Insurance company claims personnel tend to view the concept of “ambiguity” as the last refuge of a scoundrel.  That’s because unhappy policyholders often reflexively argue that a particular term in dispute is “ambiguous.” On the other hand, miserly insurance companies often argue that the term is perfectly clear. Neither side usually understands what the term “ambiguity” actually means.

“Ambiguous” does not mean “vague.”  (“Vagueness” can in itself be a vague concept, which calls to mind Justice Potter Stewart’s famous definition of “pornography”: “I know it when I see it.”) Nor does “ambiguity” mean that the definition of a term is in dispute. Instead, “ambiguity” has a very specific meaning, as a Federal Court recently held in an interesting case involving a “newly acquired premises” provision:

“Under an objective test, a policy is ambiguous if the language is susceptible to two reasonable interpretations. We read the policy as a whole when determining whether the contract has two equally plausible interpretations, not seriatim by clauses. If the policy is ambiguous, we adopt the construction most favorable to the insured. An insurance policy is not ambiguous, however, just because the parties disagree as to the meaning of its terms.”  (Citations omitted.)

This raises an interesting question. If two different Courts view the same insurance terminology in entirely different ways (as we saw for many years with the pollution exclusion), isn’t the term by definition “ambiguous”?  No judge could actually be “unreasonable,” right?  Personally, I think that’s a great argument…but I’ve never actually gotten it to work.

In any event, the recent case that gave rise to the Federal Court’s discussion of “ambiguity” involved Amera-Seiki, a company that imports computerized industrial equipment for customers in the United States. Amera-Seiki bought a vertical lathe from a manufacturer in Taiwan for delivery to a customer in Illinois. The equipment was transported to Los Angeles, where it was to be stored temporarily until a flatbed truck could take it to the customer. Unfortunately, while the lathe was being held in Los Angeles, a longshoreman at the terminal was moving it by tractor, when it fell and was destroyed.

Cincinnati Insurance Company had sold a commercial property policy to Amera-Seiki, and paid $10,000 in transportation coverage on the claim. Amera-Seiki, however, argued that there was additional coverage under an extension for “newly acquired property”. The “newly acquired property” extension provided coverage for loss to “business personal property, including such property that you newly acquire, at any location you acquire other than at fairs, trade shows or exhibitions.”  (Emphasis added.)

Because Amera-Seiki had paid $1950 to store the lathe at the terminal, Amera-Seiki contended that it had temporarily acquired a “location” at the terminal, meaning that the claim fell within the “newly acquired property” extension.  Amera-Seiki also argued that Cincinnati had specifically excluded the temporary acquisition of a location at “fairs, trade shows, or exhibitions,” showing that other temporary locations were in fact covered. (Otherwise, “fairs, trade shows or exhibitions” wouldn’t have to be excluded). Finally, Amera-Seiki argued that, if Cincinnati had intended to require greater permanency at a location, Cincinnati should have so defined the term “acquire” in the policy, or expressly limited the “newly acquired property” extension, in the same way Cincinnati limited other policy provisions.

Cincinnati of course disagreed, arguing that temporary storage arrangements were too passive and too transient to qualify the terminal as a location the policyholder had “acquired,” under any reasonable interpretation of the “newly acquired property” extension.

In the end, the Court found that both interpretations suffered their “own flaws and both fray at the edges, but given the breadth of the policy language, neither is unreasonable.” The Court therefore held that a “genuine uncertainty” existed as to which of the meanings was the proper one; so, because the policy was “ambiguous” as that term is properly defined (two contrary but reasonable interpretations), the Court held that coverage existed.

This case nicely showcases the (sometimes frustrating) chess game that takes place when interpreting insurance policies. But, even though Amera-Seiki won this one, the case also demonstrates something else from the policyholder perspective: It’s important to have an experienced insurance broker or consultant review the nature of all of your business operations in advance, and determine whether your specific insurance coverage applies to all apparent risks. Amera-Seiki was in the business of importing expensive equipment. It would have been nice to know beforehand that coverage existed for equipment stored at a temporary location, instead of having to litigate the issue. Given the complexity of commercial insurance, it’s sometimes difficult to determine whether coverage for every aspect of your operations exists; but you can certainly increase your chances.

You can read the full decision in Amera-Seiki v. Cincinnati Insurance Company by clicking here.

In a recent decision in the federal district court here in New Jersey, Judge Irenas wrote:  “Plaintiff Marjorie Brooks alleges that her insurance company paid her too much money after her home was damaged by Hurricane Sandy. The court thus takes judicial notice of the following facts: pigs can fly and hell has frozen over.” 

How can I NOT discuss such a case on this blog?

Brooks had flood insurance under the NFIP. She filed a flood loss claim with Fidelity, the servicing carrier, and hired a public adjuster. The public adjuster negotiated an $80,000 payout with the insurance company’s independent adjuster, which Brooks accepted. She hired a contractor to handle the repairs to her home, but the contractor eventually walked off the job for reasons that are unclear, leaving her with a mess. Brooks then sued the contractor, her public adjuster, and the carrier’s independent adjuster, arguing that there had been “overpayment by fraud.” She contended that the damage to her home only totaled approximately $5000.   (She didn’t sue the carrier, and her lawyer represented to the Court during oral argument that she would return the alleged overpayment to the carrier in the event she won her case.  I know that this will drive my carrier-side readers nuts – how can she have it both ways? – but I only report the facts, I don’t make them up.)

Why would a policyholder ever claim that damages were actually lower than the insurance company offered? There could be a number of reasons. For one thing, in New Jersey, insurance companies and policyholders constantly fight over whether claims litigation will be in state court (perceived as more favorable to policyholders) or federal court (perceived as more conservative, and therefore more favorable to insurance companies). In an insurance case involving diversity jurisdiction (which generally won’t include residential flood claims, which are governed by federal statute), there must be at least $75,000 in dispute for the case to be heard in federal court (and the case must be between citizens of different states). On a claim in the neighborhood of $75,000, I can envision a policyholder arguing that less than $75,000 is involved, to gain a perceived tactical advantage by being in state court.  (The flip side of that is that many of our state courts are short of judges and take forever to move cases.)

Insurance companies also don’t like state court in New Jersey because of a procedural rule relating to “offers of judgment”. Generally, New Jersey law doesn’t allow policyholders to recover attorneys’ fees on first- party claims.  (There have been a number of efforts to rectify this problem in the Legislature, and to date all have failed.) There is, however, a mechanism provided under the New Jersey State Court rules, for policyholders to obtain such a recovery. It’s the offer of judgment rule, and it works like this:  The plaintiff files a settlement demand with the Court.  If the defendant doesn’t accept within 90 days of service of the demand, or 10 days before trial (whichever period expires earlier), and the plaintiff recovers at least 120% of the demand, then the plaintiff gets reasonable attorneys’ fees back, plus 8% interest.  (The current interest rate in the New Jersey courts, apart from the offer of judgment provision, is a whopping 0%.)  Insurance companies hate this rule, and there’s no rule providing equivalent relief in federal court.

As I indicated above, diversity jurisdiction normally isn’t an issue in residential flood claims, though.  As Judge Irenas noted, 42 U.S.C. §4072 provides for original jurisdiction in the federal courts of any claim against FEMA or the servicing carrier for nonpayment, or alleged underpayment, of an insurance claim.  The twist here is that neither FEMA nor the servicing carrier were defendants in the Brooks case.  Ultimately, Judge Irenas remanded the case to the state court because of a procedural defect – the defendant that removed the case to federal court had not obtained the consent of all other defendants as required by rule.

What other reason could there be for a claimant to argue that the claim payout (or proffered claim payout) was excessive?  Well, if a “pre-FIRM” home is determined to have been damaged by any cause for which repair costs are 50% or more of the value of the building, then, by law, the homeowner must elevate the structure upon rebuilding.  (“Pre-firm” means a structure built before December 31, 1974 or the date upon which the policyholder’s community began participating in the National Flood Insurance Program.) You can read more about that in this FEMA publication.  Since the cost to elevate can be substantial, some homeowners might not want their carriers to determine that there’s been excessive damage to the home.

The Brooks v. Foglio decision is also interesting because Judge Irenas provides a good primer on how the federal flood insurance program works.  He writes, for example:  “The NFIP is a federally supervised and guaranteed insurance program presently administered by the Federal Emergency Management Agency pursuant to the National Flood Insurance Act and corresponding regulations. Initially, a pool of private insurance companies issued flood insurance policies and administered the SFIP [short for “Standard Flood Insurance Policy”]  pursuant to a contract with the United States Department of Housing and Urban Development. This system is referred to as Part A. In 1978, HUD ended its contractual relationship with the private insurers, and established Part B. Under Part B, FEMA began administering the NFIP. In 1983, FEMA created the ‘Write Your Own’ program which allowed private insurance companies to write their own insurance policies. These WYO companies then directly issue federally underwritten SFIPs to the public, and may hire subcontractors or insurance adjustment organizations to investigate and adjust claims made under an SFIP. Regardless of whether FEMA or a WYO company issues a flood insurance policy, the United States treasury funds pay off the insured’s claim. Further, WYO companies have no authority to alter, vary, or waive any SFIP provision.”  (Citations and internal quotation marks omitted.)

You can read the entire Brooks v. Foglio decision here.  

A lot has been written lately – both by judges and observers – about the so-called “business risk” exclusions and their applicability to construction defect claims.  (We’ve previously discussed them here, for example.)  Some judges have ruled that faulty workmanship can never constitute a covered “occurrence” under a general liability policy.  Lately, though, more and more courts (for example,  in West Virginia and Connecticut) are holding (properly, in my view) that, under certain circumstances, faulty workmanship can lead to a covered loss.

As for the judges that side with the insurance industry on this issue, I pose a couple of questions:

  1. Isn’t “faulty workmanship” a form of negligence, and isn’t negligence covered under liability policies?
  2. Why would “business risk” exclusions remove (at least in part) coverage for faulty workmanship, if faulty workmanship weren’t a covered occurrence in the first place?

I think that a lot of confusion would be removed on this issue if insurance coverage questions were approached in a logical order, rather than conflating exclusions with the coverage grant, which is what many judges do.  The logical order is as follows:

  1. Does the claim stem from a covered “occurrence” such as a negligent act?
  2. Is there an exclusion that removes coverage for that “occurrence”?
  3. Is there an exception to the exclusion that reinstates coverage under certain circumstances?

The better-reasoned decisions are easy to follow and understand, because they follow that construct.  But just when I thought that judges were starting to understand insurance, along comes the recent Eighth Circuit decision in Spirtas Company v. Nautilus Ins. Co.  (I knew I was in trouble with this one when I read the following statement in the case:  “Because the policy exclusions preclude coverage, it is unnecessary to address the coverage issues.”  Huh?)

The Spirtas case asks the following unusual question:  Can a river be considered “your work”?

Facts:  Spirtas is a demolition company that got hired to take down the bridge over the Seneca River in Illinois.  Spirtas subcontracted the blasting and demolition of the longest span to Dykon Explosive Demolition Corporation. 

It’s never good when the Court’s opinion says in part:  “The operation did not go as planned.”  Apparently the charges malfunctioned and part of the bridge fell into the river in what the Court describes as a “mangled mess.”  Divers had to come in to identify the pieces of the bridge and cut them apart.  Then the debris had to be removed from the river.  Spirtas obviously incurred additional unbudgeted costs as a result of having to clean up the mishap, and filed a claim with Nautilus, its liability carrier.  Nautilus denied the claim.

Nautilus relied in part upon an exclusion removing coverage for “that particular piece of real property on which you or any subcontactors or contractors working on your behalf are performing operations, if the ‘property damage’ arises out of those operations.” The Court approved the denial, writing:  “Dropping the bridge span into the river was an integral part of demolition.  Therefore, both the bridge and the river were the ‘particular part of real property’ on which Spiritas’s operations occurred.”

Now, wait a minute.  “Real property” is generally defined as land and fixtures.  Click here to read the legal definition.  A river is most definitely not “land” or a “fixture.”  I respectfully suggest that this Court, like many, applied an exclusion by pounding a square peg into a round hole, because of the “faulty workmanship is never covered” rule apparently taught in judge school.

As further evidence of the square peg/round hole problem, an endorsement to the policy provided coverage for “property damage” arising out of the “inadvertent or mistaken demolition of property resulting from the insured’s demolition or wrecking operations.”  Nautilus contended that this clause applied only when an incorrect structure is demolished.  The Court agreed.  But the endorsement, by its terms, does not bar coverage for “demolition of mistaken property”; rather it bars coverage for “mistaken demolition of property.”  That is a distinction with a difference.  Dictionary.com defines “mistaken” to include “erroneous; incorrect; wrong: a mistaken answer.”  (Emphasis in original.)  This case arose from “incorrect” demolition.  The Court here did not bother to refer to the dictionary, instead accepting the insurance company’s unilateral definition of what the exclusion actually meant.

The decision cites other exclusions as well, and I don’t mean to suggest that it’s entirely wrongheaded (although, since I’m on the policyholder side, you can pretty well guess what I think).  The real trouble is that if a given number of Courts (or even claims personnel) were faced with a claim like this one, their answers as to whether coverage exists would vary.  It’s very difficult to do risk management planning if you’re unsure whether the insurance company will pay.  The sad truth is that many Courts and claims personnel don’t look to find coverage; they look only to find exclusions that can erase coverage.

Here’s a quote from a 1983 Travelers manual for its claims personnel, from a section captioned  “Analysis of Liability Coverage”:  “[There is] a requirement to meet the duty of good faith to the insured.  The most positive way to do that is to look for coverage in our policies, and not to look for ways to deny coverage.”

I guess times have changed.

You can read the full Spirtas decision here.

I confess:  I sometimes wonder whether some claims personnel have ever heard of the “red face” test.  In other words, you should only take a negotiating position if it doesn’t actually cause you to blush.  Otherwise, how could seemingly rational people contend that buying “expanded” coverage means that the policyholder has no coverage?  (And how do they get some judges to agree with them?)

Let me explain, in the context of the oft-misunderstood coinsurance penalty contained in most property insurance policies.  Coinsurance is a type of “fine” that the carrier  imposes on the policyholder for under-insuring the value of tangible property or business income. The penalty is based on a percentage stated within the policy and the amount under-reported.  The most common penalty is 80%, but it can be as high as 100%.  

As an example: A building actually valued at $1,000,000 is insured for only $750,000 under a policy containing an 80% coinsurance clause. Since the building’s insured value is less than 80% of its actual value, when a loss happens, the claim payment will be subject to the underreporting penalty. If the policyholder suffers a $200,000 loss, the policyholder will recover $750,000 ÷ (.80 × 1,000,000) × 200,000 = $187,500 (less any deductible).  So, in this example, the underreporting penalty would be $12,500.  You can see why accurately reporting property values to the carrier is important.

Now let’s look at an actual case involving coinsurance.  Buddy Bean Lumber Company (no I’m not making the name up) operates a lumberyard in Arkansas (of course).  Someone stole a supply of valuable electrical wire from Buddy Bean’s lumberyard.  Buddy Bean filed a claim with its carrier, Axis, asking to recover the actual cash value of the wire.

With respect to this particular claim, the Axis policy contained a few important provisions. 

First, the policy had a 90% coinsurance provision tied to the value of Buddy Bean’s saw and planing mills, which stated:  “Axis will not pay the full amount of the loss if the value of Covered Property at the time of loss times the Coinsurance percentage shown for it in the Declarations is greater than the Limit of Insurance for the property.”  The policy defined “value of Covered Property” as the property’s “actual cash value as of the time of the loss or damage.” 

Second, for an additional premium, Axis sold Buddy Bean “optional replacement cost coverage” that allowed Buddy Bean to choose whether to file a claim on an actual cash value basis or on a replacement cost basis.

The stolen wire had an actual cash value of $725,000, but Axis refused to pay that amount, arguing that the claim was subject to a huge coinsurance penalty.  According to Axis, the value of the saw and planing mills for purposes of the coinsurance provision should not be measured by actual cash value ($4,050,000) but instead by replacement cost ($21,024,000).  The Axis theory:  The effect of Buddy Bean’s buying optional replacement cost coverage was the substitution of “replacement cost” for “actual cash value” in the coinsurance provision. Since the policy limit for the mills was only $3,837,500, way short of the replacement cost of the mills, Axis argued that Buddy Bean had failed to buy adequate insurance.

Buddy Bean, on the other hand, argued that it had the right under the policy to choose to have the claim processed on an actual cash value basis, meaning that the mills should be valued at actual cash value for purposes of the coinsurance provision.  Hence, no penalty.

What’s amazing to me is that the district court agreed with Axis, holding that “the policy language was unambiguous and…the value of the mills should be measured by their replacement cost because Buddy Bean had purchased replacement cost coverage, thereby changing the definition of ‘value’ in the coinsurance provision.”  (Um, judge, what about the fact that Buddy Bean retained the option to file claims on a cash value basis?  Court:  Don’t bother me with details!)

I suppose this is why the Lord invented appeals courts.  The Eighth Circuit (properly) reversed, writing: “The proper interpretation of the coinsurance provision depends on whether the insured has filed an actual cash value or a replacement cost claim.   Here, Buddy Bean filed a claim with Axis for the actual cash value of its stolen wire.  In order to calculate whether Buddy Bean is subject to a coinsurance penalty on that claim, the term ‘value’ in the coinsurance provision should be read as the actual cash value of Buddy Bean’s saw and planing mills…Contracts of insurance should receive a practical, reasonable and fair interpretation consonant with the apparent object and intent of the parties…Buddy Bean’s choice to purchase a type of expanded coverage was not intended to vitiate its basic coverage…If Buddy Bean’s decision to buy replacement cost coverage would automatically change how to calculate the coinsurance provision, the insured would always suffer a substantial coinsurance penalty even on actual cash value claims.”

What would the Axis claims person say about all this?  Probably what Robert DeNiro’s (character’s) kid said in “A Bronx Tale”: “Hey, I took a shot.”  In any event, if you’re buying replacement cost coverage, check the coinsurance provisions very carefully.  

You can read the full Buddy Bean decision by clicking here. 

Insurance claims personnel have a natural, probably genetic, aversion to certain topics.  One of them is insurance coverage for “advertising injury.”  So, if your advertising injury claim is in any way unusual, chances are that as a policyholder you’re going to run into trouble with your carrier.

Some brief background:  Commercial general liability policies typically provide coverage for claims of “personal and advertising injury.” This generally includes, for example, coverage for liability claims brought against the policyholder that allege “oral or written publication, in any manner, of material that slanders or libels a person or organization or disparages a person’s or organization’s goods, products or services.” 

But what if the policyholder is accused of false advertising bragging about its own product, and not specifically trashing, or even mentioning, the competitor’s product?  Does the “advertising injury” coverage contained in standard commercial general liability policies apply to so-called “implied disparagement”?

Let’s take a look at two recent cases involving the question of coverage for “implied disparagement,” one of which involved the venerable Kim Kardashian, who’s famous for being famous.  Kardashian was once quoted as saying:  “I’m Armenian, so I’m obsessed with laser hair removal.”  Fittingly, then, a company called Tria, Inc. hired her as its celebrity spokesperson in connection with a line of products aimed at, you guessed it, hair removal (as well as acne removal).  Tria later became embroiled in trademark litigation with a competitor, Radiancy, Inc., in which Radiancy claimed that Tria (and Kardashian) had made false and misleading statements in its advertising. 

The interesting aspect of this is that Tria’s advertising said nothing at all about Radiancy.  Instead, Tria’s advertising simply touted its own products as being, for example, “faster,” “superior,” “more powerful,” and more “advanced” when compared to other (unnamed) products on the market.  Radiancy claimed that Tria’s advertising, although not directly addressed to Radiancy, nevertheless caused Radiancy to lose sales, and damaged Radiancy’s goodwill.

Tria’s carriers disclaimed coverage for the claims against Tria, arguing that Radiancy had only contended that Tria had made misleading claims about its own products.  If Tria did not directly disparage Radiancy’s products, the argument went, there could be no “advertising injury” coverage.

Wrong, said the Court, writing: “It is significant that the disjunctive policy language (‘slanders or libels…or disparages’) did not delineate specific causes of action to which ‘disparagement’ applied.  This was done in the exclusions section, which carved out a variety of subject matter from coverage.  Given this structure, reading the policy broadly to cover implied, ‘own-product’ disparagement would be consistent with a reasonable insured’s objective expectations.”  (Emphasis added.)  (Alas, the Court then went on to negate coverage for other reasons, such as an intellectual property exclusion.  Not sure why the Court went through the exercise of explaining how “advertising injury” coverage works, only to eviscerate the coverage on other grounds, but so be it.)

You can read the full Tria decision here.      

In another recent case involving insurance coverage for “implied disparagement,”  a pharmaceutical manufacturer named TPU, which sold a prescription topical analgesic called Lidoderm, claimed that the policyholder (JAR) had made false and misleading statements in the course of advertising its own product, a nonprescription topical analgesic called LidoPatch.  The allegedly false statements included:  “Like the prescription brand, LidoPatch will provide relief for up to 24 hours!”  The LidoPatch advertising did not mention Lidoderm by name. 

The Court held that TPU’s allegations were sufficient to trigger the carrier’s duty to defend, writing:  “That plaintiff’s statements did not identify Lidoderm by name is immaterial…Whatever words plaintiff used, TPU clearly understood (and alleges that ‘a substantial segment of consumers’ would likewise believe) that plaintiff’s implicit ‘message’ was about Lidoderm…[and] a statement equating a competitor’s product with an allegedly inferior one is logically indistinguishable from, and no less disparaging than, a statement describing one’s own product as ‘superior’ to the competitors’.”

These cases turn on the reasonable expectations of the policyholder.  If the policy doesn’t expressly limit “false advertising” claims to cases in which the policyholder explicitly and directly disparages a competitor’s product, why shouldn’t coverage exist?  Otherwise, aren’t claims personnel just engaging in what we euphemistically call “post-loss underwriting”?

You can read the full JAR case here.

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.

Claims-made policies were supposed to simplify things.  In an article a few years back, insurance expert Fred Fisher noted that the idea behind such policies was to provide greater actuarial certainty for insurance companies, by ensuring that there would be no more claim activity following the end of a policy period (eliminating the “incurred but not reported” problem under occurrence-based policies).

But, of course, we humans are experts at complicating the simple.  One bedeviling issue under claims-made forms can be:  When is a “claim” actually “made”?  Specifically, when can claims be deemed “related”, so that a later claim outside the policy period is so closely tied to a prior claim inside the policy period that both are covered?  This tricky issue recently surfaced in a federal court case in Washington state involving EPLI and D&O coverage and a whistleblower claim.

Facts: Richard Klein was the CFO of a biopharma company called Omeros.  Klein claimed that Omeros unlawfully terminated him for internally reporting financial irregularities relating to a grant supervised by the National Institutes of Health.  Under a reservation of rights, Carolina Casualty defended a whistleblower lawsuit brought by Klein, and apparently spent over a million dollars in fees doing so.

During discovery in his lawsuit, Klein learned of additional facts that he felt supported a qui tam claim on behalf of the United States.  He moved to amend his complaint, asserting that Omeros had violated the federal False Claims Act.  The motion to amend was filed after Carolina Casualty’s policy period had ended.  Carolina Casualty agreed to defend Klein, again under a reservation of rights, but later filed a declaratory judgment action arguing in part that the qui tam claim was not covered.  The question was whether the qui tam claim “related back” to Klein’s original complaint, and therefore fell within the Carolina Casualty D&O policy.  That policy provided, in part, that “all claims based upon or arising out of the same Wrongful Act, or one or more series of any similar, repeated or continuous Wrongful Acts or Related Wrongful Acts, shall be considered a single claim.”

Carolina Casualty argued that the two claims were separate and distinct, in part because (A) the retaliation claim sought recovery for damage to Klein personally, while the qui tam claim sought recovery for damage to the government; and (B) the retaliation claim did not require Klein to prove that Omeros actually made false claims, while the qui tam claim did require Klein to do so.

But the Court rejected the carrier’s arguments, writing:  “This court holds that the qui tam claim and the anti-retaliation claim Mr. Klein raised in his initial complaint are based on related wrongful acts.  As the court has already noted, Mr. Klein’s initial complaint discloses his belief that Omeros made false claims.  That he chose not to pursue a qui tam claim based on that belief is immaterial, what matters is whether the qui tam claim is (in the language of the policy) ‘logically…connected’ to the anti-retaliation claim by reason of ‘any common fact, circumstance, situation, transaction, casualty, event or decision.’…Omeros’s alleged false reporting is a common event that logically connects the anti-retaliation and qui tam claims.” According to the Court, “Any common fact or event is sufficient to make two wrongful acts related.”  So, a win for the policyholder.

This ruling reminded me of two tangentially related insurance items (or concepts).

First, when determining whether the duty to defend exists, carriers aren’t supposed to depend on labels; they’re supposed to assess the substance of what’s being alleged.  As the New Jersey Supremes have written:  “Insureds expect their coverage and defense benefits to be determined by the nature of the claim against them, not by the fortuity of how the plaintiff, a third party, chooses to phrase the complaint against the insured. To allow the insurance company ‘to construct a formal fortress of the third party’s pleadings and to retreat behind its walls, thereby successfully ignoring true but unpleaded facts within its knowledge that require it, under the insurance policy, to conduct the putative insured’s defense’ would not be fair.”  SL Indus. v. Am. Motorists Ins. Co., 128 N.J. 188, 198-99 (1992) (citations omitted). 

Since Klein’s claims all stemmed from alleged financial improprieties engaged in by Omeros with respect to government work, wouldn’t Omeros reasonably expect the claims to be “related” for purposes of determining coverage?

Second, remember the protracted insurance fight over whether the World Trade Center attacks constituted one “occurrence” or “event,” or two?  As this 2004 article points out, the resolution of that issue depended upon the policy form being used, and also upon the jury deciding the issue.  Which leads me to the following question:  if the insurance company can’t obtain summary judgment on a coverage claim, doesn’t that mean that the policy can be reasonably interpreted in more than one way?  And if so, isn’t the policy by definition “ambiguous”?  (Ambiguities are supposed to be construed in the policyholder’s favor.)   The dictionary seems to say so.  But what does Webster know, anyway?

You can read the full Omeros decision by clicking here.  

I’ve been working on reviewing a general contracting agreement for a rebuild following Sandy, and the attendant insurance requirements.  I just came across a very useful 50-state survey on the enforceability and construction of indemnification agreements, which you can access by clicking here.  If you’re involved with this area of the law, I think you’ll find it helpful. 

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.

As the Sandy-related insurance disputes develop along the New Jersey coast, we’re seeing what we anticipated:  general liability and homeowners’ carriers are disclaiming coverage on the ground that the damage was caused by flood, and is therefore excluded.  Policyholders, on the other hand, are trying to establish that a good portion of the damage wasn’t flood-related, but rather resulted from severe, sustained winds and wind-driven rain in advance of the storm surge.  And here’s a twist:  One policyholder that I know of sustained severe damage when a pipe under its building burst during the storm.  So, what happens when there are multiple potential causes of loss that combine to cause damage?

The starting point, as always, is the policy language.  Many first-party property policies contain “anti-concurrent causation” clauses.  A typical anti-concurrent causation clause reads:  “We do not insure for loss caused directly or indirectly by any of the following.  Such loss is excluded regardless of any other cause or event contributing concurrently or in any sequence to the loss:  [flood, earth movement, etc.]”  If you’re on the policyholder side and you’re faced with such a clause, you may need some engineering help to determine whether identifiable areas of damage are separately attributable to covered causes of loss (such as wind).

Putting to one side the anti-concurrent causation clause language, New Jersey follows “Appleman’s rule.” Under Appleman’s Rule, the loss is covered if a covered cause starts or ends the sequence of events leading to the loss.  Let’s take a look at how this works.  In Stone v. Royal Ins. Co., 211 N.J. Super. 246, 252 (App. Div. 1986), for example,  the policyholders’ basement flooded as a result of a rupture in a hose that connected their sump pump to a drain. The policy covered loss due to “[a]ccidental discharge or overflow of water or steam from within a plumbing, heating or air conditioning system or from within a household appliance.” The carrier disclaimed liability under a clause that excluded “loss resulting directly or indirectly from … [w]ater damage, meaning … water below the surface of the ground …”  According to the carrier, the sump pump was pumping out water that originated beneath the surface of the ground; hence, no coverage.

The Court disagreed, writing:  “Here, the underground water, an excluded peril, started the loss-producing chain of causation, but the last event, the ruptured hose on the appliance, was a covered risk.”  The Court therefore remanded the case to the trial court (which had granted summary judgment in favor of the carrier) for a determination of the extent of damage caused as a direct result of the ruptured hose, as distinguished from any damage caused by water seepage alone.

For a situation in which a concurrent loss-type claim was not covered, consider Brindley v. Firemen’s Ins. Co., 35 N.J.Super. 1, (App.Div. 1955).   In Brindley, the policyholder owned a beachfront home in Lavallette.  In November 1953, a severe windstorm took place, resulting in serious damage to the house, including shingles blown from the roof and side, a television antenna torn down, linoleum on the floors damaged by water, a storm door blown off, and sand blown high against the rear of the building, requiring its removal and causing such scaling of the exterior paint that repainting was needed.  Windstorm was a covered peril under the policy; flood was not.  In addition, damage to the interior of the home was not covered if caused “by water, rain, snow, sand or dust, whether driven by wind or not, unless the building covered or containing the property covered shall first sustain an actual damage to roof or walls by the direct force of wind or hail and then [the carrier] shall be liable for loss to the interior of the building or the property covered therein as may be caused by water, rain, snow, sand or dust entering the building through openings in the roof or walls made by direct action of wind or hail.”  (Who writes this stuff?)

At the coverage trial, witnesses testified that the interior damage was caused by “the storm,” but did not specifically testify as to how the damage was caused.  Was it caused by holes ripped into the building by the wind, and then rain entering through the holes (hence, covered)?  Was it caused by flood (hence, excluded)?  The trial court (this was a bench trial) apparently concluded that the damage was caused by a covered peril, but the policyholder had produced no specific evidence to allow that conclusion.  Interestingly, the insurance company offered no evidence on its own case, instead simply arguing that the policyholder’s proofs were insufficient.  (This was the early fifties, when trial lawyers weren’t afraid to take a position and stick to it. I can’t imagine such a thing happening in a New Jersey courtroom today.)  

The appeals court reversed, writing:  “[T]here is no direct evidence here to support a finding that the wind, rather than tidal or ocean water, or rain seeping through the roof or walls, caused any of the damage complained of. All of the evidence is circumstantial. Most of it is tenuous. We know from the testimony that there was unusually high water at least in the immediate vicinity of this building on the day of the storm. There is nothing shown either to support or negate the hypothesis that ocean water swept through this building. There is a distinct possibility that it did. The finder of the facts could not say, on the basis of the testimony of persons who saw the property the day after the storm or later, that the sand piled against the house, the missing storm door, or the water on the floor were not the work of high water or rain rather than wind alone… ‘it was incumbent upon [the policyholder] to establish by a fair preponderance of the evidence that the proximate cause was windstorm.’”  (Citation omitted.)

From the policyholder side (and since the Brindley judges are all long gone and can’t hurt me!), I’ll say that the decision in Brindley is wrongheaded in a number of respects.  The statement that “the evidence is circumstantial” is vacuous; many trials, even criminal trials using a “beyond a reasonable doubt” burden of proof, are decided based upon “circumstantial” evidence.  Did the court expect the policyholder to stand in front of the house in the middle of a cyclone and take pictures?  Equally vacuous is the statement that “[t]here is nothing shown either to support or negate the hypothesis that ocean water swept through this building.”  The burden is on the carrier to prove the applicability of exclusions, and not on the policyholder to prove their inapplicability.

But Brindley does contain an important lesson for policyholders.  Sandy claims, and any claims involving multiple causes of loss, need to be approached carefully.  You have to show the finder of fact that some or all of the damage was caused by a covered peril.  That may require experts, such as engineering experts – and, unfortunately, experts are expensive.  And carriers know that.