Here are a few universal truths. If politicians can raise taxes, they will.  If lawyers can bill, they will. And if judges can find a way to help clear their docket, they will.  That last truth can create a serious problem for the unwary dealing with insurance claims.

Many business property policies and homeowners’ policies contain a specific limitations period, meaning a deadline by which the policyholder must commence suit against the carrier. Typically, the policyholder is required to sue within one or two years of the date of loss. This can shorten the applicable statute of limitations considerably. In New Jersey, for example, the general statute of limitations for breach of contract is six years, and Courts generally construe that to mean six years from the date of wrongful denial of the claim. 

 [By the way, you also need to be very careful with proof of loss requirements in policies. Many policies contain time periods within which a proof of loss is required. Many Courts interpret the requirements strictly, which can lead to unfair results for the policyholder.]

Recently, in Boisvert v. State Farm (D.N.J.),  an unfortunate policyholder learned these lessons the hard way.  The Boisverts owned property that was damaged by Superstorm Sandy on October 29, 2012.  They filed a claim with their homeowners’ carrier, State Farm. On July 26, 2013, State Farm denied the claim, claiming that all the damage was pre-existing, and was caused by poor workmanship. State Farm’s letter also cited policy language requiring that any suit be commenced against State Farm within one year of the date of loss (meaning, by October 29, 2013).

The Boiverts waited to sue State Farm until September 16, 2014. According to the Boiverts,  because of ambiguous language  in State Farm’s coverage position letter,  they were unsure whether State Farm was continuing to investigate the claim. The State Farm letter had suggested that the Boisverts could submit additional information to State Farm, which State Farm would consider. The letter had also advised the Boiverts that they could file an appeal with the New Jersey Department of Banking and Insurance (otherwise known as the legal equivalent of closing your head in a car door repeatedly).

The Boisverts were right about the legal standard to be applied. Under New Jersey law, the contractual limitations periods in insurance policies are in fact tolled during the period that the insurance company investigates the claim, until the time that liability is formally declined. A main case standing for that proposition is Peloso v. Hartford, 56 N.J. 514, 521 (1970). But here, the Court rejected the idea that the limitations period had been tolled, writing:  “Although the [denial] letter in this case stated that Defendant would accept ‘additional information,’ it clearly stated that there was a ‘denial’ of the claim, that the damage for which Plaintiffs sought payment was not ‘covered by the [the] policy,’ and that any ‘action must be started within one year after the date of the loss or damage.’ Faced with nearly identical language, courts have found an unequivocal denial.”  And so did this Court.

The Boiverts also argued that the contractual limitations period needed to be equitably tolled because they had gone to nonbinding mediation with State Farm, which caused a 30 day delay. But the Court rejected this argument as well, writing: “Plaintiffs have submitted no authority indicating that a non-binding mediation program – that was initiated by Plaintiffs – tolls the statute of limitations. Mediation is not a prerequisite for bringing a suit. Plaintiff’s exercise of their right to present their claim before a mediator does not constitute conduct by Defendant that was ‘calculated to mislead [Plaintiff] into believing that it was unnecessary to seek civil redress’ within the limitations period.”

In any event, the argument over whether mediation tolls the limitations period was moot, because even if the statute of limitations were tolled 30 days during mediation, the Boiverts’ claims were still untimely.

Here are some takeaways.  First, when dealing with an insurance claim, always check the policy for the limitations period and make sure you file suit within that period if need be, because otherwise you may lose your rights.  You might have some awesome arguments about why the limitations period should be tolled because you were negotiating with the insurance company, or because the insurance company requested more information. Many judges won’t care, because they’re overworked and are looking for any way to lighten their load. And, of course, don’t expect any help from the insurance company if you try to argue that negotiations were ongoing.   Second, if you’re in discussions with the carrier and the suit deadline is approaching, try to obtain a tolling agreement extending the time to sue. Many claims representatives will be only too happy to agree to such an extension, to avoid litigation if possible.

In other words, as the referee says to the boxers before the fight begins:  Protect yourself at all times. 

You can read the full State Farm v. Boisvert decision here.

Here are a few universal truths. If politicians can raise taxes, they will.  If lawyers can bill, they will. And if judges can find a way to help clear their docket, they will.  That last truth can create a serious problem for the unwary dealing with insurance claims.

Many business property policies and homeowners’ policies contain a specific limitations period, meaning a deadline by which the policyholder must commence suit against the carrier. Typically, the policyholder is required to sue within one or two years of the date of loss. This can shorten the applicable statute of limitations considerably. In New Jersey, for example, the general statute of limitations for breach of contract is six years, and Courts generally construe that to mean six years from the date of wrongful denial of the claim. 

 [By the way, you also need to be very careful with proof of loss requirements in policies. Many policies contain time periods within which a proof of loss is required. Many Courts interpret the requirements strictly, which can lead to unfair results for the policyholder.]

Recently, in Boisvert v. State Farm (D.N.J.),  an unfortunate policyholder learned these lessons the hard way.  The Boisverts owned property that was damaged by Superstorm Sandy on October 29, 2012.  They filed a claim with their homeowners’ carrier, State Farm. On July 26, 2013, State Farm denied the claim, claiming that all the damage was pre-existing, and was caused by poor workmanship. State Farm’s letter also cited policy language requiring that any suit be commenced against State Farm within one year of the date of loss (meaning, by October 29, 2013).

The Boiverts waited to sue State Farm until September 16, 2014. According to the Boiverts,  because of ambiguous language  in State Farm’s coverage position letter,  they were unsure whether State Farm was continuing to investigate the claim. The State Farm letter had suggested that the Boisverts could submit additional information to State Farm, which State Farm would consider. The letter had also advised the Boiverts that they could file an appeal with the New Jersey Department of Banking and Insurance (otherwise known as the legal equivalent of closing your head in a car door repeatedly).

The Boisverts were right about the legal standard to be applied. Under New Jersey law, the contractual limitations periods in insurance policies are in fact tolled during the period that the insurance company investigates the claim, until the time that liability is formally declined. A main case standing for that proposition is Peloso v. Hartford, 56 N.J. 514, 521 (1970). But here, the Court rejected the idea that the limitations period had been tolled, writing:  “Although the [denial] letter in this case stated that Defendant would accept ‘additional information,’ it clearly stated that there was a ‘denial’ of the claim, that the damage for which Plaintiffs sought payment was not ‘covered by the [the] policy,’ and that any ‘action must be started within one year after the date of the loss or damage.’ Faced with nearly identical language, courts have found an unequivocal denial.”  And so did this Court.

The Boiverts also argued that the contractual limitations period needed to be equitably tolled because they had gone to nonbinding mediation with State Farm, which caused a 30 day delay. But the Court rejected this argument as well, writing: “Plaintiffs have submitted no authority indicating that a non-binding mediation program – that was initiated by Plaintiffs – tolls the statute of limitations. Mediation is not a prerequisite for bringing a suit. Plaintiff’s exercise of their right to present their claim before a mediator does not constitute conduct by Defendant that was ‘calculated to mislead [Plaintiff] into believing that it was unnecessary to seek civil redress’ within the limitations period.”

In any event, the argument over whether mediation tolls the limitations period was moot, because even if the statute of limitations were tolled 30 days during mediation, the Boiverts’ claims were still untimely.

Here are some takeaways.  First, when dealing with an insurance claim, always check the policy for the limitations period and make sure you file suit within that period if need be, because otherwise you may lose your rights.  You might have some awesome arguments about why the limitations period should be tolled because you were negotiating with the insurance company, or because the insurance company requested more information. Many judges won’t care, because they’re overworked and are looking for any way to lighten their load. And, of course, don’t expect any help from the insurance company if you try to argue that negotiations were ongoing.   Second, if you’re in discussions with the carrier and the suit deadline is approaching, try to obtain a tolling agreement extending the time to sue. Many claims representatives will be only too happy to agree to such an extension, to avoid litigation if possible.

In other words, as the referee says to the boxers before the fight begins:  Protect yourself at all times. 

You can read the full State Farm v. Boisvert decision here.

There’s an excellent, but sad and haunting, nonfiction book written by Jeff Hobbs called  “The Short and Tragic Life of Robert Peace.”  It’s about a kid who grew up among poverty, gangs and tough guys in a rough section of Newark, but who was naturally gifted and ended up at Yale. Unfortunately, he couldn’t outrun his upbringing. He returned to Newark with a degree in science and ended up using his education to build an illegal pot growing facility in a friend’s basement. Some gang members didn’t appreciate the competition, and things ended badly for him.

I thought about that book when reading a recent decision from the Southern District of New York, United Specialty Ins. Co. v. Barry Inn Realty, which similarly involved an illegal pot-growing operation.  Barry leased part of a building to Castelliano, who said he would be opening a sports bar and restaurant there. Months went by and the restaurant never opened. Nor did Barry exercise its right under the lease to inspect the premises. It turns out that Castelliano had basically gutted part of the building, and installed a sprinkler system and illegal wiring. He was growing and selling pot. The NYPD executed a search warrant, and busted Castelliano.

There was no evidence that Barry had any idea that the pot-growing operation existed.  In fact, Barry had run a background check on Castelliano that came up clean before leasing the space to him. Unfortunately for Barry, though, the extreme humidity needed to grow pot caused significant damage throughout the building, and required major demolition and replacement costs. Barry filed an insurance claim for the damage.

The policy contained an “illegal acts” exclusion, reading as follows:  “[The carrier] will not pay for loss or damage caused directly or indirectly by…[d]ishonest or criminal acts by…anyone to whom [the policyholder] entrusts the property for any purpose.”  (Emphasis added.)  The carrier, United Specialty, denied the claim based on the exclusion, and coverage litigation resulted.

In an effort to get around the exclusion, Barry Inn focused on the “entrustment”   requirement. Barry argued that it hadn’t really “entrusted” the property to Castelliano, because Castelliano had lied had about his intentions.  This was a tough argument to make, because the dictionary definition of “entrust” doesn’t focus on the recipient’s intent.  Webster’s defines “entrust,” for example, as “to deliver something in trust to.”

The Court upheld the coverage denial, writing: “In arguing that Barry did not entrust the Premises to Castelliano, Barry cites a number of cases in which a recipient of property lied about his or her in identity and no entrustment was found. In each of those cases, however, the recipient’s identity was ‘solely self-generated,’ and the insured never investigated the recipient’s identity…[The] course of dealing [here] establishes that Barry and Castelliano had a ‘consensual relationship’ and that Castelliano’s status was accepted by Barry…[I]t is immaterial that Castelliano abused Barry’s confidence and had an undisclosed intent to use the Premises to grow marijuana…[I]t is clear from the record that Barry intended to surrender, deliver, or transfer possession of the Premises to Castelliano.”

This decision may seem unfair, because Barry got duped. A couple of points to consider, though. First, insurance is always a poor substitute for proper controls.  In business, trust but verify. Barry may have believed that proper procedures had been followed, because Barry had run a background check on Castelliano.  But that wasn’t enough. Had Barry monitored the situation properly after signing the lease, Barry might have been able to avoid or minimize the damage. Second, despite all the wonderful ads you see on TV with cute little lizards and guys named “Mayhem” who have your best interests at heart, you can’t rely on insurance.  Insurance companies are in business for profit, and if they can figure out a way to deny large claims, they will.  When you buy insurance, you’re really buying a right to sue an insurance company.  Which is why the first point in this paragraph is so important.   

Labor Day has just passed as I write this, and this summer (that went by too quickly) was a busy one for the New Jersey appellate courts, insurance-wise.  The New Jersey Supremes, for example,  dealt with a question often posed by our clients in construction defect cases: Namely, can a claimant proceed directly against a defendant’s insurance company?  (That is, sue the defendant’s insurance company directly instead of, or in addition to, suing the defendant?) In fact, as I was working over the holiday (ugh) I got a call from a potential client whose general contractor messed up her house pretty badly, and whose homeowners’ carrier is giving her a hard time about paying for the damage, which includes water infiltration and mold as the result of the GC’s shoddy work. (Why was I talking to a prospective client on Labor Day? Because, when you own your own firm, every day is “Labor Day”.) She asked whether she could sue the GC’s insurance carrier directly, since she didn’t think the GC had any money.

The answer, at least in New Jersey, is generally no.  The new Supreme Court decision is Ross v. Lowitz.  The facts: Home heating oil leaked from a neighbor’s underground storage tank onto the property of John and Pamela Ross. In addition to suing the current and former owners of the neighboring property, the Rosses also sued the insurance companies who provided homeowners’ coverage to the former owners of the neighboring property, for bad faith in not resolving the loss fully. The Rosses argued that they were third-party beneficiaries under the neighbors’ policies, and therefore were entitled to bring a direct claim.

But the Court disagreed, writing: “It is a fundamental premise of contract law that a third party is deemed to be a beneficiary of a contract only if the contracting parties so intended when they entered into their agreement. Here, there is no suggestion in the record that the parties to the insurance contract at issue had any intention to make plaintiffs, then the neighbors of the insured, a third-party beneficiary of their agreements. Nor does migration of oil from [the neighbors’] property to plaintiffs’ residence retroactively confer third-party beneficiary status on plaintiffs. The insurer’s duty of good faith and fair dealing in this case extended to their insured, not to plaintiffs.”

To the extent that the neighbors’ liability coverage (as opposed to first-party coverage) is implicated, though, this doesn’t make sense. Of course the purpose of liability insurance is to confer a benefit upon an injured third-party. I guess with the Court really meant to say was, unless there is specific intent to confer a benefit on a specific claimant, then third-party beneficiary status does not exist.

The coverage aspect of the Ross case only dealt with the question of whether a third party could sue for bad faith.   It remains to be seen how the case will be applied in other contexts.  Generally, until now, a claimant would have to take a judgment against a defendant in a specified amount, prove that the defendant is insolvent and cannot pay the judgment, and then request permission from the trial court to pursue the defendant’s liability carrier directly.

You can read the Ross case here.

Another case that came down this summer is 213-15 76th Street Condo Assn. v. Scottsdale Ins. Co. , a federal court decision that stemmed from a Superstorm Sandy related first-party wind damage claim. The case involved the question of whether recovery of attorneys’ fees is permitted in first-party cases in New Jersey. The policyholder argued that discovery “might” show that the insurance company acted in bad faith in handling the claim, and that attorney’s fees should be allowed as damages in bad faith cases. The (quirky) rule in New Jersey (R.4:42-9)  is that attorneys’ fees are recoverable by a successful claimant in a third-party (liability) coverage lawsuit, but not specifically in a first-party case. 

The Court basically punted, writing:  “Under New Jersey law, counsel fees may be awarded when an insurer refuses to indemnify or defend its insured’s third-party liability to another, but an insured who brings direct suit against his insurer for coverage is not entitled to a fee award… Plaintiff asserts that a bad faith claim would support its request for attorneys’ fees, [but] the complaint does not contain any allegations that defendant acted in bad faith… There is no basis for plaintiffs request for attorneys’ fees at this time.”  (Emphasis added.)

I’m not sure why defense counsel would waste time filing a motion to strike a claim for attorneys’ fees before an application for attorneys’ fees is actually made, but I guess nothing succeeds like success.  Presumably the carrier felt that striking the claim for attorneys’ fees would reduce the settlement value of the case from the plaintiff’s perspective.

You can read the 213-15 76th Street case here.

Earlier this year, I posted about whether a policyholder has a right to independent counsel when a possible conflict of interest appears between the carrier and the policyholder.  (You can read that post here.)  We’re frequently asked that question, because when insurance companies agree to defend a claim, they often send a reservation of rights letter that contains dozens of exclusions and limitations that the carrier says may lead to no coverage later. Such letters understandably cause angst to policyholders, who paid for, and depend upon, protection from liability. Related issue: Policyholders are sometimes unhappy with the defense lawyers that the carriers appoint. I have one claim right now involving a major personal injury claim, for example, in which appointed defense counsel didn’t bother to speak with the policyholder until the morning of a mediation. Not good. And though most defense lawyers are sensitive to their duty of loyalty to the policyholder, it’s just human nature to remember who butters your bread.

An interesting case recently came down in California involving the independent counsel issue. The case, Travelers v. Kaufman & Broad, involved a construction defect lawsuit, in which a general contractor (Kaufman) was named as additional insured under a subcontractor’s (Norcraft) policies.  Travelers appointed defense counsel for Kaufman, but Kaufman was unhappy because the law firm had represented parties adverse to Kaufman in other construction defect cases.  Kaufman argued that Travelers had failed to provide it with an “immediate, full, complete and conflict-free defense.”  (To me, the conflict claim doesn’t make much sense, because the fact that a law firm has represented parties against you in the past isn’t a conflict. If the law firm worked for you, and then represented parties against you, a conflict might exist.)

On the question of whether Travelers had provided an “immediate” defense, Kaufman argued that Travelers had improperly waited four months from the initial tender of claim to appoint defense counsel.  Travelers, however, had sent a letter of acknowledgment only two weeks after receiving the claim, requesting a copy of the subcontract between Norcraft and Kaufman.  Kaufman didn’t respond until three months later, and only after Travelers had sent a follow-up letter. After receiving the subcontract and confirming additional insured coverage, Travelers appointed defense counsel.  The Court wrote: “Since [Travelers] notified [Kaufman] that it had accepted the tender approximately one week after receiving a copy of the subcontract, [Kaufman] cannot demonstrate that [Travelers] failed to provide an immediate defense.”

The Court also rejected Kaufman’s argument as to whether Travelers had provided a “complete” defense. With respect to the reservation of rights, Travelers basically stated that it reserved the right to seek contribution from Kaufman for uncovered claims in connection with settlements or judgments. The Court wrote: “Kaufman does not explain…how these provisions violate Travelers’ duty to provide a complete defense, and the court does not find that they violate the duty on their face.”

Finally, Kaufman argued that Travelers had entered into a secretly negotiated settlement agreement with underlying plaintiffs’ counsel, to resolve the claims covered by the Norcraft subcontract, and then withdrew from the underlying case once those claims were settled. The Court disagreed that the settlement was a problem, writing: “It is undisputed that Travelers had the duty to defend [and] Travelers had the right to control settlement negotiations of the covered claims without Kaufman’s participation. That Travelers settled only the claims that arose out of the work of Norcraft does not make the settlement improper, nor does it indicate that Travelers furthered its own interests, and Kaufman has not shown that it experienced increased defense fees and costs – outside of what it would otherwise have incurred – due to Travelers’ withdrawal from the [underlying] action.”

Although the Court resolved some of the coverage issues, the case went to the jury last month on the question of whether Kaufman had breached the duty to cooperate.  (Not sure why the parties or the Court bothered, at this point.)   The jury found that Kaufman had failed to cooperate with Travelers, but that Travelers had suffered no damages as a result.  (What a waste of legal fees.)

Some takeaways:  While reservation of rights letters can be frustrating and unnerving to policyholders, they do not, in and of themselves, prove that the carrier is offering less than a proper defense. Of course, I’m not sure why carriers can’t simply cover themselves by writing: “This defense is provided subject to the limitation that, if facts are later developed showing that a policy exclusion applies, the defense may be withdrawn in whole or in part.” I think it’s the 35 numbered paragraphs of exclusions and limitations that create unease for the policyholder. I have a little more difficult time accepting the Court’s conclusion that the insurance company should be allowed to conclude settlements without at least keeping the policyholder in the loop; here, however, since Kaufman couldn’t show that the settlement of the covered claims unfairly increased its expenses, it was a matter of “no blood, no foul.”

In any event, if you’re a policyholder, I think that it’s in your best interest to keep in contact with the carrier from time to time (in writing) requesting status updates on your file.  And when the insurance company asks for information in the claims process, try to provide it without delay.

Back in the days of the environmental insurance coverage wars, we on the policyholder side argued (eventually successfully in New Jersey) that the word “sudden”, as used in the 1973 version of the pollution exclusion, meant “unexpected” and did not have a temporal connotation. My friends in the defense bar often criticized us for trying to twist the clear meaning of words. The current battle over construction defect coverage has perhaps made me better understand their professed annoyance, because, for example, carriers have been arguing that the “subcontractor exception” to the “your work” exclusion isn’t actually an exception for damage caused by the work of subcontractors, and that damage to property isn’t really “property damage.”

Last week, in Cypress Point Condominium Ass’n v. Adria Towers, LLC, the New Jersey Appellate Division torched the carriers’ arguments as to the essential nonexistence of liability insurance coverage for construction defects, at least for now.  Cypress is a garden-variety construction defect case, involving a general contractor whose subcontractors performed defective work on parts of a condominium complex, such as the roof. The defective work resulted in consequential damage to other areas of the building.  The carriers naturally denied coverage for subsequent third-party liabilities under the general contractor’s policies, on the ground that the damage was simply a “business risk” (a term not used in the policies themselves), and did not constitute the required “property damage caused by an occurrence.”

The Court quickly disposed of the carriers’ arguments as to the lack of “property damage” and an “occurrence,” writing: “As to whether there exists ‘property damage,’ the consequential damages clearly constitute ‘physical injury to tangible property.’ The faulty workmanship damaged ‘the common areas and unit owners’ property.’ The interior structures, including the drywall, insulation, wall finishes, and wood flooring, were damaged by water infiltration from the faulty workmanship. As a result, the consequential damages constitute ‘property damage’ as defined under the policy.… The insurers do not contend, and we cannot reasonably believe, that the contractors either expected or intended for their faulty workmanship to cause ‘physical injury to tangible property.’ Thus, the consequential damages constitute an ‘occurrence’ as defined in the policy.”

The Court also discussed the “your work” exclusion, which, as the name indicates, precludes coverage for damage to “your work.” The 1986 ISO form of that exclusion contains an exception reading: “This exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.” Some Courts simply read that exclusion out of the policy. But the Appellate Division ruled that the exception must be given effect, writing: “As a practical matter, it is very difficult for a general contractor to control the quality of a subcontractor’s work. If the parties to the insurance contract did not intend a subcontractor’s faulty workmanship causing consequential damages to constitute ‘property damage’ and an ‘occurrence’…then it begs the question as to why there is a subcontractor’s exception.”  The Court noted: “The exception treats consequential damages caused from faulty workmanship by subcontractors differently than damage caused by the work of general contractors.”

Obviously, this is a great ruling for policyholders.  It remains to be seen whether the New Jersey Supreme Court will take it up.

You can read the full Appellate Division decision here.

The ongoing battles over construction defect coverage remind me of the good old days in the ‘80’s and ‘90s when we used to fight over asbestos and environmental coverage claims (we still have some of those claims, but to a much lesser extent). Construction defects even involve battles over the appropriate trigger of coverage!  Ah, nostalgia!

Recently, in Carithers v. Mid-Continent Ins. Co., the Eleventh Circuit wrestled with a case involving defective work by a subcontractor, which included, for example, the incorrect application of exterior brick coating. The carrier, Mid-Continent, disclaimed coverage for the subsequent liability suit on several grounds, including that the required “property damage” only takes place when the damage actually manifests itself (which, coincidentally, was outside Mid-Continent’s policy period). Mid-Continent offered two variations on this theme. First, Mid-Continent argued that damage only occurs when it’s discoverable by a reasonable inspection. Second, Mid-Continent argued that damage occurred when it was actually discovered.

The Court made short work of Mid-Continent’s arguments, writing: “The plain language of the policy does not support Mid-Continent’s reading. Property damage occurs when the damage happens, not when the damage is discovered or discoverable.” Quoting prior Eleventh Circuit authority, the Court also wrote: “There is no requirement that the damages ‘manifest’ themselves during the policy period. Rather, it is the damage itself which must occur during the policy period for coverage to be effective.”

The Carithers Court’s ruling is in accord with the New Jersey Supreme Court’s ruling in Potomac Ins. Co. v. OneBeacon, which confirmed a continuous trigger in construction defect cases. The Carithers Court  said that it was applying an “injury-in-fact” trigger, but for practical purposes, that’s essentially the same thing as a continuous trigger. All insurance policies in effect during any part of the injurious process are in play.

The Carithers Court also had some interesting things to say about the duty to defend. Mid-Continent essentially asked the Court to make new law deciding which trigger applies, and, using that law, to justify retroactively its refusal to provide a defense to the policyholder. The Court rejected that position, writing: “Given the uncertainty in the law at the time, Mid-Continent did not know whether there would be coverage for the damages sought in the underlying action because Florida courts had not decided which trigger applies. Mid-Continent was required to resolve this uncertainty in favor of the insured and offer a defense.”  (Emphasis added.)

That, of course, is the way the duty to defend is supposed to work, although insurance companies dealing with New Jersey claims frequently cite the 1970 New Jersey Supreme Court case of Burd v. Sussex, 56 N.J. 383, for the (silly) position that they never have to provide a defense if they’re questioning the merits of the claim (meaning that they’d hardly ever have to provide a defense).  As discussed elsewhere on this blog though, Burd does require a defense as long as the policyholder agrees to a reservation of rights.

In adopting the “injury-in-fact” trigger, the Carithers Court noted “the difficulty that may arise, in cases such as this one, where the property damage is latent, and is discovered much later,” and stated that its ruling was limited to the facts before the Court.  (The Court also noted that the trial court had found that the property had been damaged in 2005, during Mid-Continent’s last policy period.)  I’m guessing that when insurance defense lawyers discuss Carithers, they’ll argue that the case is limited to its facts. Still, it’s an important decision for policyholders involved in construction defect claims to know about.

You can read the full decision here.

It’s amazing to me that Nigerian banker scams continue to appear in my inbox every now and then.  After all these years, businesspeople apparently continue to fall for them.  Click here for a pretty good fact sheet from the Australian government on how these scams work, and how to avoid them.

Recently, a Minnesota bank (Avon State Bank) fell victim to a scam involving a supposed multi-million dollar estate of a “deceased African businessman.”  (The key words there are “supposed,” followed by “deceased African businessman.”) Reading the fact pattern is like watching a man sitting on a branch and sawing off the wrong end.

A long-time customer of the bank, Herdering, was contacted by “Gibson,” who claimed that his father had passed away, leaving a $9 million estate in Africa. Gibson told Herdering that the family wanted to transfer the funds to the United States, but the money was tied up in the Netherlands, and the transfer required upfront payment of taxes and other fees. (This is the garden-variety advance money scam.) Herdering (ridiculously) bought the story, and foolishly sent funds to Gibson. Herdering then approached Carlson, an Assistant Vice-President and Loan Officer at Avon, and asked for help in transferring the estate to the US, in exchange for huge returns. (Note:  If it sounds too good to be true…it is!) Carlson, relishing the prospect of easy money, arranged for a loan to Herdering from the bank, and contributed $60,000 of his own money, to be used for transferring the “estate.”

After Carlson made the loan, Avon’s president, Diedrich, told Carslon he was worried that the estate might be a scam. Carlson didn’t tell Diedrich about the personal contribution, which I presume would’ve set off even more alarm bells.  (When Diedrich found out later about the personal contribution, in fact, he fired Diedrich.)

The scam artist, “Gibson,” later requested that Herdering and Carlson cover half of a $750,000 “tax” on the estate. Carlson, although worried that he was ensnared in a scam, inexplicably recruited two other people, Imdieke and Froseth, to contribute funds, and they did (almost $500K).  Carlson wired Froseth’s funds to an account in Hong Kong, apparently on Gibson’s directions. (This was a violation of Avon’s policy that prohibited the wiring of money for non- bank customers.)

Naturally, there was no African estate, and everyone (except “Gibson”!) lost their money. So Froseth and Imdieke sued Avon for negligent and fraudulent misrepresentation. Avon’s insurance company, BancInsure, agreed to provide coverage under a D & O policy. Before trial, though, Froseth and Imdieke dropped their claim for negligent misrepresentation and proceeded only with the fraudulent misrepresentation claim, arguing that Avon was vicariously liable for Carlson’s conduct. Because the case went to trial on the question of fraud only, BancInsure informed Avon that the D & O policy did not cover the loss, because the policy excluded coverage for fraud. To make matters worse, BancInsure demanded that Avon reimburse defense costs already paid by BancInsure. Avon challenged the denial of coverage, and argued that not only the D & O policy provided coverage –  but, um, what about this fidelity bond you sold us?

The Eighth Circuit agreed that the fidelity bond provided coverage, and, as a result, saw no need to reach the D&O question.

Let’s take a look at BancInsure’s defenses, and how the appeals court dealt with them.

First, BancInsure argued that the jury verdict didn’t constitute a “direct” loss under the terms of the bond, because the case essentially involved a third-party (and not first-party) claim. According to BancInsure, the bond wasn’t intended to cover situations where third parties suffered the loss resulting from employee dishonesty, rather than Avon itself suffering loss through employee actions. The Court held that the bond was “loosely worded,” and that no such limitation appeared in the bond’s language. The bond “simply provides coverage for a loss ‘resulting from dishonest or fraudulent acts committed by an Employee,’ which precisely describes the loss Avon suffered through Carlson’s fraudulent conduct.”  Avon, after all, was being held liable for the misappropriation of funds.

Second, BancInsure argued that there was no “direct” loss because Avon was merely a “conduit,” didn’t own or hold the funds, and wasn’t legally liable for them. Wrong, said the Eighth Circuit:  “Avon held the funds, even if it did so fleetingly… Avon possessed Froseth’s and Imdieke’s funds by a lawful title. Carlson solicited the money from Froseth and Imdieke, represented that Avon would be handling the money, obtained checks made payable to Avon, deposited the checks into Avon’s accounts, and wired the money out of Avon’s accounts.”

Third, BancInsure argued that Avon’s liability didn’t “directly” result from Carlson’s fraudulent acts. According to BancInsure, when a third party is a target of the employee’s act, the insured-employer’s liability for loss doesn’t “directly” result from the employee’s actions. (I’m sure that Avon was pleased to hear that, after being tagged with a jury verdict.)  Wrong again, said the Eighth Circuit: “The loss to Avon from Carlson’s fraudulent conduct is a direct loss because Carlson acted fraudulently to benefit himself by protecting his interest and did so through acts which would necessarily make Avon liable to third parties.”

Fourth, BancInsure argued that Carlson didn’t act with “manifest intent” to cause Avon a loss or to obtain an improper financial benefit to himself or another, which were alternative requirements under the bond. The Eighth Circuit again disagreed: “Carlson acted with manifest intent to obtain improper financial benefit to himself because he committed the fraudulent acts to preserve his investment in the advance money scheme.”

Finally, BancInsure fell back upon the last refuge of an insurance scoundrel (sorry for the hyperbole): Late Notice. The bond required that Avon provide a proof of loss form within six months of discovery of the loss, which Avon hadn’t done. But the Court found that BancInsure was estopped from asserting the requirement, because it had led Avon to believe that the D & O policy covered the loss, and that pursuing coverage under the bond was pointless. The Court also noted that BancInsure suffered no prejudice from the delay, since it had been defending the lawsuit under the D & O policy anyway.

It’s great that Avon was able to enforce coverage under the bond, but what went wrong here at an operations level?  A lot of things. First example:  The idea that a corporate officer couldn’t recognize a garden-variety advance money scheme is frightening. Proper training should be given to all corporate officers and employees with respect to recognizing and avoiding such schemes.  (You can start by having them read the Australian government’s bulletin linked at the beginning of this post.) Another example:  When the bank president became suspicious that a scam was in progress, he shouldn’t simply have “mentioned” his worries to Carlson – he should have demanded to see all relevant documentation, and taken appropriate action against Carslon immediately.

This blog is about insurance coverage, but insurance coverage is usually the Alamo – the last stand. And you know what happened at the Alamo! So pay attention to your internal controls.

You can read the full Eighth Circuit decision here.

We in business are all overwhelmed with reading material, but I try to make sure that I read at least some legal and business publications every day to keep up with developing trends.  And, it seems that every day I see another article about a new hacking incident, or another dire warning about cyber-risk.  (The headline in Wired today reads:  “Hackers Hit the IRS and Make Off with 100K Taxpayers’ Files.”  Is nothing sacred??)    I also see that many major law and consulting firms have set up cyberliability practice groups to capitalize on the need for information and advice on cyber-risk. 

I’m a veteran of the Y2K debacle (“The sky is falling! The sky is falling!”), so I tend to view computer-related hysteria with skepticism.  But there’s no question that prudent risk management is a good idea when it comes to cyber-risk (and just about everything else!), and that insurance is a major part of risk management.  The problem, from a coverage lawyer’s perspective, is that there isn’t a standard form cyber-risk policy, and with so many products on the market, we’re sort of in the Wild West when it comes to figuring out where the coverage holes will be. So we’ve been watching for court decisions dealing specifically with cyberliability policies, in the hopes that some of the bases for dispute will appear.

One such decision just came down from a federal court in Utah (Judge Ted Stewart) in a case captioned Travelers Property Casualty Company of America v. Federal Recovery Services, Inc. (Judge Ted Stewart).  Facts:  FRS is a data management company that stored customer information (including credit card information) for Global Fitness, which owns and operates fitness centers. In connection with a proposed merger, Global agreed to transfer its member accounts data to LA Fitness. So, Global asked FRS to transfer the data to LA Fitness and then transfer it back, but apparently several key pieces of data (unspecified in the decision) went missing.  According to the opinion, FRS then withheld certain data until Global “satisfied several vague demands for significant compensation.”  Global sued FRS for conversion, tortious interference, and breach of contract, and FRS tendered the suit to Travelers, which disclaimed coverage.

The Travelers’ “CyberFirst” policy provides coverage for an “errors and omissions wrongful act,” which is unhelpfully  defined as “any error, omission or negligent act.”  The Court found that no coverage existed, writing:  “Global alleges that Defendants knowingly withheld…information and refused to turn it over until Global met certain demands…To trigger Travelers’ duty to defend, there must be allegations in the Global action that result in negligence.”  (Emphasis added.)

In my view, this sort of global pronouncement is what happens when judges (who understandably do not and cannot specialize in the myriad nuances of coverage law) fall back on what they know – that insurance is supposed to cover car wrecks.  The truth is that, to trigger Travelers’ duty to defend, there must be allegations that potentially fall within coverage as defined in the policy.  That’s presumably how premiums get established by Travelers’ underwriters, and that’s what Travelers’ policyholders pay for. 

In the Travelers policy, the word “negligent” is juxtaposed with “act,” but not with “error” or “omission.”  That indicates that the alleged “error” or “omission” need not be negligent.

Travelers’ advertising, in fact, makes a point that alleged “errors” or “omissions” do not have to be negligent to be covered.  According to Travelers, the CyberFirst policy protects the policyholder against loss “caused by failure to provide access to authorized users of the policyholder’s website or communications network.”  The word “negligence” is not used.  Travelers also states that CyberFirst “covers [liability from] unauthorized use of any advertising, or any slogan or title, of others.”  That doesn’t sound like “negligence.”  And, as examples of covered claims, Travelers’ advertising information presents the following scenarios, among others:

–  “You develop enterprise labor force software to integrate with a client’s HR and payroll systems. You fall behind in delivering the work, resulting in missed milestones and nonfunctioning project met modules. You contend that the client repeatedly changed the size and scope of the project. Ultimately, the client fires you and files a lawsuit, seeking to recover lost profits due to the disruption.”

 – “You place advertisements on your website and in your direct mailings to announce a new service offered by one of your important partners. The advertising contains material that your partner’s competitor claims it owns. The competitor sues you, contending you are liable for damages caused by unauthorized use of the advertising material.”

These “wrongful acts” do not appear to involve negligence. 

I think that, respectfully, Judge Stewart was relying upon the judicially-created “icky” exclusion that we sometimes see. That is, if the conduct of the policyholder seems sufficiently “icky,” then there’s no coverage. Here there were vague allegations that the policyholder essentially committed extortion (“pay us, or we won’t release the data”).  But Judge Stewart appears to have resolved any doubts in favor of the insurance company, which is the opposite of the way liability insurance is supposed to work. If there’s any possibility of coverage (not “negligence”), then a defense is supposed to be provided unless and until the insurance company can demonstrate that the claim does not fall within coverage, or that coverage is forfeited by an exclusion.  Here, all we know is that some data was (negligently?) omitted from an information transfer, and that FRS demanded to be paid.  Why doesn’t that fall within the advertised coverage for “failure to provide access to authorized users of the policyholder’s…communications network,” at least until Travelers can prove that it doesn’t?

Here’s the bottom line. While the SEC and other regulators are interested in companies’ available insurance for cyberliability problems, including data breaches, these types of claims can be quite expensive. Although the insurance company’s underwriting and marketing departments are interested in selling coverage and making money, the nature of the claims department is to look for any plausible reason not to pay.  Because of this predilection, at a recent conference of General Counsel that I attended, one prominent in-house lawyer stood up and loudly proclaimed: “Cyberliability coverage is worthless.”  I won’t go that far. I think you should have cyberliability coverage. But I also know that, like most lines of coverage, you can’t completely rely upon it. The best risk management always involves proper and prudent internal controls.

By the way, you can access Travelers’ advertising materials (at least as of the date I’m writing this) here.  You can access the CyberFirst policy form here. And you can read the FRS decision here.

I’ve sometimes commented on this blog that my first boss in the business warned me: “If you assume there’s no coverage, you won’t find any.” There are plenty of risk managers and brokers who believe that general liability insurance coverage exists primarily to protect against people falling down in the parking lot. Not suprisingly, many if not most insurance claimspeople would agree with them!  In reality, though, many “offbeat” or non-traditional claims are potentially covered under standard form policies. Which is another way of saying: If you don’t ask, you won’t get.

Along these lines, here’s an interesting coverage decision that just came down from the Fourth Circuit, which is usually considered to be pretty conservative (and hence, generally bad for policyholders). The State of West Virginia sued J.M. Smith Corporation, a wholesale drug distributor.  According to the State, J.M. Smith and other defendants were contributing to a prescription drug abuse epidemic in West Virginia by failing to identify, block, and report excessive drug orders. The complaint asked for injunctive relief to prevent the defendants from “willfully and repeatedly” violating the Uniform Controlled Substances Act, and it also alleged negligence. For example, the complaint claimed that the defendants “knew or should have known” that certain prescriptions were not for “legitimate medical purposes.”

Not too many businesspeople would think that a complaint for violation of the Uniform Controlled Substances Act could implicate general liability coverage. Liberty Mutual, the carrier in this case, didn’t think so, either.  But Liberty Mutual isn’t wearing the black robes, and here, the Court held: “The distinction between intentional acts and intended consequences is instructive. The actual conduct alleged by the state of West Virginia is the drug distributors’ failure to implement sufficient controls and systems to identify and alert regulatory authorities to suspicious prescription drug orders. In Count IV for negligence, the state alleges that these failures breached duties of care in marketing, promoting, and distributing controlled substances as well as duties to guard against third-party misconduct such as that engaged in by ‘pill mills.’ This type of failure to take reasonable care and the resultant harm is the hallmark of negligence claims, and the count contains no demonstration of any intent to harm prescription drug users or, through them, the state.”  (Emphasis added.)

Now, you might wonder, if this is a general liability coverage claim, where are the allegations of “bodily injury” or “property damage”?  Liberty Mutual’s lawyers may have lost the forest for the trees on that one, because the Court noted that the “bodily inury/property damage” argument had not been raised in the Court below, and was therefore waived.  I think, though, that a strong argument could have been made by J.M. Smith for the existence of “bodily injury” as a result of the harmful effects of misused prescription narcotics.

Here’s an interesting point:  If the claim were brought here in New Jersey, there likely would have been no immediate duty to defend, despite the existence of the negligence claims.  That’s because of our Supreme Court’s (crazy) decision in Burd v. Sussex Mutual Insurance Co., 56 N.J. 383 (1970), a classic “bad facts make bad law” case.  In Burd, the policyholder kneecapped someone with a shotgun, and was convicted of atrocious assault and battery.  The policyholder submitted the subsequent civil action to his homeowners’ carrier, who denied coverage based on the fact that, well, the policyholder had kneecapped someone with a shotgun.  The Court found that because intentional acts were alleged, the insurance company faced a conflict of interest. The carrier had a financial incentive for the factfinder to determine that intentional harm had been committed, while the policyholder had an interest in a finding of negligence. The Court “solved” that problem by converting the duty to defend into a duty to reimburse defense costs in the event that coverage were to be established.

The Burd Court specifically wrote:  “The carrier should not be permitted to assume the defense if it intends to dispute its obligation to pay a plaintiff’s judgment, unless of course the insured expressly agrees to that reservation.”  (Emphasis added.)  Many insurance claims people, and some judges, forget about the “reservation” part, and blithely assume that no duty to defend is ever triggered when intentional acts are alleged against the policyholder, at least until the policyholder succeeds in proving coverage. It’s interesting that 49 other states require the carrier to defend unless and until there’s a finding of no coverage.

Do insurance companies discount their premium rates for New Jersey policyholders, since the duty to defend is limited? (That’s what we lawyers call a rhetorical question.)

By the way, you can read the Fourth Circuit decision here.