company might prefer to roll the dice and litigate with its insured's tort victim, knowing that its liability was capped at the policy limit and that if it was lucky and won the case it would not have to pay anything. The insured would prefer the insurance company to pay right up to the policy limit if by doing so it could eliminate the danger of a judgment above that limit, since any difference between the judgment and the policy limit would be payable out of the insured's own pocket. It is entirely reasonable to suppose that had the parties to the insurance policy thought about this conflict of interest between insurer and insured, they would have agreed that the insurance company was not to exploit it, and was instead to act as if there were no policy limit when it came to decide whether to settle or to litigate.” 

(By the way, I’m not sure that a policyholder would always want the full limits paid out.  That might not be helpful at renewal time, for example, and might also create the impression among the plaintiffs’ bar that the policyholder is an easy mark.  But I do understand the Court’s point.)

As to the ability of a carrier to deny coverage, and later to take the position that the policyholder had made “voluntary payments” and was therefore not entitled to insurance, Judge Posner wrote:

“If the insured does settle and then turns around and seeks reimbursement from the insurance company, it will have to prove that the settlement was reasonable. …[There] are cases in which an insured settled in circumstances where, because the insurance company had not conceded coverage, the insured's personal assets were at risk. They are analytically similar to cases in which the insurance company's foot-dragging  places the insured at risk of an excess judgment.”

Posner’s reasoning is similar to that of the New Jersey Supreme Court in Fireman’s Fund Ins. Co. v. Security Ins. Co. of Hartford, 72 N.J. 63, 73 (1976), where the Court wrote:  “If the insurer delays unreasonably in investigating and dealing with a claim asserted against its insured, the insured may make a good faith reasonable settlement and then recover the settlement amount from the insurer, despite the policy provision conditioning recovery against the insurer on the prior entry of a judgment or acquiescence by the insurer in the settlement.”  

Bottom line:  If the insurance company denies or delays coverage, courts say that the policyholder can settle with the underlying plaintiff and, as long as the settlement is reasonable, can successfully claim reimbursement from the insurance company.  The “voluntary payments” provision does not apply.

Most lawyers brag about the cases they’ve won.  I prefer to pick apart the ones I’ve lost.  It’s cathartic.

The subject of general liability insurance coverage for supposed intellectual property offenses is hotly contested.  Depending on the “personal injury” and “advertising injury” coverage forms used in a particular policy, for example, insurance may exist for claims of patent or trademark infringement.   Generally and not surprisingly, insurance companies disagree.

So, here are the facts from a recent case we handled.  Companies A and B manufactured food preservatives overseas.  Our client -  Company C - approached the two manufacturers and offered to become the U.S. distributor for the products.  The parties signed a letter of intent, which included a confidentiality agreement as to the trade secrets of Companies A and B.

A and B alleged that C later “improperly associated itself with [the products] and promoted itself as the distributor of [the products] in the U.S., manufactured using [A and B’s] patented process and promoted itself as knowledgeable in the use of [A and B’s] trade secrets.”  A and B also alleged that C “began selling its own version of [the product] to the same customers.”

Companies A and B sued for (1) patent infringement, (2) unfair competition, and (3) theft of trade secrets. 

We then went after C’s liability insurance carrier for coverage under the “personal and advertising injury” form in the general liability policy.  In relevant part, the policy defined “advertising and personal injury” as injury arising out of “[c]opying, in your ‘advertisement,’ a person’s or organization’s ‘advertising idea’ or style of ‘advertisement.’”  The policy defined “advertising idea” as “any idea for an ‘advertisement.’”  Finally, the policy defined “advertising” as “the widespread public dissemination of information or images that has the purpose of inducing the sale of goods, products or services through…(1) Radio; (2) Television; (3) Billboard; (4) Magazine; (5) Newspaper; or…[a]ny other publication that is given widespread public distribution.”

Seizing on the last phrase (“any other publication that is given widespread distribution”), we moved for summary judgment on the duty to defend.  As you know if you’re an insurance aficionado, the carrier’s duty to defend is supposed to be triggered if there’s any possibility that coverage may ultimately exist.  We figured that the allegations in the underlying complaint (for example, that C “improperly associated itself with [the products] and promoted itself as the distributor of [the products] in the U.S.”) should suffice.

The judge didn’t buy what we were selling, though, holding in part: “The policy requires ‘widespread’ public dissemination…in order to constitute an advertisement…[T]he underlying complaint provides no support for the notion that the dissemination of information at issue was widespread.”

This (in my humble opinion) is a dopey ruling.  Under the law relating to the duty to defend, the proper question is whether there existed any possibility of widespread dissemination of information.  If so, the duty to defend should have been triggered.  I personally would like to have taken this one up to the Third Circuit for review, but we’d negotiated a high/low agreement with the carrier, so we settled following the court’s decision.  (A decent result for the client, since a less-than-perfect settlement is almost always better than a protracted litigation.  But I feel like I got cut off from dinner after the shrimp cocktail.)