In the “Cheese Shop” sketch from the old Monty Python comedy series, John Cleese plays a customer trying to buy some cheese from “Ye National Cheese Emporium, purveyor of fine cheese to the gentry (and the poverty-stricken too)”. The cheese shop proprietor, played by Michael Palin, seems to have no cheese in stock, not even common varieties like cheddar.  Cleese keeps trying, by asking for different and increasingly obscure types of cheese, but Palin only offers weak excuses like “Ohh! The cat’s eaten it.” Cleese remarks that it doesn’t seem to be much of a cheese shop, but Palin insists it’s the best around, due to its “cleanliness.” And Cleese replies: “Well, it’s certainly uncontaminated by cheese…”  (You can find the full sketch on YouTube.)

The policyholder in the recent case of Crum & Forster v. DVO found itself in a similar situation, and must’ve felt like it had bought an insurance policy uncontaminated by coverage.

DVO designs and builds equipment called “anaerobic digesters,” that create electricity from cow manure. (No, I’m not making this up.)  A company called WTE sued DVO, contending that an anaerobic digester sold by DVO failed to work properly, resulting in damages of over $2 million.

DVO quite naturally submitted the claim to its E&O carrier, Crum & Forster.  But C&F said “not our problem,” relying on an exclusion in the policy for breaches of contract.  DVO responded that C&F’s position improperly rendered the policy worthless, because any errors and omissions claim could arguably involve a breach of contract.  But the trial court held that, although coverage for professional malpractice would effectively fall within the breach of contract exclusion as to claims alleged by a client or customer, third parties could still bring tort claims against DVO that would not fall within the exclusion. So, according to the trial court, the policy had some value, and it would not be correct to say that the policyholder paid premiums for nothing.  Of course, claims by undefined “third parties” are not the main reason why companies buy errors and omissions insurance.  They’re primarily worried about claims by clients or customers.

This is why appeals courts exist. Federal courts are often no friend to policyholders, but even the Seventh Circuit recognized that C&F’s position meant that policyholders were paying for mostly worthless “protection” from errors & omissions claims.  The Court wrote: “[T]he focus…is not on the hypothetical third-party actions, but on the reasonable expectation of coverage of the insured in securing the policy. There is, after all, no reason to believe that DVO in purchasing Errors and Omissions coverage to provide insurance against professional malpractice claims had a reasonable expectation that it was obtaining insurance only for claims of professional malpractice brought by third parties.”

In short, C&F’s position rendered the coverage “illusory,” meaning that the exclusions to the policy would completely eviscerate the coverage.  The appeals court sent the case back to the trial court, with instructions to reform the policy to reflect DVO’s reasonable expectations.

A couple of observations about this. First, it is very difficult to convince a court, let alone a federal court, that an insurance policy contains “illusory” coverage. Courts will usually strain to find some type of claim that would be covered under the policy, which is what the trial court unsuccessfully tried to do here. But the “illusory coverage” argument is worth making if the carrier takes a position that makes the policy essentially worthless with respect to the types of claims that it’s really supposed to cover. Second, insurance policies are generally sold to people who aren’t insurance coverage lawyers or judges, and who do not have the time or experience to pull policies apart word by word and address arcane loopholes created by insurance companies.

In this regard, the late Justice Pashman of the New Jersey Supreme Court once wrote in a brilliant dissenting opinion:

“[General liability] insurance…is not issued to lawyers….As such, our central inquiry must be whether this policy is ambiguous insofar as the average [policyholder] is concerned — not, as the majority emphasizes, whether a jurist who had scrutinized the contract would experience any doubts as to the policy’s ambit… Moreover, the insurer could easily have avoided this ambiguity by utilizing ‘more  precise language [which]…would have put the matter beyond reasonable question.’”

That’s the truth.  And you can read the full decision in Crum & Forster v. DVO by clicking here.

If you’re involved in the legal business for any length of time, every once in a while, you’ll come across a case in which the facts are so horrible, and the result so seemingly wrongheaded, that you can’t help but feel that our entire system has failed. A recent decision from the Third Circuit, Arena v. RiverSource Life Insurance Co., which you can read here, sadly falls into that category.

Christine Arena was a successful in-house attorney for Time Warner. She had a wonderful family, with four healthy children, and was active in the Catholic Church and in her community, including serving as the President of a charitable foundation.

Because of some issues with anxiety, possibly caused by financial stress, Christine made an appointment to see a psychiatrist. The psychiatrist prescribed Klonopin and Zoloft.  These medications have the potential for serious side effects, including depression and suicidal thoughts and behaviors. There are also concerns that Zoloft can lead to anxiety and impulsivity. Christine’s anxiety didn’t abate, so the psychiatrist increased the dosage, and added another antidepressant to the mix.

Christine continued to work, but not long after being prescribed the drugs, and when her family was not home, she took two of her husband’s leather belts, wrapped them around her neck, and hanged herself.  She was discovered by her eleven-year-old daughter. She died nine days later. The police report listed the incident as a suicide attempt, and the medical examiner listed her manner of death as suicide, although neither the police nor the M.E. made any inquiry into her state of mind.

Christine had two life insurance policies from RiverSource, but both contained a suicide exclusion clause.  The clause in one of the policies, for example, provided: “If the insured, whether sane or insane, dies by suicide within 2 years from the Policy Date, our liability is limited to an amount equal to the total premiums paid.” The other policy contained a similar clause.

The insurance company denied coverage, based on the suicide exclusions. Christine’s husband Gianfranco then filed suit in state court, and the insurance company promptly removed the case to federal court (of course), which is generally considered to be a more hospitable forum for carriers.

The federal court granted summary judgment to the insurance company, and the ruling has now been affirmed by the appeals court. This is so, despite the fact that New Jersey law requires, as an element of suicide, that the decedent had an actual intent to end her life. Here, Mr. Arena had expert medical evidence that Christine suffered from a medication-induced disorder that altered her state of consciousness to the point that she was unable to understand the consequences of her actions. He also had testimony from Christine’s treating physicians, who confirmed that, because of the ill effects of the drugs, Christine was not capable of understanding the consequences of hanging herself. Lastly, Mr. Arena had testimony from Christine’s family, friends and colleagues, all of whom said that she would never have intended to end her own life had she been thinking clearly.

Soviet dictator Josef Stalin once supposedly said:  “It is enough that the people know there was an election. The people who cast the votes decide nothing. The people who count the votes decide everything.”  Which is another way of saying, you may think you have a decent case.  But the only thing that matters is who’s really making the decision.

In the view of the federal appeals court judge, the medical evidence was not “legally material,” so there was no need to allow a jury trial. The Court wrote: “The parties do not dispute that Christine took two of her husband’s leather belts, moved a chair from another bedroom into a bathroom, fastened the belts together and wrapped one around her neck, and arranged the belts in a manner to effect a hanging. Nor do they dispute that she in fact stepped off the chair and hanged herself. These actions are sufficient circumstantial evidence to establish not only that Christine had ‘awareness’ that those actions would end her life but also that she intended to do so.”

They are?  That seems circular.  The question isn’t whether she did those things.  The question is whether she consciously knew what she was doing.  In my non-judicial opinion, a jury should have been allowed to assess the credibility of the medical evidence.  I note that the Court waited until page 11 of a 12-page decision to write, dismissively:  “True enough, in actions for insurance benefits, the insurance company bears the burden of proving that an exclusion to coverage applies.”

As someone who’s practiced in New Jersey for 30 years, I can tell you that a state court judge would’ve been far more likely to allow this case to go to a jury.

I obviously do not wear judicial robes, and I mean no disrespect to the highly regarded federal judge who wrote the opinion. But we are all a product of our experience and background.  Here, the judge was a former prosecutor, and also, while in private practice, a Delaware corporate lawyer who had specialized in intellectual property law.  He was appointed to the bench by President Bush in 2006.  In short, someone who may not be fond of gray areas.   And, sadly for Mr. Arena and his children, getting a federal appeals court decision overturned is nearly impossible.

The bottom line is this. Insurance companies want to litigate their claims in federal court for a reason. The judges there tend to be more conservative and more insurance-company-friendly. (That is not even remotely suggesting that anything improper took place here.  I am only saying that judges are people too, and they have a worldview that informs their decisions.) Any time you allow a judge or jury to decide your case, whether in state court or federal court, though, you’ve just given up control of the matter, and you have no idea what will happen. So, if you can settle a claim, you should seriously think about it. Some claims, like this one, are difficult to settle, because the insurance company knows it has no real financial incentive to compromise. The carrier figures, from an economic perspective, why not file for summary judgment, which will likely be granted, and if we lose, then we can talk settlement?  But as a policyholder, you should still try to push settlement talks at the appropriate time.   See whether you can get the numbers into a range where you have a decision to make.

I know that’s unfair. You paid for the coverage.  Why should you have to compromise?

But it’s the real world.

Because most people think that insurance law is about as exciting as watching grass grow, I try to be somewhat entertaining in these posts. Probably I usually fail, but at least I keep myself amused.

If there’s one thing that we wannabe comedians hate, though, it’s being upstaged. I was recently reading a decision from a federal appeals court in a case called Sterngold Dental, LLC v. HDI Insurance Company, and the judge who wrote the opinion apparently felt that he, too, needed to entertain.  The case involved a business insurance claim by a dental products manufacturer named Sterngold.  The Court, in denying coverage, wrote things like:

“This appeal gives us an opportunity to sink our teeth into a sophisticated insurance coverage question.”

“Concluding, as we do, that Sterngold’s arguments lack bite…”

“Sterngold fights tooth and nail…”

“Reality has sharp teeth…”

Stop, Your Honor, you’re killing me. No, really, please stop.

Actually, I admit that the tooth references are inventive.  But the policyholder probably didn’t find them entertaining at all.  I pause here to note that the judge who wrote the opinion spent 15 years in private practice with a major law firm that represents insurance companies. There’s nothing wrong with that, of course, but judges are people too, and they may gain their point of reference through their life experience.

The case involved the following facts. A competitor of Sterngold, called Intra-Lock, contended that Sterngold had infringed a trademark called “OSSEAN,” which related to a dental implant coating product. The relevant policy, sold by HDI Global, contained coverage for “personal and advertising injury.” (The judge in the case, like most judges, uses the word “issued” instead of the word “sold.”  “Issued” is such an insurance company word. It suggests that the carrier was doing a favor as opposed to selling you a product.)

Basically, “advertising injury” coverage insures against the following offenses in connection with the insured’s advertising of its goods or services: libel, slander, invasion of privacy, copyright infringement, and misappropriation of advertising ideas.

Sometimes, the policies define “advertising” or “advertising idea.”  Sometimes, they don’t, leading to a reasonable conclusion that, for coverage purposes, “advertising” means any kind of publicity or solicitation. Here, Intra-Lock had alleged that Sterngold “acquired value, name and brand recognition, and goodwill in the OSSEAN mark as a result of continual and substantial advertising,” including the use of confusingly similar marks.  In the coverage litigation, Sterngold reasonably argued that Intra-Lock’s claims were therefore for misappropriation of advertising ideas, within the meaning of the policy.  The Court struggled with that concept, speculating that the OSSEAN mark could be considered an “advertising idea,” but that it could also be deemed to be a reference to the product itself.  I’m not sure that’s a distinction with a difference, but ultimately, the Court punted the issue and, for purposes of the decision, assumed that the “advertising injury” coverage had been triggered.

The far thornier issue, from Sterngold’s perspective, was an intellectual property exclusion contained in the policy, which read:

“This insurance does not apply to: . . . ‘Personal and advertising injury’ arising out of the infringement of copyright, patent, trademark, trade secret or other intellectual property rights. Under this exclusion such other intellectual property rights do not include the use of another’s advertising idea in your ‘advertisement.’”

The Court held that the IP exclusion was a valid basis for denial of claim.

The problem here is that second sentence of the exclusion is as clear as mud.  Sterngold argued that, under the second sentence, since the alleged infringement of Insta-Lock’s advertising idea was excepted from the exclusion, coverage should exist.

In response, the Court engaged in some verbal gymnastics, writing as follows: “The first sentence of the IP exclusion lists a series of IP-related claims, including trademark infringement. Each specifically articulated claim is separated from the next by a comma. The list concludes with the catchall phrase ‘or other intellectual property rights.’ This syntax, combined with the use of the disjunctive ‘or,’ clearly differentiates the listed IP-related claims from the catchall phrase ‘other intellectual property rights.’”

You can see how ludicrous this exercise becomes. No policyholder, when placing coverage, is going to go through policy forms with a magnifying glass and a book of grammar to try to figure out what is and isn’t covered.  (Only judges and insurance company claim personnel have that luxury, usually after-the-fact.) By making the policy forms so complicated, insurance companies give Courts the ability to find holes in coverage that the policyholder could never even have imagined.

When clients or potential clients ask whether their coverage is sufficient to protect their business, I always tell them the same thing:  You’re looking at the problem the wrong way. An insurance policy provides you with the right to sue an insurance company. That’s why risk management, in the sense of minimizing the chance that problems will ever occur, is so critically important.

But it’s also important to try to negotiate IP exclusions out of your policy.

You can sink your teeth into the Sterngold Dental decision by clicking here.

In Billy Wilder’s 1944 film noir masterpiece, “Double Indemnity,” Phyllis Dietrichson (Barbara Stanwyck) seduces insurance agent Walter Neff (Fred MacMurray) into murdering her husband to collect on his accident policy. (Who knew insurance could be so seedy?)  The suspicious and relentless claims adjuster, Barton Keyes (Edward G. Robinson), eventually gets to the bottom of the scheme, and along the way, delivers a great (and hilariously overdramatic) movie speech about the important role his job plays:

“Desk job? Is that all you can see in it? Just a hard chair to park your pants on from 9 to 5? Just a pile of papers to shuffle around and five sharp pencils and a scratchpad to make figures on? Maybe a little doodling on the side? Well that’s not the way I look at it, Walter. To me, a claims man is a surgeon. That desk is an operating table and those pencils are scalpels and bone-chisels. And those papers are not just forms and statistics and claims for compensation. They’re alive. They’re packed with drama, with twisted hopes and crooked dreams… A claims man is a doctor and a bloodhound and a cop and a judge and a jury and a father confessor all in one.”

(You really have to read this speech in an Edward G. Robinson gangster voice to appreciate it fully.  Maybe after an adult beverage or two.)

It’s certainly true that a claims adjuster’s desk is (metaphorically speaking) an operating table.   The problem is that, in many instances, the “surgeon” is trying to remove the very heart from your claim. I once had a life insurance case, for example, in which a young husband went on a mountain climbing trip. There was an unexpected and tragic avalanche, and he and his party were all lost, as confirmed by the authorities. When his widow put in a claim,  though, the insurance company responded by saying, in essence: No dead body, no benefits.   Fortunately, we were able to persuade the carrier of the error of its ways without filing suit, but you can see what we’re sometimes up against.  (The most amazing thing to me about that case is that a supervisor actually signed off on the denial letter.)

There’s a concept in insurance known as “post-loss underwriting,” and it’s generally considered to be unsavory if not downright illegal.  The idea is that the carrier will gladly sell you a policy and take your premium.  Just don’t file a claim, ever.  When you do, the claims department will go through the policy application and your background with a fine-toothed comb, generally making you feel like a criminal and looking for a basis to avoid paying on the ground that you were never entitled to be insured in the first place. It’s as though you were in Atlantic City playing blackjack, and every time you got to 21,  the dealer could refuse to pay and tell you that you must’ve been cheating.  And one really infuriating thing about post-loss underwriting is the number of judges who unknowingly tolerate it.

I’m not saying that’s what happened in the recent New Jersey Supreme Court case of Sun Life v. Wells Fargo Bank (really), but the asserted basis for the decision gives pause to those of us who do policyholder-side work. The case involved a $5 million insurance policy on the life of a retired middle school teacher named Nancy Bergman. The application listed the “Nancy Bergman Irrevocable Trust” as the sole owner and beneficiary of the policy.  Ms. Bergman’s grandson, Nachman Bergman, was the Trustee, and the Trust had four additional members, all of whom were strangers to Ms. Bergman. The investors paid the premiums, and the trust agreement provided that any benefits would be paid to Nachman.

About five weeks after Sun Life sold the policy, Nachman resigned as Trustee and appointed the four investors as co-Trustees.  The Trust later sold the policy for $700,000, and after a series of other transactions, Wells Fargo obtained ownership of the policy and continued to pay the (substantial) premiums, which, of course, Sun Life gladly accepted.

Ms. Bergman passed away in 2014 at age 89, and, naturally, the trouble soon began. Wells Fargo, as the now-owner of the policy, filed a claim for the paid-for benefits.  According to the Court, Sun Life then “investigated” and discovered terrible “discrepancies” concerning who actually owned the policy,  leading Sun Life to do the only morally responsible thing:  Deny the claim, of course! After all, how could Sun Life possibly pay what it owed?  It would be unlawful!  Immoral! Why, by paying these benefits, Sun Life would be grossly encouraging people to bet on the lifespans of total strangers! (As if insurance companies don’t do exactly that every day.)  The very ethical structure of our society would collapse!

Now, if I were a judge (which I’m not, and never will be, especially after writing this), I would say, let me get this straight.  You, Sun Life, conducted an underwriting process, collected information, and decided to sell a policy to insure Ms. Bergman’s life.  You collected large premiums for several years, and you saw that the checks or transfers were no longer coming from Ms. Bergman or the Trust, but from other entities, including Wells Fargo.  While you were reinvesting the buckets of premiums you collected and making a profit on them, you never asked any questions about the ultimate beneficiary.  Now Ms. Bergman has passed away, and you’re denying the claim on the ground that Wells Fargo had no “insurable interest” in Ms. Bergman’s life.

Why is that not the very definition of improper post-loss underwriting?

But, as I said, I’m not a judge, and our Supreme Court looked at the situation very differently, holding that the policy was essentially an illegal “STOLI” scheme.  No, not the vodka…but a concept known as Stranger-Originated Life Insurance.  The Court held that for an insurance policy to be valid, the beneficiary must have an “insurable interest” in the covered risk. An insurable interest includes, among other things, an interest in the “life, health and bodily safety of another individual to whom [the beneficiary] is closely related by blood or by law and in whom he has a substantial interest engendered by love and affection.” The Court held that the investors in the life insurance policy had no interest in Ms. Bergman remaining healthy, and instead were essentially gambling on the length of her life, in the hope that she’d die soon, allowing them to collect the death benefit. The Court wrote: “If a person with an insurable interest takes out a policy because he has an agreement to sell it to a third party, the transaction could be as much of an attempt to circumvent the insurable interest requirement is if a stranger had funded the policy at the outset.”

The Court also noted that the New Jersey Department of Banking and Insurance (DOBI) had submitted a brief supporting Sun Life in the case, arguing that “it is against the public policy of New Jersey for a third party to procure a life insurance policy from a life insurance company with the intent to benefit persons without an insurable interest in the insured.”

The takeaway is that, if you’re using a life insurance policy for estate planning purposes or in connection with corporate transactions, you need to be sure that the policy doesn’t run afoul of the STOLI rules as established by the relevant law.

Personally, I think the STOLI rules are downright silly. Insurance is an industry that essentially functions on gambling; carriers are forever betting on the probabilities of someone living, dying, or becoming ill. Apparently, this is a one-way street, however. As far as DOBI protecting the policy-holding public, in my view, the less said, the better.  If you’re supposedly there to help ensure fairness in the insurance market, it’s difficult to articulate a valid reason why, if an insurance company has collected millions of dollars in premiums over period of years, it shouldn’t be held to the terms of the contract it sold, instead of inventing reasons not to pay. But so it goes.

You can read the full decision here.

“Now the flood was on the earth forty days. The waters increased and lifted up the ark, and it rose high above the earth. The waters prevailed and greatly increased on the earth, and the ark moved about on the surface of the waters.” [Genesis 7:17.]

I’m guessing that people didn’t have flood insurance in the times of Genesis.  Many people and businesses don’t have it now. The problem is, if water is involved in an insurance claim in any way, and you don’t have specific flood insurance, guess what the insurance company is going to try to argue?  (Specific flood insurance often has limits that aren’t equal to the task anyway, unless you’ve bought excess flood coverage.)

Standard homeowners and business insurance policies generally don’t cover flood damage.  They’ll cover some damage from rain, but if your home or business is filled with water as a result of rising water from lakes, rivers, streams, or the ocean…you have a potentially big problem.  (Remember Sandy?)

But just because water is involved doesn’t mean the inquiry is over.  Don’t take no for an answer. Dig through the policy language and ask whether there’s any way that your problem may not fall within the specific terms of a flood or water damage exclusion. Remember, as the policyholder, you’re supposed to get the benefit of the doubt.  (Judges sometimes forget that, but it’s pretty clear law.) (Also…buy flood insurance.)

In Sosa v. Massachusetts Bay Insurance Company, for example, the New Jersey Appellate Division recently found that the carrier’s reliance on a water damage exclusion was, well, all wet. (You can read the decision here.)  The case involved a ruptured water main that caused a flood into the policyholder’s garage and basement apartment. The carrier’s adjuster inspected the property and concluded that the damage resulted from “surface and ground water intrusion.” The policy excluded losses caused by “water damage,” so the carrier disclaimed. The trial court agreed with the insurance company and dismissed the policyholder’s case.

One of the problems was that, at deposition, the policyholder testified that “There was a flood and there was damage to my home.” Insurance is a word game.  Be careful. This statement happened in a deposition, but sometimes it happens when the claim is phoned in to the insurance company claims department (sometimes on a recorded line). You’re better off having your broker or insurance coverage lawyer make the claim so you don’t inadvertently give the insurance company ammunition for a denial.

The carrier’s own policy language, though, defined flood as “a general and temporary condition of partial or complete inundation of normally dry land areas.” A water main break involves localized damage, not a “general and temporary condition of partial or complete inundation,” and doesn’t qualify. The flood exclusion was therefore ambiguous, and had to be construed against the carrier.

The policy also didn’t define “surface water.” Looking to New Jersey statutes and regulations, however, the Court found that “surface water” has “a permanent nature, akin to a body of water.” A water main break doesn’t meet the standard. As for water below the surface of the ground, the water main break didn’t qualify as that, either.  The Court wrote: “Simply put, the water that damaged plaintiff’s home was no longer ‘below the surface of the ground’ when it reached his property; it was above ground.”

The Court noted the insurance company’s sneaky insertion of the water damage exclusion into an endorsement dealing with sump pumps, writing: “An endorsement with no title at all would have been less problematic than the one employed here.”

Because there were unresolved factual issues as to the amount of the covered damage, the case was remanded to the trial court for further proceedings.

The bottom line is that insurance companies often perform superficial factual investigations and then attempt to fit claims within exclusions that may not necessarily apply. The squeaky wheel sometimes gets the grease, as the old saying goes.

This case was handled on the policyholder side by Jeffrey Bronster, a former prosecutor, whose background is here. To succeed on a complicated insurance claim, unfortunately, you may need a prosecutor’s relentlessness.

There’s a very true old quote about interpreting insurance policies that I (and other policyholder lawyers) like to cite.  It goes: “Ambiguity and incomprehensibility seem to be the favorite tools of the insurance trade in drafting policies. Most are a virtually impenetrable thicket of incomprehensible verbosity…The miracle of it all is that the English language can be subjected to such abuse and will remain an instrument of communication.” Universal Underwriters Ins. Co. v. Travelers Ins. Co., 451 S.W.2d 616, 22-23 (Ky. 1970).

Unfortunately, although most insurance policies are a complicated and incomprehensible mess, Courts aren’t always going to help untangle the thicket, especially if a policy exclusion is noted on the schedule of exclusions in ALL CAPS.  An unfortunate plaintiff recently learned that the hard way in Evanston v. A&R Homes, which you can read here.

Sharkey was a worker for a company called YVPV Construction. A&R is a general contractor that got hired to build a four-story, three-unit apartment building in Jersey City. A&R brought in YVPV as a subcontractor. Sharkey was working on the site when he fell 20 feet and hurt himself. This being America, litigation ensued. Sharkey filed a complaint against the property owner, A&R and its owner (Aponte), and the property management company, for negligence.

Evanston had sold liability coverage to A&R.  Following the declarations page of the policy was a schedule of attached forms. One of the forms was listed as: “EXCLUSION – EMPLOYER’S LIABILITY AND BODILY INJURY TO CONTRACTORS OR SUBCONTRACTORS.”  The purpose of the noted exclusion seems pretty clear, since it removes coverage for “bodily injury” to any “contractor or subcontractor while working on behalf of any insured,” including any employees of “of such contractor or subcontractor.” Uh-oh.

A&R tendered the claim to Evanston, and Evanston agreed to defend under reservation of rights, citing the subcontractor exclusion. Once Evanston figured out that Sharkey had been employed by YVPV (the sub), Evanston filed a complaint seeking a Court ruling that it was no longer obligated to defend the case.

Now, here’s an interesting phenomenon that I sometimes experience with even seasoned businesspeople. Instead of hiring an attorney to defend the declaratory judgment action brought by Evanston to get out of coverage, all of the defendants (including A&R) apparently dumped the complaint into the “circular file,” as a result of which Evanston got a default judgment negating coverage. Sharkey, who also received notice of Evanston application for default judgment, didn’t bother to oppose.

Several months after the default judgment got entered, Sharkey demanded discovery from Evanston about the available coverage. Evanston responded with a summary judgment motion, in part on the ground everyone had defaulted. The Court told Sharkey, sorry, that train has left the station. And the Court went on to say that, even if there hadn’t been a default judgment, there would be no coverage.

Sharkey argued that he had a reasonable expectation of coverage, because the declarations page of the Evanston policy didn’t refer to any exclusion limiting the typical broad general liability coverage. He also argued that the subcontractor employee exclusion was ambiguous, because the title of the exclusion (“Employer’s Liability”) suggested that the provision only excluded A&R’s workers compensation liability.

Here’s where this gets interesting. The Court cited case law involving car insurance for the proposition that if an exclusion isn’t  clearly noted in the declarations page it shouldn’t apply, writing: “We deem it unlikely that … the average automobile policyholder would… undertake to attempt to analyze the entire policy in order to penetrate its layers of cross-referenced, qualified and requalified meanings.”

In rejecting Sharkey’s claim, though, the Court wrote: “A&R’s insurance broker obtained the Evanston policy and was familiar with commercial liability insurance, unlike the average, unversed automobile policyholder, who is likely to rely on the declarations page.” The Court also noted that, while the declarations page may not have clearly identified the exclusion, the form attached to the policy identified the exclusion in ALL CAPS.

A couple of takeaways from this.

First, the judge-made fiction that using a broker to obtain coverage somehow transforms businesspeople into sophisticated insurance experts who deserve less coverage is, of course, ridiculous. But it does show that, if you’re in business, you can’t afford to put your head in the sand. You should at least review the list of exclusions and the declarations page to make sure that you’re comfortable with the apparent coverage, and, if you have questions, you should raise them with your broker. Parenthetically, cases like this are the reason the insurance industry has successfully lobbied for a new law in New Jersey (which almost certainly will be signed by the Governor), providing that brokers and agents will no longer be held to a fiduciary standard, but rather, only to a standard of ordinary care.  You can read about that here.

And second, if you receive a summons and complaint (or a subpoena), PAY ATTENTION. Putting it in a drawer and hoping it will magically go away is rarely an effective strategy.

The great American humorist and writer Ambrose Bierce (1842-circa 1914) published a famous work called “The Devil’s Dictionary,” in which he provided astute (if sardonic) definitions of many common terms in the English language. Bierce defined “insurance” for example, as “An ingenious modern game of chance in which the player is permitted to enjoy the comfortable conviction that he is beating the man who keeps the table.”

I’m thinking of starting “The Devil’s Dictionary: Killian Edition,” in which “federal court” will be defined as “A place where insurance claims go to die.”  That can be especially so when water is involved, in any way.

A recent decision, Villamil v. Sentinel Ins. Co. (which you can read here), involved water damage to a nail salon in Princeton.  Apparently (at least according to the Borough Engineer), a major rainstorm caused a floor drain in an exposed exterior stairwell to fail outside the salon, resulting in water backing up into the salon itself. Of course, since the outside stairwell was exposed to the elements, rain also apparently contributed to water in the stairwell.

The salon owner’s property insurance coverage generally excluded damage caused by flood, but provided coverage for “physical damage to Covered Property solely caused by water that backs up from a sewer or drain.”  (Emphasis mine.) The policy also stated:

THIS IS NOT FLOOD INSURANCE

We will not pay for water or other materials that back up from any sewer or drain when it is caused by any flood. This applies regardless of the proximity of the flood to Covered Property. Flood includes the accumulation of surface water, waves, tides, tidal waves, overflow of steams or other bodies of water, or their spray, all whether driven by wind or not that enters the sewer drain system.  (Emphasis mine.)

When the damage happened, the salon owner, Tere Villamil, called her carrier (Sentinel) to report a claim, and spoke to a claim representative on a recorded line. Insurance, unfortunately, is a word game, and most businesspeople have no experience in how it works. Instead of referring to the problem as “water damage,” Villamil stated: “We have had a flood in our lower level yesterday that was quite awful.” Upon hearing the magic word “flood,” the claim representative began asking pointed questions to continue to “cement” the loss into the exclusions, such as: “And you said it was a flooding, correct?”

Naturally, the carrier denied coverage, and just as naturally, the trial court parsed the language of the policy to find support for the denial.

First, the Court held that “to acquire coverage, Plaintiffs must show that the salon sustained damages ‘solely’ from water that backed up from a sewer or drain…Stated differently, Plaintiffs bear the initial burden of demonstrating that floodwater did not, in any way, contribute to the damages which the building sustained.” (Emphasis mine.) The Court held that the policyholder had not sustained its burden, in part because “the water which accumulated at the bottom of the stairwell, at a minimum, included surface water which subsequently entered the premises through the salon’s glass door.”

I love the use of the words “acquire coverage” in the opinion, because they show the mindset of the Trial Court in analyzing the problem:  Insurance (as Bierce said) is a game of chance, and, in order to get what you paid for, you have to play your cards correctly.  Otherwise, the house wins.

Of course, the policy does not “in any way” use the words “in any way.” The more appropriate inquiry is, was any of the damage caused only by the water that backed up from a sewer or drain? (The Borough Engineer said yes, because rainwater had overwhelmed the capacity of the drain.) The Court’s interpretation of the language instead seems to create a difficult standard that, if one drop of “flood” water contributed to any of the damage “in any way,” there’s no coverage.  That can’t be what a policyholder would reasonably expect.

Second, the policy stated that a “flood” included “surface water.” In constructing its finding of no coverage, the Court helpfully inserted a definition that does not appear in the policy, concluding that “surface water” means “waters on the surface of the ground, usually created by rain or snow, which are of a casual or vagrant character, following no definite course and having no substantial or permanent existence.” The Court held that since “flood,” as defined by the policy, includes “the accumulation of surface water,” and since rain landed on the exposed steps and created “surface water,” there was no coverage.

Of course, Webster’s defines “surface water” to mean “natural water that has not penetrated much below the surface of the ground.”  Here, the water did penetrate beneath the surface of the ground, because it entered subsurface drainage pipes and then backed up when the drain failed.

Finally, the Court relied upon an anti-concurrent causation clause, reading:  “We will not pay for loss or damage caused directly or indirectly by [flood]. Such loss or damage is excluded regardless of any other cause or event that contributes concurrently or in any other sequence to the loss.” According to the Court, this clause excludes “all coverage for a loss occasioned by a flood, even when a flood acts concurrently or sequentially with a covered peril, such as sewer backup.”

Of course, this means that sewer backup would never be covered if it causes a “flood,” which then causes damage.  So, apparently, the policy only covers sewer backups that somehow do not involve water.  I suppose if your drain starts spewing cannellini beans, though, you’re good to go.

So where does this leave us?  The obvious point is, don’t rely on your general property coverage to protect you from water loss.  Given the impenetrable thicket of exclusionary language (with pro-carrier definitions to be inserted by the Court!), it probably won’t.  Buy flood coverage, and ask about excess flood coverage if the risk is severe enough.  Also, despite what cute little green lizards with British accents or “Mr. Mayhem” would have you believe on TV, insurance claims people are not your friend.  If a loss is substantial, it would be better to allow your insurance consultant or lawyer handle the claim, so you don’t inadvertently give the carrier the words to support a claim denial.  If the unfortunate policyholder here had not used the word “flood,” but instead simply said that water had backed up from a drain and gotten into the salon, things might’ve turned out differently.  Maybe.

Back in the 80s and 90s, during the environmental insurance coverage wars, each side (insurance companies and policyholders) frequently accused the other of trying to insert imaginary language into insurance policies after losses had happened. Many lawyers put their kids through college arguing about the meaning of the words “sudden” and “accidental,” for example, in the standard-form pollution exclusion.

Both sides were fond of quoting from “Alice in Wonderland” in their legal briefs, and particularly this passage:  “’When I use a word,’ Humpty Dumpty said, in rather a scornful tone, ‘it means just what I choose it to mean—neither more nor less.’ ‘The question is,’ said Alice, ‘whether you can make words mean so many different things.’ ‘The question is,’ said Humpty Dumpty, ‘which is to be master—that’s all.’”

It eventually got to the point where we all declared a moratorium, by agreement, on any future Lewis Carroll references.

I still occasionally quote Lewis Carroll in briefs, though, when insurance companies seem to be engaging in “post-loss underwriting.” I see that pretty often these days in computer fraud claims (where insurance companies argue that their policies required an actual “hack” into their policyholder’s computer systems, even though the policy says nothing of the sort). But you can find post-loss underwriting creeping through many types of coverage disputes, and I often wonder where the insurance industry would be if defense-friendly judges stopped letting carriers get away with it.

In a recent Delaware case, for example, the Court essentially decided to rewrite an exclusion in a Directors & Officers Liability Policy to create a restrictive test as to whether coverage would be provided.

Before I go further, let me discuss what D&O coverage is supposed to do.  This is what the website of a major carrier (The Hartford) says, for example: “Directors and officers (D&O) liability insurance protects the personal assets of corporate directors and officers, and their spouses, in the event they are personally sued by employees, vendors, competitors, investors, customers, or other parties, for actual or alleged wrongful acts in managing a company.  The insurance, which usually protects the company as well, covers legal fees, settlements, and other costs. D&O insurance is the financial backing for a standard indemnification provision, which holds officers harmless for losses due to their role in the company. Many officers and directors will want a company to provide both indemnification and D&O insurance.”

The Hartford website gives many examples of the types of claims for which coverage is supposedly provided, including breach of fiduciary duty resulting in financial losses or bankruptcy; misrepresentation of company assets; misuse of company funds; fraud; failure to comply with workplace laws; theft of intellectual property and poaching of competitor’s customers; and lack of corporate governance.

Anyway, that’s what the people selling this type of insurance generally say.  The people handling claims often have a different point of view, and they sometimes find kindred spirits in the judiciary.

Goggin v. National Union (which you can read here), for example, involved two former directors (Goggin and Goodwin) of a bankrupt entity called U.S. Coal Corporation.  During their terms as U.S. Coal investors and directors, Goggin and Goodwin tried to reinvigorate US Coal through debt purchase and other capital restructuring, in part by forming two investment vehicles, called the ECM Entities.

The reinvigoration efforts didn’t work, and the Bankruptcy Trustee later alleged that Goggin  and Goodwin had engaged in self-dealing with respect to the ECM Entities, diverting assets for personal gain.  For purposes of D&O insurance, the key point to remember here is that Goggin and Goodwin formed the ECM Entities while acting as directors of U.S. Coal, ostensibly in an effort to help resuscitate U.S. Coal.

Goggin and Goodwin duly submitted the claim to National Union, their D & O carrier, requesting a defense.

National Union denied coverage, relying on a so-called “capacity” exclusion.  The exclusion removes coverage for claims “alleging, arising out of, based upon or attributable to any actual or alleged act or omission of an Individual Insured serving in any capacity, other than as an Executive or Employee of a Company, or as an Outside Entity Executive of an Outside Entity.”  (Emphasis mine.) Since Goggin and Goodwin supposedly formed the ECM Entities as part of U.S. Coal’s recovery efforts, while serving as executives of U.S. Coal, the exclusion seems to be irrelevant, right?  Wrong.

Notice that the words “but for” are nowhere to be found in this exclusion. Undeterred, the Court decided that it would employ a “‘but-for’ test to determine if a claim ‘arises out of’ a manufacturer’s product in a product liability suit.” Of course, this was not a product liability suit. It was an insurance coverage suit, and the policyholder is entitled to the benefit of the doubt when it comes to insurance policy language that can be construed in more than one way. The Court wrote, though: “[T]he Trustee Claims – which give rise to this declaratory action – would not have been established ‘but-for’ Goggin and Goodwin’s alleged ECM-related misconduct. Indeed, the alleged formation and use of the ECM Entities to engage in self-interested dealing benefiting themselves and those ECM Entities, all at the expense of U.S. Coal, are no collateral matters but rather the core of the Trustee Claims. ‘But for’ Goggin  and Goodwin’s roles as managers/members of ECM Entities, the…Claims would fail.”

Of course, “but for” Goggin and Goodwin’s roles as directors of U.S. Coal, the claims would also fail.  The Bankruptcy Trustee brought the claims, after all, on behalf of U.S. Coal, for Pete’s sake.

This case nicely illustrates a big problem that policyholders sometimes face.  I’m not singling out the Delaware judge who wrote this decision, but I note from reviewing his bio that he was a government lawyer and prosecutor for 20 years before ascending to the bench. Many judges do not have a background in insurance law, and substitute their own experience and analogies for how policies are supposed to work. Here, the judge used the tenets of product liability law to construe an insurance policy, which is a comparison of apples to oranges.   Viewed through the correct prism of insurance law, the allegations of the underlying case should never cause a forfeiture of coverage unless and until they’re proven to be true, and unless and until the actual misconduct clearly and unequivocally supports the application of a policy exclusion.  Until then, in general, the insurance company should be providing a defense.

I guess the main lesson here is, think carefully before taking a Board position.  If something goes wrong, your carrier may not be there to help you.  And do everything you can to prevent claims from happening in the first place. Honesty is always the best “policy.”  (See what I did there??)

I once had a coverage case that involved a claim for environmental contamination at a chicken farm. (Yes.  A chicken farm. In New Jersey.)  When we were able to pry the claim file loose in discovery, we noticed that the carrier had spent a grand total of $24 to investigate the complex pollution claim, which involved millions of dollars in cleanup costs. Using that evidence, we were able to get a well-respected judge to hold that the carrier had engaged in bad faith by failing to evaluate fairly the merits of our client’s claim. The win was particularly satisfying because the senior lawyer I worked for at the time (this was a long time ago) had dismissively told me that my argument was, and this is a direct quote, “a lead pipe cinch loser.” Take that, smart guy.

Insurance companies hate to give up their claim files, but claim files are essential to coverage litigation.  As one Court (in Omni Health Solutions v. Zurich, discussed below) put it: “Bad faith actions against an insurer, like actions by client against attorney, or patient against doctor, can only be proved by showing exactly how the company processed the claim, how thoroughly it was considered and why the company took the action it did. The claims file is a unique, contemporaneously prepared history of the company’s handling of the claim; and in [a coverage action] the need for the information in the file is not only substantial, but overwhelming.”  And claim files are useful not only in proving the carrier’s lack of good faith; they sometimes contain useful admissions that can be used to prove coverage, or other comments by the claim handler that you can parade in front of a judge or jury.  (I recently had a case in which the claim handler described my client as an “agitator” for refusing to accept a denial of coverage.  Wonderful stuff.)

Let’s look at a couple of recent cases involving claims files.

Omni Health Solutions v. Zurich, from a federal court in Georgia, involved the question of insurance coverage for hail damage at a business location.  (As an aside, insurance companies hate hail damage claims. They have a stable of experts who will find that any roof damage following a storm was the policyholder’s fault due to poor maintenance. I actually had to try one of these cases to  verdict a couple of years ago.)

The Zurich adjuster (Ferunden) visited the property a month after the storm, and told the policyholder that there was no hail damage to the roof. The policyholder, not taking no for an answer (take note, policyholders!), hired an engineer, who provided a professional opinion that the roof had been damaged by hail. Ferunden later agreed. But the battle then morphed into how much Zurich was obligated to pay, and the policyholder demanded an appraisal under the policy.  Coverage litigation resulted when Zurich refused to pay the full amount of the appraisal. The policyholder then demanded production of Zurich’s claim file, which Zurich tried to withhold based upon the “work product” doctrine, which protects information prepared in anticipation of litigation.  Zurich basically argued that it had anticipated litigation for a very long time.

The Court disagreed with Zurich, ruling that all claim documents prepared up to the point when the policyholder actually demanded an appraisal were fair game. In other words, the “subjective” feelings by the carrier as to when litigation was first anticipated were irrelevant. The Court also held that documents prepared after the demand for appraisal could be relevant to a bad faith claim against the carrier, and might need to be produced if and when the policyholder proved that Zurich had breached the policy.

Pro tip: if the carrier argues that the claim file (or certain documents in the claim file) would only be relevant to a bad faith claim, and need not be produced until the policyholder proves breach of contract, think of other ways to make those documents relevant. If, for example, the insurance company has denied coverage or reserved its rights on the ground of late notice, the documents in the claim file could be relevant to showing that the insurance company would’ve done nothing differently even if earlier notice had been received, and therefore was not prejudiced. Another good argument, of course, is that the claim file may contain nonprivileged admissions as to the existence of coverage.

You can read the Omni Health Solutions decision here.

Another recent decision, Rickard v. Central Mutual (this one out of New York), involved an auto claim. The carrier denied supplementary uninsured motorist benefits. The plaintiff asked for the claim file, and the carrier responded by providing the plaintiff with the contents of the file up until the date the coverage lawsuit had been commenced. That made the plaintiff unhappy, because he wanted the entire file, including the parts generated after the lawsuit had been filed. The trial court agreed, and ordered that all claims documents be produced. The appeals court said that the claim file was fair game, but that, with respect to documents generated after the coverage lawsuit had been commenced, the insurance company should’ve been permitted to prepare a privilege log, followed by an in-camera review by the judge of any documents as to which the carrier claimed privilege.

You can read the Rickard decision here.

The bottom line is that carriers do not like producing their claim files, because their claim files may contain useful admissions or other information that the policyholder can use to prove coverage. And that’s why you, as a policyholder, need to do whatever you can to get the claim file in your case.

Earlier this month, I woke up to the sound of sirens and the smell of smoke. My neighbors and friends from around the block suffered a catastrophic fire, and lost their home and all of their belongings, escaping with literally the shirts on their back (and their dogs). Fortunately, no one was injured, but now they have to go through the time-consuming and laborious process of having their insurance claim adjusted. The important thing was (and always is) that everyone was okay.

When you suffer a catastrophe in business, the impact can obviously be similarly enormous, especially if your income flow is cut off while you’re trying to get back up and running. That’s why business interruption and extra expense insurance are so critical. But, like many things insurance-related, they can be as clear as mud.

(Short lesson here for those not familiar with insurance lingo:  Business interruption insurance, also known as business income insurance, is a type of insurance that covers the loss of income that a business suffers after a disaster. The income loss may be due to disaster-related closing of the business facility, or due to the rebuilding process after a disaster. The loss is generally measured over a time known as the “period of restoration,” or the reasonable time it would take to repair the property, although policyholders can add coverage  for loss of income suffered during a specified period of time after the damaged property has been repaired, also.)

Back in September 2013, five years to the date that my neighbors lost their house,  an 11-alarm fire destroyed  a food warehouse down in Burlington County, owned by a company known as Black Bear. At the time, a company called MIMCO had stored a whole lot of dairy products in the warehouse, because it had a five-year distribution contract with a milk marketing cooperative called Dairy Farmers of America.  As a result of the fire, the dairy products and the contract all went up in smoke.  (You can read about the fire here.)

MIMCO terminated its contract with Black Bear, which said it would not be rebuilding the warehouse.  MIMCO then couldn’t find sufficient warehouse space to continue the contract with DFA, so that contract had to be terminated, too.

Travelers paid MIMCO $11.6 million for the loss of business property, business income (approximately $3 million), and extra expense. MIMCO argued, however, that Travelers still owed $7 million in business insurance coverage, and for extended business income loss.

Travelers contended that the period of restoration for the business interruption coverage was based on the reasonable time it would have taken Black Bear to rebuild the facility, which Travelers said was 23 months. MIMCO, on the other hand, argued that the proper method to determine the period of restoration was based on its unfulfilled contract term with DFA – 48 months, plus an additional 24 months in extended business interruption coverage – because Travelers shouldn’t be allowed to measure the loss by using a hypothetical restoration period, when MIMCO had no control over the rebuilding process.

The Court didn’t buy what MIMCO was selling, writing:  “The Court is not unsympathetic to MIMCO’s observation that it is ultimately entitled to less coverage for a more severe loss over which it had no control. Perhaps there is [a type of available] insurance to cover the total cessation of business or a contract that cannot be fulfilled, but that is not what the Travelers’ Policy provides to MIMCO. The Policy affords BI based on a period of restoration from the date MIMCO suspended operations until ‘[t]he date when the property at the described premises should be repaired, rebuilt or replaced with reasonable speed and similar quality’… The [period of restoration] based on an estimation of rebuilding governs the amount of BI MIMCO is entitled to.”

So, “poof” went MIMCO’s claim for addition business interruption coverage.

You can read the Court’s decision here.

Especially in the federal court system, judges tend to read insurance policies very restrictively, and tend to look for the most conservative position on coverage that they can find. (There are exceptions, depending upon the case.) Stuff happens in life, and it would be a good idea, when your policies come up for renewal (or sooner), to review your business interruption coverage, and to consider whether, in the event of a catastrophe, you’d be in a position to keep the “milk” flowing.