Limitations periods and notice provisions in insurance policies

When I was a kid in Maplewood, New Jersey, our next-door neighbor was a feisty Irish widow named Anne Byrne.  (She was related to our former Governor, Brendan Byrne, but I forget how.)  When I would do something stupid, which usually involved putting some kind of ball through one of her windows, she would grab me by the ear, look me in the eye and ask: “When are you going to learn to use your head for something other than a hat rack?”  (This was back in the days before safe spaces.)

I still occasionally do dumb things (okay, if you ask my wife, more than occasionally), but 30 years of practicing insurance law have taught me that one of the dumber things we can do is lose insurance coverage by failing to comply with policy conditions. A trio of very recent cases will illustrate my point.

Ryan v. Liberty Mutual, from the federal district court here in New Jersey, is a Sandy case.   The homeowners’ insurance policy contained a one-year suit limitation. The carrier denied coverage, primarily because of a flood exclusion, but agreed to pay a small amount for non-flood-related damages. The partial denial letter was sent on November 30, 2012, and apparently received by no later than December 10, 2012.

For a lengthy period of time, the policyholders engaged in negotiations with the carrier to try to get the carrier to revisit the claim. During this period, the policyholders promised to send additional information to the carrier supporting their claim, but never did so.

On October 10, 2014, the policyholders filed suit. Naturally, the carrier moved for summary judgment based on the one-year limitations period, which the Court granted.  The policyholders argued that coverage had never been fully and finally denied, since negotiations were ongoing. Wrong, said the Court:   “The one-year statute of limitations in plaintiff’s homeowners policy began to run on October 29, 2012 – the date that Hurricane Sandy damaged plaintiff’s home – and was tolled from October 30, 2012 – the date plaintiffs made a claim for homeowners insurance benefits – until the date defendant declined liability…It is plain from the face of the [partial denial] letter that Defendant is denying Plaintiffs coverage for flood-related damage. The language used is clear and unequivocal, and would be interpreted by any reasonable reader as a denial of benefits. Accordingly, the statute of limitations began to run again on the date on which plaintiffs received the [partial denial] letter. After December 10, 2013, plaintiffs were barred from bringing suit.”


OneWest Bank v. Houston Casualty Co., from the Ninth Circuit Court of Appeals (recently in the news for political reasons), involved a suit against OneWest by Assured Guarantee Municipal Corporation. Assured contended that OneWest, as a loan servicer, had failed to mitigate or avoid losses on mortgage loans for which Assured had guaranteed the principal and interest payments. OneWest entered into settlement negotiations with Assured, and the parties prepared a term sheet reflecting the agreed-upon settlement terms. After agreeing upon the term sheet, but apparently before executing the final settlement documents, One West reported the loss to its professional liability carrier. The professional liability policy contained a standard condition prohibiting OneWest from “admitting or assuming any liability,” or “entering into any settlement agreement” without the carrier’s prior written consent. The Court concluded that “the term sheet provided all the relevant terms of a settlement agreement”…and “poof” went the insurance claim.

Ugh, again.

Minasian v. IDS Property Casualty Insurance Company, from the Second Circuit, involved a claim for burglary.  The policy required that notice of loss be given to the carrier “as soon as reasonably possible,” “immediately,” and “as soon as practicable.” The policyholders lost jewelry through a burglary, but didn’t notify their carrier until three months later. The carrier (naturally) denied coverage based upon late notice. The policyholders argued that they reasonably believed a police investigation was ongoing, and that the stolen jewelry might be located, and that they notified the insurance company promptly after learning that the police investigation was closed.

The Court held that, in light of the notification provisions in the policy, “such a belief cannot form a reasonable – and thus excusable – basis for notice delay.”

Ugh, a third time.

I have an old Travelers claims manual in my office.  At one point, it says:  “[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.” That’s a wonderful sentiment, but usually it’s not how the real world operates. Insurance policies are (intentionally) complex webs of exclusions, limitations, and arcane language, that are interpreted differently by different courts. If you submit a large claim to your carrier, the claims department is understandably going to comb through the policy looking for applicable exclusions. Don’t help them by failing to comply with the policy requirements about giving notice.

The Shortcomings of D&O Insurance

Here’s how a major insurance company (Travelers) describes D&O insurance: “Directors & Officers (D&O) Liability insurance helps cover defense costs and damages (awards and settlements) arising out of wrongful act allegations and lawsuits brought against an organization’s board of directors and/or officers. These types of claims have become increasingly common and directors and officers themselves could be held personally liable. To attract and retain qualified executives and board members it’s crucial to have Travelers Directors & Officers Liability insurance.”


The problem with D&O insurance is that, while it sounds wonderful in theory, it contains loopholes big enough to drive a tractor-trailer through.  Which is not to say that it isn’t essential.  It’s just that, if you ever need to make a claim under the coverage, you’ve already probably allowed things to go too far.  Think prevention.

A couple of recent federal cases dealing with the “insured v. insured” exclusion illustrate my point.

In a Ninth Circuit case, FDIC v. BancInsure, Security National Security Pacific Bank became insolvent, and the FDIC took over as receiver. The FDIC filed suit against Security Pacific’s former directors and officers, seeking to enforce coverage for losses from alleged negligence and breach of fiduciary duty. But the D & O Policy excluded coverage for suits brought “by, or on behalf of, or at the behest of” Security Pacific, or by “any successor, trustee, assignee or receiver.” The FDIC argued that it was not a “receiver” within the meaning of the exclusion, because, by statute, it had a “unique role” representing “multiple interests,” including the interests of shareholders. So, the FDIC argued, its lawsuit could essentially be considered a shareholders’ derivative action, and the insured-versus-insured exclusion contained an exception for such actions.

The Court said nice try, not buying. “The shareholder-derivative-suit exception does not render the insured-versus-insured exclusion ambiguous with respect to the FDIC as receiver merely because the FDIC also succeeded to the right of Security Pacific’s shareholders to bring a derivative action – which right (1) is secondary to the FDIC’s right to bring the same claims directly as Security Pacific’s receiver and (2) may be exercised only if the FDIC does not exercise its primary right to bring the claims directly.”

The interesting aspect of this case is that the policy separately excluded coverage for losses arriving arising from “any action or proceeding brought by or on behalf of any federal or state regulatory or supervisory agency or deposit insurance organization.” But the policy specifically deleted that exclusion by endorsement, which pretty clearly shows that suits brought by government regulators (like the FDIC) were supposed to be covered.  No problem, said the Court, we can reason our way around that one: “The regulatory endorsement deleted the regulatory exclusion but did not vary, waive, or extend any of the other terms of the D & O Policy, and thus did not alter the scope of the insured-versus-insured exclusion. As a result, the FDIC’s claims remain barred by the insured-versus-insured exclusion.” (Huh?)

Jerry’s Enterprises v. U.S. Specialty Insurance Co., out of the Eighth Circuit, involved a dispute over the valuation of shares in a grocery store chain (JEI). The founder’s daughter, Cheryl Sullivan, inherited 28.06% of the company, and her daughters Kelly and Monica received 2.4% and 1.2%, respectively. Sullivan (a former director of JEI) and her daughters later filed suit against JEI, alleging multiple acts of misconduct by JEI directors designed to lower the value of their shares. JEI settled, and sued its D&O carrier for defense costs and the amounts paid under the settlement agreement.  The Court found that the “insured- versus-insured” exclusion barred coverage for any lawsuit brought by a former director, and that Sullivan fell into that category.

The problem for the carrier (and the Court) was that the policy also contained an allocation clause, which basically required the allocation of insurance coverage between covered and noncovered claims. JEI argued that neither of the daughters had been directors or officers of the company, so at least their part of the lawsuit should have been covered. Nah, said the Court: “Cheryl Sullivan was the driving force of the litigation. She…owned the vast majority of shares at issue in the underlying lawsuit, and she was the former director who repeatedly raised concerns about the valuation of shares to JEI’s Board of Directors.”  (Did the policy contain a “driving force” exclusion?)  In other words, stop bothering us with pesky facts.  We made our decision, and that’s that.

The JEI Court’s discussion of “judge world” is particularly entertaining. See, those of us who have done coverage work for any length of time know that there are parallel universes. One contains “judge world,” and the other contains the “real world.” Here’s the JEI Court’s discussion of the insurance-buying process in “judge world”: “JEI’s argument exhibits a fundamental misunderstanding of the insurance policy and our role in analyzing the policy’s language… JEI and US Specialty entered into an agreement in which they defined the terms of that agreement. It is our responsibility to give effect to that contracted language.”  (Emphasis added.)

That makes it sound as though the insurance company and the policyholder sat down together over a cup of joe and negotiated what the contract would say, and exactly how it would be applied. That, of course, is nonsense. Insurance policies consist largely of preprinted forms, or, at the least, language drafted by the insurance industry. There may be some limited ability for a policyholder to negotiate minor variations in policy language, but by and large, it’s a take-it-or leave-it proposition.

But enough of my ranting about how courts buy into what the claims department says about policies, as opposed to what the sales department says.  The bottom line is that D&O insurance is important, because it does provide protection against certain types of lawsuits (although, not all of the types of lawsuits that you would reasonably expect). Just keep in mind that your internal controls and procedures are far more important than your insurance. If you don’t analyze your risks carefully, and take aggressive steps to minimize them, you are putting yourself at the mercy of the claims departments of insurance companies.  And, for all of their advertising about avoiding mayhem and being a good neighbor, insurance companies are in the business of making the largest returns possible for their shareholders.  Poor loss control also puts you at the mercy of judges, many of whom (forgive me) don’t really understand how insurance works, and don’t really want to understand, because they’re way too busy.

Policy rescission because of misrepresentations on an insurance application

There’s an old joke about lawyers and clients.

A man is flying in a hot-air balloon and realizes he’s lost. He spots a guy down below. He lowers the balloon and shouts, “Excuse me, can you help me? I promised my friend I would meet him half an hour ago, but I don’t know where I am.”

The man below says: “Yes, you’re in a large red hot air balloon, hovering 30 feet above this field between 40 & 41 degrees latitude and about 74 degrees west longitude.”

“You must be an attorney,” says the balloonist.

“I am,” replies the man. “How did you know?”

“Well,” says the balloonist, “everything you have told me is technically correct, but it’s of absolutely no use to me and I still don’t know where I am.”

The man below says, “Ah, and I can tell from your reaction that you must be a client.”

“Well, yes,” replies the balloonist, “but how did you know?”

“Because,” says the man below, ” You’re in the same position as you were before we met, but somehow now it’s my fault.”

The point here (to the extent I have one) is that, once you have to rely on a litigator to clean up a mess you made, it may be too late.  But sometimes clients (even major corporate clients) do things thinking that they’re solving problems in the short term, and end up creating major long-term problems. That’s the situation in H.J. Heinz Co. v. Starr Surplus Lines Insurance Co., currently on appeal to the Third Circuit.

This case involves the rescission of a business insurance policy because of misrepresentations in the insurance application. (That’s a situation that you never want to be in.) According to the trial court decision, the risk manager for Heinz wanted to obtain a lower self-insured retention in the company’s product contamination insurance. Unfortunately, in an effort to accomplish his goal, he failed to disclose a substantial history of product contamination claims, including an incident in China involving baby cereal products that were contaminated with nitrite, resulting in a $12 million loss; another incident in China involving tuna-based baby food that was contaminated by mercury; an incident in the United States, in which a processing facility was found to be contaminated with listeria, resulting in a loss of $12.7 million; and other smaller losses, including one in Canada and two in New Zealand. The risk manager succeeded in obtaining a lower self-insured retention ($5 million, instead of $10 million or $20 million), but the problems began when the company was later sued for lead-tainted baby food.

The carrier, Starr, understandably raised the issue of intentional misrepresentation on the application, and the case was tried to an “advisory jury” on that issue for two days.  (20/20 hindsight is a wonderful thing, but I’m not sure why a policyholder would ever agree to an “advisory jury.” That sounds like being “almost pregnant.”)   Despite the bad facts, the jury came back with a verdict in Heinz’s favor, finding:

  1. Heinz had misrepresented material facts in the insurance application (bad finding for Heinz).
  1. Heinz had not deliberately omitted material information from the application (good finding for Heinz).
  1. Starr had waived its right to assert a rescission claim by agreeing to sell the policy despite actual knowledge of the incorrect information (good finding for Heinz). Apparently, Heinz had disclosed at least some of the complete and correct information in a prior policy application, and Starr’s underwriting file contained a newspaper article discussing the undisclosed product liability incidents.

Presented with the advisory jury’s findings, the trial judge essentially said, “Are you nuts?”  (In a bit of perhaps unintended humor, the judge stated that he departed from the advisory jury’s findings “only” on the answer to question 3, which of course was the question that, because of the judge’s reversal, led to the forfeiture of Heinz’s coverage.)

With respect to Heinz’s risk manager, the trial judge wrote: “His demeanor and evasiveness added to his loss of credibility. It was not credible that, as Global Insurance Director, he was without knowledge as to what information was required by the clear and unambiguous language of this standard Application form, commonly used in the industry.”

This is an interesting decision to read, in part because of the judge’s decision to negate a key finding by the advisory jury, but the bottom line is simple: Make sure your insurance applications are accurate. You may think you’re saving a few dollars now, but if a major claim rolls in, you could be in serious trouble. And no one needs a reported court decision floating around saying that he or she isn’t trustworthy.  Looks bad on a resume.

You can read the complete Heinz decision here.

The law of subrogation, and how it affects policyholders

“Subrogation” seems to be a simple concept. You suffer a loss. Your insurance company pays for the loss. Your insurance company then assumes your rights against the party that damaged you. But, like everything in the insurance world, subrogation can result in numerous complications. The problem, of course, is that if your insurance company doesn’t have a good subrogation claim against a third party, the insurance company can be less enthusiastic about settling with you.

To illustrate some of the problems that can result from subrogation claims, consider the recent convoluted mess in Franklin Mutual Ins. Co. v. Castle Restoration and Construction, Inc., decided by the New Jersey Appellate Division.  Ploschansky owned a unit in Harmon Cove Towers (“HCT”), a condominium community in Hudson County. FMI insured Ploschansky’s condominium under a homeowners’ policy. HCT hired Falcon as a consulting engineer for a restoration and waterproofing project. HCT also hired Castle to perform renovations. Ploschansky contended that the work was a disaster, and that his condo was flooded, causing significant damage.  A spate of lawsuits resulted:

  1. Ploschansky sued HCT and Taylor, the company that managed the condo community for HCT, in Hudson County. HCT then filed a third-party complaint against Falcon and Castle, alleging negligence and breach of contract. Ploschansky did not amend his complaint to bring direct claims against Falcon or Castle. Ploschansky eventually settled his Hudson County case against HCT, and the case was dismissed.
  1. FMI filed a complaint in Hudson County against HCT, Taylor and Castle, as the subrogee of another condo owner.
  1. Ploschansky filed a coverage complaint against FMI in Passaic County, arguing that FMI had wrongfully refused to pay his damages claim. In his complaint in this case (Lawsuit No. 3), Ploschansky disclosed the existence of Lawsuit No. 1.  Ploschansky won the coverage case, following a bench trial. The trial judge awarded Ploschansky $107,160 in damages.
  1. FMI filed yet another case, this one against Falcon and Castle, again in Hudson County, arguing that it was entitled to reimbursement from Falcon and Castle as Ploschansky’s subrogee.

Got all that?  Good.  Now, here’s the problem from FMI’s standpoint.  Falcon and Castle argued that Lawsuit No. 4 should be barred by the Court since FMI’s claims could have been brought in Lawsuit No.1, but weren’t.  New Jersey’s “entire controversy” doctrine generally requires that all claims against all parties relating to the same transaction be brought in a single proceeding.  Unfortunately for FMI, the Appellate Division agreed, writing: “It remains clear that, regardless of when FMI’s subrogation rights accrued, FMI was standing in Ploschansky’s shoes as his subrogee on July 31, 2014, the date it filed its complaint against Falcon (in Lawsuit No. 4). By that date, Falcon had already been dismissed from the Hudson County action and, under the entire controversy doctrine, Ploschansky could no longer file a claim against Falcon for its role in the construction project that damaged the condominium. Because Ploschansky’s claims against Falcon were barred, FMI could also not file a claim against Falcon as its subrogee…FMI had a fair and reasonable opportunity to litigate its claim prior to the dismissal of the claims against Falcon in the Hudson County action (that is, Lawsuit No. 1).”

Why is subrogation a problem for policyholders and not only their insurance companies?  In Ploschansky’s situation, it wasn’t, because he won his coverage trial against his carrier and (presumably) got paid.  But it can become a problem, as I suggested above, if you’re in settlement negotiations with your carrier, and the carrier doesn’t believe that it has a good subrogation claim.   The most important thing to remember is to protect your carrier’s subrogation claim to the extent possible. Preserve all evidence, and make sure that you notify your carrier of the claim in a timely fashion so that the carrier can’t claim “prejudice.” The more viable a subrogation claim is, the easier it is for your carrier to settle a claim with you.

By the way, there’s a doctrine related to subrogation law called the “made whole” doctrine, which requires that the policyholder actually be “made whole” before the carrier’s subrogation rights accrue. A Wisconsin law firm, Matthiesen, Wickert & Lehrer, S.C., has put together a very handy 50-state survey of the law on that issue, which you can access by clicking here.

You can read the full decision in Franklin Mutual Insurance Co. v. Castle Restoration and Construction, Inc. by clicking here.

The assignment of insurance policies and claims

I’ve been a trial lawyer for over 30 years, and I think I need to point out that corporate/transactional lawyers aren’t real lawyers.  If you haven’t been on the receiving end of an evidence ruling that makes you wonder whether the judge attended law school in a Winnebago, then I’m sorry, you may be a “practitioner,” but you’re not a real lawyer. On the other hand, corporate/transactional lawyers…er, practitioners…are way, way smarter than we litigators are. They have to understand things like complicated tax laws and how to structure complex commercial deals, which is generally far above our pay grade.  Most of us became trial lawyers because we can’t do math.

In structuring transactions, one issue that sometimes comes up is whether insurance claims, or insurance policies, can be assigned to another party. This issue also occasionally arises in the litigation context, when a plaintiff may be willing to settle a case in exchange for the assignment of the defendant’s insurance claim with its carrier.  (That may include an assignment of the bad faith claim, if any.)

Warning:  Assignments can be tricky.  But, while insurance companies may attempt to disclaim coverage based upon any assignment of a policy or claim, in general, the assignment has to increase the carrier’s risk in order to provide a valid basis for denial of a claim.

The New Jersey Appellate Division recently considered the implications of an assignment in Haskell Properties, LLC v. American Ins. Co.  The case involved certain insurance companies’ refusal to provide coverage for the cleanup of a contaminated property that Haskell had acquired in an asset sale approved by the bankruptcy court. The carriers argued “no pay,” in part because (according to them) any assignment was invalid since Haskell did not obtain the consent of the insurance companies beforehand.

The Appellate Division first considered Section 541 of the Bankruptcy Code, which defines property that is considered part of the debtor’s estate. Haskell argued that the Bankruptcy Code preempted any contractual provision that attempted to limit or restrict the rights of the debtor to transfer or assign its interests in bankruptcy. The Court held: “Section 541 effectively preempts any contractual provision that purports to limit or restrict the rights of a debtor to transfer or assign its interests in bankruptcy.” But, “it does not govern transfers to third parties from the estate approved by the bankruptcy court under 11 USCA §363, as was the case here”. According to the court, “there is no provision under Section 363 that authorizes the trustee to sell property in violation of state law transfer restrictions.”

So, the Court ruled that insurance companies did not have to cover losses that occurred after a policy was assigned in contravention of a consent-to-assignment clause. If a policy prohibits assignment, and the insurance company does not consent to assignment of the policy…it’s a no go for the policyholder.

These prohibitions do not apply to claims that accrued before the assignment, however. The Court wrote: “The Seller’s claims for coverage under the policies relating to occurrences that happened before the transfer to plaintiff were freely assignable by the Seller, to the extent the policies were ‘occurrence policies.’ Those policies insure ‘the occurrence itself,’ and provide coverage ‘once the occurrence takes place…even though the claim on may not been made for some time thereafter.’”  (Emphasis mine; citations omitted.)

The key is whether, by virtue of the assignment, the risk to the carrier increased. According to the Court, “no-assignment [provisions within insurance policies] do not prevent the assignment after loss for the obvious reason that the clause by its own terms ordinarily prohibits the assignment of the policy, as distinguished from a claim arising thereunder, and the assignment before loss involves a transfer of a contractual relationship while the assignment after loss is the assignment of the right to a money claim…The purpose behind a no-assignment clause is to protect the insurer from having to provide coverage for risk different from what the insurer had intended…once the insurer’s liability has become fixed due to a loss, an assignment of rights to collect under insurance policies is not a transfer of the actual policy but a transfer of a right to a claim of money.”

Bottom line:  assignment of the policy generally requires the consent of the carrier.  Assignment of an existing claim, not so much.

You can read the full Haskell decision by clicking here.

Insurance lessons from the Penn State tragedy: “Within the scope of employment”

I remember sitting in a continuing legal education class once, where the speaker was an experienced employment defense lawyer. He said that, normally, he liked to open his talks with a funny story or a joke, but he couldn’t do that during this particular talk, because there was absolutely nothing funny about sexual harassment; in many instances, it ruined lives. While I like to keep most of these posts somewhat light, the horrible events that took place at Penn State University fall into that “nothing funny” category. I’m sure you’re aware of the widely-reported situation, so there’s no need to provide great detail. Briefly, Jerry Sandusky, an assistant football coach to the legendary Penn State head coach Joe Paterno, was a pedophile who abused young boys on and around the Penn State campus for many years. He’s now in jail, where he belongs, and a good argument can be made that the whole debacle literally killed Coach Paterno.

As you can imagine, the terrible events spawned numerous legal proceedings, and wherever there are liability suits, there are usually insurance claims. Penn State paid out millions in settlements to Sandusky’s victims, and one of the issues was whether Penn State’s commercial general liability insurer, Pennsylvania Manufacturers, should cover some or all of those costs.

Under many of the insurance policies, that issue turned on whether Sandusky was acting within the scope of his employment when he committed his terrible crimes. That’s because the policies contained a “Abuse or Molestation” Exclusion (or “AME”), which provided that coverage would not apply to bodily injury arising out of “the actual or threatened abuse or molestation by anyone of any person while in the care, custody or control of any insured.”  The policies defined “insured” to include Penn State’s employees, “but only for acts within the scope of their employment by [Penn State],” or “while performing duties related to the conduct of [Penn State’s] business.”

I think you can see where this is going.

(By the way, the question of whether an employee is acting “within the scope of employment” can be very important in a number of different contexts. For example, depending upon the circumstances, the answer to that question may govern whether an injured employee will be compensated by workers’ compensation or general liability insurance. Sometimes, a corporate policyholder has an interest in having a claim processed under one of those types of policies and not the other.)

The carrier, naturally, took the position that all of Sandusky’s acts of molestation took place while Sandusky was “performing duties related to the conduct of [Penn State’s] business’” and that therefore there was no coverage.  The trial court agreed, essentially ruling that because Sandusky used his status as a Penn State football coach to attract his victims, he was acting as an “insured” within the meaning of the policy. In so holding, the court wrote the following (very unfortunately worded) sentences: “When he brought the children on campus and abused them in the locker room, or took them with him to PSU football games and abused them in motel rooms, he was simultaneously enjoying the privileges and perquisites of his position as a PSU Assistant Coach. His concurrent, non-abusive, acts on campus and at games were ‘acts within the scope of his employment by [PSU]’ or ‘duties related to the conduct of [PSU’s] business.’”

The Court also wrote: “Sandusky’s acts of abuse were obviously not part of his job. To use an employee’s job description to protect the insured from application of the AME would render the exclusion meaningless in every instance of abuse. The court will not do so.”

Respectfully, I can’t help but conclude that this case is a paradigm example of bad facts making bad law. If this Court is correct, it means that even if an employee goes rogue and commits horrendous (criminal) acts not authorized by the employer, he or she is potentially acting within the “scope of employment” for insurance purposes.  If that’s what carriers want the AME to mean, then they should write it that way.

The coverage case, by the way, is being handled by my old boss Jerry Oshinsky, one of the best insurance lawyers in the country.  Penn State has moved for an interlocutory appeal of the Court’s ruling, and this is part of  what Jerry wrote in his brief: “The opinion could be argued to turn the law of vicarious liability on its head…by seeking to impose ‘some responsibility’ upon employers for any tortious or criminal act their employees commit, based solely upon the title of the employee, regardless of whether the conduct occurs off-site, outside working hours, and well beyond the scope of the employee’s job duties and responsibilities. Under the opinion’s reasoning, the employee’s title supersedes the nature of the employer-employee relationship and its relation to the unlawful conduct.”

Interlocutory appeals (that is, appeals taken before all proceedings are closed in the trial court) are almost never granted.  If the appeals court declines to accept this interlocutory appeal, though, they’re going to hear about the issue again at the end of the trial court proceedings, for sure.

As an aside, this case goes to the heart of what risk management is all about. Insurance coverage should always be a last resort. Never count on it, because if a carrier can figure out a way not to cover a loss, the denial letter is coming. The best way to lessen your chances of liability is to have appropriate supervision and controls in place at all times, and to foster and encourage a proper reporting system within your organization, regardless of the potential bad publicity.  Larry Donnithorne’s little gem of a book “The West Point Way of Leadership” is required reading at our firm, and sets forth the following steps for ethical decision-making (also known as “choosing The Harder Right”), which should be considered by all leaders:

  1. What are the relevant facts of the situation?
  2. What are the alternative actions available?
  3. Who will be affected?
  4. What moral principles are involved?
  5. How would these principles be advanced or violated by each alternative action?

You can read the trial court’s Sandusky decision here.  The case raises several other important issues, and I will discuss some of them in future posts.

Yes, construction defects are covered “occurrences” in New Jersey

Are you the parent of a teenager?  Have you ever been the parent of a teenager? If the answer to either of those two questions is yes, have you ever felt like you’re banging your head against the wall? You think you’re speaking plain English, but they’re just not getting it.

That’s the way I sometimes feel about Court. As I’ve written on this blog before, I understand and empathize with the difficult job that judges have. I’ve spent 30 years practicing insurance law, and I still don’t understand it fully. Yet we routinely appoint judges to the bench, pay them what first-year associates are making at major law firms, and expect them to master every area of the law from Admiralty to Zoning, often with no seasoned law clerk to help them navigate the process.  Not a great situation, especially given the tremendous workload we dump on them.

The nationwide struggle between insurance companies and policyholders over whether lawsuits for construction defects should be covered under commercial general liability policies reminds me of raising a teenager, if you’re on the policyholder side.  You think you’re speaking English, but sometimes you feel like it’s just not getting through to overworked judges or carriers.

While commercial insurance policies are (in my view) often unnecessarily complicated, reading them should essentially involve a simple three-step process.

First, what does the insuring agreement say? (In other words, what does the policy cover, as a general matter?)

Second, what’s excluded from coverage?

Third and finally, what do the exceptions to the exclusions restore to coverage?

In the construction defect field, some insurance claims people and judges ignore the three necessary steps. For example, without specifically citing the language of the insuring agreement, they contend that “faulty workmanship” can never be a covered “occurrence’” because it’s a “business risk” (whatever that means).

But an “occurrence” is basically defined by insurance policies as an “accident.” “Faulty workmanship” is, by definition, negligence, and negligently-caused damage (which is an accident) is covered by liability policies.

As for construction defects constituting a “business risk,” that language doesn’t appear in the policies either, and almost everything involved with the conduct of a business (or everyday life) involves a quantifiable risk. Every time you getting your car to drive to the supermarket, there’s a risk that you’ll become involved in an accident – a risk that can be actuarially determined. (What if you got into an accident and your insurance company refused to cover it, because the accident was the result of a “personal risk”? The coverage would be worthless.)

I recently had the chance to apply the proper three-step analysis in a construction defect case that we argued before the New Jersey Appellate Division (thankfully they agreed!). And now, in great news for general contractors, builders and developers, the New Jersey Supreme Court has adopted the three-step analysis in Cypress Point Condominium Association, Inc. v. Adria Towers, L.L.C.  (You can obtain a complete copy of the Cypress Point decision by clicking here.)

Cypress Point  involved a condominium project in which the subcontractors apparently botched some of the work, causing problems such as roof leaks and water infiltration at the interior window jambs and sills of residential units. The Condominium Association brought an action against the developer and several subcontractors. The question was whether the developer was covered for liability associated with damage caused by the subcontractors’ work.

With respect to the insuring agreement (step one), the Court stated: “Under our interpretation of the term ‘occurrence’ in the policies, consequential harm caused by negligent work is an ‘accident.’ Therefore, because the result of the subcontractor’s faulty workmanship here – consequential water damage to the completed and nondefective portions of Cypress Point – was an ‘accident,’ it is an ‘occurrence’ under the policies and is therefore covered so long as the other parameters set by the policies are met.”

The Court then turned to the topic of the “your work” exclusion (step two), which generally excludes coverage for damage to a contractor’s work. The Court noted that the version of that exclusion used in a particular policy was critical, because the 1986 version of the exclusion (in common use today) contains an exception to the exclusion for work done by subcontractors (step three). The Court noted that the typical subcontractor exception resulted from the demands of the policy-buying public, which wanted this sort of coverage, and the view of insurance companies that their products would be easier to sell with the subcontractor coverage included.

Accordingly, the Supreme Court wrote: “The insurers here chose not to negotiate away the subcontractor exception and instead issued the developer a series of 1986 ISO standard form CGL policies which explicitly provide coverage for property damage caused by a subcontractor’s defective performance.”  Case closed.

I expect that the battle will now turn to the question of what constitutes covered “consequential damage.” Nevertheless, despite the comments of some of my colleagues in the defense bar that Cypress Point isn’t a watershed victory for policyholders in the construction and building field…it is.

Developments in insurance coverage for asbestos-related liabilities

I’m not sure which is more grimly entertaining:  watching old advertisements for cigarettes (see here), or watching old advertisements for asbestos products (see here).  If you’re an executive in the front office of a company that acquired an asbestos manufacturer, however, you might fail to appreciate the dark humor.  A few years back, RAND Corporation estimated the cost of asbestos-related liabilities to American companies at $265 billion.  Transaction costs (including legal fees) have consumed half of that amount.

The amazing thing about asbestos litigation is that, much like the product that spawned it, it seems to be virtually indestructible. I was involved with it over 30 years ago as a summer associate at a major New Jersey law firm; and I’m still involved with it. The battle has shifted over the years from the question of whether asbestos liabilities are covered (under policies not containing an asbestos exclusion, and sometimes even then) to the question of how to allocate asbestos-related liability among insurance companies. The New Jersey Supreme Court has issued several major decisions on this issue, yet the issue seems never to be fully resolved. Two weeks ago (as I write this), the New Jersey Appellate Division handed down yet another decision trying to untangle the various questions raised by complex toxic tort insurance coverage cases. The decision was rendered in the case of Continental Insurance Co. v. Honeywell Corp., and you can obtain a full copy by clicking here.

In this post, I wanted to touch briefly upon two aspects of the decision. First, the fact that every excess and umbrella policy should be carefully examined when purchased, because these policies may provide significantly less coverage than you believe you’re getting. Second, the question of when a policyholder is entitled to recover its counsel fees from the insurance company when it has to sue to enforce coverage.

Honeywell’s corporate predecessor, Bendix, manufactured brake and clutch pads that contained asbestos.  Honeywell has been sued in tens of thousands of cases alleging exposure to asbestos from Bendix products, and between Honeywell and its insurance companies, over $1 billion has been spent to resolve the claims. After 13 years of coverage litigation, Honeywell managed to settle with all of its insurance companies except for two high level excess carriers: St. Paul and Travelers.

The Honeywell case serves as a reminder that the language of excess and umbrella policies is not uniform and may represent a trap for the unwary policyholder.  In this case, the relevant policies defined “loss” as “the sums paid in settlements of losses for which the Insured is liable after making deductions for all other recoveries, salvages and other insurances (other than recoveries under the policy/ies of the Primary Insurer), whether recoverable or not, and shall exclude all expense[s] and costs.”  “Costs” was defined to include “interest on judgments, investigations, adjustments, and legal expense[s] (excluding, however, all expenses for salaried employees and retained counsel of and all office expenses of the Insured).” (Emphasis added.)

Honeywell raised a number of arguments as to why this (and similar) language in its excess policies did not negate the defense obligation.  The Court, however, disagreed, finding that the language of the excess policies unambiguously excluded defense costs.  So:  When placing and reviewing excess or umbrella policies, pay close attention to the definition of “loss.”  Is there a defense obligation, or not?  If there isn’t, are you comfortable with assuming the costs of defense once the underlying policies are exhausted?

A more troubling aspect of the case, at least for those of us who do coverage work from the policyholder side, is the court’s denial of counsel fees to Honeywell.  In New Jersey, under R. 4:42-9(a)(6), a “successful claimant” in “a liability or indemnity policy of insurance” is entitled to recover its attorneys’ fees.  The Honeywell Court conceded that “[f]ee shifting…discourages insurance companies from attempting to avoid their contractual obligations and force their insureds to expend counsel fees to establish the coverage for which they have already contracted.”   And, as the New Jersey Supreme Court ruled in Owens-Illinois v. United Ins. Co., 138 N.J. 437 (1994), “[i]nsurers 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. For failure to provide coverage, a policyholder may recover costs incurred under the provisions of Rule 4:42-9(a)(6).”

Here, Honeywell prevailed on several issues (such as on Travelers’ argument that numerous coverage years should be allocated to Honeywell, because Honeywell ostensibly had “self-insured” its risks for those years).  Yet the Court refused to allow Honeywell to recover attorneys’ fees because, in part, “this is a case about nothing more than allocation…not a case about denial of coverage.”  That language is extremely troubling, and, with all due respect to the esteemed Court, is something that only an “insurance dilettante” could write.  As anyone experienced in mass tort coverage cases in New Jersey knows, “allocation” is the new denial of coverage.  Carriers, in many cases, take the most expansive reading of Owens-Illinois (and its offspring, Carter-Wallace v. Admiral Ins. Co. 154 N.J. 312 (1998)) possible, often in an effort to shrink their coverage to as close to zero as possible. Policyholders are then forced to expend large sums of money on coverage litigation, in an effort to create a fair allocation.

In reaching its decision, the Court also seems to have fallen for the usual insurance company argument that larger corporations should somehow be afforded less coverage than smaller companies based upon the same policy language, writing: “[T]his is not a situation concerning a contract of adhesion.  Honeywell is a large and sophisticated corporation with a knowledgeable risk management division. Accordingly, Honeywell and its predecessor Bendix, were on equal bargaining positions when they negotiated their insurance contracts with their insurers.”

That statement may be true in judge-world, but not in the real world. No matter how large a corporation is, it is never on an equal bargaining footing with an insurance company. Yes, corporate risk managers may be able to negotiate certain favorable endorsements or minor changes in policy language. But that’s about it. Trying to change language in a preprinted policy form has about the same chance of succeeding as Rutgers does of winning the National Division I Football Championship this year.  (Calm down, Rutgers fans, I’m just keeping it real…)

Unfortunately, I expect that insurance companies will use the language in this unreported decision to argue that in any case involving allocation, the policyholder should not be allowed to recover its fees as a “successful claimant.”  Hopefully, Courts won’t allow them to get away with it.

Enforcing insurance coverage for “intentional” torts

I have in my office a copy of a Travelers claims manual from the 1980s. In discussing the duty to defend, the manual says, in part: “Ambiguity…means that the words are capable of being understood in two or more reasonably logical ways. Ambiguity should be resolved in favor of the insured. Prompt decisions must be made and effectively communicated to the insured. Defense obligations are broader than the obligation to pay. More and more jurisdictions require the insurer to look beyond the allegations in a lawsuit to determine if the loss is covered. Underlying these principles is the 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.”  (Emphasis mine.)

Sounds like a policyholder brief!  Respectfully, though, there are some areas in which claims personnel do seem to look for ways to deny coverage. One of these areas is Coverage B of the standard commercial general liability policy, which covers “advertising injury” and “personal injury.” That includes protection against claims for torts such as defamation and invasion of privacy.  The problem is that the covered offenses often include an element of intent on behalf of the policyholder; and claims personnel are taught that any injury expected or intended by the policyholder is never covered.

This thorny issue recently came up in a case in the Second Circuit, National Fire Ins. Co. of Hartford v. E. Mishan & Sons, Inc.  The case involves class action lawsuits alleging that the policyholder (Emson), which imports promotional products and other merchandise, engaged in a scheme to deceive customers into incurring recurring credit card charges.  The policy contained the standard coverage for “personal and advertising injury,” defined in part to include “the oral or written publication, in any manner, of material that violates a person’s right of privacy.” But the policy also excluded coverage for personal and advertising injuries resulting from “knowing violations” of another’s rights. The policyholder contended that the claims involved allegations of violation of the right to privacy. But the insurance company contended that the “knowing violations” exclusion provided it with a way out.  (The insurance policy giveth, the insurance policy taketh away…)

The Court disagreed with the carrier, though, because the possibility existed that Emson’s violation of privacy could have been negligent, not intentional.  Specifically, the Court wrote: “We cannot conclude with certainty that the policy does not provide coverage, because the conduct triggering the knowing violation policy exclusion is not an element of each cause of action. Therefore, Emson could be liable to plaintiffs even absent evidence that it knowingly violated its customers’ right to privacy. Furthermore, while the underlying plaintiffs alleged generally that Emson acted knowingly and intentionally, the actual conduct described does not rule out the possibility that Emson acted without intent to harm.”   (Emphasis mine.)

The Court noted that the duty to defend exists “until it is determined with certainty that the policy does not provide coverage.” Given that test, the Court held that it was improper for the insurance company to deny the claim.

(Side note of the “toot my own horn” variety:  In holding that coverage existed, the Court relied extensively on CGS Industries, Inc. v. Charter Oak Fire Ins. Co., 720 F3d 71 (2d Cir. 2013). The CGS Court rejected application of the “knowing violation” exclusion in a Lanham Act coverage case, because even under the Lanham Act, the policyholder may have inadvertently, as opposed to intentionally, infringed. I served as local counsel on that case for David Gauntlett of Gauntlett & Associates in Irvine, California.)

A couple of observations about this decision.  First, because the case was decided under New York law, the Court held that the carrier had “a duty to defend the entire action brought under any of the Policies, including the uncovered claims.” Under New Jersey law, conversely, if there is a reasonable way to allocate defense costs between covered and uncovered claims, the insurance company is only obligated to provide a defense as to the covered claims. This is why choice of law can be so critical in insurance coverage actions (and also why you should review proposed policy forms carefully for choice-of-law provisions before binding coverage.). Second, if you’re on the policyholder side, and an exclusion is used to remove coverage that has been specifically granted, think about the concept of “illusory coverage” as a way to support your claim.  See  Russell v. Princeton Laboratories, Inc., 50 N.J. 30, 38, 231 A.2d 800 (1967) (holding that contracts should not be interpreted in a way that gives the promisor – in our context, the carrier –  the ability to make its promise “illusory,” or worthless).

A potential business insurance coverage trap: the Professional Services Exclusion

When my daughter was little, we loved putting jigsaw puzzles together. We would dump the pieces on the floor and spend hours trying to figure out how they fit. Sometimes there would be a “gap” in the puzzle, and we’d eventually get frustrated and assume that we were missing a piece. But somehow, the missing piece would almost always show up. In many ways, that’s how insurance exclusions work. They often create a (frustrating) “gap” that’s intended to be filled by other types of insurance. The so-called professional services exclusion is an excellent example of that phenomenon.

In insurance-speak, many businesses have two separate components: (A) the commercial, and (B) the professional.  “Professional services” exclusions ostensibly serve the purpose of limiting a general liability carrier’s exposure in an area in which the policyholder is supposed to buy separate errors and omissions coverage. Many courts have found that losses falling within the insuring provision of an errors and omissions policy are excluded by the typical professional services exclusion in a commercial general liability policy.

But here’s the foundational question:  What are “professional services”?  It’s not always so clear, but generally “professional services” are acts that require the actor to draw upon his or her professional training or expertise.  As an example of wrestling with this question, in Guaranty Nat. Ins. Co. v. North River Ins. Co., a patient died after jumping out a hospital window.  After an earlier incident in which a psychiatric patient had escaped through a window, the hospital had inserted screws in the window sashes to prevent the windows from being opened more than a few inches.  But they didn’t work. The carrier tried to disclaim coverage for liability resulting from the patient’s death, arguing that the “professional services” exclusion applied, because the decision on how best to secure the windows involved professional, medical judgment. The Court disagreed, writing: “The decision to protect…patients through screws in the window sashes rather than through fixed, protective screens over the windows was an administrative, business decision and was not a professional, medical decision.”  (Emphasis mine.)

(You can read the Guaranty National case by clicking here.)

The Third Circuit recently dealt with an interesting twist on the “professional services” question. PNC Financial Services Group paid $102 million to resolve several class action lawsuits.  The suits involved an automated, fee-based overdraft program that processed debit card transactions, and charged PNC’s customers overdraft fees. PNC allegedly manipulated the order in which transactions were processed, by processing them from largest to smallest instead of chronologically, supposedly to gouge customers on the fees. The suits also contended that PNC failed to disclose to customers that they could opt out of this policy and avoid overdrafts and fees altogether.

PNC had a $25 million self-insured retention, above which sat a $25 million professional liability policy sold by Houston Casualty Company. Axis sold a $25 million excess policy, over the Houston coverage.

The policies defined “damages” to mean “a judgment, award, surcharge or settlement… and any award of pre-and post-judgment interest, attorneys’ fees and costs.” But the policies excluded “fees, commissions or charges for Professional Services paid or payable to an Insured” from the definition of “damages.”

“Professional Services” were defined to mean “services performed… for the benefit of, or on behalf of a Customer or potential Customer of the Insured for a fee, commission, or other consideration…”

The Court held that PNC’s practice of charging overdraft fees constituted “professional services,” and were therefore excluded from the definition of “damages” under the policy. Approximately $30 million of the settlement related to the underlying plaintiffs’ attorneys’ fees and costs, and the Court held that those weren’t covered either.

The Court wrote: “We conclude that the approximately $30 million awarded to class counsel as attorneys’ fees and costs do not constitute an award of attorneys’ fees and costs that PNC was legally obligated to pay. Rather, PNC was legally obligated to pay $102 million to reimburse class members for charged overdraft fees, from which the class plaintiffs – not PNC – paid their attorneys approximately $30 million for their services. Accordingly, the entire $102 million in settlement payments constitute a refund of fees or charges for Professional Services that class members paid to PNC…and as such, are excluded from coverage pursuant to the Professional Services Charge Exception.”

A couple of takeaways from this case.

First, I wasn’t personally involved with the case and therefore I’m sure I’m missing something, but I don’t understand the assumption that a program for charging bank fees necessarily constitutes “professional services,” in light of the case law on that issue. It seems more like a ministerial function, more akin to the decision to use screws on the windows that we saw in the Guaranty National case.  From the policyholder’s perspective, the first question always has to be, are these really “professional services” – that is to say, services that require some level of professional judgment – at all?

Second, from a coverage perspective, always be careful how you describe payments in settlement documents. Here, the policyholder may have left $30 million on the table because, the Court said, the fees were simply part of a larger settlement payment intended to compensate the underlying plaintiffs for improper overdraft fees. It’s possible that a more insurance-savvy approach to categorizing the fee payment in the documents could have supported coverage. (And again, armchair hindsight is always 20/20.)

(You can read the PNC decision by clicking here.)