Every once in a while, I wonder where the last 30 years have gone, and I think about all the cases and clients that we’ve handled during that time. A lot has changed since I started practicing law. In the old days, for example, we actually relied upon a dictation pool! We would dictate our briefs and letters into a tape recorder, then send the tapes to a word processing pool, where typists would transcribe the tapes and return paper documents to us for markup with a red pen. Can you imagine?   (That last question was for our millennial readers.  I know that a lot of you boomers do remember.)

But some things never change. Back in the 80’s, the firm that I was with had a very active practice group in asbestos defense. You would think that over the years, asbestos cases would dwindle, since asbestos was banned from many applications in the United States in the 1970s.  Yet people continue to contract mesothelioma and other asbestos-related diseases, and asbestos litigation proliferates. I’m currently involved in trying to negotiate settlements of coverage disputes on behalf of several manufacturers whose products allegedly contained asbestos at some point in the distant past. The interesting (infuriating?) thing about these particular matters is that almost all of my clients’ exposure has been for defense costs. Very few of the plaintiffs have proven that my clients’ products actually injured them. But the beat goes on.

Recently, an interesting case came out of the Eastern District of Pennsylvania, dealing with the proper interpretation of an asbestos exclusion in an excess liability policy. The policyholder, General Refractories (GRC), manufactured and supplied heat-resistant products that, at some point, may have contained asbestos. GRC ended up as a defendant in many asbestos-related suits throughout the United States. It managed to settle with all of its carriers except one – Travelers. Travelers disclaimed coverage for the asbestos suits, because of an exclusion in its policies for injuries or loss “arising out of asbestos.” GRC argued that “arising out of asbestos” did not mean the same thing as “arising out of asbestos-containing products.” According to GRC, asbestos was a raw mineral, while asbestos-containing products were…well, products.

According to Travelers’ lawyers: “Asbestos meant asbestos.  It didn’t mean asbestos in one particular form. It meant asbestos, the stuff that was causing these injuries, causing these diseases and that was causing these lawsuits.”

I think that many defense-oriented judges would have agreed with Travelers. In this case, however, the Court held a bench trial on the interpretation of the exclusion. At trial, GRC presented the testimony of an expert (Gene Locks, a lawyer, who was the only live witness presented by either side). Locks testified that from the late 1970s until 1985, the terms “asbestos” and “asbestos-containing product” had distinct meanings and usages in the insurance industry. According to Locks: “Asbestos was the raw fiber. Asbestos-containing products were products manufactured by companies that sold them in interstate commerce that contained some asbestos fiber.” As support for its position, GRC also introduced evidence that several other major insurance companies used policy forms in the 1970s and 1980s that differentiated between asbestos in its raw form, and products containing asbestos.

Noting that the term “asbestos” contained a “latent ambiguity as to what it denotes,” the Court resolved the issue in favor of GRC, writing as follows: “As between the parties’ conflicting interpretations of the Asbestos Exclusion, it need not be decided which is the more reasonable. Each is not without its objective reasons. Yet, in order to prevail, Travelers must show not only that its interpretation is reasonable, but also that GRC’s interpretation is not reasonable. This has not been done. Accordingly, the Exclusion’s phrase – ‘arising out of asbestos’ – is ambiguous.  In other words, it is reasonably susceptible of different constructions and capable of being understood in more than one sense. This requires a ruling that favors insurance protection for the policyholder.”

Interestingly, GRC had argued to the Court that the exclusion was not ambiguous – that is, that “asbestos” unambiguously did not mean “asbestos-containing products.” The Court expressly disagreed with GRC’s position, and held that the exclusion was in fact ambiguous. I’m pretty sure that GRC wasn’t too upset that the Court rejected its argument.

I think that what this case demonstrates most of all is excellent lawyering for the policyholder. The use of a credible expert to explain the differentiation in the insurance industry between asbestos and asbestos-containing products had an impact on the Court, as did the introduction of the other policy forms differentiating between asbestos and asbestos-containing products. If the decision makes it to the Third Circuit, I’m very interested to see what will happen.  Meanwhile, if your company faces asbestos lawsuits, read your policies carefully.

You can read the full decision here.

I was saddened to learn that Judge Ruggero Aldisert, formerly of the Third Circuit, recently passed away.  I never had the privilege of appearing before Judge Aldisert, and I never met the man, but I feel indebted to him for writing two excellent books that were published through NITA:  “Logic for Lawyers” and “Winning on Appeal.”  I think they’re must-reads for litigators, as they focus upon the logical requirements of good argument.  Judge Aldisert once wrote:  “A fallacy can be defined as…a form of argument that has intuitive appeal but does not withstand rational scrutiny.”

I thought of that definition when I read the recent decision in in CV Ice Company v. Golden Eagle Insurance Co., 2015 U.S. Dist. LEXIS 1070 (C.D. Cal. Jan. 6, 2015).  The CV case involved (in part) a type of coverage that’s come up frequently here on the East Coast post-Sandy:  Ordinance or Law coverage.  Basically, this is coverage for loss caused by the enforcement of ordinances or laws regulating the construction and repair of damaged buildings. Older structures that are damaged by a covered cause of loss, for example, may need upgrades due to municipal codes.  The upgrades may include electrical work; heating, ventilating, and air-conditioning (HVAC) work; and plumbing units. Many communities have ordinances requiring that a building that has been damaged to a specified extent (typically 50%) must be demolished and rebuilt in accordance with current building codes, rather than simply repaired.  Ordinance or Law coverage can help with all of this expense.

In CV, an ice company used an antiquated system of machinery to make ice.  Apparently, in addition to being quite old, the piping in the machinery was corroded.  A heavy piece of metal accidentally fell into the piping, puncturing the machinery and rendering it inoperable.  The insurance company contended that the puncture could be repaired with some localized welding.   But according to the ice company, in order to comply with existing codes (which required seamless piping for ammonia-circulating systems, while the older, damaged piping had seams), all 12,000 feet of piping in the system would have to be replaced, at a cost of over $500,000. The ice company also argued that localized welding wasn’t logistically feasible, due to the corroded state of the damaged pipe.

Now, I’m a policyholder-side guy, but my first thought was, this claim had some problems.  “Ordinance or Law” coverage is generally meant to apply to the building, and not to damage to processing equipment.  But that point didn’t come up in the decision.  Instead, in denying Ordinance or Law coverage, the Court turned to a convoluted analogy: Assume that there’s a store.  Two laws apply to the store for purposes of the discussion: (1) a law requiring a wheelchair-accessible restroom, and (2) a law requiring fire sprinklers. A car crashes into the storefront.  The damage requires extensive repair.   According to the Court, the carrier would have to pay not only for the damage, but also for the cost of expanding the existing restroom, “because the covered cause of loss triggered obligations under a law requiring restroom construction.”  But, according to the Court, the carrier would not have to pay for the installation of fire sprinklers, “because that deficiency and obligation pre-dated the occurrence of the covered cause of loss.”  The difference, according to the Court, is that “the restroom law does not require immediate action,” but only requires an upgrade “if the storeowner decides to remodel other aspects of the store.”  The sprinkler law, on the other hand, “is immediately applicable; if the store does not have working fire sprinklers at any time, it is violating the law.”  The Court wrote that “a causation element” had to be “read into” the coverage provision, or the results would be “absurd.” 

In honor of Judge Aldisert, let’s give this a little “rational scrutiny.”  What does the coverage actually say?  It says:  “If a Covered Cause of Loss occurs to covered building property, we will pay…for the loss in value of the undamaged portion of the building as a consequence of any ordinance or law that…[r]egulates the construction or repair of buildings, or establishes zoning or land use requirements at the described premises; and [i]s in force at the time of loss.”  In other words, if the building has to be rebuilt or repaired, the carrier will pay for compliance with all code requirements.

Presumably, before setting premium rates, the carrier felt that it had gathered adequate information about the building. If the carrier intended that the Ordinance and Law coverage should not apply to code requirements that existed prior to the occurrence of a Covered Cause of Loss, the carrier could have specified that in the policy easily enough.  The last clause of the coverage could have stated that the policy applied to code requirements “in force at the time of loss, unless the insured failed to comply with immediately applicable requirements of the ordinance or law prior to the time of loss.”  Using the Court’s analogy, the requirements to make the bathroom ADA-compliant were not “applicable” until remodeling, so coverage for bringing the bathroom into compliance would exist.  The sprinkler requirements were “applicable” before the building was damaged, conversely, so coverage would not exist. 

But I repeat:  That’s not what the policy said.  Any “absurdity” in the policy was created by the carrier, not the policyholder.  Why should the policyholder lose the coverage actually provided by the policy language based upon a requirement that the Court “reads in”? The carrier’s rates are premised upon what the policy says, not what a judge thinks it should say.

That’s one of the frustrating things about risk management. Often, if you ask ten judges what a policy means, you’ll get ten different opinions.  I think this is because most judges aren’t experts in how insurance works, so they try to import concepts from other areas of law.  In CV, the Court seemed to import concepts of “proximate cause” from tort law.  That may have “intuitive appeal,” but it does not withstand rational scrutiny.

One additional interesting tidbit about this case:  The Court refused to dismiss the policyholder’s bad faith claim against the carrier. Why? Because apart from the “Ordinance or Law” coverage, there was a dispute over whether the carrier had reasonably assessed other damages.  The Court wrote:  “Peerless has not yet demonstrated that it acted reasonably in setting a five-week restoration period [on the business interruption portion of the claim] and in not paying for…additional items highlighted by CV Ice [such as the cost of replacing baskets and cans that had been damaged in the accident].”  

I know that this is hard to believe, but even when an insurance company complies with its duty to defend, the interests of the insurance company and its policyholder may not be aligned.  The policyholder may want to settle, while the insurance company wants to roll the dice; or, vice-versa.  Or, the policyholder may want to make certain strategic moves that the insurance company refuses to take.  Or, the policyholder may not be comfortable with assigned defense counsel.  Or, the carrier may contend that certain claims aren’t covered and offer a defense under only a reservation of rights to disclaim coverage later. So, I’ve been asked by a number of clients and brokers: Does the policyholder have the right to independent counsel, paid for by the carrier?  (By which I mean, non-panel counsel selected by the policyholder but paid for by the carrier.)

A number of states do provide for independent counsel.  In California, for example, policyholders have the right to independent counsel, paid for by the carrier, whenever “there are divergent interests of the insured and the insurer brought about by the insurer’s reservation of rights based upon possible noncoverage under the insurance policy.” San Diego Navy Fed. Credit Union v. Cumis Ins. Society, Inc., 208 Cal. Rptr. 494, 506 (Cal. Ct. App. 1984). California even has a statutory provision codifying the law with respect to independent counsel, Cal. Civ. Code §2680.

In New Jersey, the law with respect to independent counsel isn’t as good for policyholders. The seminal case is Burd v. Sussex, 56 N.J. 383 (1970), a case proving the adage that bad facts make bad law. In Burd, the policyholder kneecapped someone with a shotgun and was convicted of atrocious assault and battery. In the subsequent civil suit, our hero attempted to call upon his homeowners’ coverage to pay for his defense.  The carrier refused to provide a defense, on the understandable ground that the policyholder had intentionally caused harm.  The policyholder argued that one of the counts of the underlying complaint alleged negligence, and that he was therefore covered.  

The New Jersey Supremes resolved the conflict as follows:  “If the [underlying] trial will leave the question of coverage unresolved so that the insured may later be called upon to pay, or if the case may be so defended by a carrier as to prejudice the insured thereafter upon the issue of coverage, the carrier should not be permitted to control the defense. In such circumstances the carrier should not be estopped from disputing coverage because it refused to defend. On the contrary 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. This is not to free the carrier from its covenant to defend, but rather to translate its obligation into one to reimburse the insured if it is later adjudged that the claim was one within the policy covenant to pay.”

As a result of Burd, in New Jersey, if you have a “right” to independent counsel, you may have to pay for it yourself unless and until you can establish that the supposed non-covered claim is in fact covered. (Think about Tom Sawyer, who convinced his friends that painting a fence was fun, and then got them to pay him for the privilege.)

One important thing to recognize is that, under policies that give the carrier the right to control the defense (read your insuring agreement!), policyholders don’t have the right to independent counsel just because they’re unhappy with the strategy being employed.  There has to be an actual conflict.

Here’s a related question:  What if the policyholder wants to assert affirmative claims (counterclaims against the plaintiff or cross-claims against co-defendants) in the underlying action?  Does the carrier have to pay for those?  I know of no reported New Jersey authority on-point, but a Pennsylvania federal case,  Safeguard Scientifics, Inc. v. Liberty Mut. Ins. Co. 766 F. Supp. 324, 334 (E.D. Pa. 1991), aff’d in part and rev’d in part on other grounds without opinion, has been cited by a number of other courts and is instructive.    In Safeguard Scientifics, the Court held that an insurance company was obligated to cover the costs of counterclaims filed by the policyholder and raised in the same lawsuit if pursuit of those claims was “inextricably intertwined” with the policyholder’s defense and “necessary to the defense of the litigation as a strategic matter.”

One final point:  In some circumstances in which my clients have been unhappy with appointed defense counsel, we’ve convinced carriers to let our clients select new counsel from the carrier’s approved list.  It can’t hurt to ask.

By the way, Tressler, LLP, which is a national law firm that represents insurance companies, has compiled a very useful 50-state survey on the right to independent counsel, which you can access here.

Representing people who have lost homes and businesses following Sandy has been gut-wrenching.  And, I have to say, many of the carriers haven’t made it any easier. I could catalog some of the problems we’ve seen, but that would make this a very long post. Instead, I’d like to focus on one aspect: The use of engineering “experts” who derive substantial income from representing insurance companies. 

In his book, “Delay, Deny, Defend,” Rutgers professor Jay Feinman writes:  “An insurance company’s greatest expense is what it pays out in claims. If it pays out less in claims, it keeps more in profits. Therefore, the claims department became a profit center rather than the place that kept the company’s promise.”  Professor Feinman goes on to discuss the unholy alliance between State Farm and an engineering company known as Haag Engineering, and specifically the allegations that State Farm hired Haag to help “investigate” claims, “knowing that the firm would produce reports favorable to the insurer about the cause and extent of the damage, giving State Farm an excuse to deny or reduce payments.”

In a recent Sandy case, Raimey v. Wright National, a Federal Magistrate in New York confronted a similar issue, and imposed evidentiary sanctions on the carrier.  Raimey involved a flood insurance claim, and the carrier hired an outfit called U.S. Forensic to examine a storm-battered house, which was situated about one block from the beach.   U.S. Forensic produced a report confirming structural damage to the house associated with flooding from Sandy, and stating that “repair of the building is not economically viable.”  But the carrier never sent this report to the policyholder. Instead, U.S. Forensic mysteriously produced a second report about a month later, this one reversing course 180 degrees and stating that there was no structural damage associated with flooding,  and that any damage to the house was caused by “long-term differential movement of the supporting soils at the site,” and therefore not covered.

Guess which report the carrier relied upon?

Coverage litigation followed, and Wright National’s counsel withheld the first report from discovery.  But through what the Court described as “happenstance,” policyholders’ counsel obtained access to the first report.  At a hearing to address Wright National’s  failure to produce the earlier contradictory report, and the circumstances surrounding the preparation of the earlier contradictory report, the Court unflatteringly described the issues as follows:  “The evidence adduced in this matter demonstrates that U.S. Forensic, an engineering firm retained by defendant Wright National Flood Insurance Company to examine a storm-battered house in Long Beach, New York, unfairly thwarted reasoned consideration of plaintiffs’ claim through the issuance of a baseless report. The engineer sent by U.S. Forensic opined in a written report that the home at issue had been damaged beyond repair by Hurricane Sandy. A second engineer, who did little more than review the photographs taken by the inspecting engineer, secretly rewrote the report, reversing its conclusion to indicate that the house had not been damaged by the storm, and attributing — without sufficient evidence — defects in the home to long-term deterioration. This process, euphemistically dubbed a ‘peer review’ by U.S. Forensic, was concealed by design from the homeowners, and remained uncovered during the Court-assisted discovery process…In a misguided attempt to defend these flawed practices, defendant has elicited evidence that this ‘peer review’ process may have affected hundreds of Hurricane Sandy flood insurance claims — and possibly more.”  (Emphasis added.)

Yikes.

The Court then entered an order prohibiting Wright from obtaining a new expert for trial, and restricting Wright’s expert testimony to that of Henemar, the U.S. Forensic engineer who prepared the original report (the one subsequently doctored through “peer review”). Given these restrictions, I imagine that any trial will not go well for the carrier. (In other words, it’s probably time to make a phone call for authority to settle.)

The Court also allowed sanctions directly against the carrier’s counsel, writing:   “Given discovery failures by defendant’s counsel, the unreasonable response by defendant to the allegations, and counsel’s shocking attempt to curtail inquiry during the hearing [with respect to the two contradictory reports], it is reasonable to charge the costs associated with the hearing to defendant’s counsel. Plaintiffs’ counsel, therefore, may make application for reimbursement from defendant’s counsel for all reasonable costs associated with the motion, the hearing and all related briefing, including attorneys’ fees, travel costs and transcription costs.”

On appeal, the District Judge affirmed the Magistrate’s rulings.

All in all, not a very good day for Wright National – and the part about sanctions being issued directly against counsel is unpleasant to think about for all lawyers.

When I was in college, there was an English professor named Frank Kinahan, who taught a class called “The Little Red Schoolhouse.”  A lot of my fellow students (not me, of course!) apparently thought that if they could just write their papers in enough of an arcane and convoluted manner, people (including their professors) would think they were really smart and advance them in life.  Professor Kinahan believed that it was his job to disabuse the students of that notion. He was pretty good at it.  His motto was straightforward and clear. Simple writing is persuasive writing.

Given the hornbook rules of insurance policy construction (all ambiguities are construed against insurance companies, for example), you might think that insurance companies would follow Professor Kinahan’s advice and go out of their way to make things simple. They don’t. I’m not sure whether they don’t because the nature of the risks they seek to cover is too complicated, or because they think that if they write in enough of an arcane and convoluted manner, they’ll have “wiggle room” when coverage disputes arise. Either way, it creates work for people like me, so I suppose I shouldn’t complain.

The concept of business interruption insurance is pretty simple. A covered event happens. Your business shuts down. You’re insured for your “but for” income during the period of restoration – that is to say, “but for” the unfortunate event, you would have made X dollars, and instead you made Y dollars (or lost money).  As you can guess, the concept of BI coverage, because it’s largely an effort to predict the future, leads to more than its share of disagreements.

An interesting wrinkle recently arose in a case in Massachusetts.  A company called Verrill Farms ran a farm store.  The store burned down.  Within two days of the fire, Verrill reopened its business at alternate locations at reduced capacity. Within a month, Verrill resumed full capacity at temporary facilities. After the fire and during the process of restarting the business, no employees were laid off. All employees who remained on the payroll were involved in operations that allowed Verrill to maintain its business and generate income.

Verrill submitted a claim under its businessowners policy, based on its loss of net income in the year after the fire. A disagreement arose as to what expenses could be included in the calculation of net profit or loss. The policy contained a 60 day limit for claims relating to payroll expense. The carrier (Farm Family) argued that it didn’t have to pay for the cost of ordinary payroll expense during the period of restoration, beyond that 60 day limit.

But Verrill never made a claim for a direct payment of the cost of its ordinary payroll; it sought only to include payroll expense in the calculation of net profit or loss for the appropriate time period. The question, then, was whether the cost of ordinary payroll could be included in the calculation of net profit or loss in order to determine the loss of business income.  

In ruling for the policyholder, the Court first described the purpose of the ordinary payroll coverage endorsement:  “The purpose of this coverage is to make a direct payment to the insured for the cost of ordinary payroll, for a specified period of time, in the event that the business cannot resume its operations immediately or not at all during the period of restoration. When the business is able to restart its operations, a direct payment of the expense of ordinary payroll is no longer necessary because the business is generating income which pays its payroll expenses. Here, Verrill was able to resume its business operations at alternate locations, within two days of the fire at its store… Since the salaries of ordinary payroll employees were being paid, at all times, from revenues generated by the resumption of operations, Verrill made no claim for direct payment pursuant to the limited ordinary payroll endorsement.”

Next, the Court described the way in which ordinary payroll expense figures into the calculation of net income or loss:  “By refusing to include the cost of ordinary payroll as a deduction from gross revenue in the calculation of net profit or loss, which is the basis to determine loss of business income, Farm Family is artificially inflating Verrill Farms’ net revenue for the year after the fire. The artificial increase to net revenue also incorrectly decreases Verrill Farms’ actual loss of business income…The only rational reading of the policy, considering the contract as a whole as well as its purpose of making Verrill Farms whole, is that it requires the loss of business income to be determined by the difference between the amount of net profit or loss earned during the partial resumption of operations and the amount of net profit or loss that Verrill Farms would have earned had no fire occurred. The gross income earned during the period of partial resumption of operations (the restoration period) has to be reduced by the amount of legitimate and necessary expenses for that period, including ordinary payroll, in order to determine net profit or loss.”

This case represents another example of the Number One tenet for policyholders:  Always read the policy (no assumptions allowed), and, if there‘s a reasonable construction supporting your position, don’t take “no” for an answer.

The Court’s decision contains an excellent explanation of business interruption coverage generally, and you can read it here.

Years ago, there was a Bell Labs facility behind my house, and on Sunday afternoons, the engineers (mostly Indian and Pakistani) would get together and play cricket on the large lawn. I watched the matches quite a bit, but I never could get a grip on the rules. Then a British friend told me that it was all quite simple. That phrase (“it’s all quite simple”) and its variants always send a chill down my spine, because I know that I’m about to be hit with an involved explanation. And I was. And I still don’t understand the rules of cricket.

Here’s where I’m going with this. Additional insured coverage should be pretty simple, right?  Basically, Party X adds Party Y to its general liability coverage as an additional insured. But somehow, this area is fertile ground for befuddlement and complications, especially given the variations in “additional insured” language contained in insurance policies and ISO endorsements. It gets to the point where I can’t assure my clients that they can rely on additional insured coverage without the potential for coverage litigation.

Here’s what happened in a recent case in federal district court in Connecticut.  A steel web structure was installed on a construction project at Yale University.  The general contractor (Shawmut) retained a subcontractor (Shepard) for steel fabrication and construction in connection with the structure.  Shepard subcontracted installation work to a second subcontractor (Fast Trek).

The structure collapsed, injuring several ironworkers, and tragically causing the death of one of them.  Personal injury litigation resulted.  

Fast Trek’s general liability policy contained a blanket additional insured endorsement. The endorsement provided in part that coverage was extended to “any person or organization for whom you are performing operations when you and such person or organization have agreed in writing in a contract or agreement that such person or organization be added as an additional insured on your policy.”  Shawmut (the GC) argued that it was an “additional insured” under Fast Trek’s policy, which had been sold to Fast Trek by First Mercury Insurance Co. 

First Mercury disclaimed coverage, contending that there was no direct contractual relationship between Shawmut and Fast Trek. In response, Shawmut argued that privity of contract was unnecessary, and pointed to the language in Shawmut’s contract with Shepard, which required Shepard to obtain additional insured coverage for Shawmut on a primary, non-contributory basis. Shawmut also argued that Shepard’s contract with Fast Trek expressly incorporated the language in Shawmut’s contract with Shepard, which included a requirement that sub-subcontractors assume the same obligations to Shepard that Shepard assumed with respect to Shawmut.

The Court agreed with Shawmut and found coverage, writing: “Fast Trek and Shawmut could agree that Shawmut would be added as an additional insured and both parties’ agreement could be memorialized in separate contracts without requiring a direct contractual relationship between the two parties. Nothing in the text of the Additional Insured Endorsement explicitly requires a direct contractual relationship between Fast Trek and an additional insured…If First Mercury wanted to limit its coverage in this way to only those in direct contractual privity with Fast Trek it readily could have done so with explicit contractual language to that effect.” 

First Mercury also argued that additional insured coverage should be restricted to situations of vicarious liability, and here, there were allegations that Shawmut itself was negligent in failing to supervise the project properly. The Court again disagreed, writing: “That Shawmut’s and Shepard’s ‘liability’ must be ‘caused, in whole or in part’ by Fast Trek’s acts or omissions means that coverage under the Additional Insured Endorsement is not limited to Shawmut’s and Shepard’s vicarious liability for Fast Trek’s acts or omissions but instead refers more broadly to liability that is caused, at least in part, by Fast Trek, but excludes situations involving only the independent acts of negligence of the additional insureds.”

Perhaps the trouble could have been avoided by a simple e-mail to the carrier at the outset of the project confirming that Shawmut was an additional insured. While Shawmut won this skirmish, the bottom line is that coverage litigation (an expensive proposition with an uncertain ending) was required. That fact alone should make anyone relying on “additional insured” coverage uncomfortable. Never make assumptions: always review the contracts, the policies, and the project with your insurance professional so you can fully assess the risks and coverage.  I know, I know, who has the time for that?  Let me ask: Would you rather spend your time trying to prove coverage before a Court?

You can read the full decision by clicking here.

The great CLE instructor Jim McElhaney, a Professor Emeritus at Case Western, used to tell the story of a “professional expert” testifying at trial on cross-examination.  The guy was apparently a kindly old gentleman with an Irish brogue, and also an engineer, and indeed made most of his money in the litigation game.

“You’re a professional witness, aren’t you? You do this for a living!” sneered the examining attorney.

Without missing a beat, the old gentleman responded (in full Irish mode): “Son, this is no job for an amateur.” 

Ouch.

Sometimes when I read judicial opinions in the area of insurance, that line comes to mind. This really is no job for an amateur. And I sympathize, because judges are required to be superhuman, and to master and apply many arcane areas of law, from antitrust to zoning.  Meanwhile, those of us who focus on insurance law spend years trying to understand it (and usually don’t succeed).

With that preamble, let’s look at a troubling aspect of the New Jersey Appellate Division’s recent coverage decision in IMO Industries v. Transamerica, which you can read by clicking here.  

For years, long-tail claims (such as asbestos and environmental claims) consumed buckets of money on fights over the meaning of such scintillating terms as “sudden and accidental.” Now that the meaning of many, if not most, coverage terms under general liability policies has been resolved, the main fight has turned to the issue of allocation – namely, what percentage of the loss does each party pay, and how is that decided?

In days of yore, when multiple  insurance policies were triggered by asbestos or environmental claims, many courts (including those in New Jersey) would impose “joint and several” liability on the responsible carriers. The policyholder would then choose which policies it wanted to respond to the claim, and the carriers would later allocate loss among themselves.  This had the virtue of simplicity, and of protecting the policyholder first, which, after all, is the purpose of insurance.

That all changed in New Jersey with the decisions in Owens-Illinois, Inc. v. United Ins. Co., 138 N.J. 437 (1994) and Carter-Wallace, Inc. v. Admiral Ins. Co., 154 N.J. 312 (1998). In New Jersey, allocation is now done by a “pro rata by limits” method. Basically, the total coverage limits under triggered policies (primary and excess) for the entire triggered period are added together and become the denominator in a fraction. To figure out the exposure in any triggered year, the limits in that year are added together and become the numerator. To use a very simple example, if you have 10 triggered years, each with $1 million in coverage, the denominator is $10 million, and the numerator for any one year is $1 million, meaning that 10% of the loss would be allocated to any one year.

The analysis becomes more complicated when dealing with defense costs.  In many general liability policies, the payment of defense costs doesn’t erode the indemnity limit, and the carrier’s duty to defend continues until the indemnity limit is extinguished by payment of judgment or settlement.  That, of course, is a significant benefit to the policyholder – and it’s the risk upon which the premium is based.  I’ve seen allocations of defense costs in which special masters or economics experts have used statistical assumptions as to when indemnity limits would be wiped out, and have calculated assumed defense costs to that point to do a proper allocation. As you can imagine, some of these calculations become fairly involved.

IMO dispensed with the niceties. The case involved the allocation of loss for asbestos-related personal injury claims.  The policyholder contended that the appropriate allocation should take into account the fact that the obligation to pay defense costs continued until the indemnity limit under a particular policy was exhausted.  The insurance companies derided this as a “running spigot” theory of coverage, because, since indemnity limits might never be eroded, the primary carrier would have a never-ending obligation to pay defense.

The IMO Court ruled that Owens-Illinois and Carter-Wallace “superseded” the specific terms of insurance policies, and that defense costs should be allocated identically to indemnity expense.  The structure of the opinion is itself a bit maddening, because while the Court recites the holdings of various Supreme Court decisions on allocation, the Court does not really explain its reasoning.  The Court simply refers to the “undeniable implication of Owens-Illinois…that defense costs are also allocable, subject to policy terms, in the same manner as indemnity expenditures.”

So, the Appellate Division has basically converted commercial general liability policies, in which defense costs are unlimited, into eroding limits policies – that is, insurance policies in which the payment of defense costs “erodes” the indemnity limit. That may be a simplistic and straightforward solution to the allocation issue, but it is not the basis upon which premiums were calculated when the policies were sold.

I don’t know whether an appeal is planned, or what the Supreme Court might do with such a petition, but I do know that a lot of people (including me) are watching with great interest. 

I’m not a big fan of arbitration.  I think it costs too much (which kind of goes against its main marketing point), and I don’t particularly like the fact that there’s no right of appeal absent the arbitrator committing fraud. Having said that, and with so many Sandy-related claims still pending in New Jersey, I thought I might point out that most first-party property insurance policies contain a form of “arbitration” provision that can help bring claims to closure. I’m talking about the so-called “appraisal” procedure.

A typical appraisal clause reads as follows:

“If you and we fail to agree on the amount of loss, either party may make a written demand that each selects an independent appraiser. In this event, the parties must notify each other of their selection within 20 days. The independent appraisers will select an arbitrator within 15  days. If an arbitrator is not agreed upon within that time, either party may request the arbitrator be selected by a judge. The independent appraisers will then appraise the loss and submit any differences to the arbitrator. A decision in writing agreed to by the two appraisers or either appraiser and the arbitrator will be binding. Each appraiser will be paid by the party that has selected the appraiser. You and we will share the expenses of the arbitrator equally.”

The first question that clients often ask is: What, exactly, gets decided by the appraisal process? Basically, the process (a kind of expedited arbitration hearing) results in a decision as to the allowable damages under the claim. Does that mean that the insurance company waives its right to present coverage defenses in court later, such as, say, late notice?  Or that the policyholder waives its bad faith claims?  No.  In Hala Cleaners v. Sussex Mutual Ins. Co., 115 N.J. Super. 11 (Ch. Div. 1971), for example, the Court ordered that an appraisal process take place, even though the carrier argued that it had valid defenses to the claim, leaving the argument as to the so-called “valid defenses” for another day. The thinking of most Courts is that if the appraisal takes place, the case is likely to settle –  and judges love it when cases settle.

Let’s look at a couple of recent decisions involving appraisal procedures.  In both cases, the carrier moved to compel an appraisal process.  (Our post-Sandy experience, on the other hand, is that carriers tend to fight the appraisal process tooth-and-nail.)  I guess the lawyers for the policyholders  thought that they would do better on damages with a jury.  

In SCVT v. National Fire and Marine (S.D. Texas Aug. 18, 2014), an apartment complex was damaged by fire, and the apartments were uninhabitable while they were being renovated. The carrier (National Fire) and the policyholder (SCVT) disagreed on the amount of loss, including SCVT’s entitlement to lost rental income; the amount of loss per unit; and the date upon which SCVT’s entitlement to lost rental income ended. SCVT argued that National Fire had waived its right to an appraisal by waiting an unreasonable amount of time before making the demand.

National Fire had demanded an appraisal almost a year after SCVT’s coverage lawsuit had been commenced. The Court, however, held that the important date to consider was not the date a coverage lawsuit was filed, but the date when the parties “became aware that additional negotiation would be futile.” Here, National Fire supposedly did not become aware that further negotiation would be futile until an unsuccessful mediation took place in the context of the lawsuit; and National Fire filed its request for mediation only a month later. So, the Court wrote: “National’s demand for appraisal, less than one month [after the mediation], was within a reasonable time and does not indicate that National intentionally relinquished its right under the Policy to demand an appraisal.…It is difficult to see how prejudice could ever be shown when the policy, like the one here, gives both sides the same opportunity to demand appraisal. If a party senses that impasse has been reached, it can avoid prejudice by demanding an appraisal itself.”

Another recent case,  Orhan Redzepagic v. CSAA General Insurance (D. Nev. Aug. 18, 2014), involved an auto accident resulting in damage to a Lexus LS 400. The policyholder argued that the carrier was obligated to pay the “actual cash value” of the vehicle, while the carrier offered only “market” value. The carrier then sought to compel appraisal, which the policyholder resisted.  The Court granted the carrier’s motion to dismiss the coverage suit in favor of appraisal, writing as follows: “Here, the policy terms are clear and unambiguous. The policy contains an appraisal provision that allows either the insurer or the insured to demand an appraisal of the loss and prescribes the process for appraisal. The policy also contains a ‘legal action against us’ provision that states in relevant part:  ‘We may not be sued unless there is full compliance with all the terms of this policy…’  The policy makes no exceptions as to the source of the dispute and applies so long as the parties cannot agree on the amount of loss. Plaintiff does not dispute that on June 11, 2014, [the carrier] invoked the appraisal provision.”

The Orhan Court also stated:  “Until an appraisal is completed, it is impossible to know whether [the insured’s] claim in fact was undervalued, such that her claims for breach of contract, breach of the covenant of good faith and fair dealing, and [violation of the state’s unfair competition code] are viable.”  (Citations omitted.)

The takeaway:  Always consider the appraisal provision of the policy.  Under certain circumstances, it can be an effective weapon. 

Since the economy tanked, we’ve seen a number of cases in our office (particularly in the area of construction defects) where a defendant (such as a subcontractor) has become insolvent, and we’ve been called upon to pursue a direct action against that defendant’s insurance company.  Surprisingly, insurance companies don’t really care for this. So, the question becomes, when is such a “direct action” permissible?

Generally, in New Jersey, you first have to obtain a judgment for a sum certain against the defendant, and try to collect on that judgment without success. Recently, a variation of this situation came up in an Appellate Division case, Ferguson v. Travelers Indemnity Company, which presents an interesting scenario because an insurance company was essentially the claimant. You can read the decision by clicking here. 

The facts in Ferguson are a bit convoluted, but basically, an insurance company called Clarendon allegedly got some bad advice from an outside insurance program manager and managing general agent called Raydon.  Raydon had unwisely encouraged Clarendon to get involved in a reinsurance program known as “LMX” that was a poor risk. The program caused Clarendon to suffer significant losses. In a later corporate transaction, Clarendon’s shareholders were assigned Clarendon’s rights against third parties (including Raydon).

So, the shareholders sued Raydon in Bermuda for professional negligence. Since Raydon had gone bust, the suit was uncontested. The shareholders obtained a judgment against Raydon for $92 million, and then went after Raydon’s errors and omissions carrier, Travelers. You’re not going to believe this, but Travelers wasn’t enthralled by the prospect of writing a $92 million check. Coverage litigation followed here in New Jersey, and the Trial Court dismissed the case,  holding that the shareholders didn’t have standing to bring a direct suit against Travelers, because no statutory or contractual basis existed for doing so.

But the Appellate Division has now disagreed.

The Appeals Court first analyzed the term “direct action,” noting that the tern “has sometimes been utilized to describe to situations that are analytically distinct. The first is where a third party either skips an action against the insured outright and sues the insurer alone, or seeks to join the insurer in an action against the insured. The other scenario is, as here, a case where the third party has sued and obtained judgment against the insured, and thereafter initiates a second lawsuit to collect an unpaid judgment against the insurer. We think the latter could more appropriately be labeled a ‘post-judgment action’ or ‘derivative action.’”

The Appeals Court then held:  “An injured plaintiff, having obtained a judgment against an insured tortfeasor which remains unsatisfied due to insolvency, ‘stands in the shoes’ of the insured with respect to the insurance policy and thus acquires standing to pursue an action against the insurer.”

The Appeals Court disagreed with the Trial Court’s reliance on New Jersey’s so-called “direct action statute,” N.J.S.A. 17:28-2, which basically requires insurance companies to cover the tort liabilities of belly-up policyholders.  Travelers had argued that the statute authorizes “direct actions” solely for particular types of personal injury and property damage lawsuits. But the Appeals Court held that the statute only meant that when certain types of policies are triggered, the carrier is not free to prohibit contractually a lawsuit by an injured third-party for an unsatisfied damages judgment.

The Court concluded that “Plaintiffs have alleged a valid cause of action to recover damages from defendants under the applicable insurance policies as judgment creditors of Raydon and N.J.S.A. 17:28-2 does not act as a bar to plaintiffs’ lawsuit.”

The upshot of all this is, whenever you’re dealing with an unpaid debt, think about the possibility of tapping the deadbeat’s insurance coverage.