My old law partner Carl Salisbury is on the warpath against carriers’ efforts to escape construction defect coverage.  He has some interesting things to say about a recent pro-carrier South Carolina decision.  You can read Carl’s excellent blog post by clicking here.  (I promise not to call them “business risk” exclusions any more, Carl.)

Here’s some advice I would give to anyone contemplating becoming a general contractor:  Don’t.   The liability insurance coverage picture is too muddy, and coverage for completed operations is too uncertain.  My secondary, and perhaps more realistic, advice: Review your subcontractors’ general liability coverage and make sure there’s adequate protection if you need to bring suit against the subs for negligence.  Don’t rely on certificates of insurance. (My general contractor clients laugh when I tell them things like that. Who has the time to review actual policies, they say, even if the subs would give them to us.  I guess that should make me happy, since it creates more work for litigation attorneys.)

Completed operations coverage (supposedly) insures against the liability incurred by a contractor for property damage or injuries that may happen to a third party, once contracted operations have ceased or been abandoned.  But sometimes, the question is whether operations have ceased or been abandoned, or not.  If there isn’t complete cessation, there may be no coverage.    

Let’s take a look at a recent Third Circuit case, Allegheny Design Management, Inc. v. Travelers Indemnity Co., which you can read by clicking here.  In Allegheny, the general contractor (ADM) hired a couple of subcontractors to work on a retail store.  Elite was hired to install windows, and Gold Star was hired to do the final cleaning of the windows.  Gold Star began cleaning the windows, but then informed an ADM representative that the windows were scratched.  ADM told Gold Star to finish cleaning the glass, and the store later asserted a claim (“informally,” whatever that means) against ADM.

Travelers denied coverage, invoking common provisions in ADM’s insurance policy that excluded coverage for “property damage” to:

“That particular part of real property on which you or any contractors or subcontractors working directly or indirectly on your behalf are performing operations, if the ‘property damage’ arises out of those operations; or…
That particular part of any property that must be restored, repaired or replaced because ‘your work’ was incorrectly performed on it.”

The “your work” exclusion contained an exception for “’property damage’ included in the ‘products-completed operations hazard.'”

So, I think you can see where this is headed.   ADM (the general contractor) argued that the exclusionary language didn’t apply, because the loss fell within the exception for products-completed operations.

The Court disagreed with ADM, writing:  “ADM argues that the glass was no longer physically possessed by ADM and had been put to its intended use by Finish Line (the store lessee). Once the glass was installed in the storefront, it urges, it was put to its intended use because Finish Line had begun stocking, inventorying and moving into the store…The District Court found, and we agree, that the damage to the glass occurred before the glass was put to its intended use. The purpose of the glass was clearly to serve as a window through which potential customers could survey items for sale. Accordingly, ADM’s work (the glass) was only put to its intended use by Finish Line when the store opened for business – two days after the damage was first noticed. The glass was not put to its intended use before the store was open to the public. For this reason, the damage did not constitute a products-completed operations hazard.”  (Emphasis added.)

The idea that the glass was only put to its “intended use” after the store was opened is logically shaky, and I’m not sure that all courts would agree with it.  The actual  “intended use” was to enclose the store from the outside mall corridor, after all.  The bigger problem, though, is that the subcontractors had not really finished their work when the glass was damaged…so, by definition, the Court found that “operations” were not “completed.”

You can see how difficult general liability coverage can be for general contractors. I think, though, that this case gets at the root of the real purpose of the “your work” exclusion. Here, a faulty part (scratched glass) was used, and replacement of that faulty part was necessary.  The faulty part, however, didn’t cause other damage to the store.  The purpose of the “your work” exclusion, really, is to preclude coverage for the replacement of defective workmanship. If, however, that defective workmanship causes other damage that must be repaired, then coverage should exist for the other damage. In the context of construction litigation, the problem is that many insurance companies and judges read the exclusion very broadly, so that if a defective part causes damage to other aspects of the project, there’s no coverage for anything, because the whole project is (I think incorrectly) considered to be “your work” for purposes of the exclusion.

Bottom line:  If you’re a general contractor, you can’t really  go into a project knowing that you can rely on your own general liability insurance to cover mishaps. You’d better make sure that there are other sources of potential protection. 

“For want of a shoe, the horse was lost,” goes the old saying.  If you handle claims from the policyholder side, nothing will aggravate you more than seeing a perfectly good claim go awry because of poor risk management controls in an organization, especially the failure to give notice under potentially applicable insurance policies.

The law varies from state to state with respect to the insurance company’s ability to void coverage based on late notice. In New Jersey, under occurrence-based policies, the carrier must demonstrate “appreciable prejudice” before a forfeiture of coverage can occur. If evidence is irretrievably lost due to late notice, for example, and the carrier cannot adequately reconstruct what happened through secondary evidence, many Courts will relieve the carrier of its coverage obligations.

It’s important to recognize that the same rule doesn’t apply to claims-made coverage. If you’re new to the insurance coverage arena, occurrence-based coverage is triggered when damage takes place during a policy period. Under a claims-made policy, however, coverage is triggered when a liability claim is made against the policyholder during the policy period, and is reported to the carrier within the time limits specified by the policy.

The bottom line is that if you have a claims-made policy, you need to pay extra-careful attention to the notice requirements, because the “prejudice” rule won’t apply.  The New Jersey Appellate Division recently made this clear in Templo Fuente de Vida v. National Union, Docket No. A-4516-12T1 (June 6, 2014). 

The case involves a mortgage company (Morris Mortgage, Inc.) that allegedly was negligent in failing to secure proper financing for a real estate project (a church and day care center).  The mortgage company settled the negligence lawsuit brought by its client, Templo, in part by assigning its E&O coverage claim to Templo.

Problem:  the policy contained the familiar language requiring that the policyholder give written notice to the carrier of any claim “as soon as practicable,” and either during the policy period (or during the discovery period specified in the policy), or within 30 days after the end of the policy period. For reasons that are unclear from the decision, while the policyholder was served with the suit on February 21, 2006, it did not provide notice of the complaint to the insurance company until August 28, 2006. This was within the policy period, but the question the Court addressed was whether notice was given “as soon as practicable.”

The court noted that no explanation had been given for the delay, and denied coverage, writing: “The policy defendants provided to the insureds clearly required that notice be provided both within the policy period and as soon as practicable… Because the insureds did not meet both of the notice provisions that were unambiguously expressed in the policy, we conclude that coverage was properly denied to the insureds and, by extension, to plaintiffs as their assignees.”

The Court specifically observed that a “prejudice” rule does not apply to claims-made policies, writing that “for claims made policies, an insurer need not show that it was prejudiced by an insured’s failure to provide notice ‘as soon as practicable.’”

This decision does not make a whole lot of sense to me, since the carrier received notice of the claim during the policy period. If the policy period had lapsed, and the policyholder was still attempting to justify late notice, that might be understandable. Here, though, we’re talking about a six-month delay and no apparent prejudice to the insurance company (since, as we all know, litigation moves at a snail’s pace). On the other hand, I don’t wear a robe.  (To work, I mean.)

In any event, Templo Fuente shows the importance of paying attention to risk management procedures in your organization. No one should ever assume that a claim made against the company is not covered. I often hear clients worry that if they provide notice of claim, their premiums will go up. Would you rather take the risk of having a six or seven figure liability assessed against your company, or deal with an increase in premiums? Your choice. Also, taking an assignment of an insurance claim as part of a settlement is a fairly common technique. Before you do it, though, you’d better examine the claim thoroughly and make sure it’s viable.

Lawyers and insurance companies are forever reserving their rights.  Sometimes I think it’s a reflex action against ever being forced to take an actual position.  But in the world of insurance coverage, “reservation of rights” letters do serve a function. Insurance companies fear that if they undertake the investigation or defense of a claim, for example, the policyholder may later argue that the carrier has waived its right to deny coverage for that claim.  It’s common practice, therefore, for an insurance company to send what’s known as a “reservation of rights letter,” preserving the right to deny coverage later if circumstances warrant. And, in fact, the law in New Jersey is fairly clear: “Unreasonable delay in disclaiming coverage, or in giving notice of the possibility of such a disclaimer, even before assuming actual control of a case or a defense of an action, can estop an insurer from later repudiating responsibility under the insurance policy.”  Griggs v. Bertram, 88 N.J. 347, 357 (1982).

I’ve been involved in more than a few arguments over the years about whether particular reservation of rights letters are actually proper or effective.  Recently, the Eleventh Circuit had a lot to say on that subject, in a (somewhat convoluted) case captioned Wellons Inc. v. Lexington Insurance Company.

Boiled down to its essence, here’s what happened: Wellons installs capital equipment for the forest product industry. Wellons entered into two contracts with Langboard, agreeing to provide systems to produce energy for the production of “oriented strand board” (“OSB,” which is basically particleboard) for use in home construction and flooring. Wellons also agreed to erect and install the energy system.

The Wellons system didn’t work properly; beyond that, a portion of the system collapsed, causing extensive property damage.  Two separate lawsuits resulted. After the first suit was filed (for property damage) but before the second suit was filed (for replacement of the system), Lexington reserved its rights. As an example, Lexington wrote: “Lexington continues to reserve all of its rights in connection with this claim and failure to set forth any policy provision that may be applicable is not intended to constitute a waiver of any of Lexington’s rights to rely on any applicable policy provisions or law.”  But Lexington never reserved its rights in writing with respect to the second suit. 

Lexington eventually settled the first suit (for property damage caused by the collapse of part of the system).

The dispute in the coverage case involved the second suit, in which Langboard argued that the energy system never worked properly, because the system was not able to meet emissions requirements or produce sufficient heat. Lexington’s claim person orally advised Wellons that Lexington would provide a defense under a reservation of rights. And Lexington retained counsel to do so, but later denied coverage on the ground that the facts developed during discovery did not meet the definition of either “occurrence” or “property damage” under the CGL policy. According to Lexington, discovery showed only “that the superheaters never operated as expected and the only damages are for less production of OSB than expected as well as lack of energy for cogeneration purposes.” Although Lexington denied coverage, it continued the defense.  (Why?  Not clear.) The jury awarded Langboard over $8 million.

Wellons argued that Lexington had not adequately reserved its rights, and was estopped from asserting coverage defenses under its primary and umbrella coverage.

The Court was unimpressed with Wellons’ position, writing:  “By permitting Lexington to go forward with Wellons’ defense in [the second suit] with no objection, Wellons implicitly consented not only to a defense under a reservation of rights but also to the terms of the reservation, including the nonwaiver clause contained in the [earlier reservation of rights letters]…Lexington’s oral and unambiguous reservation of rights in November 2007, coupled with the nonwaiver clauses in the March and April 2007 letters, satisfied [the] law as to a reservation on [the second suit].”

The balance of the opinion contains an interesting logical conflict.  Lexington was both the primary and umbrella carrier on the claims. Lexington argued that Wellons had not given proper notice of the second lawsuit under the umbrella policy.  The Court agreed:  “Wellons does not contest in its brief that it never provided Lexington with a formal notice of claim under the Umbrella Policy, but suggests…that Wellons’ mention of the Policy in [letters] to Lexington put Lexington on notice of a claim under the Umbrella Policy. Even if we assume that Wellons’ February 2009 mention of the Umbrella Policy constituted notice, we nonetheless conclude this notice was not timely.…A delay of over one year does not constitute ‘immediate’ notification as required by the Umbrella Policy. Further, Wellons cites no Georgia authority suggesting Lexington had an obligation to presume notice under the Umbrella Policy simply because Lexington was the issuer of both the CGL and Umbrella Policies.”

So: The appeals court first ruled that a general reservation of rights letter was sufficient to encompass a later-filed lawsuit, which involved a different claim. In other words, the appeals court gave the benefit of the doubt to the carrier. But with respect to notice, the appeals court said that notice of the first claim was not sufficient to encompass the second claim. In other words, on the notice issue, the appeals court refused to give the benefit of the doubt to the policyholder.

Here are some takeaways from this case.  First, if I advised carriers (which I don’t), I would tell them never to issue an “oral” reservation of rights. The carrier got away with it here, but in some courts, I’m sure that wouldn’t be the case. Conversely, if you’re a policyholder, always document all conversations with the insurance company (“this will confirm our telephone conversation of today, in which you told me…”). I’ve been doing this job long enough to know that if something isn’t in writing, it doesn’t exist. Second, I think many courts would have given Wellons the benefit of the doubt on the question of notice under the umbrella policy, especially since Lexington was both the primary and umbrella carrier. But again, if it isn’t in writing, it doesn’t exist. It’s very important to follow the notice requirements of all of your policies, to the letter, so you don’t have to fight this fight later. And finally, in this case, Wellons essentially conceded that there was no coverage, and argued only that Lexington failed to reserve its rights properly. Courts don’t like forfeiture, and don’t like technicalities. If estoppel is the only argument you’re proceeding upon, the ice can be mighty thin indeed. 

A few months back, I got a call from the general counsel of a construction company.  His employer was the general contractor in a construction defect case, and he needed some advice with respect to the applicable “additional insured” coverage. “Now, you do know about this stuff, right?” he asked.  “I don’t want to have to educate you.”

I thought that was sort of funny, given the amount of misunderstanding that takes place in the business community generally with respect to additional insured coverage.  I previously posted here, for example, about how a small difference in a single word in the policy can change the meaning of additional insured coverage entirely. Now let’s briefly look at another particular problem that can arise.

A “certificate of insurance,” without more, is an interesting source of information, but is really evidence of nothing.  (Certificates of insurance are printed on ACORD forms – ACORD being an insurance industry trade organization – and, in my view “ACORD” stands for “A Crappy Option to a Real Document.”)  A certificate of insurance is a form usually prepared by the named insured’s broker – not the carrier – and so is not binding upon the carrier.  The certificate is basically a representation by the broker that, at a point in time, a certain type of coverage with certain limits existed.  But a policy could be canceled after the COI is issued, for example, or the available limits could be impacted by other claims, and you might never know. Without an actual copy of the policy, and an obligation of the carrier to notify you of cancellation or impacted limits, the COI is nothing more than a piece of paper.  More importantly, without reviewing the insurance policy itself, you may not have the coverage you think you have.

Let’s review an Illinois case from a few years back, United Stationers Supply Co v. Zurich American Ins. Co., 896 N.E.2d 425 (Ill. App. 2008), to give you an idea of what can happen when people get sloppy with insurance documents.  United hired Taylor to repair a roof at United’s commercial building.  As part of the contractual arrangement, Taylor agreed to name United as an “additional insured” under its insurance program, and duly provided United with a certificate of insurance showing United as an additional insured on Taylor’s general liability insurance policy.

A United employee, Dirck, fell from a ladder that had been left on-site by Taylor, and sued Taylor; Taylor then sought contribution from United.

Unfortunately for United (or for the plantiff’s lawyer), United actually had not been named as an additional insured on Taylor’s general liability policy, despite what the certificate of insurance said. In fact, in the contract between United and Taylor, Taylor was not specifically required to name United as an additional insured on the general liability coverage. The agreement only required Taylor to maintain proper workers’ compensation insurance, employers’ liability insurance, contractual liability insurance, auto liability insurance, and a hazardous materials liability policy. While the contract required Taylor to name United “as an additional insured on a primary and non-contributory basis,” the contract did not specify the type of insurance as to which United was required to be named as an additional insured. 

United argued that, by its terms, the certificate of insurance conveyed additional insured coverage, but  the Court disagreed, noting that the certificate specifically stated that it was “issued as a matter of information only and confers no rights upon the certificate holder. This certificate does not amend, extend or alter the coverage afforded by the policies [specified in the certificate].”   The Court held:  “There is no record evidence of an oral agreement or internal Zurich memoranda that showed United Stationers specifically was supposed to be named as an additional insured on the CGL policy. The record shows Zurich consistently has denied that United Stationers is an additional insured. The written agreement between United Stationers and D. C Taylor does not include specific language requiring United Stationers to be named as an additional insured under the CGL policy…Where the certificate refers to the policy and expressly disclaims any coverage other than that contained in the policy itself, the policy should govern the extent and terms of the coverage.”  

As you can see, there were a number of breakdowns in this case, not the least of which was a failure to make sure the contract included a provision requiring that United be named an additional insured on Taylor’s CGL policy.  Here are a few takeaways:    

1.  Always insist on obtaining a copy of the actual policy and the endorsement listing the names of the additional insureds.

2.  Confirm the type of coverage provided.  Does the coverage match the contract?

3.  Always negotiate notice provisions with the other contracting party.  You should be notified immediately in the event of a cancellation or modification of coverage, or any impairment of the policy limits.

Finally, keep in mind that even if your company is an additional insured, your company’s employees and officers probably aren’t.

On May 20, 2014, I’ll be speaking at Perrin’s Emerging Insurance Coverage & Allocation Issues Conference at The Rittenhouse Hotel in Philadelphia, PA. My panel (shared with the inimitable Gary Kull of Carroll, McNulty & Kull, representing the insurance industry view of things), will focus on “Best Practices for Additional Insureds.” If you can make it, be sure to stop by and say hello!  Conference information and registration information can be found by clicking here. 

When I was in grammar school, the class wise guy was a kid named Nicky DeLuca.  One day, we were in gym class, and the coach was trying to teach us the importance of fundamentals in basketball. 

“You have to have a strong foundation,” the coach said.  “It’s like building a house.  You have to build a house from the bottom up.  How can anyone build a house from the top down?”  (This was what we lawyers call a rhetorical question.)

There was a moment of silence.  Then Nicky said: “Balloons.” 

(“Laps,” said the coach.)

The coach, of course, had a point, and one that I wish Courts would remember in the ongoing battles over whether commercial liability policies provide coverage for construction defect claims.  In insurance, the main fundamental is: Read the policy.  Too many judges, lawyers and claims adjusters make unwarranted assumptions.  (The idea that “faulty workmanship” does not fall within the definition of “occurrence” is one such assumption. Under the definition of “occurrence,” unless the damage caused by the faulty workmanship was deliberate, it had to be accidental; and if the damage was accidental, then there was an “occurrence.”  Whether exclusions may apply is a separate question.)

By actually taking the time to read the policy in a recent construction defect coverage case in Alabama, some excellent lawyers posed an excellent question: How can the so-called “your work” exclusion eviscerate a homebuilder’s coverage for completed operations, when the policy specifically contains a “completed operations” sublimit of $4 million?

The case involved the construction of a new house for $1.2 million. Within a year, the homeowners (the Johnsons) were experiencing serious issues, such as water leaking through the roof, walls, and floors, resulting in water damage to those and other areas of the house. The homebuilder unsuccessfully attempted to fix the problems, and the homeowners eventually sued. The cause of the problem was defective workmanship, such as the incorrect installation of flashing by a subcontractor.  (The policy did not contain the subcontractor exception to the “your work” exclusion.)

The insurance company, Owners’ Insurance Company, argued (of course) that faulty workmanship can never constitute an “occurrence”.  But the Court, citing other Alabama authority and reversing an earlier decision it had made, wrote: “Faulty workmanship itself is not an occurrence but…faulty workmanship may lead to an occurrence if it subjects personal property or other parts of the structure to ‘continuous or repeated exposure’ to some other ‘general harmful condition’…and, as a result of that exposure, personal property or other parts of the structure are damaged.”  (Emphasis added.) The Court also wrote: “The fact that the cost of repairing or replacing faulty workmanship itself is not the intended object of the insurance policy does not necessarily mean that, in an appropriate case, additional damage to a contractor’s work resulting from faulty workmanship might not properly be considered ‘property damage’ ‘caused by’ or ‘arising out of’ an ‘occurrence.’”  (Emphasis added again.) 

What this means, of course, is that if a defective window frame leaks, coverage doesn’t exist for the homebuilder’s cost of repairing the defective window frame.  But if leakage causes damage to other parts of the home, nothing in the standard policy language precludes coverage for that consequential harm.

Of equal interest is the Court’s focus on the “completed operations” coverage contained in the policy. The policy contained the standard “your work” exclusion, removing coverage for damage to “your work” that’s “included in the products-completed operations hazard.” The problem here was that the policy contained a $4 million sublimit for completed operations.  In other words, the policyholder had specifically purchased completed operations coverage. (“Completed operations” provisions address bodily injury or property damage that occurs away from premises owned by or rented to the policyholder, and after the policyholder has completed work or relinquished custody of its product.)

The Court held that, under the circumstances, enforcing the “your work” exclusion would create impermissible illusory coverage in the policy. Specifically, the Court wrote: “Owners’ argument that the ‘Your Work’ exclusion should nevertheless apply even though this supplemental coverage was purchased is unavailing. Thus, because there is no dispute that [the homebuilder’s] ‘operations’ on the Johnsons’ house were completed at the time of the alleged occurrences, that coverage applies to the Johnsons’ claims and, pursuant to the terms of the Owners policy, Owners must indemnify [the homebuilder] for the judgment entered against it.”

Since I’m writing this during holy seasons in the Judeo-Christian religious tradition, what the Court essentially said is, an insurance company cannot both giveth and taketh away in the same policy. If you’re a policyholder facing a construction defect claim, always check to see whether you’ve purchased “completed operations” coverage. If you have, then you may have an additional argument for coverage.  

I heard free-market economist Lawrence Reed speak today at a Foundation for Free Enterprise luncheon.  Mr. Reed made the point that for free markets to function properly, citizens must assign top priority to raising the caliber of their character, and learning from those who display the highest ethics. His point was that society descends into barbarism when people abandon what’s right in favor of self-gratification at the expense of others; when lying, cheating, or stealing are “winked at” instead of shunned.  We’ve seen a lot of lying and cheating in recent years, from Enron to Bernie Madoff.  And, as a result, the current litigation climate isn’t so great for corporate officers and directors, the vast majority of whom are decent, hard-working people.

Not surprisingly, following the collapse of the financial markets in 2008, many coverage attorneys (including me) have been answering a lot of questions about the applicability of D&O coverage to lawsuits brought by unhappy investors and by regulators.  Seemingly, not a day goes by without media coverage of a major settlement or lawsuit relating in some way to the Great Fiscal Meltdown. As I write this, J.P. Morgan, for example, has just paid $218 million to settle class-action litigation relating to the Madoff mess.

An interesting recent case out of Federal Court in Kansas dealt with the question of whether, when the FDIC brings a lawsuit, the “insured v. insured” exclusion negates specifically-purchased coverage for actions brought by regulatory agencies. The case involves the now-defunct Colombian Bank and Trust Company and its directors and officers. The Bank went belly-up in 2008, and the FDIC alleged that the bank’s directors and officers had breached their fiduciary duties by approving risky commercial real estate loans and failing to supervise bank lending functions properly.  The FDIC eventually resolved its suit against the directors and officers for $5 million.

BancInsure, which had sold D&O coverage to the Bank’s directors and officers, disclaimed coverage for the FDIC suit, and filed a declaratory judgment action seeking to justify its “no pay” position. 

The policy contained an “insured v. insured” exclusion with unique language, providing in part that BancInsure would not be liable for losses in connection with any claim against the directors or officers “based upon, arising out of, relating to, in consequence of, or in any way involving…a claim by, or on behalf of, or at the behest of…any… Receiver” of the Bank. 

BancInsure cited the “insured v. insured” exclusion as part of the basis for its denial.

The Policy also contained a regulatory exclusion, which relieved BancInsure of liability for “any action…brought by or on behalf of any Federal or State regulatory or supervisory agency or deposit insurance organization…[including] any type of legal action which any Agency may bring as receiver.”

But: The policy contained an endorsement stating that the policy “is hereby amended by the deletion of the [Regulatory] Exclusion.”

The policyholders argued, quite logically, that by purchasing the endorsement, they had purchased protection for lawsuits brought by regulatory agencies, including the FDIC. Therefore, the policyholders contended, the specific coverage for suits brought by regulatory agencies trumped the “insured v. insured” exclusion.

Alas, the Court ruled in favor of the carrier.  The Court noted a split of authority on the issue of whether “insured v. insured” exclusions in D & O policies can apply to claims by the FDIC. The majority view holds that coverage exists for FDIC claims, even though the FDIC steps into the shoes of a failed bank (in other words, the FDIC is considered to be an “insured” under certain D&O policies). The problem for the policyholders in this case, though, was that here (unlike in the cases making up the majority view), the policy specifically excluded coverage for claims by entities acting as successors, receivers, assignees and trustees. The Court noted: “Not only does the ‘insured v. insured’ provision exclude claims brought by or on behalf of the Bank against the individual defendants, but it also expressly excludes claims brought by or on behalf of receivers of the Bank.”

Citing a Federal Court decision from Georgia also involving BancInsure, the Court wrote: “The [Georgia] court noted that the ‘insured v. insured’ exclusion and the regulatory exclusion overlap when a regulatory agency brings an action as a receiver, but that removing the regulatory exclusion did not affect the application of the ‘insured v. insured’ exclusion. A reasonable person in the position of the insured would understand that the ‘insured v. insured’ exclusion means that claims by FDIC as receiver are excluded.”

It’s always interesting when Courts speak about the mythical “reasonable person in the position of the insured.” Here, we have policyholders who specifically purchased the deletion of the regulatory action exclusion –  but the purchase of that deletion appears to have been meaningless based on the Court’s construction of the policy.  Doesn’t the Court’s opinion here make the paid-for coverage for regulatory actions an illusion?

I think the important lesson is that, with regulatory enforcement on the rise, it’s very important for D&O policyholders to read all insurance policy provisions dealing with coverage for regulatory actions very carefully.  If there appears to be any conflict in the policy language, don’t be shy about trying to negotiate with the carrier or through your broker.

My late Uncle Carmen was an accountant who worked for the IRS.  One tax season, I was grousing about how complicated the 1040 form could be. Uncle Carmen didn’t suffer fools gladly, and, with the veins bulging from his neck, insisted that NOTHING ON EARTH COULD BE SIMPLER.  My response was to engage in a strategic retreat.   And to hire an accountant.

I sometimes wonder whether insurance underwriters have Uncle Carmen’s attitude about the coverage they construct. I have to laugh at the admonition in some policies or insurance company letters, instructing the policyholder to “Read the policy!” The language in the policy is often an impenetrable forest of jargon, and whether or not you’re covered for particular factual scenario can often be a crapshoot.

Take the coverage for an “additional insured.”  Conceptually, it’s quite simple.  Businesses often work together with other businesses for a mutual customer. But how does Company A’s business insurance operate to protect against the risk of Company B (say, a subcontractor) causing damage to that customer’s property?  Ostensibly, that’s where the “additional insured” language comes in. One party will add the other party as an “additional insured” on its commercial liability business insurance policy.

Unfortunately, in the insurance world, the simple is often complicated. Let’s have a look at the recent Third Circuit decision in Arcelormittal Plate, LLC v. Joule Technical Services.   Joule (whose offices are right down the street from mine) is a specialty staffing firm that supplies experienced technical workers to its customers. AMP, which operates a steel production facility in Pennsylvania, contracted with Joule for workers to handle maintenance and repair work at its plant. The contract required Joule to maintain certain insurance, including a commercial general liability policy, and required that AMP be named as an additional insured for all claims including, but not limited to, claims made by Joule’s employees. The contract also required that the CGL policy provide coverage in an amount not less than $5 million per occurrence.  (Apparently, the coverage obtained by Joule had only a $1 million limit, but that’s another issue.)

The CGL policy, which Joule purchased from Liberty Surplus Insurance Corporation,  contained an “employer’s liability exclusion.” The exclusion stated as follows: “This insurance does not apply to… ‘bodily injury’ to an employee of the insured arising out of and in the course of (a) employment by the insured; or (b) performing duties related to the conduct of the insured’s business.”

I think you can see where this is headed. While climbing down a ladder at the AMP plant, one of the Joule employees (Greene) fell and seriously injured himself. Greene and his wife sued AMP for damages. One of the questions in the case was whether the “employer’s liability exclusion” contained in the Liberty policy precluded coverage for the Greene incident. AMP argued that the provision wasn’t meant to bar a claim for coverage for a lawsuit brought by employees of a different insured on the same policy.

The Court held that under New Jersey law (which applied since that was where the policy was sold), coverage was not barred for AMP (an additional insured) with respect to a lawsuit brought by an employee of Joule. The Court wrote, in part: “The reference in the employee exclusion… is to ‘the insured’ – not to ‘an insured’ or ‘any insured’ – and as such is a specific, exclusive reference to a particular insured, rather than a general, inclusive reference to all insureds… The question remains, however, whether the specific insured to whom the clause refers is the principal insured, or the insured making the claim. That question is answered by the policy’s severability clause, which states that ‘this insurance applies…as if each Named Insured were the only Named Insured; and…separately to each insured against whom claim is made or ‘suit’ is brought.”

The Court specifically noted that, unlike New Jersey law, Pennsylvania law suggested that “employer’s liability exclusions” in CGL policies generally bar coverage for claims against one insured by a different insured’s employee. This distinction points out the importance of choice-of-law analysis when it comes to insurance coverage; but more importantly, it raises a question that I often ask. If two presumably competent judges in two different jurisdictions can look at the same language and interpret it in diametrically opposed ways, doesn’t that necessarily mean that the language is ambiguous (in other words, subject to more than one reasonable interpretation); and if the language is ambiguous, shouldn’t it always be interpreted in the policyholder’s favor? Also, and perhaps most importantly, why can’t I ever get anywhere with that argument?

Although the AMP decision came out in the policyholder’s favor on the “additional insured” issue, the decision does contain some unfortunate language (from the policyholder’s perspective) with respect to bad faith.  AMP argued that Liberty had premised its claim denial on spurious grounds. The Court held that there was no bad faith, in part because Pennsylvania law would have barred coverage. The Court wrote: “Thus, because Liberty denied coverage based on factual and legal grounds that were at least plausible at the time of Liberty’s decision, we conclude that Liberty is entitled to summary judgment on AMP’s claim for bad-faith denial of coverage.”  (Emphasis added.)

It seems that every time I read a bad faith case decided under New Jersey law, the standard for proving bad faith becomes higher and higher. Now, all the insurance company apparently has to do is assert a coverage defense that’s “plausible.” The dictionary defines “plausible” as “having an appearance of truth or reason.” How hard is it for an insurance company to hire a coverage lawyer to prepare an opinion showing that an argument has “the appearance of truth or reason”? This problem becomes even more acute for policyholders in first party cases, because under New Jersey law, policyholders can’t recover their attorneys’ fees if they have to bring suit to enforce property coverage.

Every once in a while, I come across a case in which the facts are just so perfect, I can’t not write about them.  Take, for example, the recent Sixth Circuit decision in Stafford v. Jewelers Mutual. A 5.56 carat pink diamond.  A deal by a diamond merchant to buy the jewel (for cash, at the ridiculously low price of $8000) from a shady German “businessman” at a Las Vegas hotel. After the sale, the “businessman” disappears without a trace.  Then the diamond disappears from a sealed box. If you’re of a certain age, this should remind you of a series of Peter Sellers films.  (The Court, in fact, described the fact pattern as “scripted for a movie.”)

The Stafford case involved “personal injury” coverage, which, along with “advertising injury” coverage,  constitutes “Coverage B” in standard commercial general liability policies.  This is an oft-misunderstood and vexing area.  Basically, persons and organizations have certain legally protected rights that, if violated, may result in damage to them. These include a right to privacy, and a right not to be disparaged. Under certain circumstances, Coverage B provides protection against claims that such rights have been harmed.

In the Stafford case,  Stafford, the company that bought the “Pink Panther” from the shady businessman, shipped it to Julius Klein Diamonds (“JKD”), via Brinks truck, in a sealed box.  JKD and Stafford had an ongoing business relationship, and JKD planned either to buy the diamond, or to certify it for Stafford’s jewelers and return it. JKD received the package the same day Stafford shipped it, but claimed that the diamond was missing from the box.

Stafford then sued JKD, as well as Stafford’s carrier, Jewelers Mutual Insurance Company, for damages relating to the loss of the diamond.  (Jewelers Mutual had sold Stafford a “Businessowners Special Policy,” which apparently contained both property and liability coverage.) JKD counterclaimed, arguing that Stafford had made false representations concerning the shipment (specifically, by falsely representing to JKD that the pink diamond had been placed inside the shipping box). The case went to trial, and a jury found in Stafford’s favor, awarding over $1.7 million in damages against JKD. Stafford, however, was not entirely happy with the outcome, because the costs of successfully defending against JKD’s counterclaim amounted to more than $1 million. Stafford wanted Jewelers Mutual to pay the defense costs under the liability portion of the policy, which Stafford argued included personal injury coverage for offenses such as disparagement.  Stafford maintained that JKD’s counterclaim was based on “disparagement,” since Stafford had essentially accused JKD of theft, which JKD (unsuccessfully) contended was a meritless claim.

Jewelers Mutual disagreed with Stafford’s position, and so did the Court.

Apparently, throughout the lawsuit against JKD, Stafford had characterized the JKD counterclaim as one for “fraud.” The Sixth Circuit grabbed onto that fact like a terrier latching onto an ankle, writing: “Because Stafford took the position that JKD’s counterclaim involved nothing but fraud throughout the [underlying] case, and because Stafford then prevailed on that claim when it was presented to a jury, it cannot now assert the counterclaim instead alleged disparagement, defamation, or negligent misrepresentation.”   

Really? Who cares what “label” was placed on the counterclaim, even by the policyholder? For purposes of interpreting coverage, shouldn’t the appropriate inquiry simply be into what the policy actually says, as compared to the allegations in the counterclaim?  If not, then lawyers and policyholders need to be even more extremely careful about everything they write, for fear that their statements may “trump” the actual language in the relevant documents (the policy and the operative complaint).

Perhaps the New Jersey Supreme Court best characterized this dilemma in Voorhees v. Preferred Mut. Ins. Co. [128 N.J. 165, 174 (1992)] when it wrote:  “The duty to defend …is determined by whether a covered claim is made, not by how well it is made. A third party does not write the complaint to apprise the defendant’s insurer of potential coverage; fundamentally, a complaint need only apprise the opposing party of disputed claims and issues.”  (Emphasis mine.)

Alas, even if the “label” hurdle had been overcome here, the substantive insurance claim failed anyway. The Sixth Circuit concluded that there was no slander, libel or disparagement (as required by paragraph “a” of the “personal injury” coverage) because there was no “publication” of material to a third party – only to JKD. The Court also noted that the counterclaim did not “include allegations that Stafford said anything about JKD or its services,” only about the diamond not being in the box.  (That last point is sort of silly, but I don’t get to make these decisions, only complain about them.  If the diamond wasn’t in the box, then Stafford was accusing JKD of theft.) 

As to the “publication” requirement in certain personal injury-type claims, we saw this situation recently in the cyberliability context, in the Connecticut case of Recall Total Information v. Federal Insurance.  There, IBM hired a contractor (Recall) to transport and store electronic media tapes containing personal information (including social security numbers) of 500,000 IBM employees. The tapes fell out of the back of a truck that was rolling down the highway, an unknown person picked them up, and IBM claimed $6 million in damages to remediate the problem (primarily consisting of costs to identify and notify the persons whose data potentially had been compromised). Recall filed a claim with its liability carrier, under the “invasion of privacy” provisions in the “personal injury” coverage.  But, as in Stafford, the Court held that no “personal injury” because there was no proof of “publication”.  Specifically, there was no proof that anyone had actually downloaded the data from the tapes.  The Court wrote: “Regardless of the precise definition of publication, we believe that access is a necessary prerequisite to the communication or disclosure of personal information.”

Back to the Stafford case. One possible avenue of recovery in the policy (not discussed by the Court) was the additional “malicious prosecution” coverage under the personal injury part (an offense that does not require “publication”). After all, JKD essentially contended (unsuccessfully) that Stafford improperly prosecuted the claim of the missing diamond, in an effort to commit insurance fraud.  The problem is that, for a malicious prosecution lawsuit to have merit, the underlying claim has to terminate unfavorably for the alleged “malicious prosecutor” (here, Stafford). Stafford won its lawsuit against JKD, so the personal injury coverage for malicious prosecution wouldn’t work. Note to risk managers: Try to have personal injury coverage endorsed on the policy for “abuse of process,” not only “malicious prosecution.”  “Abuse of process” does not require the plaintiff (policyholder) to lose its case, and therefore coverage for “abuse of process” is broader.

As for Stafford and the Pink Panther, well, sometimes, things just don’t work out quite as well as you’d like.