The "Wrongful Acts" Exclusion and the Duty to Defend

Posted by Gene Killian on April 30, 2013

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.

Toughening New Jersey's bad faith law

Posted by Gene Killian on January 28, 2013

If an insurance company wrongfully denies a third-party liability claim, then, under the New Jersey Court Rules (R. 4:42-9(a)(6), to be exact), if the policyholder has to sue to enforce coverage for the claim, the policyholder is entitled to recover its attorneys’ fees.  Due to a weird quirk in the Court Rules, however, a policyholder currently is not entitled to recoup attorneys’ fees on a wrongfully denied first-party claim.  Since a bad faith ruling is very difficult to obtain in New Jersey on a first-party claim (many judges deem any investigation to be a good investigation), there’s little disincentive for a carrier to drag out a first-party claim indefinitely (perhaps in the hope that an unnoticed internal one or two-year limitations period in the policy will pass).  (For those not familiar with insurance terminology, “first party” coverage applies to damage to your own property; “third party” coverage applies to claims brought against you for damage to someone else’s person or property.)

There’s now a proposed bill in the New Jersey Senate, S-2460, that would allow policyholders (both corporate and individual) a private right of action under New Jersey’s Unfair Claims Settlement Practices Act (“UCSPA”), N.J.S.A. 17:29B-4(9).  Under this bill, if the policyholder can establish a violation of UCSPA, such as refusing to pay a claim without a reasonable investigation based upon all available information, the policyholder would be entitled to relief including punitive damages and “reasonable attorney’s fees.”  The sponsors of the bill are Sen. Nicholas P. Scutari (D-Middlesex, Somerset and Union) and Sen. Jennifer Beck (R-Monmouth).  The relief would apply in both the first- and third-party context.  The insurance industry’s response to Sandy seems to be the driving factor behind the proposed law.

This is a new version of a bill that Sen. Scutari had proposed some time ago, and that died on the vine.  I assume that this one will meet a similar fate, since the insurance industry has a powerful lobby and I have it on good authority from a legislative aide that the industry has already made its displeasure with the bill known.  Truth be told, the only provision in the bill that I really care about is the ability of policyholders to recover their fees on first-party claims.  I think that an insurance contract establishes a quasi-fiduciary relationship, and there should be consequences when a carrier denies coverage wrongfully, or stalls on payment, in any context (first or third).  For a policyholder, especially a small business or individual, to have to finance a potentially expensive court battle with a recalcitrant insurance company is unfair and, in many cases, difficult if not impossible. Hopefully, eventually, this wrongheaded quirk in the Court Rules will be rectified, either by S-2460 or otherwise.

By the way, a number of states already already do allow for a private right of action under UCSPA.  Here’s a handy state-by-state survey.   

Insurance coverage for cyberliability

Posted by Gene Killian on January 11, 2013

At the end of this month (January 26, to be exact), assuming that the Mayans remain incorrect, I’ll be doing a presentation to the New Jersey Institute for Continuing Legal Education on the topic of insurance coverage for cyberthreats.  Of course, I probably should be disqualified from making any comments whatsoever about trends in computer-related coverage, since I was a charter subscriber to the Mealey’s Y2K Litigation Reporter, the litigation world’s version of the Ford Edsel.

In any event, Willie Sutton is supposed to have remarked that he robbed banks because “that’s where the money is.”  (He denied making such a comment, but I’m not going to let the facts get in the way of a good story.)  Nowadays, the money is accessible without dynamite, drills or guns, to a new breed of criminal – so much so that the SEC now recommends that companies disclose the extent of their cybersecurity risks, including the availability of “relevant insurance coverage.”  (You can read the SEC guidance here.)  Liability associated with network security breaches is extreme.  According to one study of 137 events that took place between 2009 and 2011, the average total cost per incident was $3.7 million (including remedial costs and legal fees).     

I’ve previously blogged about Retail Ventures, Inc. v. National Union, 691 F.3d 821 (6th Cir. 2012), in which a chain of shoe stores had its wireless network hacked, and the Court found coverage under a computer fraud rider to a blanket (first-party) crime policy.  You can read that post here.

I’d now like to review briefly an interesting cyberliability case involving third-party coverage, Eyeblaster, Inc. v. Federal Ins. Co., 613 F.3d 797 (8th Cir. 2010).  (You can read the full Eyeblaster decision here.)  Facts: Eyeblaster is a marketing company that helps run advertising campaigns on the internet.  A computer user (Sefton) sued Eyeblaster, alleging that Eyeblaster injured his computer, software, and data after he visited an Eyeblaster website, through, among other things, the unauthorized installation of cookies on Sefton’s computer. Sefton contended that, after Eyeblaster did its thing, his computer slowed to a crawl and he had difficulty remediating the problem.

With respect to Eyeblaster’s general liability coverage, the issue was whether there had been damage to “tangible property,” so as to trigger property damage coverage.  The Court said yes,  writing as follows:  “Federal did not include a definition of ‘tangible property’ in its General Liability policy, except to exclude ‘software, data or other information that is in electronic form.’ The plain meaning of tangible property includes computers, and the Sefton complaint alleges repeatedly the ‘loss of use’ of his computer. We conclude that the allegations are within the scope of the General Liability policy.”

What we see here is that, at least under general liability policies, hardware tends to be viewed as more “tangible” than software, so that if there are allegations of any harm to hardware, there’s more likely to be coverage.

Along these lines, for those of you who may be dealing with cyberliability issues under standard liability policies, keep in mind that there are ISO exclusions that may apply.  The 2001 version of the exclusion reads: “For purposes of this insurance, electronic data is not tangible property.”  The 2004 version of the exclusion excludes ”[d]amages arising out of the loss of, loss of use of, damage to, corruption of, inability to access or inability to manipulate electronic data.”  Even if the 2004 exclusion had been in play in Eyeblaster, however, the Court likely would have found coverage.  The Eyeblaster Court focused on the idea that the hardware itself did not work, as opposed to electronic data (which may be an intangible concept) being corrupted.

As to the E&O coverage, Federal argued that there was no coverage for intentional acts, even if they result in unintentional damage.   The Court disagreed with that argument as well, writing:  “Sefton alleges that Eyeblaster installed tracking cookies, Flash technology, and JavaScript on his computer, all of which are intentional acts. However, Federal can point to no evidence that doing so is intentionally wrongful. As Eyeblaster points out in an affidavit filed with the district court, Federal's parent company utilizes JavaScript, Flash technology, and cookies on its own website. Federal cannot label such conduct as intentionally wrongful merely because it is included in the Sefton complaint; Federal has a duty to show that the use of such technology is outside its policy's coverage.”  (I always admire good lawyering; going to Chubb’s website and finding similar applications there was a nice touch.)

There are, of course, new insurance products coming onto the market specifically to deal with cyberliability issues, such as Marsh’s “Cloud Protect,” which is designed to protect small and midsized businesses against losses stemming from a cloud service provider’s failure.  When reviewing any of the new policies, pay specific attention to the definition of the terms “computer system” or “computer network,” to make sure that what you want to have covered, is in fact covered.

Crime Policies and Computer Fraud Coverage

Posted by Gene Killian on August 31, 2012

Can a first-party insurance policy ever provide coverage for third-party loss?  Well…that depends on what the policy actually says, which goes back to the first rule of all coverage work:  Read The Policy.  (Corollary rule:  Assumptions Are The Mother of All Foulups.)

Here are the facts from a very recent case decided by the U.S. Court of Appeals for the Sixth Circuit on this topic.  DSW operates shoe stores.  Hackers used the local wireless network at one DSW store to get unauthorized access to the DSW computer system and download credit card information for 1.4 million DSW customers at 108 stores.  A slew of fraudulent transactions followed.

Following the data breach, DSW incurred substantial expenses for customer communications, public relations, customer claims and lawsuits, and attorneys’ fees in connection with investigations by seven state Attorneys General and the FTC.  DSW eventually entered into a consent order with the FTC requiring DSW to shore up its security system.  The biggest hit taken by DSW, though – roughly $4 million – arose from the compromised credit card information: costs associated with chargebacks, card reissuance, account monitoring, and fines imposed by VISA/MasterCard.  DSW’s total loss was about $6.8 million.

National Union had sold DSW a Blanket Crime Policy.  The policy provided coverage for “Loss which the Insured shall sustain resulting directly from…The theft of any Insured property by Computer Fraud.”

The Policy defined “Computer Fraud” as “the wrongful conversion of assets under the direct or indirect control of a Computer System by means of (1) The fraudulent accessing of such Computer System; (2) The insertion of fraudulent data or instructions into such Computer System; or (3) The fraudulent alteration of data, programs or routines in such Computer System.”

But, the Policy excluded the costs of defending lawsuits, “except as may be specifically stated to the contrary.”

National Union argued that, given the exclusion for defending suits, the policy was essentially a Fidelity Bond providing only first-party coverage, and that losses associated with third-party claims (such as those made by the FTC and customers) were not included within the insuring agreement.

But the Court wrote that “the label given to a policy is not determinative of coverage,” and focused on the coverage grant.  “Loss” is a broad term. What did it mean that a covered “Loss” must “result directly from the theft”?  National Union argued that the “resulting directly from” language required that the theft of property by computer fraud be the “sole” and “immediate” cause of the policyholder’s loss.  The Court, however, found that the language was ambiguous, writing:  “We find that the phrase ‘resulting directly from’ does not unambiguously limit coverage to loss resulting ‘solely’ or ‘immediately’ from the theft itself.”  In other words, “proximate” cause of a loss was all that was needed...and that was enough to encompass the costs of dealing with the third party claims, taking them out of the exclusion for defending suits and claims.  There was no question that DSW had suffered a “financial loss,” even if part of that loss was attorneys’ fees, and there was a “sufficient link” between “the computer hacker’s infiltration of [DSW’s] computer system” and the financial loss. 

National Union also pointed to an exclusion in the policy reading:  “Coverage does not apply to any loss of proprietary information, Trade Secrets, Confidential Processing Methods, or other confidential information of any kind.”  The Court held that this exclusion did not apply.  Basically, the Court found that the exclusion was meant to apply to the policyholder’s information, used in the policyholder’s business, which gives the policyholder the “opportunity to obtain advantage over competitors who do not know or use the information.”  Here, the information belonged to customers, and not really to DSW.

Given the exclusion for defending claims, insurance company folks may argue that this case is an example of a Court bending over backwards to find coverage where none really exists. But I think that, in a way, this case represents the flipside of bad faith.  If a claim is “fairly debatable,” then the insurance company can’t be held liable for bad faith in refusing to cover it.  But…if the application of policy language is “fairly debatable,” then the policyholder should (and usually does) get the benefit of the doubt as to whether coverage exists.  After all, the carrier writes the policies, and the carrier has to deal with the consequences if the language is not 100% clear.        

The "Eight Corners" Rule and the Duty to Defend

Posted by Gene Killian on July 13, 2012

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. 

What is an "occurrence"?

Posted by Gene Killian on June 08, 2012

When I started in this business at Anderson Kill back in the 1980s (when the firm was still Anderson Russell Kill & Olick, P.C.), junior lawyers (including me) would do anything, and I mean anything, to keep from sliding into the abyss known as the Insurance Coverage Group.  Who wanted to while away his or her limited days on this mortal coil wrestling with the arcane nuances of insurance policies?  Ugh. We all wanted to try the next great RICO case.  But when the late Gene Anderson came into my (shared) office and told me that I was going to be doing coverage work, there was no right of appeal. 

Thank goodness for that.  Over the years, my insurance coverage practice has exposed me to situations that most lawyers will never see, from sinking flowline bundles in the North Sea to crusty old manufacturing plants in the Upper Peninsula of Michigan.  The point is that insurance coverage practice can take you to a lot of strange and interesting places, and raise a lot of strange and interesting questions. 

Like, for example, the village of Kivalina, Alaska, and one of the weirder coverage cases to come down the pike lately.  (I guess I should have expected it, since I’ve read that some BigLaw firms are starting “global warming” practice groups.)   

Kivalina is located on the tip of a small barrier reef on the northwest coast of Alaska, approximately 70 miles north of the Arctic Circle. In 2008, Kivalina sued AES, a Virginia-based company involved in generating and distributing electricity.  Kivalina claimed that AES had engaged in energy-generating activities using fossil fuels that emit carbon dioxide and other greenhouse gases, and that the emissions contributed to global warming, causing ice on the village’s shoreline to melt.  This allegedly exposed the shoreline to storm surges, resulting in erosion of the shoreline and making the village uninhabitable.

Steadfast (a Zurich Financial Services company) had sold CGL insurance to AES, and AES tendered the suit.  Steadfast disclaimed coverage and refused to defend.

The main question in this case was:  Do allegations of the causation of global warming equate to allegations of “property damage” caused by an “occurrence,” triggering coverage under the policies?

Before I give you the Virginia Supreme Court’s answer to that question, a word here about the history of the comprehensive general liability policy (prudently renamed by the industry the “commercial” general liability policy).  Many years ago, if a company wanted to buy liability insurance, it had to go to the carrier and specify its exposures.  If the exposures weren’t listed, there was no coverage.

Then, in the early part of the 20th century, the insurance industry marketers got a bright idea:  “Let’s provide comprehensive coverage, so that everything’s covered unless excluded.  That’ll be a lot easier to sell.”  Hence the birth of the CGL policy. 

Many courts don’t really grasp how this works.  So, if an offbeat claim comes along, they figure there’s no coverage, and they try to back into a reason why.  That’s the exact opposite of how the policy is supposed to operate.

You can see where I’m headed with this.  In the AES case, the Court held that there was no covered “occurrence,” writing:  “Kivalina plainly alleges that AES intentionally released carbon dioxide into the atmosphere as a regular part of its energy-producing activities.  Kivalina also alleges that there is a clear scientific consensus that the natural and probable consequence of such emissions is global warming and damages such as Kivalina suffered.  Whether or not AES’s intentional act constitutes negligence, the natural and probable consequence of that intentional act is not an accident.”  (Emphasis added.)

Let’s break down the Court’s logic on that one, and you can see the fallacy:

Major premise:  If the policyholder meant to cause the damage that resulted from its intentional acts, there is no coverage.

Minor premise:  Scientists say that releases of carbon dioxide cause damage.

Conclusion:  Therefore, the policyholder intended to cause the damage that resulted.

I regret to say that this reasoning is intellectually dishonest.  The major and minor premises do not lead to the conclusion that AES intended to cause damage, because what unnamed “scientists” think is not relevant to determining the policyholder’s subjective intent, and the typical policy form speaks in terms of what is intended “from the standpoint of the insured.”  Since the possibility exists that AES itself did not intend to cause the specific damage alleged here, a duty to defend should exist.

Lest the reader think that there had been an editing error in the opinion, the Court confirmed its misunderstanding of insurance by writing:  “If an insured knew or should have known that certain results were the natural or probable consequences of intentional acts or omissions, there is no ‘occurrence’ within the meaning of a CGL policy.”  (Emphasis added.)  In support of this rather astonishing proposition, the Court cited a treatise written by two lawyers who have spent their professional careers defending insurance companies in coverage litigation.

Folks, “should have known” is a negligence standard.  If negligence isn’t covered by liability insurance, we’re all in a lot of trouble.

You can read the full decision here.

Business Risk Exclusions

Posted by Gene Killian on May 31, 2012

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 (1st 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.)

Coverage for class action settlements

Posted by Gene Killian on April 05, 2012

Here’s a fairly frequent scenario in the insurance world.  The carrier takes a “no- pay” position on a liability claim.  The policyholder settles the case and then seeks reimbursement from the carrier in a coverage suit.  What exactly does the policyholder have to prove in order to get paid?  

In Fireman’s Fund v. Security Ins. Co., 72 N.J. 63, 71 (1976), the New Jersey Supremes long ago set forth the general rule, writing:  “Where an insurer wrongfully refuses coverage and a defense to its insured, so that the insured is obliged to defend himself in an action later held to be covered by the policy, the insurer is liable for the amount of the judgment obtained against the insured or of the settlement made by him…The only qualifications to this rule are that the amount paid in settlement be reasonable, and that the payment be made in good faith.” 

A couple of weeks ago, this issue again came up, this time before the Appellate Division in GAF v. Allstate, 2012 N.J. Super. LEXIS 35.  A class of homeowners filed a class action lawsuit against GAF, alleging that GAF’s roofing shingles were defective because they began to deteriorate “only a few years after installation.”  National Union denied coverage for the suit, in part based on an “own product” exclusion, and GAF eventually settled the case on its own for $63 million.

In the subsequent coverage suit, GAF argued that the underlying claimants had alleged that there had been damage to items other than GAF’s shingles (GAF’s own product), such as other parts of the homeowners’ roofs.  GAF contended that that was enough to trigger coverage for the settlement, without GAF having to prove that, in fact, items other than the GAF shingles had been damaged.

Following 12 years of expensive litigation and a 23-day jury trial, the jury came back with a no-cause against GAF, now affirmed by the Appellate Division.

The Appellate Division wrote: “It is incumbent upon the insured to articulate to a reasonable degree of certainty what portion of its overall damages constitute a covered loss. This can be accomplished either by direct evidence of payment for third-party damages or by competent testimony demonstrating that third-party losses were a reasonably likely consequence of damages to the insured's product.”  It’s somewhat difficult to understand where this ruling leaves policyholders in complex coverage litigation involving multiple underlying claimants, such as in a class-action setting.  Assume, for example, that GAF had put up an expert to say that “third-party losses were a reasonably likely consequence of disintegration of the shingles.”  The carrier would likely have argued (A) that this testimony was impermissibly speculative and (B) that GAF had to prove third-party damage with respect to each individual class member.  In other words, the carrier will almost certainly attempt to make the bar in such a coverage dispute unreachable, and we really don’t know how a trial court will respond. 

The unreachable and ever-moving bar seems to be contrary to the New Jersey Supreme Court’s public-policy based ruling in Owens-Illinois v. United Ins. Co., 138 N.J. 437 (1994).  There, the Court stated that in complex coverage litigation, a “rough measure” was all that was needed to establish coverage, writing:         “Because the defendants refused to involve themselves in the defense of the claims as presented, they should be bound by the facts set forth in the plaintiff's own records with respect to the dates of exposure and with respect to the amounts of settlements and defense costs. Those losses for indemnity and defense costs should be allocated promptly among the companies in accordance with [a] mathematical model developed, subject to policy limits and exclusions. We stress that there can be no relitigation of those settled claims…Available data should enable the master to grasp the generality of the underlying claims and the exposures involved.”  (Emphasis added.)

We almost certainly have not heard the end of this issue.  The one seemingly certain thing is that policyholders can’t enforce coverage for underlying settlements simply because the underlying claimants alleged covered damage.  At the very least, in the class action product-liability property damage context, the Court will likely require an expert to review a statistically significant portion of the underlying claims and opine that, in the words of the GAF court, “third-party losses were a reasonably likely consequence of damages to the insured's product.”   (Isn’t insurance law fun?)

The "Absolute" Pollution Exclusion

Posted by Gene Killian on March 30, 2012

In State Automobile Mutual Ins. Co. v. Flexdar, the Indiana Supreme Court has just held that the so-called “absolute” pollution exclusion contained in general liability insurance policies from 1986 forward is ambiguous and unenforceable.  The Court basically found that the exclusion does not define “pollutant” with sufficient specificity, and that, read literally, the exclusion would apply to any substance introduced into the environment.  (The Flexdar case itself dealt with TCE.)

The Court wrote:  “Applying basic contract principles, our decisions have consistently held that the insurer can (and should) specify what falls within its pollution exclusion. In fact, State Auto has over the years promulgated an Indiana ‘business operations’ endorsement…and an Indiana endorsement defining ‘pollutant’...Where an insurer's failure to be more specific renders its policy ambiguous, we construe the policy in favor of coverage. Our cases avoid both the sometimes untenable results produced by the literal approach and the constant judicial substance-by-substance analysis necessitated by the situational approach. In Indiana, whether the TCE contamination in this case would ‘ordinarily be characterized as pollution’ [as argued by the insurance company] is, in our view, beside the point. The question is whether the language in State Auto's policy is sufficiently unambiguous to identify TCE as a pollutant. We are compelled to conclude that it is not.”

New Jersey hasn't gone quite this far (yet), although in Nav-Its v. Selective, our Supremes ruled that the APE did not apply to toxic fumes from a floor sealant, and that the APE only applied to "traditional environmental pollution," whatever that means. 

Fidelity insurance and Ponzi schemes

Posted by Gene Killian on March 19, 2012

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. 

"Business Risk" Exclusions in CGL Policies

Posted by Gene Killian on October 25, 2011

The late, great comedian Alan King used to tell a story that went like this:   “The other day, my house caught fire.  My lawyer said, ‘Shouldn’t be a problem.  What kind of coverage do you have?’  I said, ‘Fire and theft.’  The lawyer frowned.  ‘Uh oh.  Wrong kind.  Should be fire OR theft.’” 

Recently, a lot of builders and manufacturers have been experiencing similar unhappiness with their coverage for so-called “faulty workmanship” claims.  Carriers have been arguing that faulty workmanship can never constitute a covered “occurrence” that triggers insurance, and also that, even if an “occurrence” happened, liability coverage is precluded by the “your work” exclusion (one of the so-called “business risk” exclusions).

The typical “your work” exclusion in a commercial general liability policy precludes coverage for the following:

“’Property damage’ to ‘your work’ arising out of it or any part of it and included in the ‘products-completed operations hazard.’  This exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.”

Later versions of the language eliminate the subcontractor exception.

So, what’s the purpose of the exclusion?  Some time ago, a pretty good article in Claims Magazine gave the following example:  A policyholder builds a retaining wall for a customer.  The wall falls down.  Under the exclusion, there’s no coverage for damage to the wall itself.  If the falling wall crushes a claimant’s patio furniture, though, coverage exists.  In other words, there’s no coverage for fixing defective work, but there IS coverage for consequential losses caused by the defective work.  

A few courts don’t quite seem to grasp this concept.    And now, let me distribute some sour grapes:  I lost the issue at the trial court level not long ago in Bob Meyer Communities Inc. v. James R. Slim Plastering Inc. The case involved the allegedly faulty installation of window flashing by a subcontractor, and resultant water damage to luxury homes.  The judge decided that the entire homes were the general contractor’s “work,” and that the general contractor therefore could not recover from liability insurance for allegations of faulty workmanship limited to the window flashing made by the homeowners.  The court wrote: 

“If the completed residence is viewed as [the policyholder’s] work product, under its CGL policies, [the policyholder] bears the risk of faulty workmanship causing damage to any part of the residence.”

The problem with this analysis is that the whole residence was not defective – only the window flashing installed by the subcontractor.  The consequential damages resulting from the defect (as opposed to replacement of the flashing itself) should therefore be covered, under the logic in the Claims article.  

But, there is hope. In Port Imperial Condominium Association v. K. Hovnanian, my good friend Lynda Bennett of Lowenstein Sandler (an excellent coverage lawyer) recently successfully navigated her client around the exclusion.  The case involved water damage to condominiums in a waterfront development due to allegedly improper framing, installation and flashing of balcony doors.  

In response to the carriers’ “no pay” argument, and as a result of Lynda’s great work, Judge Sarkisian (Hudson County) wrote:  “It is clear…that general liability coverage is available for consequential property damage that flows from an insured’s faulty workmanship, and that other courts have recognized that faulty workmanship can result in accidental, unexpected, and unintended damage to third party property which satisfies the definition of ‘occurrence’ of the standard general liability policy.” 

In an analogous context, the Fifth Circuit recently tried a Solomonic approach, guaranteed to make everyone unhappy.  American Home Assurance v. Cat Tech LLC involved damage to a “hydrotreating reactor,” allegedly caused by a repair contractor.  There were three categories of property damage involved:

 (1)  Damage to the specific parts of the reactor upon which Cat Tech (the policyholder) performed defective work.

(2)  Damage to the parts of the reactor upon which Cat Tech performed non-defective work, but which were damaged because of later mechanical problems in the reactor.

(3)  Damage to property upon which Cat Tech did not work, but which was nevertheless harmed, apparently because of the later mechanical problems.

The Court held that items (1) and (2) should be excluded, but not (3), writing:

“The ‘your work’ exclusion precludes coverage for damage to that part of [the reactor owner’s] property upon which Cat Tech performed repair services, defective or otherwise.  It does not preclude coverage for any damage to [the reactor owner’s] property that Cat Tech did not repair or service.”

Question:  If policy language can be this elaborate and confusing, shouldn’t the policyholder get the benefit of the doubt?

 

 

 

   

Developments in insurance bad faith law

Posted by Gene Killian on September 22, 2011

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.

The Duty to Defend in New Jersey

Posted by Gene Killian on July 15, 2011

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. 

 

 

 

Insurance coverage for SEC investigations

Posted by Gene Killian on May 24, 2011

The SEC has been getting more and more aggressive with investigations into alleged securities fraud, as well as with filing civil securities fraud actions.  In fact, we just got an SEC securities fraud action dismissed against one of our clients a couple of weeks ago...but it was an expensive fight.  Over at Property Casualty 360, they've posted an excellent article on insurance coverage for SEC investigations.  If you're with a public company, or if you advise public companies, it's worth a read. 

Extreme business interruption insurance

Posted by Gene Killian on May 19, 2011

Saw this post over at Property-Casualty 360 and got a kick out of it.  Enjoy.

The Duty to Defend an Unclear Pleading

Posted by Gene Killian on January 26, 2011

So here’s a frustrating aspect of coverage work.  The underlying plaintiff sues the policyholder based on a complaint that was inartfully drafted (which, in some instances, is a nice way of saying that the complaint looks like it was written while the lawyer was tripping on mescaline).  The carrier denies coverage because nothing in the complaint seems specifically to trigger coverage.  And now the policyholder is in a dogfight with the carrier. 

I admire the plaintiffs’ bar.  Most of them are truly terrific lawyers.  But how can they draft complaints without even considering the insurance coverage aspects of what they’re saying?  Are they trying to punish the defendant by making it hard to tap into applicable policies?  If so, how are they complying with RPC 1.3, which requires the exercise of “reasonable diligence” in representing a client? 

This issue now rears its ugly head again before the New Jersey Supreme Court.  The case is Abouzaid v. Mansard Gardens Associates, and the facts are unpleasant.  (By the way, I’m not suggesting that the plaintiffs’ lawyer in Abouzaid was tripping on mescaline.  There was definitely a nuance of insurance law that may have been missed, though.)  A pilot light in a stove ignited vapors from a paint thinner that had been applied to a kitchen floor by the underlying defendant’s employees.  Three kids were horribly burned. 

Count one of the underlying complaint specifically addressed the claims of the minor children only, asserting a conventional theory of negligence.  Count two incorporated the allegations of the first count and also added a negligence claim under the theory of res ipsa loquitur. In count three, 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 carrier of course denied coverage for count three, 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, the underlying 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."

In a slightly snarky opinion, the Appellate Division held that there was no duty to defend count three in the original complaint, but that there WAS (barely) a duty defend count three in the amended complaint.  The panel wrote, for example:

“The third count merely recounted the adult plaintiffs' grievance of ‘hav[ing] been forced to endure emotional distress and suffering.’ On its face, this allegation does not constitute the type of harm that triggers coverage for a ‘bodily injury, sickness or disease.’ This stands in stark contrast with the plaintiffs' amended complaint and newly minted third count claiming that the adult plaintiffs ‘had to incur the cost of medical treatment for the physical impact caused by their emotional distress and suffering.’ Although not couched in the most graceful language, these statements were enough to impel [the carrier] to intercede and thereafter provide a defense to Mansard. The differences in language are not mere semantic nitpicking; they go to the heart of the definitional linchpin required for coverage--and a defense--under the insurance policy.” 

I should note that in SL Indus., Inc. v. Am. Motorists Ins. Co., 128 N.J. 188, 198-99, 607 A.2d 1266 (1992), the New Jersey Supreme Court specifically held that the determination of the duty to defend does not depend on the writing skills of the underlying plaintiffs’ counsel. ("To allow the insurance company 'to construct a formal fortress of the . . . 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." (internal citations omitted)). 

Both sides in Abouzaid appealed to the New Jersey Supreme Court.  The carrier contends that there should be no duty to defend even the amended count three, because the original complaint demonstrated that the only injuries at issue with respect to the parents were “intangible emotional injuries.”  The policyholder contends that the duty to defend should relate back to the original complaint, because the emotional harm caused a physical impact, which the amended complaint merely clarified.   Policyholder counsel argues that his clients suffered from post-traumatic stress disorder, which, he says, is definitely a “bodily injury.”

Arguments were held before the Supremes a couple of weeks ago.  Trying to discern the eventual outcome of the case based upon oral argument is reading tea leaves, of course.  But during the argument, Justice Barry Albin asked the carrier’s lawyer whether the carrier had done anything in its investigation to elicit any information about physical injuries suffered by the adult plaintiffs.  "I don't know," said the lawyer. "I assume they did not." Albin said that was "problematic." 

Stay tuned...

English & American Underwriting Agency Pools

Posted by Gene Killian on January 25, 2011

Got an e-mail from my friend John Denton at Marsh Risk Consulting about The English & American Underwriting Agency Pools ("EAU") and their Scheme of Arrangement closure. Any historic London excess placements probably would have included one or more of the EAU companies as carriers. There are actions necessary to safeguard any outstanding claims, whether known or unknown ("IBNR" losses).  

Failure to act by  the April 11, 2011 Claim Bar Date will mean that the EAU shares of any outstanding or future claims will be lost forever.

To prevent this from happening, John recommends that those with legacy liabilities that impact historical policies (e.g. asbestos, pollution, historical health hazards, etc.), act now to assess the amount of exposure they have to the proposed EAU Scheme.

John can be reached at john.denton@marsh.com or 212-948-2036.

That is all.  For today, anyway.

Insurance coverage for construction defects

Posted by Gene Killian on November 30, 2010

It’s amazing how, when the economy tanked, construction defects began to multiply exponentially.  I’m not (necessarily) trying to ascribe purely financial motives to the plaintiffs in these cases, but there’s no doubt that, at my firm at least, we’ve seen a marked increase in the amount of coverage litigation over construction defects.

So, what’s the coverage fight all about?  A lot of it involves the so-called “your work” exclusion contained in general liability policies.  (In the ongoing game of words, insurance companies like to refer to this as the “business risk” exclusion, even though the words “business risk” don’t actually appear in the policy forms.)  Boiled down to its essence, this type of exclusion says that if you get sued for damage to your “own work,” there’s no coverage.  So if you’re a builder, and you install stucco on a building, and the stucco falls apart, and you get sued as a result, there’s no coverage under your general liability policy  for repairing the stucco.

This begs the question:  What if the crummy stucco falls on somebody else’s truck (or head) and totals it?  If you’re the general contractor and you get sued, you’re not covered for the repair of the stucco – but how about the replacement cost of the truck (or head)?   

Lots of cases say that faulty workmanship that causes damage to other property is a covered “occurrence” under a general liability policy.  See Weedo v. Stone-e-Brick, Inc., 81 N.J. 233 (1978) (a contractor's general liability policy typically does not cover an accident of faulty workmanship but rather faulty workmanship which causes an accident); Firemen=s Insurance Company of Newark v. National Union Fire Insurance Co., 387 N.J. Super. 434 (App. Div. 2006) (drawing a distinction between economic loss to faulty workmanship and faulty workmanship that causes damage to other property); Hartford Insurance Group v. Marson, 186 N.J. Super. 253 (App. Div. 1982) (noting that claim against policyholder for damage done by its defective workmanship to metal panels installed by another contractor is not excluded).

A few years ago, in United States Fire Insurance Company v. J.S.U.B., 979 So.2d 871 (Fla. 2007), the Florida Supreme Court provided a detailed history of the evolution of the “your work” exclusion, which is useful to anyone dealing with one of these claims.  The Court noted that the 1986 version of the standard form commercial general liability policy contained language specifically stating that that the exclusion for faulty workmanship did not apply to work within the products-completed operation hazard.  The 1986 policy also added a new “your work” exclusion - with an express exception for work done by subcontractors.  The exception was later removed from certain standard forms.

The takeaways here:

  1. If you’re in a business (or if you’re representing a business) where products/completed operations coverage may be an issue, carefully examine the exclusions for “your work” and “your product” and make sure you have adequate protection before problems happen.
  2. Broad disclaimers of coverage based upon so-called “business risk” exclusions generally aren’t appropriate.  Remember, for example,  that the “your work” exclusion is designed to preclude coverage for damage to “your work” – and only “your work.”  If defective work causes damage to other property, coverage exists.   
  3. If a property damage claim is brought against a policyholder and the complaint lists “breach of contract” as the source of the claim, the insurance company should examine the facts of the incident carefully and not simply assume that  breach-of-contract claim is never covered by a general liability policy.

 

Coverage for invasion of privacy

Posted by Gene Killian on November 16, 2010

The subject of invasion of privacy has been in the news (pretty tragically) lately with the terrible suicide death of a Rutgers University freshman.   Classmates allegedly had been spying on his personal life through a webcam, which upset him to the point that he took his own life. 

I don’t mean to seem insensitive or disrespectful  by leading off this post with such a heart-wrenching case.  But it’s a stark reminder of the facts:  With the proliferation of electronic gadgetry and the ever-expanding reach of cyberspace, the environment is right for invasion of privacy cases to increase exponentially.  From a risk management perspective, these cases frequently generate insurance issues under the “personal injury” coverage part of general liability policies.  Personal injury insurance coverage generally protects the policyholder against liability arising from claims of false arrest, detention or imprisonment, or malicious prosecution; libel, slander, defamation, or violation of right of privacy; and wrongful entry, eviction, or other invasion of right of private occupancy.   As the years have gone by, this type of coverage has gotten more and more restrictive.  Some coverage forms limit “invasion of privacy” to situations where a landlord actually interferes with a tenant’s privacy in a rented room, for example.  So you need to read the coverage form carefully.

In any event, a Pennsylvania school district and its insurance company have just settled a case of first impression over whether the personal injury provisions of a commercial general liability policy cover claims stemming from secret video surveillance inside a home.  Settlement details were not included in court papers, and an attorney for the insurance company, Graphic Arts Mutual Insurance Co., declined to shed light on the agreement in the press.

The facts of the case are, well…weird.  Lower Merion School District, outside of Philadelphia, issued laptops to students that were equipped with webcams. For reasons known only to school authorities and the Almighty, school administrators remotely activated the cameras to take pictures of students in their homes, and the photos were later used in disciplinary proceedings against the students.

For you “Get Smart” fans out there, this sounds like something K.A.O.S. would have pulled.  But one of the students, upon learning of the spying activities, understandably was not amused. The student brought a putative class action against the school district, alleging invasion of privacy, wiretapping violations and intellectual property theft against the district. Graphic Arts agreed to defend the case under a reservation of rights, and filed a declaratory judgment action alleging no coverage.

(By the way, I sometimes close my e-mails with a quote from the American lawyer and statesman Elihu Root [1845-1937], who once said:  “About half the practice of a decent lawyer consists in telling would-be clients that they are damned fools and should stop."  Spying on students in their homes would have fallen within that category had anyone from the school district asked me.)

In the DJ action. Graphic Arts argued that the claims in the underlying complaint did not fit into any of the defined offenses included in the personal injury coverage, and moved for judgment on the pleadings.

Graphic Arts and the school district  settled before the judge had a chance to rule on the motion. R. Bruce Morrison, an attorney for Graphic Arts, is quoted in the press as follows:  “Recognizing the existence of these issues is the most significant feature going forward, but we don't have a judicial decision. I don't know that it is likely to arise again in this exact context, but given the advances in technology, I'm confident that we're going to see variations of this issue going forward.”

The insurance settlement came shortly after the underlying case ended.  The district court issued a permanent injunction preventing the school district from remotely activating the webcams and restricting its access to student-created files on the laptops.  The school district also agreed to pay $610,000 in settlements.

The insurance case is Graphic Arts Mutual Insurance Co. v. Lower Merion School District et al., case number 10-1707, in the U.S. District Court for the Eastern District of Pennsylvania.

The underlying case is Robbins et al. v. Lower Merion School District et al., case number 10-665, in the U.S. District Court for the Eastern District of Pennsylvania.

 

"Green Buildings" and mold

Posted by Gene Killian on November 02, 2010

From the "no good deed goes unpunished" department:  Over at Claims Magazine, they recently published an article called "The Hidden Risks of Green Buildings."  "Green" (or "sustainable") buildings involve processes that are supposedly environmentally responsible and resource-efficient throughout a building's life-cycle: from siting to design, construction, operation, maintenance, renovation, and deconstruction.  So, for example, while standard buildings stress hydrocarbon-based materials, "green" buildings are supposed to stress carbohydrate-based materials.   The EPA has a portion of its website devoted to this subject.

But the authors of the Claims article (J. David Odom, Richard Scott and George H. Dubose) argue that "the very concepts intended to enhance a building's performance over its entire lifetime are many of the same things that make a building highly susceptible to moisture and mold problems during its first few years of operation."

For purposes of risk management, the two main points raised in the article are:

(1)               Green buildings are supposed to incorporate innovative, locally produced products.  Problem:  The potential failure of new products to meet promised performance levels (more likely with new materials than with proven materials found in traditional buildings).

(2)               Green building standards reward the introduction of more outside air, which can lead to indoor humidity problems and mold growth.

The authors contend that green buildings will result in increased litigation and insurance costs, as a result of the buildings' failure to perform to expectations. Targets for lawsuits include designers and building owners. 

This situation reminds me of the numerous environmental problems associated with the Toyota Prius, the car of choice for the environmentally conscious. The Prius's battery contains nickel, which is mined in Ontario, Canada. The plant that smelts this nickel is nicknamed "the Superstack" because of the amount of pollution it puts out; the area for miles around it is a wasteland because of acid rain and air pollution.

That smelted nickel then has to travel (via container ship) to Europe to be refined, then to China to be made into "nickel foam," then to Japan for assembly, and finally to the United States. All this shipment for each tiny step in the production process costs a great deal, both in dollars and in pollution.  What was supposed to be an environmental dream begins to look more like an environmental nightmare.

In any event, if you're thinking of "going green" in your business, it would be wise to develop a detailed green building risk management plan.  Such a plan needs input from green building specialists, moisture control specialists, construction attorneys, and your insurance broker. 

Remember:  Many problems involving mold will be excluded under standard insurance policy forms.  See, for example, the Environmental Risk Resources Association website.