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

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

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

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

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

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

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

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

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

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

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

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

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

You can read the full Sandusky decision by clicking here.