Here’s a question that perhaps should be posed to a magician:  How can an insurance company turn an $85,000 claim (on a policy with a $100,750 applicable limit) into an $850,000 bad faith verdict?  If you’re Merrimack Mutual, apparently it’s quite easy. 

I wrote about this case some time ago when the jury verdict first came down.  The verdict has now been affirmed on appeal, and the Appellate Division’s decision is here.

Boiled down to its essence, the case involved a claim for damage for a 100-year-old retaining wall following a severe windstorm.  Merrimack sent an investigator out to inspect the damage.  The investigator did not have any background in engineering, but nevertheless concluded that the damage to the wall was not caused by the windstorm, but by faulty maintenance; specifically, vegetation that had grown around and under the wall.  Unlike the carrier, the policyholder then obtained and submitted a report from an actual engineer, certifying that the vegetation growth behind the two failed areas of the wall was “not significant,” and that the wall had been properly maintained.  The policyholder also obtained an $85,000 estimate to repair the wall, in which the contractor noted that the damage to the wall was increasing with each passing day as the two breached areas in the wall became increasingly destabilized.  This was apparently ignored by Merrimack, and the damage to the wall and the surrounding property did in fact multiply while Merrimack fiddled around with the claim.  

In an effort to get Merrimack to see the light, the policyholder filed an internal appeal.  Merrimack reversed the denial, but offered only $62,549.46, which it said was its adjuster’s estimated cost of repair ($108,813), “depreciated by 43% because of the wall’s age.”  The policyholder rejected the check and filed suit. Merrimack then moved to commence the appraisal process specified in the policy, which the Court allowed.  At the conclusion of that process, Merrimack tendered $100,750, the policy sublimit, for the damaged retaining wall.  But the policyholder then amended his complaint to include a claim for bad faith in delaying the resolution of the matter, in part arguing that due to the carrier’s delay in paying the valid claim, the wall had deteriorated further and that additional damage had resulted to the wall and his yard. 

The case went to trial on the issue of Merrimack’s bad faith. At the 10-day trial, the policyholder offered expert testimony that the 43% “depreciation” penalty imposed by the carrier had no support in the claim file or in any published standards.   The jury ultimately came back with a $624,023.20 award, representing the total estimated cost to replace the wall and landscape the policyholder’s yard, and without setoff for sums previously paid by the carrier.  (On a bad faith claim, the finder of fact is not constrained by policy limits; it can award consequential damages stemming from the carrier’s bad behavior.)   The trial judge added $195,583.34 in attorneys’ fees, and $31,346.41 in costs.

In affirming the jury verdict, the appeals court wrote:  “Although a fairly debatable claim is a necessary condition to avoid liability for bad faith, it is not always a sufficient condition.  Rather, we are satisfied that the appropriate inquiry is whether there is sufficient evidence from which reasonable minds could conclude that in the investigation, evaluation, and processing of the claim, the insurer acted unreasonably and either knew or was conscious of the fact that its conduct was unreasonable.” (Citations omitted.) 

This seems to expand upon the definition of bad faith laid out in Pickett v. Lloyd’s, 131 N.J. 457 (1993), where the Supremes wrote: “In the case of denial of benefits, bad faith is established by showing that no debatable reasons existed for denial of the benefits. In the case of processing delay, bad faith is established by showing that no valid reasons existed to delay processing the claim and the insurance company knew or recklessly disregarded the fact that no valid reasons supported the delay.” It will be interesting to see what happens if Merrimack petitions the Supremes for certification.

In any event, in the Merrimack case, the appeals court confirmed that the carrier had acted unreasonably because (A) Merrimack knew that the damage had been caused at least in part by wind and was therefore covered, yet denied the claim anyway; (B) one of the adjusters on the file had noted that the “investigator” sent out by the carrier was not an engineer, and that he (the adjuster) “did not like doing business that way”; and (C) another adjuster on the file testified that he intended to have an actual engineer re-inspect the wall damage, but did not do so prior to denying the claim a second time.

A couple of takeaways here.  First, note that this policyholder affirmatively obtained his own engineering reports and submitted them to the carrier for consideration. From a practical standpoint (as viewed by a finder of fact), that can effectively (if not procedurally) shift the burden of proof to the carrier at trial…not a bad idea.  Second, from the carrier’s perspective, what’s going on here?  You’re really going to go to the mat on a case worth $85,000, based on the report of a guy who has no engineering background?  That’s pretty dumb.  

The policyholder’s counsel on this one was Joel Garber.

One of the issues that frequently comes up in complicated third-party cases is:  How far outside the underlying complaint does the carrier have to go to determine whether coverage exists?  New Jersey is not an “eight corners” state (in which all the court considers is the four corners of the policy and the four corners of the complaint). The New Jersey Supreme Court has specifically held: “Insureds expect their coverage and defense benefits to be determined by the nature of the claim  against them, not by the fortuity of how the plaintiff, a third party, chooses to phrase the complaint against the insured. To allow the insurance company ‘to construct a formal fortress of the third party’s pleadings and to retreat behind its walls, thereby successfully ignoring true but unpleaded facts within its knowledge that require it, under the insurance policy, to conduct the putative insured’s defense’ would not be fair.’” SL Industries, Inc. v. American Motorists Insurance Co., 128 N.J. 188, 197 (1992) (citations omitted).  

Along these lines, some time ago, I wrote about the New Jersey Appellate Division’s decision in Adams-Stiefel Funeral Home v. Zurich American, which involved issues of coverage for companies that were essentially “innocent bystanders” in an illegal plot to harvest body parts from corpses.  In a companion case, the New Jersey Supremes have now affirmed the Appellate Division’s ruling of no coverage.  The case facts are a little unique (and ghoulish), but the decision raises some important questions about the scope of the duty to defend.  The Supreme Court decision is here.  

Memorial Properties and Mt. Hebron are the owner and manager (respectively) of a cemetery known as Liberty Grove Memorial Gardens.  They were implicated in a scheme in which a New Jersey dentist and a New Jersey “master embalmer” worked in conjunction with funeral homes and crematories to obtain access to human remains, and to sell body parts.  Memorial and Mount Hebron denied any involvement in the plot, and consistently maintained that, when they received bodies from funeral directors for cremation, the remains were already in sealed containers that were not opened by Memorial and Mt. Hebron prior to cremation. They also argued that the documentation accompanying the remains appeared proper.    

The families of the decedents alleged that, following the deaths of their relatives on various dates in 2003, 2004 and 2005, two persons not connected with Memorial Properties or Mt. Hebron extracted tissue, bones and organs from the remains without authorization, sometimes replacing harvested bone with polyvinyl chloride (PVC) piping so that the bodies would appear intact. The families contended that these persons falsified decedents’ medical and funeral records to conceal the illegal tampering with the remains.  The families allege that they were unaware of the “harvesting” until law enforcement authorities told them about it in 2006.  They claimed, among other things (and understandably), damages relating to emotional distress.

Two insurance companies – Assurance and Maryland Casualty – denied coverage for the families’ claims. The policies involved are specially tailored to the funeral home industry, but they basically contain “occurrence”-based coverage.

The Assurance policy provided coverage for the year 2003 for claims arising from damage to human remains and bodily injury, including mental anguish.  Assurance took a “no pay” position, on the ground that the occurrences were outside of the policy period, since the families only learned of the harvesting scheme in 2006. 

In upholding the Assurance denial, the Supreme Court wrote in part:         “The decedent’s surviving spouse seeks damages for ‘severe pain and suffering, severe emotional distress and harm, [and] financial or economic loss,’ including lost wages. Her alleged damages derive from her distress upon learning of the unauthorized harvesting of her husband’s tissue, bones and organs, and not from a purported cause of action based on property damage to her decedent’s remains. Accordingly, in the New Jersey case in which the harvesting took place in 2003, the ‘occurrence’ was the plaintiff-spouse’s alleged emotional distress upon discovery of the harvesting scheme in a 2006 conversation with law enforcement, and her claim falls outside of the policy period set forth in the Assurance policy.”

In other words, the Supremes divorced damage to the body (the “property”) from the emotional damage suffered by the plaintiffs.  Since the plaintiffs’ emotional damage only took place after 2003 (hence outside the policy period), no coverage.  Burt how does this square with the principles of SL Industries?  Since the cause of action was in fact based upon damage to the decedent’s body (without that, there would have been no “emotional distress”), wouldn’t a reasonable policyholder expect coverage for this claim?

The other carrier, Maryland Casualty, denied coverage based upon an exclusion removing coverage for claims based upon such activities conducted “by any insured or anyone for whom the insured is legally responsible” including “disarticulation” of body parts from a deceased body, “distribution, sale, loaning, donating or giving away” parts of a deceased body, and “any criminal act.”  Based upon this exclusion, the Supremes wrote in part that the underlying plaintiffs had alleged “an active role by Memorial and Mt. Hebron in the harvesting scheme” which fell “squarely within the parameters of the exclusionary clause.”  

The problem with the ruling in favor of Maryland Casualty is that the policyholders presented evidence that they had not participated in the scheme, and that the bodies had been delivered to them in sealed containers with appropriate certifications.  The Supremes simply resolved that issue against the policyholder without apparently conducting the outside-the-eight-corners analysis required by SL Industries…which is disappointing, to say the least. 

Here’s an interesting question recently confronted by the Ninth Circuit:  Is it bad faith for an insurance company to refuse to initiate settlement discussions in a third-party context when liability has become reasonably clear?  The carrier (Deerbrook, an Allstate company) took the position that bad faith could not exist unless the carrier failed to respond to a settlement demand.  (If you do coverage work, then you know that this is part of the dance.  In large-loss third-party cases, the carrier rarely will volunteer an offer.  The claims rep usually wants a demand on the table first.  Probably this is to set a “celling” on the negotiations.)  

The facts of the Ninth Circuit case were simple:  a car accident in which four people were injured.  The policy had a liability limit of $100,000 for each individual claim, with an aggregate maximum of $300,000 for any one accident.  The lawyer for the underlying plaintiffs submitted a global demand of $300,000.  The claims rep refused to negotiate, saying that there was insufficient information regarding the injuries sustained by three of the four plaintiffs.  Plaintiffs’ counsel then suggested that they try settle the claim of one of the plaintiffs (Yan Fang Du) separately, but did not make a specific demand.  The claims rep refused, stating that Deerbrook had to pay its $300,000 limit and settle all claims.  Later, the carrier offered to pay in its $100,000 “per person” limit with respect to Du.  Du’s counsel rejected the offer as “too little too late.”

The jury came back with over $4 million on Du’s claim.  Deerbrook paid in its $100,000 limit with respect to Du.  The underlying defendant then assigned his bad faith claim to Du in exchange for a covenant not to execute.  Coverage litigation followed, in which the “policyholder” argued that the case would have settled within policy limits had the carrier initiated earlier negotiations. 

To me, the question of whether a carrier has an affirmative duty to initiate settlement discussions is resolved by a simple review of the Unfair Claims Settlement Practices Act, which is codified in New Jersey at N.J.S.A. §17:29B-4(9).  (While the Act does not create a private right of action in New Jersey, the New Jersey Supreme Court has held that it “declare[s] state policy.”  Pickett v. Lloyd’s, 131 N.J. 457, 468 (1993)).  Like New Jersey’s version of the Act, California’s (where the accident took place) identifies as an “unfair claims settlement practice” “’[n]ot attempting in good faith to effectuate prompt, fair and reasonable settlements of claims in which liability has become reasonably clear.”  (In California, this provision appears at Insurance Code section 790.03(h)(5).)

The Ninth Circuit cited the California provision and wrote:  “[T]he conflict of interest that animates the duty to settle exists whenever there is a significant risk of a judgment in excess of policy limits and there is a reasonable opportunity to settle within those limits; this conflict obtains regardless of whether a settlement demand is made by the injured party.  If, as the general duty of good faith requires, the insurer ‘conduct[ed] itself as though it alone were liable for the entire amount of the judgment,’ a rational party should attempt to settle if there is a ‘substantial likelihood in excess of those limits,’ and there is a reasonable likelihood to settle within those limits.”  (Citations omitted.)

But take heart, you carrier types out there.  Under the specific facts of this case, the Court held that Deerbrook did not breach its duty of good faith and fair dealing.  Despite repeated requests, Deerbrook was not given sufficient information to evaluate the claimant’s injuries, and “could not base a settlement offer solely on the representations of plaintiff and plaintiff’s lawyer.”  Therefore, the carrier could not be liable for bad faith in refusing to settle earlier.      

One other interesting thing about this case.  Citing the California Supreme Court in Johansen v. Cal. State Auto. Ass’n Inter-Ins. Bureau, 123 Cal. Rptr. 288, 292-93 (1975), as well as other authority, the Court stated that “a good faith belief in noncoverage does not insulate an insurer from liability for failure to settle a claim.”  So, at least in California, unless the carrier has actually obtained a declaratory judgment of noncoverage, it remains exposed. 

Let’s say you own a factory building.   Construction activity on an adjacent lot causes damage to the structure.  You have the standard first-party property insurance policy providing coverage for “direct physical loss or damage,” and the policy gives the carrier the option of paying either the “cost of repair” or “loss of value.”  If the carrier elects to repair the building, must it also pay for diminution in value of the property caused by the “stigma” of having been physically damaged?  

This question was very recently answered by the Georgia Supreme Court in Royal Capital Development, LLC v. Maryland Casualty Company.  The carrier acknowledged that damage to the building was a covered loss under the policy and paid out over $1 million for the estimated costs of repair.  But the carrier refused to pay anything for the alleged diminution in value due to stigma.   

Citing to, and analogizing to, its prior authority in the context of automobile coverage, the Court unanimously held:  “An insurance policy, drafted by the insurer, promises to pay for the insured’s loss; what is lost when physical damage occurs is both utility and value; therefore, the insurer’s obligation to pay for the loss includes paying for any lost value.”

The Court also wrote that “recognition of diminution in value as an element of loss to be recovered on the same basis as other elements of loss merely reflects economic reality…the measure of damages…is intended to place an injured party, as nearly as possible, in the same position they would have been if the injury had never occurred.” 

Carriers may argue that, under the usual policy language, they have a right to pay for either (A) the costs of repair or replacement or (B) the loss in value.  In the Royal Capital case, for example, the form required Maryland Casualty to pay either “(a)…the value of lost or damaged property; [or] (b)…the cost of repairing or replacing the lost or damaged property.”  By making stigma damages an element of the costs of repair, the argument goes, the Court has muddied the distinction.   

The problem with that argument may be the actual wording of the form.  Subpart (b) of the language quoted above speaks of repairing or replacing the property.  Webster’s defines “repair” as “to restore to a sound or healthy state,” and defines “replace” in part as to “to restore to a former place or position.”  And the Georgia Court found that to accomplish either of these things required the policyholder to be placed in as good a position as it would have been in had the injury not occurred. 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

You can read the full decision here.

Those of us who represent contractors in coverage disputes have had to wrestle a lot over the past few years with so-called “business risk” exclusions, such as the “your work” and “your product” exclusions.  Cynicism may be unhealthy, but the cynic in me says that insurance companies are twisting these exclusions far beyond their intended application, and that some judges (mostly the ones who used to work for defense firms or for insurance companies themselves) are letting them get away with it. 

The supposed purpose of a business risk exclusion is to remove from coverage any claims based upon faulty workmanship that relate to repair of the faulty workmanship itself – not unforeseen and unexpected damage to other property. Example:  I install a boiler in your house.  The boiler blows up and takes out your family room.  My liability carrier won’t pay for damage to the boiler (my work) – but it should pay for the consequential loss (repairing the family room). 

That’s pretty much what the New Jersey Supreme Court held in Weedo v. Stone-E-Brick, 81 N.J. 233, 240 (1979), writing:  “When a craftsman applies stucco to an exterior wall of a home in a faulty manner and discoloration, peeling and chipping result, the poorly-performed work will perforce have to be replaced or repaired by the tradesman or by a surety.  On the other hand, should the stucco peel and fall from the wall, and thereby cause injury to the homeowner or his neighbor standing below or to a passing automobile, an occurrence of harm arises which is the proper subject of risk-sharing as provided by the type of policy before us in this case.” 

As another example, let’s take a look at the First Circuit’s very recent decision in Oxford Aviation, Inc. v. Global Aerospace, Inc., Docket No. 11-2208 (1st Cir. May 18, 2012).  I should point out that the decision is notable not only for what it says, but because retired U.S. Supreme Court Justice David Souter sat on the panel.

Facts:  Oxford repairs airplanes.  Airlarr owned an airplane and hired Oxford to fix it.  During the flight home from Oxford’s facility in Maine to Airlarr’s home base in Pennsylvania, one of the plane’s windows cracked.  Airlarr also contends that, following Oxford’s repairs, Airlarr was left with uncomfortable seats, leaking fuel injectors, a cracked turbocharger, and an improperly installed carpet.              

Oxford’s general liability carrier (Global Aerospace) disclaimed coverage for the resulting lawsuit, including any duty to defend, based upon the business risk exclusions. 

But the First Circuit ruled in favor of the policyholder.  As for the “your work” exclusion, the Court wrote:  “[T]he your-work exclusion by its terms does not apply to ‘property damage occurring away from premises you own or rent and arising out of your product or your work,’ and Airlarr explicitly alleged that the crack [in the window] occurred in-flight.”

As for the “your product” exclusion, the Court wrote:  “Neither the complaint nor the incorporated estimate sheet say that the side window was a product installed by Oxford; and Global has not suggested otherwise, beyond a half-hearted argument that ‘your product’ should be read broadly in the context of the whole agreement.”

The Court similarly dispatched the carrier’s arguments based upon the “products completed” exclusion and the “impaired property” exclusion.

Here’s what the First Circuit had to say about so-called “faulty workmanship” claims generally:  “For obvious reasons (e.g., to cover consequential damages claimed by third parties), the CGL policy does not have an exclusion broadly written to exclude all claims arising from faulty workmanship.  Rather, [the carrier] has crafted complex exclusions occupying several pages of text; and they have created an opportunity in some cases for a complaint to circumvent all of them.  Here, at least one scenario relating to the cracked window, occurring in flight and away from Oxford’s facilities, does fall within coverage and could plausibly avoid all cited exclusions.”   (Emphasis added.)

Therefore, opined the Court, although coverage was a “close call,” the duty to defend existed.

For those of you who might want more reference material on the business risk exclusions, the Fall 2011 edition of the ABA Tort Trial & Insurance Practice Law Journal (Volume 47, Issue 1) contains a great article entitled “Recent Developments in Insurance Coverage Litigation,” which contains a section captioned “Coverage Related to Faulty Workmanship Claims.”  The authors review a number of different recent decisions, and cite a South Carolina case, Crossman Communities of N.C., Inc. v. Harleysville Mut. Ins. Co., Op. No. 26909 (S.C. Jan. 7, 2011), withdrawn on rehearing and superseded by 717 S.E.2d 589 (S.C. 2011), in which the Court concluded that this area of the law is an “intellectual mess.” 

Hmmm.  If it’s really such an “intellectual mess,” and if the policyholder gets the benefit of the doubt on questions of policy construction…shouldn’t coverage be deemed to exist in any case not involving repair to the faulty workmanship itself?

(The Journal is available through TIPS here, although for some reason they don’t have a listing for Volume 47, Issue 1 on the ABA website yet.)

The New Jersey Law Journal reports that defense contractors’ employees who worked in Iraq and Afghanistan are suing Prudential Insurance, alleging that it sold policies without disclosing that war-zone deaths and injuries were not covered.

The policies, sold to civilians at U.S. military bases overseas, were worthless as a result, the plaintiffs charge in Menkes v. Prudential, No. 12-2880, filed in federal court in Newark last week.

Long-term disability, supplemental term life and supplemental accidental death and dismemberment policies excluded claims “due to war, declared or undeclared, or any act of war.” The putative class action seeks compensation for workers for defense contractors in Iraq or Afghanistan from Feb. 10, 2006, to the present who bought the policies that contained the war-zone exclusion. It also seeks compensation for a subclass of workers whose claims were denied based on the exclusion.

The plaintiffs are represented by Michael Galpern, of the Locks Law Firm in Cherry Hill.

The case will be interesting to follow.  In my experience, New Jersey federal courts tend to be defense-oriented, but this matter has a large sympathy factor involved.

Here’s an interesting situation that recently came up.  A general contractor (Aristone) got sued in a construction defect case involving continuous water damage to a building over several policy periods, involving several insurance companies.  One of Aristone’s carriers – OneBeacon – stepped up to provide a defense.  Another – Pennsylvania Manufacturers – took a “no pay” position, but agreed to go to binding arbitration with Aristone on the coverage dispute.  Aristone won the arbitration against Pennsylvania as to coverage, and Pennsylvania then agreed to settle the insurance claim with Aristone for $150,000.  In exchange for the payment, Aristone executed a general release in Pennsylvania’s favor, encompassing “[a]ll claims that have been brought against [Pennsylvania] or could have been brought against [Pennsylvania] in  [the coverage] action brought by Aristone.”  The release stated that it applied to Aristone and “[a]nyone who succeeds to [Aristone’s] rights and responsibilities.”  

Later, OneBeacon filed suit against Pennsylvania, seeking reimbursement for Pennsylvania’s supposed allocated share of defense costs ($105,773.50, according to OneBeacon).  Interestingly, the attorney who brought the coverage suit against Pennsylvania was the lawyer who had been previously appointed by OneBeacon to defend Aristone in the underlying suit (and who had negotiated the release with Pennsylvania on Aristone’s behalf).  In response to OneBeacon’s suit, Pennsylvania naturally argued that OneBeacon’s claim was barred by Pennsylvania’s earlier settlement with Aristone.  

The New Jersey Appellate Division, citing California authority, disagreed, writing:  “Where two or more insurers independently provide primary insurance on the same risk for which they are both liable for any loss to the same insured, the insurance carrier who pays the loss or defends the lawsuit against the insured is entitled to equitable contribution from the other insurer or insurers…As a corollary to this principle, we hold that one insurer’s settlement with the insured is not a bar to a separate action against that other insurer or insurers for equitable contribution or indemnity.”     

As to the effectiveness of the release, the Court wrote: “Because OneBeacon had an independent, rather than a derivative, right to contribution, Aristone’s release of its rights, like the settlement itself, did not, by itself, extinguish OneBeacon’s right to seek contribution.” (Emphasis added.)  But the Court went on to hold that this specific release, by its terms, was ambiguous as to whether the parties actually intended to bar a future claim by OneBeacon against Pennsylvania for contribution. After criticizing the lawyers who drafted the release and who seem to have intentionally left it ambiguous, the Court ruled that the interpretation of the release would be an issue for trial.

The policyholder, Aristone, seems to have made out all right in this case – it got a full defense as well as a $150,000 payment against the claim.  (It’s not clear whether the $150,000 was for a total policy buyback, which would raise its own set of separate issues, but that’s a subject for another post).  But it seems that OneBeacon may have found itself in trouble here because of its failure to clarify the coverage picture up front as required by the New Jersey Supremes in Owens-Illinois v. United Ins. Co., 138 N.J. 437, 479 (1994).  There, the Court specifically stated:  “Insurers whose policies are triggered by an injury during a policy period must respond to any claims presented to them and, if they deny full coverage, must initiate proceedings to determine the portion allocable for defense and indemnity costs.”

Put another way, in a recent article in Claims Magazine, Ken Brownlee wrote:  “When the auditor is reviewing a claim in litigation for declaratory relief, he or she should look for evidence that the adjuster sat down and reviewed the policy with the insured, seeking advance agreement that the coverage did not apply or applied to only part of the claim.  If that is missing, the file was not well adjusted.”    

I can easily imagine situations where, because of ambiguity as to who was covering what, Aristone would not have made out as well.  What if, for example, OneBeacon had argued that it was entitled to attach the $150,000 settlement payment from Pennsylvania on equitable grounds, to contribute to the defense costs?  (That may have been difficult to do here, because OneBeacon’s own appointed defense lawyer negotiated the release on Aristone’s behalf, but just suppose.)  That’s why the idea of intentionally leaving settlement documents ambiguous makes me very nervous.  I don’t know what specific provisions were in the release relating to contribution, but I’d have wanted some sort of protective language or indemnity agreement to deal with the possibility that someone would later want to attach the settlement funds paid to the policyholder.

One last item of interest:  Insurance companies frequently disclaim coverage for construction defect claims based upon the so-called “business risk” exclusions (such as the “your work” exclusion).  Here, it seems that OneBeacon did not do so.   

The full citation for the Aristone case is Potomac Ins. Co. of Illinois v. Penn. Mfrs. Ins. Co., Docket No. A-3164-09T2 (N.J. App. Div. Apr. 13, 2012), and the full decision is here.

Asbestos defendants who file for reorganization under the U.S. Bankruptcy Code and seek to establish a personal injury trust for the payment of claims may transfer their liability insurance recovery rights to the trust even if the insurance policies include provisions barring the transfer of such rights, the U.S. Court of Appeals for the Third Circuit has ruled in a precedential opinion. The court held, in In re Federal-Mogul Global, that the plain language of a U.S. bankruptcy law statute, 11 U.S.C. 1123(a)(5)(b), permits the transfer of estate property to the trust “notwithstanding any otherwise applicable nonbankruptcy law” and pre-empts any anti-assignment provision within the individual insurance policies.

Here’s a fairly common circumstance in large commercial liability claims.  A policyholder settles with the carrier in Layer 1 for less than its limits, leaving a gap between Layer 1 and the next layer up.  Does the carrier in Layer 2 then have an obligation to contribute to settlement with the underlying plaintiff?  

Example:  I recently had a circumstance in which Carrier A and Carrier B each had a $7.5M quota share of a $15M excess layer.  The client settled with each carrier for $5M (total $10M).  The settlement amount of $10M with these two carriers left a $5M gap before reaching the next layer of coverage, occupied by Carrier C.  Carrier C argued that its coverage wasn’t triggered, and that it had no obligation to contribute to settlement with the underlying plaintiff, because the limits beneath its coverage hadn’t been properly exhausted.  

Carrier C’s exhaustion language read:  “The Insurer shall pay the Insured…for Loss by reason of exhaustion by payments of all applicable underlying limits by either the Underlying Insurers…or the Insured.”  (Emphasis added.)  

Under this policy language, it seems pretty clear that if the policyholder covers the gap in Layer 1, then the coverage in Layer 2 is triggered. But it’s also possible that a policyholder might not even be required to cover the gap in order to get to Layer 2.  .  (In the matter I’m talking about, the issue is currently being negotiated.  Hopefully the carrier will see the light.)  

The venerable one-page decision in Zeig v. Massachusetts Bonding, 23 F.2d 665 (2d Cir. 1928) is still good law on this issue.  The Zeig Court wrote:  “[The excess carrier] had no rational interest in whether the insured collected the full amount of the primary policies, so long as it was only called upon to pay such portion of the loss as was in excess of the limits of those policies. To require an absolute collection of the primary insurance to its full limit would in many, if not most, cases involve delay, promote litigation, and prevent an adjustment of disputes which is both convenient and commendable.”  (So, under Zeig, it wouldn’t even be necessary for the policyholder to pay the $5M gap.) 

In JP Morgan v, Indian Harbor, 2011 NY Slip Op. 51055 (N.Y. Sup. Ct. N.Y. County May 31, 2011), which was decided under Illinois law, the Court distinguished Zeig and held that there was no exhaustion unless and until the underlying carrier actually paid the full extent of its policy limits – but in that case, the policy required the underlying excess insurers to have “admitted liability” and “paid the full amount of their respective liability” before the next layer’s liability attached. 

Another recent decision, Maximus v. Twin City, No. 1:11cv1231 (LMB/TRJ), slip op. (E.D. Va. March 12, 2012), includes a very good discussion of case law on this issue.  The Court wrote:  “The Axis Policy’s exhaustion provision is ambiguous in that it does not clearly require all underlying insurance carriers themselves to pay the full amounts of their policy limits in order to trigger the Axis Policy’s coverage and does not clearly provide that settling for less than the policy limit, even if the insured fills the gap, fails to satisfy the exhaustion requirement.” (Emphasis added.)

As you can see from the decisions cited above, there is no standardized policy language on this issue.  But if you’re in settlement discussions that may trigger several layers of coverage, it’s critical to review the exhaustion language of all excess policies before concluding the settlement.  Otherwise, you may leave a large self-insured gap, with no ability to trigger the upper layers.