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

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

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

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

I recently got interviewed by Ed Beeson of the Newark Star-Ledger as part of his article about the looming Superstorm Sandy insurance coverage litigation.  The insurance industry has definitely circled the wagons, and the first suits are now being filed.  There will be a lot of battles over causation (e.g., wind versus flood), as well as E&O litigation against brokers.  You can read the full article here. 

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

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

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

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

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

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

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

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

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

A group of owners of hurricane-damaged homes have brought a putative class action in federal court in Newark, arguing that their flood insurance carriers are short-changing them by calling their first floors “basements”.  The case is Donnelly v. New Jersey Re-Insurance Co., Docket No. 12-cv-7629, and was filed by Union City solo Jeffrey Bronster.

FEMA policies define a “basement” as a space with all four walls underground, but, according to the plaintiffs, many homes have a first floor that is partially underground.  The difference is significant because the policies provide lower coverage, or none at all, for damage in the basement.  The class representative is Patrick Donnelly, who had his home damaged by Irene.  The carrier deemed the first floor the “basement”, even though the rear wall of that floor is entirely above ground.  (I’m sure this is going to be an issue with Sandy claims as well.)

The eight named defendants are New Jersey Re-Insurance Co., which is a subsidiary of New Jersey Manufacturers Ins. Co.; Fidelity National; Hartford; Liberty Mutual; Selective; Philadelphia Contributionship; State Farm; and Travelers.  

New York’s highest court issued an interesting decision last week on the professional duties of insurance brokers.  This is a topic of renewed interest following Sandy, as I’m sure that more than a few policyholders will claim that their brokers provided them with insufficient coverage to weather the storm (pun intended).  I know, for example, that carriers are denying claims out on the Barrier Islands without even bothering to send out adjusters, so there are going to be a lot of unhappy policyholders around.

The policyholder in the New York case, American Building Supply, sells building materials to general contractors, and is the sole tenant in a subleased building which is used only by ABS employees and not open to the general public.  ABS claimed that, in discussions with its broker, it specifically requested general liability coverage for its employees in the event of injury.  Unfortunately, the policy involved in the case contained a cross-liability exclusion clause that provided in part:  “This insurance does not apply to any actual or alleged ‘bodily injury’…to…a present, former, future, or prospective partner, officer, director, stockholder, or employee of any insured.”  Neither the broker nor ABS actually read the policy when it was sold.  And you can guess what happened next:  an injured employee and a denial of liability coverage.

The broker (Petrocelli) attempted to defend the resulting malpractice suit by arguing that ABS was itself negligent, by failing to read and understand the policy it purchased.   The Court disagreed with that position, writing:  “The failure to read the policy, at most, may give rise to a defense of comparative negligence but should not bar, altogether, an action against a broker.” The Court also wrote:  “To set forth a case for negligence or breach of contract against a broker, a plaintiff must establish that a specific request was made to the broker for the coverage that was not provided.”  Here, issues of fact existed as to whether ABS had specifically requested coverage for its employees in the case of accidental injury, so the appeals court sent the case back to the trial court for resolution of that issue. 

In rendering its decision, the Court noted that Petrocelli’s position was illogical:  “Since no one but employees ever entered the premises, the coverage [Petrocelli] obtained, which excluded coverage for injuries to employees, hardly made sense.” 

You can read the full ABS case by clicking here.

The rule in New Jersey is slightly different.  The key New Jersey case is Aden v. Fortsh, 169 N.J. 64 (2001).   In Aden, the husband-and-wife policyholders bought a $48,000 condo and contended that they asked Fortsh, an insurance broker, to cover both the condo and $16,000 in contents.  Fortsh contended that he advised the Adens to consult the condo association policy to make sure that anything not covered by the policy he sold would be covered by the association’s policy.  As an aside, the first policy that Fortsh offered had a $120 annual premium, which the Adens rejected as too expensive.  Fortsh then got the Adens a policy with a $98 annual premium.  (Note to professionals:  when clients nickel-and-dime, there’s trouble just over the horizon.)  Fortsh completed the application for the policy and signed it with the Adens’ permission (a mistake in retrospect, since had the Adens signed it, the subsequent malpractice case would have been harder to sustain). Unfortunately, the policy had only $1000 in total coverage.

The Adens never read the policy.  A fire happened, and they had to pay $20,000 for repairs out of their own pocket.  Result:  malpractice suit.

The Court said that the Adens’ failure to read the policy didn’t matter:  “To hold that an insured must read the policy, and therefore is not entitled to rely on the broker’s expertise… would make the insured responsible for ‘self-inflicted harm,’ despite the broker’s express obligation to protect the insured from that harm…A broker is not an ‘order taker’ who is responsible only for completing forms and accepting commissions.”

The Court noted that its ruling would not preclude brokers from arguing that the policyholder’s failure to read the policy was the true cause of the harm.  But, the Court said, the broker’s lawyer had tried to do just that at trial, and the jury had rejected his efforts.  The Court wrote:  “Even had he read the policy, [Aden] would have been entitled to assume that the $1000 in dwelling coverage was sufficient coverage in light of Fortsh’s professional obligation to ensure that the condominium association’s policy and the policy he was procuring for Aden, in the aggregate, provided adequate coverage.”

You can read the full Aden decision by clicking here.

Here’s my take on all this.  Insurance policies are often a bewildering forest of arcane and discordant trees and weeds.  (From my perspective as a coverage lawyer, thank heaven for that!) Expecting policyholders to understand them when judges can’t agree on what they mean is usually downright nutty.  The best practice is for a broker to take the time at least to review the declarations page carefully, go over it with the client, and make sure everyone’s on the same page. 

When Hurricane Sandy struck New Jersey last week, one of my out-of-state lawyer friends, employing the sort of dark humor that perhaps only other lawyers can appreciate, congratulated me on my “happy positioning in the world’s greatest business interruption insurance goldmine.”  I told him that, unfortunately, this time I might be a plaintiff instead of coverage counsel.  Luckily, through yeoman’s work by my firm’s staff, we were able to get up and running again fairly quickly (although without heat for awhile). 

I know that, in the wake of this terrible disaster (described by some as “Katrina without the body count”), virtually every insurance broker and coverage lawyer is rushing to publish articles and blog posts on property coverage.  Given my friend’s comment, and not to be outdone, I thought I would take a brief look at a couple of important aspects of the law relating to business interruption insurance, based upon a Third Circuit case from a few years back.

The case is Eastern Associated Coal Corp. v. Aetna, 632 F.2d 1068 (3d Cir. 1980), and while it involved a fire rather than a hurricane, it neatly illustrates some of the typical problems encountered with business interruption claims.

Basically, Eastern owned a coal mine that suffered an underground fire.  With respect to the business interruption aspect of the claim, Eastern wanted reimbursement in two areas.  First, Eastern wanted compensation for the sales value of a portion of the coal that would have been mined by Eastern during the interruption covered by the policy.  Second, Eastern wanted reimbursement for expenses incurred by Eastern in obtaining alternative coal to fulfill its contractual obligation to supply metallurgical coal from the mine to Sharon Steel Corporation.

Let’s begin with the good news for Eastern.  There’s no question that there was a covered loss – fire was a peril covered by the policy – and that the potential for business interruption coverage therefore existed.  Without physical damage caused by a covered peril, there can be no business interruption coverage.  This showcases the need to follow the first rule of coverage work:  Read The Policy.  You can bet there will be a lot of battles in the Sandy arena over whether a covered peril exists.  First party policies, for example, may exclude flood damage but include wind damage. 

Now, let’s briefly define the type of coverage provided by business interruption insurance.  BI insurance is meant to cover “but for” income – that is to say, income that the policyholder would have realized “but for” the physical damage.  Business interruption loss, then, is the difference between (A) what the policyholder would have earned, and (B) what the policyholder actually earned, during the loss period.  If net income equals revenue less expenses, then lost income for BI purposes equals (1) “but for” revenue minus “but for” expenses, LESS (2) actual revenue minus actual expenses.

This formula may seem simple, but it’s precisely where many disputes arise between policyholders and insurance companies.   Insurance companies are forever contending, for example, that the “but for” side of the equation is too speculative – which is exactly what happened in the Eastern case.

Under the coal supply contract, Eastern agreed to furnish Sharon’s metallurgical coal requirements, estimated at 250,000 tons annually, for a ten-year period. The contract contained base prices for coal, and an escalator clause to cover increases in the cost of production. The contract contained a provision that required all metallurgical coal to have a sulphur content of less than 1.6%. 

The insurance companies argued that all of the metallurgical coal would have been sold to Sharon under the contract. If so, the total recovery under the policies for lost production would have been $5.3 million.  Eastern, however, argued that 77,000 of 181,000 tons of lost metallurgical coal production would have been rejected by Sharon because they would have had a sulphur content in excess of the 1.6% requirement under the contract. If so, the 77,000 tons would have been sold on the open market and would have been valued at a higher market price, increasing the recovery from the carrier by almost $900,000.

To prove its point, Eastern submitted evidence of the sulphur content of the coal remaining in the metallurgical portion of the mine at the time of the fire. This data had been obtained by analyzing bore samples of coal from the metallurgical section of the mine. Eastern argued that this data showed that approximately 77,000 tons of metallurgical coal in the mine had a sulphur content ranging from 1.6% to 2.0%.  The jury bought this argument.  Unfortunately for Eastern, though, there was testimony at trial that the coal routinely underwent a “washing” process before sale, which would reduce the sulphur content by an unspecified amount.  The appeals court overturned the jury verdict, writing:  “Without evidence of the effectiveness of the washing process, the jury could only speculate concerning the sulphur content at the time of delivery. There is no evidence from which the jury could infer the effectiveness of washing.”

It’s easy for me to play Monday morning quarterback 30 years later, but how difficult would it really have been to provide an analysis of the effectiveness of the washing process?  Probably not very.  That leads me to two possible conclusions.  First, the data was not good for the policyholder, in which case the policyholder was simply hoping for a $900K windfall.  Second, someone got lazy.  Never get lazy on a business interruption claim, especially a sizable one.  The carrier is going to look for any way it can find to knock down the policyholder’s number or argue it’s too speculative.  It’s important to think through all aspects of the claim and provide conservative, justifiable data.  Always be thinking about how things will play out in Court (and try to avoid getting there).

The second element of the claim involved additional expense incurred by Eastern to comply with its supply contract with Sharon.  On this element, the Court interpreted the policy quite strictly, writing:   “Eastern argues that its substitute and brokerage coal expense was ‘incurred by the Assured to reduce loss’ caused by the interruption and, therefore, is covered by the policy. We do not doubt that Eastern’s liability to Sharon was reduced by its resort to substitute and brokerage coal. However, Eastern fails to take account of the exact words of the policy. The provision compensates insureds for expenses incurred ‘to reduce loss hereunder’. We believe the phrase ‘loss hereunder’ plainly refers to loss compensated under the policy.”  In other words, the additional expenses were not aimed at reducing loss under the policy, but at reducing contractual liability to a third party.

From the perspective of Sandy, the reason I mention this second ruling is that you can’t simply assume that all additional expense will be covered under a business interruption form.  In fact, until you have a commitment in writing from the carrier, it’s safest to proceed from the assumption that none of the additional expense will be covered, unless and until a court decides otherwise.  As a wise man once said, bank in the bank, not in your head.

If you’re interested in reading the entire Eastern Associated decision, click here.  

I’m reading a wonderful book right now called “Young Men and Fire,” by Norman Maclean.  The book is about a horrific forest fire that took place in Montana in 1949.  Amazing how small sparks can result in a conflagration beyond all belief.   Those of us involved in the litigation game are familiar with that problem.  How about an $11 million claim by a client against a law firm resulting from a discovery violation, spawning several lawsuits and a major insurance battle? That was the situation recently faced by the Third Circuit in Post v. St. Paul Travelers, which has been approved for publication.  The case has some interesting things to say about how far the duty to defend extends, and about the essential elements of a bad faith claim.   

The facts:  Post and another attorney at the firm of Post & Schell, P.C. got themselves into hot water for improperly redacting information from documents produced by their client Mercy Hospital in a medical malpractice suit.  Unfortunately for Post, the misconduct came up during testimony at trial.  Mercy immediately fired Post, but became extremely concerned that the jury believed there had been a “cover-up,” which could lead to uninsured punitive exposure.  So, Mercy settled with the plaintiffs for $11 million – its full liability limit.

Mercy then retained counsel to bring a malpractice suit against Post.  The malpractice lawyer asked Post to advise his carrier (Travelers) of the claim, but did not immediately file suit. 

The plaintiffs in the underlying case commenced a sanctions proceeding against Post and his firm for the redactions.  Here’s where this gets interesting, from an insurance perspective.  Post filed a claim for coverage for the sanctions proceeding under his E&O policy on the ground that, although styled as a sanctions proceeding, the complaint was basically a claim for legal malpractice, and facts developed in the sanctions proceeding could be used against him in a malpractice suit.  (Note:  The underlying plaintiff, not Post’s client, filed the sanctions petition.) 

Travelers denied coverage based upon an exclusion for “civil or criminal fines, forfeitures, penalties or sanctions.”  Travelers also denied coverage on the ground that a covered “claim” is defined in the policy as a “demand that seeks damages,” and sanctions are not “damages.” 

Then, the plot thickened.  Mercy (or perhaps its carrier, perhaps sensing a potentially quick way to recover some insurance money) intervened in the sanctions proceeding, arguing that it had an “important interest” in the proceeding because the misconduct of its former counsel was at issue.   Mercy requested whatever relief was “just and equitable” from Post, including “costs, attorneys’ fees and expenses.”  Mercy’s Chief Executive Officer confirmed at deposition that Mercy sought money damages in the sanctions proceeding, including the amount of the settlement and compensation for negative publicity.

At this point, Travelers “saw the light” and offered to contribute to Post’s defense costs in the sanctions proceeding, subject to various qualifications.  Post agreed to Travelers’ terms, and submitted legal invoices for over $400,000, which included $250,000 in fees incurred in the sanctions proceeding before Mercy had intervened.  Travelers, bless its heart, generously offered to pay $36,000 of the $400,000.  Post was not happy.  Later, Mercy offered to mediate its malpractice claim with Post, and Travelers again generously agreed to contribute $3000 toward the mediation.  Post was even unhappier.

Meanwhile, Post sued the underlying plaintiffs’ lawyer (Quinn) for defamation and tortious interference, thinking that, faced with such a suit, Quinn might withdraw the sanctions petition, preventing Mercy from getting “free discovery” to be used in the yet-to-filed malpractice suit.  The “best-defense-is-a-good-offense” tactic worked, and the underlying plaintiffs withdrew their claim.  Mercy then sued Post for malpractice, and Post filed a separate suit against Mercy (not a counterclaim), presumably for fees.  Ultimately, Mercy and Post dismissed their claims against each other, with no money exchanging hands.

In the inevitable coverage litigation between Post and Travelers over defense costs incurred in the various litigations, here were the main issues and how they were resolved:

1. Did Travelers have to pay defense costs associated with the sanctions proceeding (in addition to the malpractice suit)?  Answer:  Yes, but only after Mercy (Post’s client) joined the proceeding and sought damages from Post.  The Court wrote:  “No amount of participation by Mercy in the sanctions proceedings would be sufficient prior to the filing of a ‘suit’ – which means under the Policy ‘a civil proceeding that seeks damages’ – a prerequisite to Travelers’ liability…that prerequisite was satisfied [when] Mercy filed its answer to the sanctions petition and sought damages against Post.”  Once that condition was met, however, the sanctions proceeding and the malpractice claim were inextricably intertwined, so the defense of one necessitated the defense of the other.   

2.  Did Travelers have to pay the costs of Post’s separate suit against Mercy, which was interposed as part of his overall defense strategy?  Answer:  No, although had Post asserted a counterclaim instead of a separate suit, Travelers would have been compelled to cover the costs of prosecuting the counterclaim, because “the pursuit of the counterclaims [would have been] inextricably intertwined with the defense.”  The Court wrote:  “However, Post did not simply assert counterclaims in the same proceeding; rather, he filed a separate civil action in a different venue…to hold that Post’s separate action was covered by the Policy simply because it related to Mercy’s suit would condone, and perhaps even encourage, the multiplicity of litigation.”

3.  Did Travelers commit bad faith by denying coverage based upon the “sanctions exclusion” when it knew that actual damages were sought? Answer:  No, because according to the Court, there was no “dishonest purpose.”  Specifically, the Court wrote:  “Travelers did not frivolously decline to provide a defense to Post; rather, after an investigation and retention of outside counsel, Travelers reasonably concluded that the sanctions exclusion in the Policy applied to Post’s claim and denied coverage.  Even if Travelers’ claims-handling was not ideal, there is no evidence in the record…to indicate that Travelers’ purported handling of Post’s claim was motivated by dishonest purpose or ill will.”  (Emphasis added.)

One observation on the bad faith issue. “Dishonest purpose or ill will” is a pretty murky standard.  Exactly how would a policyholder go about proving that?  Not every case involves a statement from a claims person saying:  “Even though we should, we’re not paying, and, by the way, I hate you.”  Maybe judges should avoid formulating standards that are difficult if not impossible to apply in the real world.  If the insurance company takes a coverage position that is not legitimately debatable and is not reasonably supported by documents in the claim file, that’s bad faith…which most people in the insurance industry understand.

You can read the full decision by clicking here.   

The answer is maybe, under some circumstances.  Unfortunately for the major accounting firm BDO Seidman, however, such circumstances didn’t exist in a recent New York coverage decision.  You can read the full opinion by clicking here.

BDO’s coverage dispute stemmed from a $92 million Florida jury verdict against BDO (ouch), which included $55 million in punitive damages.  The jury found that BDO had prepared fraudulent audits of a failing retirement home that went bankrupt.  The estate of philanthropist George Batchelor sued BDO and Deloitte Touche, saying it relied on the fraudulent audits when investing in a company that acquired, financed and managed assisted living residences.

The carriers disclaimed coverage for the punitive damages award under BDO’s professional indemnity insurance, which contained an exclusion for punitive damages reading as follows:

“This policy excludes…to the extent it is uninsurable by law…any claim for claims for fines, penalties, punitive or exemplary damages imposed by a judgement [sic] or any other final adjudication.”  (Note that, under this exclusion, coverage for punitive damages is precluded only if such coverage is prohibited by law.  Be sure to review exclusions carefully before concluding that there’s no coverage.)

When BDO refused to acknowledge that punitive damages were not covered under the policy, the carriers brought a declaratory judgment action in New York, and then sought summary judgment.

BDO opposed the summary judgment motion by arguing that the coverage case should be put off until an appeal in the underlying case was decided.  The Court refused to delay a ruling, writing:  “[BDO] has presented no reason for this court to question the regularity of the Florida proceedings or the legitimacy of the Florida judgment awarding punitive damages.”

As to coverage for the punitive damages award, the Court wrote:  “The purpose of punitive damages is…to punish conduct having a high degree of moral culpability and to serve as a warning to others in the future… Insurance coverage for the punitive damages in the Batchelor Action would be contrary to public policy.”

In New Jersey, directly assessed punitive damages likewise are not insurable as a matter of public policy.  There’s a question, however, as to whether vicariously assessed punitive damages can be covered.  In Malanga v. Mfrs. Cas. Ins. Co., 146 A.2d 105, 28 N.J. 220 (1958), for example, a jury returned a verdict for compensatory and punitive damages against a partnership and an individual partner, Malanga.   The Court held that the partnership was covered for punitive damages as long as the acts were not authorized by the partnership.  (The case had a Sopranos flair to it.  The partnership was a contracting company engaged in an earth-moving project.  A neighbor refused to allow Malanga onto his property to perform work.  Malanga then did the only sensible thing, running the neighbor over with a bulldozer.)

Specifically, the Malanga Court wrote:  “Since it cannot be said that the assault and battery was committed by, or at the direction of, the insured partnership, there is no reason to deny it the indemnity which it has purchased.  If the defendant intended to exclude the partnership from coverage for liability resulting from an assault by one of its members, it should have made that intention known.”

Absent a clear and specific exclusion for punitive damages, then, don’t assume that a punitive damages award isn’t covered.  It’s important (as always) to examine the policy and the underlying facts very carefully.   

By the way, the Chicago-based law firm of McCullough, Campbell & Lane, LLP, which represents insurance companies, maintains an excellent 50-state survey of this issue on its website.  You can see the survey by clicking here.

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

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

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

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

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

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

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

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

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

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

Large first-party property damage cases often come down to a battle of accountants.  In other words, unlike Olympic beach volleyball, they’re usually not particularly thrilling to watch.  (Not that I have anything against accountants.)  But the results of the battle can have a major impact on the policyholder’s balance sheet.  How is the policyholder’s claim to be measured?  Do we use an “actual cash value” or “replacement cost” analysis?  

Shockingly, the place to start is the policy itself. 

Example:  the recent Ninth Circuit case of Sierra Pacific Power Company v. Hartford, which appears here, involved the destruction by flood of a dam over the Truckee River in California.  The replacement cost of the dam was $19,800,000.  Sierra Pacific argued that it was entitled to the full replacement cost of the dam without any depreciation.  The carriers naturally argued that Sierra Pacific was entitled to a lot less, based upon statements by Sierra Pacific’s broker as to the ACV of the dam. 

In resolving the dispute, the appeals court turned to the valuation language in the policy, which read:  “actual cash value (with proper deduction for depreciation) of the property destroyed.”  The Court wrote:  “ACV means fair market value.  FMV is most commonly determined ‘by way of market data on sales of comparable property’.  In cases where there is no relevant market, however, the FMV may be ‘determined by any method valuation that is just and equitable.’  Specifically, ‘recognized alternatives to the market data approach to valuation are reproduction or replacement costs less depreciation or obsolescence.’” 

The trial court had held that the policyholder was only entitled to $1,261,200, representing what it determined to be the ACV of the dam.  But the court had primarily based its ruling upon a letter in which Sierra Pacific’s insurance broker stated to Sierra Pacific’s claims manager, “We are only agreeing that the [actual cash value] is $1,261,200 and nothing else.”  So, there was never an actual agreement between Sierra Pacific and the carrier…only a recommendation from Sierra Pacific’s broker to Sierra Pacific.  The appeals court therefore found that the trial court had erred, writing:  “Although the district court correctly announced that it would base ACV on replacement cost of the dam less depreciation, it arrived at an amount for the dam’s ACV, $1,261,200, which is not related to the figure it found as the replacement cost ($19,800,000).  The district court relied on its view that Sierra and the insurers had agreed on the value of $1,261,200 as the ACV, but the court explicitly found that the parties did not agree on that number, or any other number, as the ACV for the dam.”  

So, the proper measure to apply under the policy was $19,800,000 (the replacement cost) less appropriate depreciation.

There were a couple of other matters of interest (to us insurance geeks, anyway) that the appeals court resolved in this case.  First was the question of whether increased costs of repair were excluded by the policy’s Building Ordinance or Law Exclusion, which stated in part:  “This policy does not insure loss or damage caused by or resulting from…any increase in the loss due to any ordinance, law or regulation, rule or ruling restricting or affecting repair, alteration, use, operation, construction or installation.”

The court held that the exclusion only excluded damage caused by the peril of building ordinances (it appeared in a section entitled “PERILS EXCLUDED”).  It did not exclude increased construction costs caused by building ordinances when the loss itself is caused by a covered peril – here, a flood.

Finally, what about $4 million spent by Sierra in preparation for rebuilding the dam (engineering studies, etc.)?  The policy contained a provision reading:  “In the event of loss or damage to property which is not repaired, rebuilt or replaced within two years from the date of loss or damage, the company shall not be liable for more than the actual cash value (with proper deduction for depreciation) of the property destroyed.” The carriers argued that, because the policy by its terms did not pay for replacement cost if the dam was not rebuilt within two years, they were not obligated to pay anything more than ACV until the dam was actually rebuilt. 

Wrong, said the appeals court:  “This provision does not state that the Insurers will not pay more than ACV until the property is actually replaced.  Rather, it merely limits the Insurers’ ultimate liability if the property is not replaced within the allotted time.”  The “preparation expenses” were recoverable if they were properly included in the ACV: “We agree that the money Sierra has already spent in preparation for rebuilding should be included in the estimate of replacement cost which is then used to determine the ACV, and we assume it was included in the estimated replacement cost ($19,800,000) the district court found reasonable.  However, if the district court intended that Sierra is entitled to recover expenses in addition to the ACV, there is no support for such a ruling.”

Notably, the trial court found that “Insurers unreasonably denied coverage ultimately available under the policy”…a finding referenced by the appeals court in its own decision.

The takeaway:  When dealing with insurance claims, there’s no substitute for reading the policy.  Carefully.